Dear Members, following on from my recent straw on The Environmental Group (ASX:EGL), I wish to introduce you to another of my core holdings: Pro-Pac Packaging (ASX:PPG).
PPG manufactures and distributes commercial and industrial packaging in Australia and New Zealand. The Company purchased Integrated Packaging in 2017 and pivoted from an industrial distribution company to a leading manufacturer of flexible packaging. Flexible packaging is the second largest packaging material in Australia. It is lightweight and made from plastic film and small additional strips of lightweight material such as metal. Technological improvement has created packaging which is fit-for-function and versatile for products in the food, pharmaceutical, electronics and medical industries. A flexible package is any package whose shape can be readily changed. Examples include stand-up and gusseted pouches, sachets, shrink film, MAP-packaged products, ‘heat and eat’ food containers, bubble wrap, tubes and sleeves. Flexible packaging has a lower carbon footprint than conventional packaging, is lighter and easier to transport, keeps food fresh for longer, is re-usable and convenient, and is more versatile in terms of its branding and aesthetic capabilities. A recent survey by the Flexible Packaging Association (FPA) found that 83% of brand owners had switched to flexible-type packaging and most were looking for ways to reduce their use of rigid packaging in the future. The global flexible packaging market is expected to grow at a CAGR of 6% in the next 10 years, with some products like Bi-axially orientated polypropylene (BOPP) predicted to grow at 10%. In Australia, the flexible packaging market is $1.8B. Amcor is the largest player. PPG has 14% share of this market. There is a long tail of small independent operators who will eventually be acquired by one of the larger participants.
With this in mind, there is clearly a realisation within PPG’s management that flexibles is the target market to drive growth and profitability for the Company. To this end, they have been focused on bedding down their acquisitions (Integrated Packaging and Supreme Packaging), rationalising their manufacturing facilities (closing down the plant at Chester Hill), driving efficiencies within the organisation through enterprise resource planning, and by investing in best-in-class technology at their Integrated Packaging site. They have been paying down some debt and they carry a lower debt/equity ratio (77%) than competitors Pact Group (244%) and Amcor (112%). They have been able to maintain their working capital ($81M) despite carrying additional inventory to cope with Covid supply disruptions. This puts them in an opportunistic position for making more acquisitions to grow their flexibles business. PPG has historically lagged the performance of its peers in profitability and in ROE. I think this is because it is a business in transition which is re-aligning and consolidating itself towards the more profitable side of the packaging business. PPG has a small market capitalisation ($178M) compared to the big competitors that it is trying to measure up against (Pact: $1.3B; Amcor: $13.6B). Its enterprise value-EBITDA-ratio is 5.8X vs 8.6X (Pact) and 10.48X (Amcor) suggesting it is relatively undervalued.
The biggest risk facing PPG in my opinion is the growing sentiment which is pushing back against the use of single use plastics and the use of plastic packaging in general. There is a lot of rhetoric about improving the circular economy for these materials but we don’t have the technology or the infrastructure to do this. Australia generates 2.5M tonnes of plastic waste each year and it recycles less than 20% of it, of which about half is recycled locally. About 130,000 tonnes of plastic waste leaks into the environment annually. To avert the risk of government legislation, participants in the industry have subscribed to the Australian Packaging Covenant Organisation (APCO) which has set voluntary targets for the industry. The 2025 targets include 70% of plastic packaging being recycled or composted and 50% average recycled content in packaging (30% in plastic products). If they don’t meet these targets, Government will likely intervene. Under the NSW Waste and Sustainable Materials Strategy, Stage 1: 2021-2027, NSW has adopted several targets including the phase out of single use plastics -like straws, stirrers, cutlery and plastic cotton bud sticks-, reducing plastic litter items by 30% by 2025 and tripling the plastic recycling rate by 2030. What this means for PPG is difficult to predict. There is always the risk that EPR legislation will place the cost of collection, sorting and recycling (Stewardship) of plastics onto the manufacturer. There is also the risk that the use of plastics will be restricted or that a tax will be placed on items that use only virgin resins. How this impacts PPG will depend on whether they seek to take a pro-active and leadership position in driving this necessary change, or they wait for others to lead the way. I spoke with CEO Tim Welsh and he wasn’t forthcoming on this, but I believe there are initiatives underway within the Company to increase the recycling of its products.
Consumers have grown dependant on the convenience of flexible packaged products. Manufacturers can see the economic, aesthetic, and product marketing advantages. The industry is primed for growth and PPG can participate in this but they will also have to be part of the environmental solution in the future.