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Edited Transcript of PGH.AX earnings conference call or presentation 14-Aug-19 12:00am GMT

Full Year 2019 Pact Group Holdings Ltd Earnings Call

RICHMOND Nov 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Pact Group Holdings Ltd earnings conference call or presentation Wednesday, August 14, 2019 at 12:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Richard Betts

Pact Group Holdings Ltd - CFO

* Sanjay Dayal

Pact Group Holdings Ltd - MD, Group CEO & Director

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Conference Call Participants

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* Brook Campbell-Crawford

JP Morgan Chase & Co, Research Division - Analyst

* Grant Slade

Morningstar Inc., Research Division - Analyst

* John Purtell

Macquarie Research - Analyst

* Keith Chau

MST Marquee - Building Materials & Packaging Analyst

* Larry Gandler

Crédit Suisse AG, Research Division - Director

* Owen Birrell

Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst

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Presentation

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Operator [1]

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Thank you for standing by, and welcome to the Pact Group 2019 Full Year Results Conference Call. (Operator Instructions) I would now like to hand the conference over to Mr. Sanjay Dayal, Managing Director and Chief Executive Officer. Please go ahead.

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Sanjay Dayal, Pact Group Holdings Ltd - MD, Group CEO & Director [2]

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Good morning, everyone, and welcome to Pact Group's 2019 Full Year Results Briefing. I'm Sanjay Dayal, the Group Chief Executive Officer of Pact Group. I'm joined today by Richard Betts, our Chief Financial Officer. Today, I will provide you with an overview of our full year results before handing over to Richard to take you through the financials. I will then return to talk to you about our priorities and our near-term outlook. We'll be pleased to take questions at the close of the presentation.

I started with Pact in April this year. The time I have spent with the company has provided me with many insights. These, I will touch on later in the presentation.

Over the years, Pact has built a business portfolio and a management team, which is a privilege for me to lead. I'm really pleased to present to you my first results with the company and talk to you about its performance and prospects. I'm committed to maintaining an open and transparent dialogue with the investor community as we move on the journey ahead.

At a headline on Slide 3, the group reported a statutory net loss after tax of $290 million. This includes significant items after tax of $367 million, of which $327 million relates to the noncash impairment of assets taken in the first half. Revenue was up 10% on the prior year. EBITDA was down 3% at $231 million. NPAT before significant items were $77 million. The Board has determined not to pay a final dividend.

FY '19 was a very challenging year for Pact. Earnings were impacted by higher raw material and energy cost, and volumes in several sectors were weaker than expected. Pleasingly, headwind from raw material input cost eased in the second half and pricing improved. This enabled the recovery of some adverse pricing lags, which had impacted earnings in previous period.

The business remained focused on managing controllables, delivering operational efficiencies and overhead reductions, and we made meaningful steps in the transformation of our packaging network. During the period, we secured long-term customer agreements, which will underpin growth in our pooling and reuse business in FY '20. This included a long-term agreement with ALDI for produced crate pooling services. This arrangement commenced on schedule earlier this month. Our partnership with ALDI is testament to the service quality and capability we have developed in our pooling business. It has indeed been an outstanding achievement.

Recently, we were awarded a long-term contract with a major retailer in U.S.A. for supply of reuse services. This partnership will significantly expand our garment hanger reuse capability in the largest retail market in the world. Pact's unique capability in supplying sustainable packaging and supply chain solutions is really an exciting opportunity for growth.

Through the period, we managed our balance sheet with discipline. Operating cash flow was strong, and capital expenditure was well controlled. Leverage was improved in the second half, and we extended debt of $380 million, reducing near-term refinancing risk.

We also established a subordinated term loan facility, increasing our funding flexibility. These measures, alongside disciplined capital management, provide a balance sheet capacity for the group to progress planned rationalization activities and complete existing growth projects.

Since joining Pact in April, I spent significant time within our operations understanding our people, our processes and products. I've talked extensively with our customers, shareholders and other key stakeholders. Pact has an enviable market-leading capability in the sectors it participates. Our innovative capability is industry recognized. Pact's employees are talented and dedicated, yet our performance across many metrics does not reflect our capability. We have room to improve, and much work needs to be done. Driving improvement in our core business and clarifying our strategy is critical. I will speak of this in more detail later in the presentation.

Moving to safety performance on Slide 4. It is pleasing to see an improvement on the prior year. There has been an ongoing focus on processes and systems in safe behaviors and training for our people. Undoubtedly, we have room for improvement. This will certainly be one of my priorities in the year ahead. No injuries are ever acceptable, and 0 harm has to be our goal.

With these opening remarks, I will now hand over to Richard to run through the financials in more detail. I will then return to talk to you about our priorities and near-term outlook. Richard?

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Richard Betts, Pact Group Holdings Ltd - CFO [3]

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Thank you, Sanjay, and good morning, everyone. Turning now to Slide 5, the financial results summary. As Sanjay highlighted, the operating environment has been challenging, and this is reflected in our earnings. The group's full year sales revenue of $1.8 billion represented an increase of 10%, driven primarily by the Asian acquisition undertaken in the second half of financial year '18 and the acquisition of TIC Retail Accessories completed in October 2018. Underlying sales revenue was generally in line with the previous corresponding period. Higher pricing reflecting the partial pass-through of input costs was offset by lower overall net volumes.

Group EBITDA of $231 million was 3% lower. Earnings were improved in the Packaging and Sustainability, and Materials Handling and Pooling segments. Earnings in Contract Manufacturing were lower. Increased depreciation and higher interest on longer-term debt following our recent investments pushed EBIT and NPAT lower.

Operating cash was adversely impacted by lower EBITDA and higher inventory following a change to our resin sourcing model. The sourcing change saw the business move to a more reliable sourcing strategy. However, as anticipated, this increased our resin supply chain from 2 weeks to a peak of 12 weeks resulting in a one-off increase in working capital.

Good work was done in the second half to reduce our inventory levels. However, the transition to a more reliable import model has placed the business in a very good position going forward. Gearing at 3x was at the top end of our targeted range but a strong improvement on the first half. And I will talk to this later.

Moving now to Slide 6 and the segment results for Packaging and Sustainability. The packaging segment delivered EBITDA of $155 million, $2 million up on the prior year. Acquisitions contributed an incremental EBITDA benefit of $11 million. Efficiency was strong, delivering benefits of $13 million in the period. This included benefits from network restructuring and ongoing efficiency across our operations.

Weaker volumes adversely impacted EBITDA by $12 million. This included lower volumes into the dairy, food and beverage sectors in Australia and New Zealand and lower demand from the agricultural sector due to the drought in Australia. Pleasingly, we saw volume growth in both our Asian operations and sustainability services businesses. Weakness in our core dairy, food and beverage sectors have been impacted by several factors. This includes losses in sectors where the high-cost operating environment in Australia has made local manufacturing uncompetitive. We are targeting improvements in this area through network restructuring.

We've also experienced some volume softness in categories where our customers have packaging alternatives perceived to be more environmentally sustainable. This highlights the criticality of sustainability to our ongoing success. To this end, we have significant pooling, reuse, recycling, innovation and manufacturing know-how. We are focused on driving growth from these capabilities to offset the impact that a shift away from plastics in some product categories may have. Sanjay will talk to these opportunities later.

Unrecovered input costs adversely impacted EBITDA by $10 million, of which $7 million related to unrecovered energy costs and $3 million related to lags in recovering higher resin costs. Pleasingly, we saw an improvement in resin cost and pricing in the second half, which enabled us to recover prior period lag of $3 million. Margins declined to 12.8% reflecting higher input costs not recovered and lower average margins in the acquired Asian businesses.

Moving now to Slide 7 and the Materials Handling and Pooling segment. Materials Handling and Pooling delivered EBITDA of $51 million, a 15% increase on the prior period. TIC contributed $10 million to EBITDA. This result included start-up costs for our new manufacturing and sorting operations in Bangladesh. These operations are now up and running and were pivotal in the recent contract win in the U.S. to provide reuse services for the garment industry.

Volumes were down in the period impacting EBITDA by $2 million, largely due to fewer available infrastructure projects and weak demand for agricultural bins due to the drought in Australia. A major council bin rollout in the second half helped to offset a weak start to the year.

Pooling volumes in Australia were improved. Higher energy costs adversely impacted earnings by $1 million as did higher costs associated with the expansion of our crate pooling operations in Australia. The EBITDA margin of 17.2% was down on the prior period with an adverse impact from product mix and lower average margins in the acquired TIC business.

Moving to Slide 8 and the Contract Manufacturing segment. Contract Manufacturing reported EBITDA of $25 million, $15 million down the prior period. Revenue was down 3%, a disappointing result after what had been a solid start to the year. Volumes into the health and wellness sector weakened significantly in the second half due primarily to customer destocking. The home care category was down impacted by customer offshoring in the second half and lower sales of home pesticides, a consequence of drier summer conditions.

Higher raw material and energy costs adversely impacted earnings by $12 million. Cost for materials, including surfactants, soda ash, sodium bicarbonate, fragrances and salt increased by around $16 million in the period, exacerbated by a weaker Australian dollar. Improved pricing in the second half saw around $4 million recovered in the market. The benefit of efficiency in automation projects delivered an improvement in EBITDA of $1 million. Disappointingly, margins of 6.7% were well down on the prior period, reflecting the impact of unrecovered input costs.

Turning now to cash management on Slide 9. We reported operating cash flow in the period of $203 million excluding securitization, representing a conversion rate of 88%. Operating cash flow was down on the prior period due to lower EBITDA and higher inventory levels, the latter impacted by the change to an import supply model for resin. Capital expenditure was low due to reduced spending on the Australian crate pooling business.

Turning now to our balance sheet on Slide 10. Net debt at the end of the period was $684 million, an increase of $84 million in the year. The increase was primarily due to payments for acquisitions of $79 million. This included the initial cash component for the TIC acquisition, the earn-out payment for Pascoe's and the completion payments for the Asian acquisition.

Pleasingly, we extended $380 million of debt to January 2022, improving average tenure of our debt to 3.6 years. Over 60% of debt now has a maturity greater than 4 years. Gearing at the end of the period was 3x. In June, we established a $50 million subordinated term loan. We have used this loan to pay down senior debt, improving headroom in our senior debt and providing a very cost-effective improvement in our balance sheet capacity. We have sufficient capacity to continue planned rationalization activity and complete existing growth projects.

That concludes my comments on the financials. I will now hand back to Sanjay.

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Sanjay Dayal, Pact Group Holdings Ltd - MD, Group CEO & Director [4]

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Thank you, Richard. Since joining Pact, my initial observations are that we have highly capable employees with strong operational and technical skills. Our customer base is diverse. We have developed strong relationship with many leading and trusted brands. I have been pleased by the focus on profitability and efficiency across the business. However, I've also observed the challenges that Pact's rapid growth has created. In several areas, Pact systems and processes need to be significantly improved to support its size and geographic spread. In many cases, the business has not been as fast as I would expect in responding to changing market conditions, resulting in falling margins and returns. This needs to be corrected.

In addition, the company needs to review what special market position and capability it has, which will deliver sustainable competitive advantage. I believe we can reinvent Pact by understanding and defining the aspirations and strategic priorities for the next era of the company's evolution, which will establish a basis for significant long-term value creation for its stakeholders. I will focus on what I see as the important first step in this journey: firstly, deliver improvement in the core business fundamentals, get the basics right; secondly, work towards our 2025 sustainability promise through delivery of profitable growth in this essential space; and finally, clarify Pact's strategy to provide direction into the future. This is critical. I will talk through each of these priorities in more detail on the following slides.

Moving ahead to Slide 13, improving the fundamentals. When we get the fundamentals right, then improvement in performance should follow. This really is about getting back to basics. In recent years, I believe the business has tried to do too much. There have been too many projects and initiatives, which have distracted the business and resulted in slippage in core business performance. Delivering improved performance from what we already have is critical.

Safety. While Pact has delivered improvement in safety recently, I'm keen to drive a step improvement in this area. Changing safety culture with improved processes and higher engagement and responsiveness from employees across the group will be one of my key priorities.

Margin management. In recent years, the company has done well to focus on improving efficiency and lowering its cost to serve across operations. There has been good progress on network design, though I believe there is still significant opportunities ahead of us. I will continue to drive this effort to ensure that our robust plan is in place to improve the quality of our operations.

Looking at the market position, it is clear that pricing and cost recovery within the business has not worked as effectively as it should. Costs have moved upward more quickly than pricing. While the business has been able to recover movements in input cost in recent periods, in some areas, it did not act strongly enough. Controls and process improvements to better manage this critical aspect of our business must be implemented. We must give our salespeople the confidence to deliver value through pricing, and we must be prepared to walk away from unprofitable business.

I also believe we can improve margins by improving the understanding of sector and product performance. We need the right analytics and market intelligence that can inform decision-making. Pact may not well be suited to all sectors and products. We must understand where resources are best placed to deliver the desired returns.

Sales. Pact has an extensive product range supported by deep manufacturing and innovation capability supplying diversified end markets. Yet, volumes have not demonstrated the resilience expected from this capability and diversification. Organic sales growth has been weak in some sectors for several consecutive periods. There is much work to be done to improve pipeline management and innovation penetration to drive volume growth.

Our customer experience. In the last 12 months, the company has invested in improving quality and delivery. A common quality system has been implemented, and management of delivery has improved. However, some customers have shared that they have continuing frustrations regarding quality and delivery. The network redesign will deliver a step-change improvement in customer satisfaction, but we must ensure that we work harder and faster across the business to regain our customers' confidence.

Finally, capital returns. Pact's capital returns have reduced and leverage has increased. We have steadfastly focused on managing our balance sheet with discipline, and as such, we now have a stricter capital allocation process. Growth is prioritized based on a strict assessment of returns. Business leaders are held accountable.

Moving to Slide 14, packaging network redesign. Restructuring our packaging network remains a priority. The network redesign is a program targeting the delivery of our scale advantage. It will create an integrated regional supply network delivering efficiencies and improved customer satisfaction. The benefits it can deliver are significant.

I have examined the proposed program of work closely. Before progressing work on several streams in the program, we will evaluate in detail product and sector returns. We will ensure the strategy review I have commenced supports further investment. I would not want to spend valuable capital improving efficiency or supply in a sector, which does not align with the future direction of the company.

In terms of progress, we have made meaningful steps in FY '19. We closed 2 facilities in the second half, rationalized another and established an import channel to support supply in several product categories. This follows the closure of 2 facilities in FY '18. Annual benefit from work complete to date is approximately $13 million on a run rate basis, of which $10 million will be delivered in FY '20. Spend to date is $30 million.

In the near term, we will continue further offshoring in products where we can leverage our Asian manufacturing footprint. The strategy review will clarify our approach for the broader program. I believe there's an opportunity to reduce the overall cost of the program from that previously indicated, but this will be better understood when we have properly evaluated our strategy.

Moving on to Slide 15, progress towards our 2025 sustainable promise. Sustainability is a core pillar of Pact's commitment to its employees, the communities in which it operates and its customers. I have been incredibly impressed by Pact's capability and commitment with respect to sustainability. Pact is the largest processor and consumer of post-industrial recycled resin in Australia and New Zealand. It offers schemes for hard-to-collect recycled packaging. It launders, reconditions and refurbishes all packaging. It actively replaces single-use packaging with pooling and reuse solution and designs products, which minimize impact to the environment.

12 months ago, Pact launched its 2025 sustainability promise, and we have made good progress in this area. We have secured considerable growth in our pooling and reuse businesses, which we will begin to realize in FY '20. We have grown capability in our recycling business leveraging government support for several exciting initiatives. We have received industry and customer recognition for continued innovation of sustainable packaging.

I will speak to the growth opportunities in our pooling and reuse business shortly but just wanted to add here that there is real growth potential in our recycling capability. We have partnered with governments on several projects, which are detailed on the slide. Development of local recycling circular economy offers growth opportunities for Pact not just as recyclers but as consumers of recycled resin in manufacturing sustainable packaging. This, in turn, enables our customers to achieve their sustainability agendas. As we look for more opportunities in this area, for me, an important consideration is to understand which projects and what part of the value chain should Pact invest in, not only to fulfill its sustainability target but also to maximize profitability and returns.

Moving on to Slide 16. Pact announced earlier this year that it had secured a long-term agreement with ALDI for supply of returnable produce crate pooling services into its stores across Australia. Service commenced on schedule earlier this month, an outstanding achievement. We are incredibly proud of the pooling capability we have developed. We have built a world-class platform delivering market-leading quality and efficiency. The pooling business delivers world-class hygiene and food safety standards. It also provides growers a unique interface, extensive data analytics for improved supply chain control.

Our crates have a low environmental footprint. We use recycled resins in their manufacture and has capability to recycle at end of life. Each crate can eliminate in excess of 100 single-use containers. With Woolworths and ALDI, we are developing a national pooling platform, which will deliver to both growers and retailers significant efficiencies. A national standard crate pool lowers freight cost, repacking cost and inventory costs. Pact continues to drive efficiency improvements to developing capability in asset tracking. This will enable real-time decision-making in the future providing significant opportunity to further reduce cost and waste in the supply chain. The developments in this area have high potential.

Moving on to Slide 17. Pact's reuse platform is an innovative and sustainable closed-loop supply chain solution, which reduces plastic wastage cost. Like our crate pooling platform, our reuse platform supports the group's commitment to providing innovative ways to assist our customers to meet their sustainability objectives. We are delighted to announce today that we have secured a long-term agreement with a major retailer in U.S.A. for the supply of reuse services. Once this agreement commences in second half of FY '20, Pact will be the leading supplier globally of hanger reuse services, an outstanding achievement. I believe Pact's leadership and unique capability in pooling and reuse services has a very exciting future.

Moving ahead to Slide 18. As I mentioned earlier, I have commenced a review of Pact's strategy. Through this review, I'm seeking to clarify the activities and operations that are core to Pact's future success. Our resource allocation and capital investments will be guided by strategy. Growth will be prioritized in those sectors Pact has special capability and a competitive advantage and where it can achieve sustainable financial returns. This will be a detailed in-depth review supported by external consultants. We will keep you updated.

To summarize today's results on Slide 19, we have been challenged by input cost and weak demand in some sectors, yet the business had made improvements in many areas. The business has maintained a strong focus on efficiency and overhead cost reduction. Meaningful progress on the transformation of the packaging network has been delivered. Crate pooling operations have been expanded. Reuse services will expand in the year ahead following a major contract win in the U.S.A. The business has made good progress towards our 2025 promise. And most importantly, our balance sheet has improved, and we have reduced our near-term refinancing risk. We are focused on developing clarity in strategy and driving business transformation that maximizes long-term shareholder value.

Turning now to perspectives for FY '20 on Slide 20. What we have done here is to provide some key perspective in relation to our FY '20 segment performance to provide more transparency for investors. In our Packaging and Sustainability segment, we expect the delivery of benefits from network restructuring. Demand environment is expected to remain subdued in Australia and New Zealand, whilst we expect modest growth in Asia and in sustainability services. Resin input costs are expected to be in line with Q4 FY '19 resulting in modest recovery of lags.

In our Materials Handling and Pooling segment, we expect benefit from ALDI's pooling service arrangement and expansion of reuse service in U.S.A. to benefit EBITDA. In our contract manufacturing segment, we expect the year ahead to be challenging. Customer destocking will drive lower demand for health and wellness products, and volumes in the home care category will be impacted by offshoring. Raw material input costs are expected to remain high. Efficiency and reducing our cost to serve will be a priority. Depreciation, amortization and net financing cost on a comparable basis are expected to be slightly higher than FY '19, and the effective tax rate is expected to be between 29% and 29.5%.

Turning now to our outlook for the year ahead on Slide 21. The group expects EBITDA before significant items in FY '20 to modestly improve subject to global economic conditions.

That concludes today's presentation. We will now take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question today comes from Owen Birrell from Goldman Sachs.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [2]

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Sanjay, welcome to Pact. Obviously, good first conference call. Just a couple of questions from me to start off with. I note that net cost recovery was a major issue across all segments. Just wanted to get your take on what you see as the major issues here. Is it a price and contractual issue? Or is it just a lag issue here?

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Richard Betts, Pact Group Holdings Ltd - CFO [3]

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Look, maybe I'll take that, Owen. It's Richard here. Look, I think in terms of cost recovery, you can break it up into 2 buckets, and you can see in our Packaging and Sustainability business where we obviously have more contracts and businesses tied to rise and fall. It is a lag issue. And you can see that in the second half where, if you go back to our first half, we were actually calling out from a net cost recovery perspective that we were about $13 million down, of which electricity was obviously the largest component there, which represented about $8 million, which is now washed through our numbers. But from a -- in terms of a raw material input cost, the resin represented about a negative $6 million. In the second 6 months, that was a positive $3 million. As we recovered the -- we started to recover in terms of seeing some price -- some of those -- the resin price falling, so as contractual mechanisms are working and working well in that segment. I think obviously, the one that is more challenging for us is in the Contract Manufacturing Services, where we -- over the course of the year, we did see a negative $12 million there, of which $8 million of that was in the first half and then $4 million in the second. So we have done work with our customer base there in terms of recovering, but it's not -- it does not work off a straight rise and fall, particularly in relation to our contracts with some of the supermarkets. They seek a more -- they're looking for fixed price for a period of time generally up to a year. And so in those environments, it's really about negotiation. We've been semi-successful in terms of recovering through those contracted periods, but I think one of the challenges with the contract manufacturing business is that it doesn't have those same mechanisms that we would be used to in the packaging business, whereby basically what we're talking about is lag. So we have to address that. It's part of the strategy review that we will conduct in terms of what is the appropriate return and the risk profile for this business. But certainly, it does have a different contract profile than the Packaging and Sustainability.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [4]

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Okay. That's great. A second question for me just on materials handling. The ALDI contract, which starts in FY '20, from what we understand was pretty highly contested. Can we expect any sort of margin contraction in that business as the mix starts including ALDI in there?

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Richard Betts, Pact Group Holdings Ltd - CFO [5]

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Look, I mean I think you're right. It was certainly highly contested, but the benefits that we have is that this represents the opportunity for us to create scale within that platform. We built -- and I think we have always talked about the fact that those -- the pooling services that we built were based around ensuring that we could take more capacity on. And so certainly, any competition that existed within that tender process has been taken into account through the opportunities of scale in the pool. And we certainly see good going forward that the opportunities that we can create for both farmers and for the retailers in terms of creating scale in an industry pool represent very -- are very attractive for them that also provide appropriate returns in line with the current returns as they are today.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [6]

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From what I'm hearing from you, it suggests that the margins are contracting at the start of FY '20 but could recover over time as you start to reveal the -- some of those benefits.

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Richard Betts, Pact Group Holdings Ltd - CFO [7]

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Well, I mean -- nowl ook, the only thing in FY '20 is that we will see the normal cost associated with start-up. This is a program where the volume exists from day 1. We've got a fully operating program. Already we've demonstrated capability through the Woolworths contract. So whilst I would see that there will be maybe a month or 2 where we'll be [seeing] start-up costs, I would think that certainly, by the time you get to the second half and probably I would expect beforehand that being conservative in the second half, we will definitely have -- we'll be definitely tracking to the margins that we expect in that business.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [8]

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Okay. Can I just also just follow on with the potential Coles contract negotiation that's coming up and how you see yourself positioned for that one?

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Sanjay Dayal, Pact Group Holdings Ltd - MD, Group CEO & Director [9]

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Yes. From my side, I would say it's a great opportunity for us to offer Coles a platform, which is an industry platform. It's really state of art. And we do have the benefit that we already have Woolworths and ALDI with us, so we would love to serve Coles to bring them to the same level as the ALDI level.

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Operator [10]

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(Operator Instructions) The next question comes from John Purtell from Macquarie Group.

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John Purtell, Macquarie Research - Analyst [11]

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Just had a couple of questions. Just in terms of the timing of the strategy review, what sort of indication can you give us on outcome regarding that?

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Sanjay Dayal, Pact Group Holdings Ltd - MD, Group CEO & Director [12]

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I think I would think, in the first half, we should have done quite a bit of it, and we'll certainly have something to say at the half year.

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John Purtell, Macquarie Research - Analyst [13]

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And just secondly, I note that your underlying volumes were 4% lower in your Packaging and Sustainability segment. Can you sort of comment on what broadly you're expecting or factoring in for fiscal '20 there? Obviously, I note your comment that demand conditions are subdued. But are you expecting sort of a further decline in '20 in relation to that?

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Richard Betts, Pact Group Holdings Ltd - CFO [14]

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I think, John -- it's Richard here. I think where we're seeing that particularly in the Australia and in New Zealand businesses is that we would expect those volumes to be flat to be slightly negative. In terms of the overall Packaging and Sustainability business, we would see opportunities for growth in the Asian business and growth in the sustainability piece. But in terms of the core Australia and New Zealand, flat to slightly negative would be the outlook that we're currently seeing.

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John Purtell, Macquarie Research - Analyst [15]

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Okay. And just the final one in relation to raw materials. Obviously, Contract Manufacturing, you're not expecting much relief there. So does that sort of imply that there's been further step-up? Or was it more of sort of a reflection of your earlier comments, Richard, that just takes time to recover?

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Richard Betts, Pact Group Holdings Ltd - CFO [16]

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It's a bit of both, John. I mean, primarily, it's in relation to the previous comments in relation to that initial step-up. I think the reality is that we are buying these raw materials in U.S. dollars with the weakness that we've seen in the Australian dollar over the course of the -- particularly the last month or so. That will flow through into the total pricing piece. So we're going to have to look at what the implications are for that in terms of the pricing and look at where we head next in terms of negotiations, in terms of the next round. But certainly, I think the important thing is the majority of that is in relation to the -- what we were talking about at the half, John.

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Operator [17]

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The next question comes from Grant Slade from Morningstar.

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Grant Slade, Morningstar Inc., Research Division - Analyst [18]

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Just a couple from me. First off, in the second half, the volume impact to the packaging segment's EBIT was similar to the first. Does that imply that there wasn't further volumes lost in the second half from further customers and we're looking at stabilization in terms of your customer base in packaging?

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Richard Betts, Pact Group Holdings Ltd - CFO [19]

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Yes. Look, Grant, I mean that is correct. Certainly, the volume position in the second half was in line. And the major component or one of the major components of that rather than being customer loss was around the actual volumes within our customer base, and obviously the area that would have been, or was the largest affected was the agricultural sector, where, as a result of the drought, we saw very low volumes in that sector. We didn't see any change in that position across the course of the year.

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Grant Slade, Morningstar Inc., Research Division - Analyst [20]

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Okay. Great. And then, look, finally, just around the network redesign, how much cost-out -- I know you've given us some numbers for fiscal 2020. But how much in total is still -- I guess are you estimating that you'd be able to strip out of the network?

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Sanjay Dayal, Pact Group Holdings Ltd - MD, Group CEO & Director [21]

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So maybe -- Sanjay here. I think from -- we have said what will be there, as you've already mentioned, for FY '20. The balance that I am -- as I've mentioned that I've -- I'm trying to see the -- review the program to see what really is it that we need to do to align ourselves with the strategy going forward. So I do not necessarily want to do a network redesign of products, which may not be long term in the -- in our portfolio for example. So I have introduced a sort of customer overlay to the network redesign program. So once that is clear, only then we will really know how much we will be spending in the whole program as well as what should be the final sort of, say, benefit of it. So there's a bit of a review there. But it's very much on track, and there is already quite a bit, which is clear needs to be done, and we are doing it. So it's not that it's on pause or anything like that. It's just the end state of it, might be a little different from what was originally envisaged.

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Grant Slade, Morningstar Inc., Research Division - Analyst [22]

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Right. Is the savings -- I mean you -- can you give us any sort of indication as to whether the savings would be sort of in line with what was sort of previously flagged with the market? Or should we expect that possibly the greater savings would be identified?

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Richard Betts, Pact Group Holdings Ltd - CFO [23]

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I mean I think, Grant, at this stage, I think, as we've said, we always envisaged this was a program that would generate us around $150 million of cost to generate $50 million worth of savings. Certainly, the core components to that program still remain in place. I think what has changed is, as Sanjay said, is that some of the projects that would have been at the back end of that Q that related to reshaping our portfolio to maximize efficiency rather than aligning with our market needs going forward. So I think -- I don't think it's appropriate at this stage to put a target on it until that strategy review is complete. But as I said, so far to date, we've generated about $15 million from that program and including the $10 million that we've called out for next year. As Sanjay said, there are projects that already will take place next year, which will give us further advantage. So I think that's probably where we are at right out today.

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Operator [24]

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The next question comes from Larry Gandler from Crédit Suisse.

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Larry Gandler, Crédit Suisse AG, Research Division - Director [25]

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Sanjay, Richard, I just joined the call, so forgive me if my questions have been asked. But the principal question I have is I understand volume loss in most recent period may have been due to the drought. I'm just wondering if there's something more general, Sanjay, in your observation. I've sort of identified quality as an issue. But as you talk to your customers, is that something that you think needs to be improved? And what sort of investment would you be making to ensure that the company has a reputation for quality and service?

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Sanjay Dayal, Pact Group Holdings Ltd - MD, Group CEO & Director [26]

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Yes. Thanks, Larry. Yes. I think what you say is very true. I think there have been quite a few incidents where the customer has not been satisfied with the quality. What I would, however, say is that the quality improvement program is actually currently already on in the company that have -- we have a common quality system now, and there's a lot of focus in reducing cost to serve as well as improving quality. I think for me, the key thing here is -- I think the program is already there. The key thing is the focus and how can we go harder and faster on this program. That would be the key thing, but that certainly is a very important area of focus. It not only improves our customer experience but also gives us the ability to increase prices and really show the customer that there is something special about us. We are just not a me too player, and therefore, it will also impact margin in a positive way going forward. So I'm certainly very focused on that.

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Richard Betts, Pact Group Holdings Ltd - CFO [27]

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Larry, I was going to say, so the other piece of that puzzle is obviously with Australian manufacturing becoming more challenged through things like high electricity costs and infrastructure costs associated with operating. We are seeing a movement towards some of our customers looking at offshoring an opportunity to take volume from imports. To that end, we've -- the rationalization project becomes critical. We have to have a low-cost manufacturing base particularly for those products that are freight friendly. We've already moved some of the work that happened this year, was around establishing that import model both in terms of manufacturing products within our own factories and also a straight distribution model. That so far has gone well, and it has to be part of our offering going forward.

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Larry Gandler, Crédit Suisse AG, Research Division - Director [28]

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Yes, I would agree with that, Richard. And the only thing is when you say low cost, it's one thing to take cost out and deliver to the bottom line, which I'm not advocating, and it's another thing to take cost out and then reinvest it in other areas of the business that perhaps shore up quality and innovation and customer service, which I think the business needs. So yes, I'm all for the cost out. It's just where it goes. And frankly, I think in the short term, it shouldn't really go to profits. The -- Richard, perhaps following on from that, then making that statement, my observation is the industry is actually growing. I know you're talking about offshoring. But I'd be interested to hear your comments, Sanjay, as to whether you think the industry is indeed growing. When I look at recycle rates or collections of plastics based on whatever data we can get, when we look at imports, imports of polymers, it doesn't appear like the industry's in decline. Supermarket volumes are up. So where -- do you think the industry is in growth?

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Sanjay Dayal, Pact Group Holdings Ltd - MD, Group CEO & Director [29]

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I agree with you. I think the industry is certainly in growth. There is a lot of talk about single-use plastics not popular and certainly some of the supermarkets have stopped that. There's a lot of talk about all that and a lot of action as well. But in an overall sense, definitely the industry is growing. And more importantly, in this space, if you have got a good recycle business and if you got a good sustainability as part of your focus in the plastics space, I think there is a huge opportunity for growth. So certainly, I'm in your camp. I think there's a lot of opportunity and a lot of growth. It's -- sorry, it's difficult to replace plastics suddenly. You can be sure of that. It is not easy.

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Larry Gandler, Crédit Suisse AG, Research Division - Director [30]

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Yes. So I guess following on from that, when should we start -- Sanjay, when would you start expecting to see volume growth in this business? We're so much talking about erasing volume erosion, but frankly, you guys have, call it, 20 plants plus. The nearest competitor has 3. When are we going to see volume growth in Pact's plastics business?

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Sanjay Dayal, Pact Group Holdings Ltd - MD, Group CEO & Director [31]

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So maybe the way I can -- Richard, you can add later. I'll just give you my perspective here. A lot of the growth that we've had in Pact over the years has been through acquisitions, and that is -- so that gives us a good feeling that we got volume growth. But I think one of the issues with that has been that you've got all that -- you've got duplication in terms of your supply network and systems and processes are behind where the company needs to be in terms of current size. So yes, I think volume growth is important. If you ask me in the near term, my focus is going to be to make sure that the volume we have, we're making good money out of that, and the customers are happy and our supply chain is really running smooth. We are buying the best priced resin that anybody can buy. The fundamentals will be my near-term focus. I'm not going to go and try to get volume at any cost. My guess is that as you sought out this part of the business and the customer experience goes up, volume will come because our position undoubtedly -- and I have met a lot of customers. A large number of customers want to partner with Pact, a huge number of them actually. They feel most comfortable with Pact. They have a good sort of trust that this is a company to partner with. They are not necessarily interested in replacing Pact with imported products, for example, but we need to improve the customer experience. And that will be my near-term focus, and I think volume will come after that.

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Larry Gandler, Crédit Suisse AG, Research Division - Director [32]

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Is there any -- sorry, I'm taking all this time. But is there any specific initiative you need to do to improve the customer experience? Is it the network engineering? Or is it sales force initiatives?

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Sanjay Dayal, Pact Group Holdings Ltd - MD, Group CEO & Director [33]

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I think all of the above. I think quality -- I mean we should -- I mean we are the largest player here in Australia and New Zealand. Why should our quality not be the best? So the quality is a key focus. Cost to serve, very, very important; strengthening the sales space, accountability and the sales experience as well. I want to drive the sales on an outcome basis, and so it's not only the issue but make sure that the sales team is really serving the customers and there's like a single-point contact for each of the customers, things like that. As I said before, fundamentals, both in the sales, in the quality and in the operations, I think a combination of these are all going to show the difference. And it's not -- my experience in the -- from doing some of this in the past is that it's not going to take years. Once you get a momentum in this space and the customer starts trusting you, things are going to pick up pretty rapidly. At least that's what I have experienced in the past.

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Operator [34]

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(Operator Instructions) The next question is a follow-up from Owen Birrell from Goldman Sachs.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [35]

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Just a couple of follow-ups from me. Just firstly on the capital structuring. You've successfully got away the subordinated debt rating earlier this half. I'm just wondering, the covenant holiday that you were able to agree with your senior lenders, just wondering when that expires. And at what point do you need to get your earnings high enough to -- or should I say the gearing level down to achieve what was essentially the covenants on the other side of that?

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Richard Betts, Pact Group Holdings Ltd - CFO [36]

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Look, I think, yes, in terms of covenant holidays, we've got -- we're through to the end of this calendar year. All our modeling indicates that we will be below that at 31 December, and we will continue to be so going forward. So at this stage, we believe that what was negotiated with the banks, the subordinated loan -- subordinated facility has also provided some alternate funding, which has supported and helped that process as well, means that the arrangement that we've put in place will line up well with the proposed reduction in our gearing anyway.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [37]

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Richard, from that comment and based on your earnings guidance that EBITDA is only going to modestly improve, can I imply that there's a lot of cash flow through destocking or inventory management that's going to get that debt level down?

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Richard Betts, Pact Group Holdings Ltd - CFO [38]

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Look, it certainly has to be a part of it. I think you will have seen that we were very disciplined in terms of our CapEx management. We need to continue to be so. There was -- last year, there was funding in terms of inventory-build as we moved to an import resin model. Towards the back end of the second half, we started to see that coming down as well as we got better at managing that. So certainly, managing our inventory levels and aligning those with the needs of the market is a critical component, both through being disciplined around CapEx and our working capital are key components to that. absolutely, Owen.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [39]

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Okay, great. And then just one last question for you, Sanjay, just on the sustainability outlook. You've sort of highlighted a number of opportunities at the, I guess, the local recycling end. I guess that's more in post collections rotation. I'm just wondering how far upstream are you considering going. Are you likely to go all the way up to collection of waste products?

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Sanjay Dayal, Pact Group Holdings Ltd - MD, Group CEO & Director [40]

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Yes. For me, the -- and that -- the question you asked is a question I'm asking myself. So sorry, I won't have an answer here. I think that's one of the things I need to understand in this -- during the strategy review. I think there's a big opportunity in the sustainability space, and there's a lot of focus particularly in Australia and New Zealand today. The point is where in the value chain do you actually get good returns. What is worthwhile us doing? And what is something which others should do and we should just participate in? And that, for me, is an important question. So I need to understand that.

And the other piece, just want to make the comment that in our core business today, we are the largest consumer of recycled product. So that itself is then -- so it's -- the also -- one of the things which Pact has really created I think over the last few years is not only the sustainability in terms of reuse and what we are doing in the pooling business, but in the core business itself, we have got a significant recycle, which I think can be built on further as well. So I need to understand that in more detail, so don't have a good answer there. But hopefully, over the next few months, we'll get some clarity there.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [41]

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Can I ask you just one question? I'm not sure if you've got the number in front of you. But in terms of your FMCG business principally, do you know what proportion of input is recycled at this point?

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Richard Betts, Pact Group Holdings Ltd - CFO [42]

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Well, not so much in relation to the FMCG specifically, but about, what do we use, about 30,000 tonnes today of recycled resin across our portfolio.

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Owen Birrell, Goldman Sachs Group Inc., Research Division - Metals and Mining Company Analyst [43]

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I think globally, it's around 2% to 3%, so it's pretty small globally. I'm just wondering whether you're slightly ahead of that or below that or in line.

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Sanjay Dayal, Pact Group Holdings Ltd - MD, Group CEO & Director [44]

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But a lot of them have 30% target. So...

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Richard Betts, Pact Group Holdings Ltd - CFO [45]

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Yes, yes. Look, here, you're right. At the moment, it's certainly a small number but, increasingly, customers are wanting us to work with them around how we can help them and support them in meeting their sustainability targets going forward. And our position in relation to being a processor and a collector of recycled resin is going to be an important piece of that for us.

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Operator [46]

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The next question comes from Brook Campbell-Crawford from JPMorgan.

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Brook Campbell-Crawford, JP Morgan Chase & Co, Research Division - Analyst [47]

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Just had a question on guidance for FY '20. I guess you're looking for modest growth, but there should be benefits coming through from restructuring the ALDI contract as well as TIC and certain number of discrete benefits there. So are you really considering here that the underlying business will continue to decline in FY '20? Or are you just being conservative here with guidance?

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Richard Betts, Pact Group Holdings Ltd - CFO [48]

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Look, I think we need to see out -- there's a couple of segments, and we've called out the health and wellness sector is one that I think, based in terms of discussions with parties in that segment, are saying that, that will be down. And I think at this stage, we don't know the extent of that, and I guess we're aligning ourselves with the views that we've been given by the customers in that segment. And to that point, we've taken, I'm not going to say a conservative view, but certainly an aligned view.

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Brook Campbell-Crawford, JP Morgan Chase & Co, Research Division - Analyst [49]

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And just on the dividends, any idea when it might be reinstated?

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Richard Betts, Pact Group Holdings Ltd - CFO [50]

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Well, I think the reality there is that dividends obviously remain a priority for us at the moment. But at this point in time, as Sanjay said, getting the business in the core right is key, and focusing on a return on capital employed is essential to that. And so improving the underlying cash in the business and then aligning that with both dividends and reduced leverage is key. I think until such time as we've prioritized our capital and our returns through the strategy work, I think it would be premature to commit to when the dividend would be returned -- would be turned back on. But what I can say is that it is a key component of whatever strategy that we'll come up with that ensures the dividend -- return of dividend is key priority.

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Brook Campbell-Crawford, JP Morgan Chase & Co, Research Division - Analyst [51]

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Fair enough. That makes sense. And just last one for me and related to that question really, but leverage is clearly elevated at this point. Would you guys consider any divestments or any businesses you think don't fit with the current portfolio?

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Richard Betts, Pact Group Holdings Ltd - CFO [52]

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Look, I think the reality is even if it wasn't a leverage issue, we should be looking at the nature of our portfolio and working out whether the returns from any part the -- all parts of the portfolio are appropriate and even whether certain businesses are -- are in the right -- are best in the hands of us as a public company. That is certainly one of the components of the strategy review, is to look at what is core to us going forward and therefore, what parts of the portfolio we're going to invest in. And some of that may actually be that we're actually looking at divestment.

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Brook Campbell-Crawford, JP Morgan Chase & Co, Research Division - Analyst [53]

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And I guess would the Contract Manufacturing business sit in the core or noncore side at the moment?

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Richard Betts, Pact Group Holdings Ltd - CFO [54]

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Look, I think at this stage, let's do the strategy work. I mean, obviously, the results in the Contract Manufacturing businesses in this period has been disappointing. So we can't move away from that. I think we've got to look at what the opportunities are both from a growth perspective and from an industry dynamic perspective, and that will drive our decisions in relation to all parts of the portfolio and not just Contract Manufacturing.

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Operator [55]

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The next question is a follow-up from Larry Gandler from Crédit Suisse.

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Larry Gandler, Crédit Suisse AG, Research Division - Director [56]

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They were just answered. I was going to ask on dividends and asset sales as well. All done.

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Operator [57]

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The next question comes from Keith Chau from MST Marquee.

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Keith Chau, MST Marquee - Building Materials & Packaging Analyst [58]

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Sanjay, I understand you're still reviewing the group strategy at this point in time, but I'm just keen to touch on the potential for Pact to continue shifting some product sourcing to the import model and just your preliminary thought on that. I think ultimately, if that happens, it will mix -- sorry, shift the mix of the business from one that generates theoretically high manufacturing margins to one that earns lower import-distribution margins that are also subject to the vagaries of currency. So I'm just keen to understand how you balance the risks associated with this strategy and at the same time, meet customer preferences of not necessarily wanting imported product. And if there are any net benefits from shifting to that model -- this is a follow-up to Larry's question, is there an intention that Pact will consider using price to improve its commercial proposition to customers or at least try to regain share? And then very lastly, just if you can characterize what portion of the product portfolio is currently being procured from offshore and how much will Pact -- could shift to the import model, please?

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Sanjay Dayal, Pact Group Holdings Ltd - MD, Group CEO & Director [59]

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I might just -- thanks for that. I might just -- sorry, Keith. I might just start. And then, Richard, you want to give some detail? I think the point for me -- firstly, we have a significant-sized Asian business now as you're aware. So the first step for us was to go to an import model in areas where we could actually service at a much lower cost and we could service the customer equally, if not, better through that model, particularly products which nest well and which actually travel easily. So that's the first import model that we're actually looking at. Some of it is already in progress, and a lot of it, we are still reviewing.

In terms of just replacing our current manufacturing with import, I think the -- for me, the key points first is can we make our own manufacturing work better. There is a lot of opportunity. We are already buying resin from overseas so -- and can we really get our raw material pricing better than what it is today? And once we have the network redesign done to some extent, we will definitely be able to reduce the cost to serve. So before we jump to an overseas model, I think the first point for me would be to see whether we can actually work our current manufacturing better.

I found it quite interesting in my travels when I have met some of the customers that a lot of them actually are pretty close to our sites, not only close to the company but actually pretty close to the sites in the sense they know what's happening in our manufacturing sites. Their teams are very closely connected with those sites. So I wouldn't jump straight to say, well, I should immediately try to necessarily go to an overseas model before I have actually proven to myself that the local manufacturing does not work. Having said that, there is no doubt that particularly our energy cost here in Australia are very high, and a lot of people can actually make product at a cheaper energy cost. But I still feel that with the freight and the rest of the cost, which is needed to serve the customer, there might be an opportunity for us to first look our own after of course we have looked at what's possible in our own Asian business. Richard, do you want to add some more to that?

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Richard Betts, Pact Group Holdings Ltd - CFO [60]

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Yes. Look, the only thing I was going to say, Keith, was exactly as Sanjay's just highlighted. The import model is only part of the solution. Yes, maintaining capacity to -- many of the customers, as I said, they need to know that you have capacity on the ground here that can meet their needs particularly during seasonal peaks, and it is going to be a blended approach. Many of our products are not -- don't fit well with freighting them large distances. And to those, it's about the manufacturing efficiency and the platform that we create here in Australia. There'll be -- for those freight-friendly products, it will be a combination of manufacturing in our facilities in Asia as well as import. And even to a certain extent, we will maintain sprint capacity for customers here in Australia to ensure that they are guaranteed that we'll meet their needs. So we have -- one of the great things that we do have and which should be taken advantage of is the flexibility we can create across that supply chain to help meet our customers' needs.

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Keith Chau, MST Marquee - Building Materials & Packaging Analyst [61]

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I'm just wondering if you can, I guess, put a number on what proportion of the product portfolio is currently being procured from offshore and the potential to ship more. I mean maybe the latter question isn't easily answerable now. But how much of it's being procured offshore at the moment?

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Richard Betts, Pact Group Holdings Ltd - CFO [62]

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Well, it's relatively low. I mean, as I said, the majority of our products, you're shipping it. There are opportunities regarding the products that, as we said, are freight friendly. The core of this will still be that we need to get our manufacturing base right here in Australia and New Zealand to be the most efficient to serve our customer needs. That is going to be the best outcome for us and for our customers. It won't be that building out a large model overseas is going to be the answer for the majority of our products.

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Operator [63]

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At this time, I'm showing no further questions. That does conclude our conference today. Thank you for your participation. You may now disconnect your lines.