These 4 companies are packaging yesterday's trash into cashflow treasure

Packaging is ubiquitous in our daily lives. The cereal or toast we devour for breakfast, the takeaway coffee we grab on the way to the office, the groceries we buy at the supermarket, the whitegoods we buy occasionally, even our favourite tipple we savour at the end of the day come in packaging: plastic, paper, cardboard, metal or glass. It all ends up in our rubbish bins.

And it presents an investment opportunity ripe for the picking in a number of sectors, once you appreciate the risks and the scope for innovation. 

I recently caught up with Will Baylis of Martin Currie on the packaging sector. As he sees it

If 25 million people in a developed country like Australia are becoming a lot more conscious about the environment, a lot more conscious about how they purchase their food and their beverages, how they actually dispose of their waste, they will respond. 

If they're not being given products that are sustainable, that consider the environment, then the company that's providing those products will invariably have a very short life cycle because the consumer ultimately determines the life cycle of many companies that we invest in.

While the shift in consumer attitudes towards packaging is motivating companies to rethink their approach to packaging, the broader industry is also responding. The Australian Packaging Covenant Organisation has set national targets 

• Packaging to be 100% reusable, recyclable or compostable;

• 70% of plastic packaging being recycled or composted

• 50% of average recycled content is included in packaging. 

That impacts companies like Woolworths (ASX: WOW), Coles Group (ASX: COL), JB Hi-Fi (ASX: JBH). Metcash (ASX: MTS) and Amcor (ASX: AMC), among others. 

So where are we at right now? Baylis explains 

If you look at recycling and the recovery rate of various materials, metals are about 80% recovery rate; building and demolition materials are also sitting around 80% recovery. Aluminium, glass, paper and cardboard have got recycling rates of 50% or higher. But it’s only 15% for plastics.

Thus there is plenty of scope for packaging companies to step in with innovative products to improve on these outcomes. 

Will Baylis, Martin Currie 

Note: this interview took place on 29 August 2023. The Martin Currie Sustainable Equity Fund has holdings in a number of the companies mentioned in this wire.

3 key risks create opportunities 

In an earlier wire Baylis explained the circular economy around packaging: producing sustainable packaging that is made from recycled materials; and consumers who put the packaging into recycling bins. 

You've then need to have sufficient capacity to recycle that package, and then it's got to go through the system and then be used again, in a circular sense. 

Our recycling habits as consumers are the key sustainability risk for Baylis. 

The second risk is industrial capacity. As Baylis reminds us, Australia used to export a lot of its waste, particularly to developing countries. "Since that practice has been banned, there is a critical need to create capacity in Australia to actually use the waste material to produce new recycled materials", he says.

We had a reminder of this lack of capacity in 2022. REDcycle was the system used by Aldi, Coles and Woolworths across nearly 2000 supermarkets to recycle the soft plastic that can't go into our yellow recycling bins. The collapse of that company in 2022 led to the formation of the Soft Plastics Taskforce, with ACCC interim authorisation to allow usual market rivals Aldi, Coles and Woolworths to cooperate on finding a solution. 

Regulatory risk is the third key risk. As Baylis sees it, the current government in Australia is very eager, with all the right intentions, to get more and more recycled plastic packaging. While governments can change their policy directions, the recent Intergenerational Report from Treasury identifies net zero and climate change as one of the five forces shaping the Australian economy over the next 40 years. 

Sorting the good from the bad to find the opportunities 

With Orora (ASX: ORA)  in a trading halt at the time of writing pending notice of a potential acquisition of Saverglass, the appeal of M&A as one route to expanded capacity with positive sustainability impacts seems evident. But it's not the only route. Says Baylis

Companies that actually invest heavily in research and development, particularly for packaging companies that teach [their customers] how to use recycled content and how to make sure that material is recycled on a continuum definitely get a higher rating from us.

As Baylis explains in a previous wire, Martin Currie has its own investment process for sustainability: 

1. identify the three key sustainability risks for a company you are considering investing in

2. consider the net benefits of the activities undertaken by the company that both mitigate or heighten those risks, and 

3. follow the pathways or the strategy to achieving whatever sustainability targets the company has set for itself. 

Take Woolworths (ASX: WOW) as an example. He identifies human capital as a big risk (Woolworths employs around 120,000 people). Cyber is another risk: "they have so much data on us". The final risk is packaging

One of their biggest complaints from the consumer is every time we buy fruit and veggies, it's all covered in plastic wrapping. Why do you have to have everything wrapped in plastic? 

Staying with this example, Baylis notes the benefits of plastic packaging: it extends the life of food, but it also allows people's budgets to be better balanced. If people do a weekly shop, that food can then be preserved a lot longer than if it wasn't in plastic. Finding the solution to plastic use - an alternative product or readily recyclable plastic - is the opportunity 

Packaging companies are responding and you will see this in the targets they set for their products. Amcor's 2025 target is to have all of its rigid and all flexible packaging as 100% recyclable. 

Orora is targeting 60% recycled content in its manufactured glass products by 2025, up from 40%. But how are they going to get there? Baylis cites Amcor as an example of a company working on tomorrow's solutions 

In rough numbers, Amcor is spending at least tens of, if not hundreds of millions of dollars in research and development every year. There is a real opportunity for Amcor to  make sure that they get that recognition with the key customers like Nestlé SA (SIX:NESNEE) and other food companies that use their packaging and those products that ultimately end up in the supermarket.

Staying with Nestlé, Baylis notes how they are increasing the use of recycled content in their packaging products; and labelling their products accordingly can benefit the packaging companies. But it's not just food companies that present opportunities for packaging companies

We get a new modem from Telstra (ASX: TLS), or we get a new add-on because we need to upgrade our wi-fi. If it's got Telstra on the packaging, the packaging is fully recyclable. There is a massive opportunity for a packaging company to have that contract and produce that packaging.

Packaging companies are innovating to produce packaging that still looks very nice, but they're getting rid of those chemicals, which in some cases can be quite toxic, thus making that packaging a lot more amenable to the environment. 

Investment opportunities with a sustainable packaging theme

• Amcor (ASX: AMC) "because it's global and heavily focused on R&D".

• Telstra (ASX: TLS) "with its approach to using packaging that is fully recyclable".

• Coles Group (ASX: COL) "with its approach to eliminating plastic bags".

• Cleanaway (ASX: CWY) is another company Baylis finds interesting. He frames the opportunity for Cleanaway to support other companies to meet their corporate objectives.  "Cleanaway can create opportunities for composting; it can create opportunities for recycling, they can build recycling plant and equipment, so that waste doesn't go to landfills."

And note, it's not just about sustainability for sustainability's sake. For Baylis

"A lot of the Australian companies I've mentioned today are what we call high quality companies. They've turned their sustainability risk into opportunities where they're consumer facing, they've listened to their consumer, and they're now trying to deliver to their consumer what they want. They're companies that have got a very proven track record of generating good return on invested capital and very good free cashflow over time. They're the sort of companies that we like to own in our portfolios."

This article was originally published for Livewire Markets on Thursday, 31 August 2023.