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Management Side
The Investment Conundrum

There are only two options for direct investment in paper manufacture in Australasia. If an investor flipped a coin and chose one option the reward for the one would be very different from the other.

The direct listed investments available to Australasians are Asaleo Care Limited and Orora Limited. Asaleo Care is the listed reincarnation of what started in 1932 as British Australian Paper Company and was acquired by Bowater Corporation in 1956. Bowater partnered with Scott Corporation in 1959 to form Bowater-Scott. This continued the natural rivalry that Scott Corporation had with K-C, which had previously partnered with Australian Paper Manufacturers to establish Kimberly Clark Australasia in 1956. This latter partnership commenced manufacture at their Millicent Mill in South Australia in 1961. In 2002 K-C acquired the 50% of equity held by AMCOR (renamed from APM).

Bowater-Scott morphed into CHH Tissue in 1995 after acquisition by New Zealand based CHH Tissue. The latter company had previously been established in 1988 to purchase New Zealand's only tissue manufacturer, Caxton Paper Mills. Svenska Cellulosa Aktiebolaget (SCA) purchased the CHH Tissue business in 2004, and is one of the three major tissue manufacturers in Australasia. In 2012, SCA sold 50% of SCA Australasia to Australia-based Pacific Equity Partners (PEP), a private equity company which had expertise in fast-moving consumer goods. PEP was also an expert in restructuring companies for a quick turnaround for an IPO (Initial Public offering) and the company was listed as Asaleo Care in 2014. To be fair, SCA has retained a 34.67% equity in Asaleo Care (with two nominee directors on the board out of a total of 6) but this part of the world is not high on the list of global priorities for SCA. Nevertheless Asaleo Care also pays significant royalties to SCA - over A$6 million annually for licence and technology arrangements.

Orora was the unwanted other child of AMCOR, the first being the now deceased PaperlinX. AMCOR had made the strategic decision to focus on flexible and rigid plastic packaging, but with the seemingly aberrant retention of paper-based tobacco packaging, in which they had established a leading global position. Tobacco does not sit well with ethical investors but AMCOR argues cigarettes are a legal product and the business adds handsomely to the bottom line. Attempts to find a buyer for what is now Orora were unrewarding (as was the case with PaperlinX) and Orora was demerged as a new company listed on the Australian Securities Exchange in late 2013.

Unlike PaperlinX, Orora has stuck to its knitting and concentrated on its established markets in Australasia and North America. Moreover it actually makes and sells products that are still in demand. Its paper manufacturing is limited to a single, large and efficient operation in Sydney with long term contracts for supplemental Kraftliner board from Australian Paper, which was once part of PaperlinX and AMCOR. Orora also manufactures corrugated packaging in Australia and New Zealand and has a strong presence in the USA through its long held packaging products distribution business based in California, which includes corrugated carton manufacture and packaging equipment services. It is of interest that in the current fiscal year 80,000 metric tons will be exported from the Australian mill to feed the North American corrugated operations. Orora also has a successful business in glass bottle manufacturing (again from a single site), beverage cans and a large carton printing and conversion business in Australia and New Zealand.

Orora has just released its annual results for the 2015-16 fiscal year and performance has been outstanding. Net profit after tax (NPAT) has increased by 28.3% and earnings per share (EPS) are up by 29.4%. North America was the standout with earnings before tax up by 38.1% and Australasia up by 10.1%. These results were built on an overall sales growth of 13%, most of which came from North America. Investors are happy and those who have held on since listing have seen their share price increase from A$1.22 per share to A$3.14 currently.

Contrast Orora with Asaleo Care Limited. That company listed with a share price of A$1.65 and is currently trading at A$1.51, after collapsing spectacularly from a high of A$2.29 on July 29. The detailed results just released for the first half of 2016 contrast starkly with Orora's results. Revenue declined by 4.3% but NAPT was down 23.2% (although "only" 16.4% on an underlying basis). Underlying EBITDA was 10.1% lower. These declines were attributed to weakening Australasian currencies causing pulp costs to increase and "retail market price deflation" across all areas of the tissue business, which probably means that prices are lower in a tough and competitive market. Opportunities to capitalise on recent pulp price reversals are unlikely to flow through until 2017. One bright aspect was strong growth in the professional hygiene area. At the same time it was also a tough market in the personal care business, characterized by increased discounting.

Company guidance for the full 2016 fiscal year forecasts underlying EBITDA will fall 10% on fiscal 2015, with underlying NAPT declining 15% and earnings per share by 9%. Given that outlook guidance in March of 2016 was for steady underlying earnings it rather seems that competitive factors were far more impactful than anticipated. The unstated elephant in the market place is the continuing growth of private label bathroom products driven by aggressive supermarket chains as they battle for market supremacy. There are two major chains battling each other and fighting a rampant intruder from Germany (Aldi). Competition is ferocious. Private labels are seen as an important opportunity to put higher margins in the hands of the retailers.

At the same time competition in the tissue business is brutal. For many years there was a reasonably comfortable co-existence between the two domestic manufacturers, even though some small competitor operations were established. Conventional wisdom was that bulk tissue could not be competitively imported but that did not take into account the desperation of, first, Indonesian and, then, Chinese manufacturers to move their significant excess capacity. The game has changed substantially and irreversibly. At its peak in 2013 nearly 48% of Australian tissue stock was imported. Details are not yet available for the recent fiscal year but for the previous year imports retreated to about 37% of the total, driven in part by Asaleo Care drawing a line in the sand. Pulp & Paper Edge describes competitive discounting as a race to the bottom, with Asaleo Care in particular locking in lower prices, driven by a determination to hold market share. It seems that Asaleo Care and K-C are determined not to supply private labels in the bathroom sector. This has meant the disappearance of established secondary brands once supplied by those manufacturers to provide consumers with a cheaper option now provided by private labels.

Some private label tissue is supplied from local manufacture; either Encore, the smallest of the local producers, or ABC Tissue, which appears to have commissioned its most recent tissue machine. Solaris, owned by APP, has made significant inroads and has set up a large converting facility to process bulk tissue from China.

When Asaleo Care launched its IPO in 2014 it estimated Australasian market shares for the consumer tissue market at 29% for KCA, 28% for Asaleo Care, 24% for ABC, 3% for APP, 2% "other" and 14% for private label. It is likely that the latest statistics, soon to be released, will show some changes with ABC probably to be number one. Whatever the market share mix becomes, it seems unlikely that the earnings outlook will be much improved any time soon. Investors in Asaleo Care will no doubt wish they had selected Orora instead, but are probably now locked in for the long term ride.


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