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Edited Transcript of ORA.AX earnings conference call or presentation 20-Aug-20 1:00am GMT

Full Year 2020 Orora Ltd Earnings Call

Oct 1, 2020 (Thomson StreetEvents) -- Edited Transcript of Orora Ltd earnings conference call or presentation Thursday, August 20, 2020 at 1:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Brian Phillip Lowe

Orora Limited - CEO, MD & Director

* Stuart G. Hutton

Orora Limited - CFO

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Presentation

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Brian Phillip Lowe, Orora Limited - CEO, MD & Director [1]

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Good morning, everybody, and thank you for joining us today for the Orora Group financial results for FY '20. I'm joined here today by Stuart Hutton, our Chief Financial Officer.

So today, I'll provide you with an overview of our results for the year ended 30 June 2020, the completion of the sale of our Australasian Fibre business, the on-market buyback that we have announced today and also some details about Orora's response to COVID-19. I'll then hand over to Stuart, who will take you through the group's financial results, cash flow and balance sheet. I will then cover a review of our strategy that we've been undertaking and the activities to support our ambition to become a leading provider of sustainable packaging solutions. And we'll conclude with an outlook. After which, we're more than happy to take questions.

Before we start though, I'd like to make sure that we take note of the information that's on Slide 2. The financial results and the position of the Fibre business are presented in our financial statements as a discontinued operation and have, therefore, been excluded from this presentation. Post-Fibre, Australia now has 2 segments. That's the Australasian and North American segments. The corporate costs have now been allocated to these segments and comparative information has been restated so that it reflects this change. The lease accounting standard has been applied since it came into effect on the 1st of July 2019. The impact on earnings is called out where appropriate. Comparative information has not been restated. However, there is a restated set of FY '20 financials, excluding the impact of the lease accounting, that's set out in Appendix 2.

And when considering the continuing businesses, underlying results are presented before significant items. So in FY '20, a significant item, loss after tax of $100.1 million, has been recognized in relation to our North American businesses, comprising of restructuring and impairment charges as a result of resetting the businesses to adjust for tough market conditions, which have been compounded by COVID-19. And these include costs associated with the closure of our Orora Visual Los Angeles site, a part of our rationalization of our Californian footprint. And these have been excluded from the underlying results to assist with comparisons from the prior comparative period.

And in the discontinued operations, a net significant profit after tax of $171.8 million (sic) $171.7 million reflects the net profit on the sale of the Fibre business, which includes transaction and restructuring costs.

So if we now turn to Slide 3 and the full year results for the continuing businesses. Operationally, group EBIT declined by 14.3%, and this was through weaker earnings in North America from margin pressures and volume weakness. And this is also unrecovered overheads associated with our G2, which is our second furnace at Gawler, the rebuild of that during the second half of FY '20, rising input costs in Australia and weaker volumes and mix in our Glass business as well as the net impact of COVID-19 across the group.

And as was communicated in May at our trading update, the net estimated EBIT impact of COVID-19 was approximately $25 million, and this is what has eventuated in our final accounts. These headwinds certainly were partially offset by some positive performance in our Cans business with volumes being up, profitability improvements and initiatives undertaken in OPS and the acceleration of synergies from our Pollock Orora business, and these related to sales in the health and safety segment, positive impacts from the translation of U.S. dollar earnings of $4.9 million on the prior period and lease accounting of $19.5 million. The above items also impacted NPAT, which was down on the prior period, and it came in at $127.7 million.

The Board has declared a final ordinary dividend of $0.055 per share. This is unfranked and 100% sourced from the conduit foreign income account. This represents a total payout of 78% of net profit. And this is after tax for the year. And this is at the top end of the revised range, and I'll cover a little bit about that revised range a bit later on.

Turning to Slide 4. The sale of Fibre was a major milestone for Orora during FY '20. The sale provides Orora with a great balance sheet strength for growth and for further capital returns as we move forward. And as you're aware, in June 2020, Orora returned $600 million to shareholders via capital return and special dividend and completed a share consolidation at that time.

Now turning to Slide 5. It's pleasing today to announce that we are undertaking on-market buyback of up to 10% of Orora's issued share capital, approximately 96.5 million shares, beginning in September 2020. The buyback has a current approximate market value of $230 million based on yesterday's closing share price. And whilst the Board and management's preference is to pursue growth, in the absence of any imminent opportunities and with a focus on organic growth in North America in the medium term, and I'll talk more about that later as well, the further return of capital is certainly appropriate.

We're now on Slide 6. And while Orora's businesses were all qualified as essential service providers during FY '20, Orora certainly had to adjust and adapt our businesses and operations to meet the challenges presented by COVID-19. And our response has been focused on primarily the health, safety and well-being of our people, customers and suppliers, also the provision of best-in-class products and preservation of supply chains, including securing appropriate PPE, and facilitating remote working for all of our teams globally and mitigating financial risk through a range of disciplined measures and adopting a cash is king approach across all of our business units.

Slide 7 sets out a range of complementary activities undertaken by the organization in response to COVID-19. And I must say I'm incredibly proud of the way our teams have responded to a very serious situation while continuing to provide the community with essential food, beverage and medical packaging. Our sites have implemented staggered shifts, increased sanitation and undertaken pandemic-specific safety training, including simulated responses. Approximately 2/3 of our global workforce continue to work remotely today.

And now on Slide 8. And despite the impact of COVID-19, we have made a tangible improvement in our safety performance during the period. We'll continue to build on these efforts with a focus on keeping our people safe during the pandemic and building on our knowledge and skills through making safe decisions in the workplace. Equally important is Orora's investment in additional mental health learning by utilizing visual and virtual digital tools and supporting mechanisms to help our team members during this time and beyond.

I'd now like to hand over to Stuart, who will take you through some of the detailed financials, starting with our Australasian beverage business.

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Stuart G. Hutton, Orora Limited - CFO [2]

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Thanks, Brian, and good morning all.

I'm on Slide 10. So just to cover the Australasian financial highlights. So during the year, the Australasian business delivered sales revenue of approximately $786 million, which was up marginally on the pcp. EBIT of $147 million was down approximately 7% on the pcp, and I'll step through this on the next slide in a little more detail.

RoAFE was below the pcp on lower earnings and recent capital upgrades with benefits to flow in the coming years. RoAFE was still very solid at 27%. The cash flow was impacted by several major projects during the year, which saw investment total approximately 240% of depreciation in this segment. Significant investments at Gawler included the $50 million G2 furnace rebuild, completion of the $35 million warehouse development and the upgrade of the second forming line of the G2 furnace. We also had to build some inventories to make sure that we ensured continuity of supply to support the Cans business. And given the strength of our position, we also unwound some customer/supplier financing arrangements in the period. Expectations going forward are for the Australasian businesses to deliver or the Australasian business rather to deliver cash conversion in excess of 70%.

Turning to Slide 11. So this is the Australasian EBIT bridge. The Cans business delivered organic growth during the period. However, EBIT across the segment was lower at $147 million, mainly as a result of unrecovered overheads from the G2 rebuild, which I just talked about, which totaled approximately $8 million. Cost headwinds, which included increases in gas and insurance costs. And in the latter, well, in the second half, the impacts of COVID-19, which had an adverse impact on volume, mix and efficiency across both Glass and Cans. And to a lesser extent, volumes are also impacted in Glass with some lower wine volumes to export markets.

Turning to Slide 12, the North American segment financial highlights. In local currency terms, EBIT declined approximately 30% to approximately $52 million and RoAFE fell to 9%. This was a result of the generally tough market conditions, which we talked about in the first half, and this was further compounded by the impact of COVID-19 in the second half, which impacted volumes and therefore, EBIT margins in OPS and also OV revenues declined fairly sharply in Q4 as bricks-and-mortar retail customers, in particular, were impacted by COVID-19. These, combined with other factors, flowed through to the EBIT margin, which was lower at approximately 3%.

Operating cash flows were in line with management's expectations of $50 million. They were down from $83 million in the pcp, which is really to do with the lower earnings and cash conversion also declined to 47% from 65% in the pcp. The decrease in cash conversion was driven primarily by electing to pay suppliers early given the strength of our balance sheet to take advantage of attractive settlement discounts on offer in the North American market. That was partly offset by some reduced capital spend as the business effectively focused on organic earnings improvement programs, especially in the second half with the onset of COVID-19. And as with the ANZ segment, expectations are that North America will deliver cash conversion in excess of 70% as we move forward.

To Slide 13, the North American EBIT bridge. So as we just talked about, North American EBIT declined by approximately 25% in Australian dollar terms. The net impact of COVID-19 was approximately $22 million. And for the sake of the analysts on the call, it's probably about half on OPS and half on OV. We can talk a bit more about that later. The business suffered a net contraction of approximately $27 million across the year on lower volume as well as margin pressures. The majority of this was in the first half.

Investors and analysts will recall was about $18 million. So at least in the second half, we saw some more stability, especially in OPS, while there's no doubt that OV still face some headwinds. After breaking even in the first half, OV did make a loss for the year of approximately USD 5 million. Another element there, which Brian talked about before, is the impact of lease accounting, which was positive $18 million in the period and a weaker Australian dollar added $5 million on translation.

Slide 14 is really just, I guess, given the number of questions we've had recently in relation to what does OPS do. So just really to remind the investor community on what it does do. OPS is a total packaging solutions provider, helping solve customers' packaging challenges, providing structural and graphic design support and creating initial concepts and prototypes while using a variety of substrates to ensure that packaging is manufactured and supplied to the highest of specifications.

The business is substrate agnostic, even though, clearly, we all know that we do have some capability in terms of producing Fibre-based products. In addition to the traditional packaging products, the OPS team offers engineering support to help streamline and automate packaging lines at the customers' sites, provides logistics support, including just-in-time deliveries and vendor-managed inventory, as well as fulfillment services to ensure the customer's product is ready to be marketed throughout the supply chain and into retail stores with point of purchase displays.

Some of this latter piece ties in with Orora Visual. OPS offers value-added services through every step of the journey to get the customer's product into the consumer's hands, effectively from concept to consumer.

In relation to that, I guess, on the back of focusing on adding value on Slide 15. This chart endeavors to show you the progress that's being made in OPS gross margins, which have steadily increased from the implementation of improvement programs that have been underway since the second half of FY '19, with gross margins returning to first half of '19 levels in the second half of this financial year. The exit rate at the end of June '20 was approximately 60 basis points higher than the pcp. And while this is pleasing, with a relatively high fixed cost base, obviously, softer volumes impacted on the EBIT margin. Now we, I guess, in the last couple of months, in a positive sense, we have seen some green shoots in terms of volumes certainly stabilizing or slightly improving in some of our regions in North America, and Brian will cover that off in more detail shortly. Further opportunities are being identified as the improvement program in OPS matures and visibility continues to be enhanced as the ERP system is optimized.

Turning to Slide 16 on Orora Corporate. Corporate costs have, as Brian mentioned, have been allocated to the continuing business segments on a broadly consistent basis with prior year's figures restated for comparison. Ongoing corporate costs are expected to reduce commensurate with those costs previously allocated to the Australasian Fibre business. The expectation is there will be minimal stranded costs held at corporate.

Just a very quick update on the Petrie decommissioning project. It's progressing as expected, with several milestones completed during the year. This resulted in approximately $9 million of deferred sale proceeds being released. The total cash spent on decommissioning was approximately $20 million across FY '20 and is forecast to be similar in FY '21.

Turning to cash flow on Slide 17. I mean, basically, earnings were converted into cash as we expected, with operating cash flows of approximately $170 million. Cash conversion of 54% was lower than 70% reported in the pcp. However, as I said, was in line with what we were expecting in what has been a transition year. The main points to note are, the decrease in cash EBITDA obviously rolled into the dollars in terms of cash flow generated. We had to build some inventories, as I mentioned before, to support the Cans business, which has seen, which is positive, some volume growth, and ensure continuity of supply to customers in the COVID-19 scenario. We did elect to pay some payables in North America to capture attractive settlement discounts, and we also unwound some supplier financing arrangements in both ANZ and North America.

Gross CapEx, which is base and growth, was approximately 167% of underlying depreciation. The G2 rebuild of $50 million was a major contributor to the heightened capital investment in FY '20 and obviously will not hopefully reappear for the next 5 years when we do G3. Working capital continues to be well-managed and was averaged 8.3% to sales, with basically, as I said, no material change. In a positive sense in the current environment, receivables management has remained strong. And as I guess mentioned in the segment pieces, cash conversion is expected to return to an excess of 70% in FY '21.

On to the balance sheet on Slide 18. So I guess post the sale of Fibre, I mean, the slide then does highlight Orora's strong balance sheet, which provides flexibility as we move forward. At June, net debt decreased to approximately $300 million with leverage at 0.9x, down from 1.9x at June 2019 and 2.3x at December 2019. The main movements since the first half include the net proceeds on the sale of Fibre of approximately $1.5 billion, partly offset by approximately $680 million of capital management, dividends and then the other items really are those that I've referred to in the lower cash conversions in each segment. We remain committed to maintaining sensible debt levels and investment-grade credit metrics. We have significant headroom in our facilities with undrawn capacity of approximately $600 million and cash reserves of over $100 million as at 30 June.

As I said, this follows the significant reduction in facilities made after the sale of Fibre to efficiently hold headroom in each jurisdiction in which we operate. The average tenor of our debt facilities is approximately 3 years. And our principal focus is to use our strong financial position to invest in organic and in time, inorganic growth to generate future shareholder returns while returning funds to shareholders in the absence of such opportunities in the nearer term.

So with that, I will conclude my comments, and I'll hand back to Brian to discuss the review of strategy and outlook for FY '21.

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Brian Phillip Lowe, Orora Limited - CEO, MD & Director [3]

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Thank you, Stuart.

And so if we move now to Slide 20. And with the announcement of the sale of our Fibre business, Orora has now completed its review of its strategy. And the review focused on a number of core elements and they were: a really critical assessment of the industries and markets in which Orora operates, the trends that will influence future performance; confirming Orora's key competencies and the points of competitive advantage that we have; clarifying the key areas of opportunities and challenge within the existing portfolio and key actions that can address those; and identifying potential new opportunities for Orora to leverage its core competencies to expand its products and services over time.

Slide 21 provides an overview of the assessment of the existing businesses. This is focused on the capabilities, the markets in which the businesses operate and how we are positioned as we move forward. And this assessment covers the near-term strategies and the approach to ensure we are generating maximum value from our operations.

Our beverage cans, glass and closures businesses are all leaders in their respective markets with operating and financial performances that compares well to best-in-class peers globally. There's been significant investment made over time in capacity and capability, which, coupled with a highly experienced team, ensures that we have a well-earned reputation for product quality and reliability with our long-standing customers.

We operate in mature and highly-concentrated markets, which renders incremental growth more challenging to achieve. And while we will continue to invest in capacity and capability and in innovation, we will actively explore opportunities to expand our footprint into other attractive end markets by leveraging our technical know-how, expertise and our customer relationships. And likewise, we'll look at whether we can establish a meaningful Australasian market presence in products and services that are adjacent and complementary to our existing business.

In OPS and OV, we have 2 businesses that have established positions in significant markets. These are underpinned by extensive network infrastructures in major commercial hubs and have strong relationships with customers across a range of end markets. And whilst OPS and OV's performance has been affected in recent years due to a range of factors, both businesses have the ability to generate significantly greater returns from their existing bases. And this will require a strong focus from the respective leadership teams.

The key for the near term is to accelerate enhancements in these businesses and their business models through enhancements in the value propositions via further investment, particularly in digital capabilities. Importantly, the digital road maps have been well developed and a range of the activities are in various stages of implementation. And a good example of this is our recently implemented ERP system, which gives OPS the power to analyze data by product, by customer. And we're generally excited about the opportunity that this granularity provides to the business.

Now on Slide 22. A set of strategic pillars have been established to support Orora to execute its objective, which is to become a leading, sustainable packaging solutions company. And these are: optimize and grow through operational improvement and best-in-class execution, enhance and expand our core products and services to strengthen our value proposition and enter new segments that are complementary to Orora's capability set.

Now on Slide 23 on Orora's refreshed shareholder value blueprint. And it's not a material change to where we've been previously, which has served us well since demerger. And we are striving to generate top quartile TSR performance for our shareholders and see that this is being driven by 3 components. Organic growth is expected to be broadly in line with GDP in the near term, supplemented by enhancements to our business models with further innovation and operational leverage to enhance returns. Returns-focused investments will include both organic capital as well as acquisitions. Any near-term M&A will be to explore expanding our beverage footprint in potentially complementary adjacencies. Any future growth initiatives will be assessed rigorously so that only value-adding investments that meet our return criteria, which is to generate a return with an appropriate premium to WACC depending on the risk assessment of that investment, are undertaken.

Now our previous target of 20% returns on M&A was always an aspirational target. Accordingly, this has been reassessed and reset in light of current interest rates, market conditions and asset valuations. Our view is return targets based on a scale of premium to WACC based on asset risk are more appropriate measure for how we should look at M&A. Following the Fibre sale, Orora is expected to have an even stronger cash flow profile, which has prompted us to increase the top end of our targeted payout range from 70% to 80%. And this will provide the Board with increased flexibility to increase returns as we have done this year.

And as shareholders will have seen since the sale of the Fibre business, Orora is also committing to return excess capital back to shareholders where there is no immediate use for that capital. And this is being reinforced with the announcement today of the on-market buyback. And lastly, Orora is committed to maintaining sensible debt levels and will maintain its target debt leverage of 2 to 2.5x.

Turning now to sustainability and then the outlook for the financial year ahead. So I'm now on Slide #25. And at Orora, we are a leading manufacturer of sustainable packaging, and we see this as a point of difference and competitive advantage for our business. And working closely with our customers, Orora is continuing to design, develop and find innovative recycled packaging solutions that appeal to our customers and end consumers. And during the period, the Australasian beverage team have secured 100% of the glass that will be generated from the Western Australian government's CDS scheme, and this will be used in our glass facility in South Australia.

And at Gawler, we already recycle approximately 80% of the glass collected through the South Australian CDS scheme. And the total recycle of our glass business or the total recycled content for our glass business will increase from its current levels of approximately 25% to 35% in time. The Cans business has also worked with our suppliers to source aluminum coils that contain more than 60% recycled aluminum.

Slide 26 sets out our new Eco Targets. And these are the same focused areas of those that Orora successfully achieved between demerger on the 30th of June 2019. These are measured as ratios against production related to metrics that are depicted in Slide 26. The metrics reflect the specific attributes of each of Orora's business divisions, ensure greater scope for effective management. The metrics are divided into manufacture of packaging which measures against tonnes produced, and separately, the distribution of packaging which adheres to floor space square meters.

Turning now to perspective for FY '21, which is on Slide 27. Orora has 4 clear priorities for FY '21: continue to respond to COVID-19, continue to implement the North American improvement programs, launch and complete the on-market buyback and begin implementation of the refreshed strategy. We certainly expect challenging conditions to continue in all markets in which Orora operates. The ongoing impact of COVID-19 in both Australasia and North America only adds to the level of uncertainty.

In Australasia, while the business has been stable, a lower Australian wine vintage will adversely impact our Glass volumes as well as subdued demand in some export markets and ongoing unfavorable mix in Cans. Approximately $6 million of the adverse earnings impact from the rebuild of G2 will reverse in the second half of FY '21. However, there will be some cost headwinds associated with energy, all in the first half, and insurance, which total approximately $3 million. The focus for North America is to consolidate and deliver on the existing earnings improvement programs. And we have seen continued improvement in the OPS gross margins, and Stuart mentioned that earlier, and that is in both June and July '20, which have delivered earnings results higher than the pcp.

Approximately $1.5 million of increased insurance costs will also impact our North American businesses in FY '21. And both North American businesses are investing further in e-commerce platforms to improve interaction, efficiency and engagement with our customers. The group is targeting cash conversion in excess of 70% in FY '21 and while capital expenditure will be approximately 90% of depreciation, excluding lease amortization.

And on Slide 28, we do talk about the overall outlook. So in terms of that, Orora does expect that challenging and uncertain market conditions to continue for the foreseeable future. And despite the COVID-19 pandemic, Orora businesses do qualify as essential services providers in both Australasia and North America and are, therefore, able to continue to operate, which is terrific for our businesses. A number of improvement initiatives have been successfully implemented across Orora businesses. And pleasingly, as we've mentioned a few times, our North American financial performance has stabilized. And we will be providing a further update at our AGM in October about the progress since then.

So with that, we've covered what we intended to present to you today. So I'll ask the operator if we can open the line for questions.