The history and development of the Liquid Packing Carton market, or aseptic packaging as it is also called, is a very interesting one. Although the industry is a huge global industry, it has over the years been almost totally dominated by one player.

In 1952 the Swedish businessman Ruben Rausing convinced a local dairy company that his peculiar tetrahedral shaped cardboard beverage carton was the way of the future. The rest as you say, is history. Aseptic packaging as it is called became the most popular way globally to sell milk products but also many other beverages, the packaging being superior in both preserving the drinks taste and ease of transportation. Later on the Tetra Brik was invented and the company Rausing created with these innovative products became Tetra Pak (part of Tetra Laval). The company today has 11.2bn EUR of Net sales. The case of Tetra Pak is interesting because the company has over the years had no to little competition in many markets – a dream situation for any company to be in. But how was it possible to be so successful and why did not more competition come in? Firstly it came down to patents, which gave the company a monopoly position in the early years. Secondly the company has and continues to be extremely well run with a clever sales strategy. Tetra Pak sell the filling machines that creates the packaging, to the beverages producers at a low price. Then making the margins on selling the cardboard box paper used by the machines, which of course will be continuously ordered. The contracts for the machines tied the customer to not buy the cardboard paper from anyone else. In this way the customers were tied to Tetra Pak and had to invest in new lines of machines, to switch to a competitor, obviously at high switching costs. In 2002 it was estimated that Tetra Pak still had 85% market share globally, but around this time things slowly started to change, partly due to regulatory intervention but also due to beverages producers who helped create companies like the one I want to present to you now.

For the interest reader here is some more history of Tetra Pak family: Tetra Pak, a Fortune Founded on a Clever Idea & The death of Eva Rausing and the decline of the Tetra Pak dynasty. For the very interested historian the story above is somewhat simplified. There was a american inventor that was even earlier than Rausing in creating a similar packaging in USA. The company, Cell-O was the beginnings of Elopak. Read the full story here: History of Elopak. 

Now moving on to my latest investment

Greatview Aseptic Packaging (468 HK)

 

+ Operating in a market with Tetra Pak as a dominant player. This creates an incentive from beverage producers to diversify supplier base.

+ Favorable shareholding situation. Company led by the founders who have large shareholdings. The largest shareholder is conglomerate Jardine Group.

+ Very compelling valuation at P/E 11 and EV/EBITDA 6, the company is net cash which de-risks it further. Swiss listed SIG is trading at almost twice the multiples for a very similar business.

+ 8.5% dividend yield with a stable track record of paying dividends.

– Price taker in the sense that they compete towards Tetra Pak on providing same product at lower price point.

– High dependency of few customers, mainly Mengniu Dairy has a very big portion of the companies sales.

– Negative trend of China profit margins and seems to struggle to grow further in China.

Press “Read more” to read further..

Background

The company was founded in its current form in 2003 when previous Tetra Pak employees, Jeff Bi and Hong Gang, foresaw an opportunity to develop a new business utilizing the capabilities of Tralin Pak, a State-owned enterprise in Shandong China. On joining the company, they immediately refocused the companies activities towards challenging Tetra Pak who more or less had a monopoly position in the fast growing Chinese market. At the same time, the aseptic liquid food packaging business within China was growing exponentially, as consumers increasingly incorporated packaged dairy and juice products into their lives. In 2007, a new anti-monopoly law in China was enacted, establishing the right of aseptic roll-fed customers to choose their supplier of packaging material and establishing a reliable market for Tralin Pak’s products. According to one of Mengniu Dairy’s early investors CDH, at one of the board meetings of Mengniu Dairy, they found that of the costs of Mengniu Dairy products where 50% for the raw milk and 30% was for packaging. Such strong position did Tetra Pak have at the time that they could enjoy such high margins on their product. Mengniu Dairy interested in lowering those margins, even took an investment in Greatview and was essential to kicking off its production of packaging. 2010, with more than 800 employees in 5 locations across China and Europe, the company listed on the Hong Kong Stock Exchange with a new name, “Greatview Aseptic”. In 2016 Tetra Pak was fined a record amount (97m USD) in China for abuse of dominant position. Link to one study of the case. Reading up on this case, it seems to have been somewhat of a milestone in anti-monopoly law in China. Although this did not totally overturn the market in favor of Greatview, it did make it easier for Greatview to gain market share in the world’s largest aseptic packaging market – China.

Current Operations

Greatview currently has three factories, which have been expanded over the years. In contrast from many other Chinese companies which are built on cheap labor, they are not very labor intensive, total employees for Greatview stands at some 1500. The invesments made in these factories over the years are very significant, but the market cap of Greatview Aseptic in only 4.2bn HKD.

Management & Ownership

In 2017 Jardine Strategic Holdings (which is the majority owner of my holding Dairy Farm) took a 22% stake in Greatview at 5 HKD per share and today holds in total 28% of shares outstanding. Given how large the Jardine conglomerate is I would see this as a very stable long term owner which also lowers the risk in this case significantly. That they would hold a 28% stake in “China hustle” company would be very unlikely.

Hong Gang (company Chairman) still holds 6% of the shares and CEO Jeff Bi hold 9.7%. Although they are not founders of the original company, they are de facto the founders of the company in its current form. A major positive to see that the company is founder led and that they have so substantial investments in the company and keep leading the business.

A recent interview with Jeff Bi

Market and Competitors

Two distinct packaging systems exist in the aseptic packaging industry. Suppliers provide aseptic packaging materials to customers either in roll form or in blank form. The two systems are not interchangeable. Because of the different filling machines and associated capital commitment required by each, customers are not able to easily switch between roll-fed and blank-filled aseptic packaging suppliers. Currently, the roll-fed system dominates the global aseptic packaging industry as it is used by Tetra Pak, the global leader. It’s hard to find recent estimates of Tetra Pak’s global market share, but a decent estimate is that it is around 70-75%. The blank-filled system is used by SIG and Elopak, SIG is the only seriously large competitor to Tetra Pak. Greatview mainly uses a roll-fed system where it’s cardboard material usually is compatible with Tetra Pak’s filling machines but has recently also developed a smaller line of blank feed products.

Roll fed

Blank fed

Aseptic Packaging vs other packaging

Within the larger beverage packaging market, aseptic packaging competes with alternative packaging formats, including rigid plastic, glass, metal cans and flexible packaging, some of which are more prevalent than aseptic packaging. Although technological advances have improved some features of these alternative formats, aseptic packaging maintains certain advantages for the packaging and storage of perishable food and beverages. Among its advantages, aseptic packaging (i) extends shelf life and enables products to be preserved for up to twelve months; (ii) decreases cost of storage and transportation given both can take place without refrigeration; (iii) further reduces logistics and storage costs because its compact, rectangular shape reduces transport and warehouse volume requirements compared to competing, cylindrical shaped packaging such as PET bottles, metal cans, and most glass, and because it is lighter than metal cans and glass. Looking at environmental aspects the packaging is far superior to plastic bottles, with most of the material coming from paper and a minority is a thin plastic layer as well as a metal film.

Competitors

Tetra Pak is the obvious main competitor and where Greatview has been mainly taken market share from in China and more lately Europe. This is also verified in Tetra Pak comments: “In our two largest markets, China and Brazil, we have returned to growth. We also saw declining sales in Europe due to tougher market conditions and customer dual sourcing strategies”. The second large competitor is SIG Combiblock which recently has been re-listed on the Swiss stock exchange after being in private hands for a number of years.

2018	Tetra Pak	SIG	Greatview
Revenue	11.2bn EUR	1.6bn EUR	0.32bn EUR
# of Packages	190 billion	35 billion	13.5 billion
EUR cent per package	5.89	4.57	2.37

The table above also gives a good picture of the price point of each players product and how Greatview can offer a very cost efficient product, especially important in the lower end segment of beverages packaging. Part of this higher margin is of course that Tetra and SIG are much larger in providing filling machines (although Greatview also has it own machines for sale in China). Since Greatview’s business case is to sell a comparable product at a lower price point, they are so to say a price taker. If competitors lower their margins, Greatview would be forced to lower theirs even further. Obviously given how small of a player Greatview still is, it probably with hurt Tetra Pak more to lower margins across the board compared to lose a bit of sales volume. Another reason why Tetra Pak might be hesitant to do so are all the anti-competition penalties it has incurred, in both Europe and China.  The Chinese fine I have already mentioned, but as early as 1991, Tetra Pak incurred penalties under EU competition law, fined EUR 75m for anti-competitive practices such as predatory pricing.

Business Outlook

Different sources claim different forecast, but from what I have been able to find the Global Aseptic Packaging will show healthy growth in the coming years. The main driver of the Aseptic packaging market is milk. It is forecasted that market size of aseptic packaging will increase to 18800 Million US$ by 2025, from 14300 Million US$ in 2018, at a CAGR of 4.0%. An interesting fact is that USA is not a driver of this market, but its rather Asia. USA has a very advanced chilled distribution network and the prevalence of Ultra High Temperature (“UHT”) milk is not so high. Whereas in countries such as Spain and France UHT is much more common, where aseptic packaging is almost the only option. It also comes down to consumer preference where Europeans are used to purchase their milk in these type of packaging and Americans are not.The picture is a bit old below, but it shows which markets that dominate and how fast China is growing.

Tetra Pak and SIG, the two largest players in the market focus on developing new innovative product shapes and sizes, as well as the machines to produce the packaging. Greatview’s business strategy is to sell packing material which is compatible with Tetra Pak and SIG’s filling machines. Given how large part of the total cost the packaging is, for large beverage producer it should be in their interest to have an alternative provider of packaging material. Just like Mengniu Dairy in China managed to pressure Tetra Pak, others in Europe have been turning to Greatview since their factory opened there. Greatview labels the segment International, but it is predominately Europe sales.

Conclusions from the data

Revenue CAGR for the past 5 years is 2.9%, but as can be seen this is from flat China sales and steadily increasing International/European sales. What is also clear is that profit margins are not as high in Europe as in China. This can also be verified from recently listed SIG Combiblock which has an Gross Profit margin of 22-23% in the past 3 years. SIG has a higher percentage of sales from Europe. From the profit margin graph notice also how high profit margins in China were when Greatview was still a very marginal player and Tetra Pak totally dominated the market. Greatview has probably done the Chinese milk industry a large favor by compressing margins also for Tetra Pak. At the same time they seem to have stagnated fairly significantly in China, showing zero growth, although the underlying market is growing fairly rapidly, what is going on? Basically Greatview is stronger in the cheaper end of the milk segment, where it makes more sense to save on the packaging. For higher end products, the packaging is a very important part of the branding of the product. Sure your milk or orange juice might taste better than your competitors, but if you are selling it at a premium price, the packaging better feel and look premium too. This is where Tetra Pak and SIG is in a different league than Greatview and mainly why they have higher revenue per sold pack. So when the market trend is towards premiumization of products, Greatview will struggle. This is basically what has happened in China.

Greatview has tried to be innovative and market leading in other in clever ways, for example being the first company to introduce QR codes on the packaging, which was a big success in the Chinese market (they used QR codes long before the western world). Greatview has also put a lot of emphasize on sourcing its paper from environmentally sustainable sources for many years now, something that probably will start to pay off given the current strong ESG trends in the market.

Latest semi-annual weak

As you also can see in the graph above, the Europe sales weakened quite significantly in the first half of 2019. The stock has taken a significant beating on the back of this and continued to trend lower. But as can be seen in the history of the company, the sales have been a bit lumpy with many weak semi-annuals. The long term trend has been very clear though, Europe has over time increased it’s appetite to utilize Greatview packaging in their production. It would be too early to tell if this is the end of the growth cycle for Greatview in Europe. Utilization wise there is plenty of spare capacity to increase sales further from it’s German factory. Another reason for the lumpy revenue development is a high dependency on a few customers. Mengniu has been mentioned in the past, together with a few other Chinese milk producers, they stand for some 50-60% of Greatview’s revenue and almost all of its China revenue.

So where does this take us going forward revenue growth wise? It’s very hard to find any sources that indicate how the sales will develop short term. If one wants to speculate on the effect from the Corona virus, probably people have been picking up some extra UHT milk to have in stock at home (I even did that actually). The forecasts of Mengniu’s revenue growth for 2020 is among analyst some 5.4% growth. That does not translate 1:1 into the packaging market though, given a trend of lower margins. I will not focus so much on the short term, but rather on how these founders long term have been able to grow this business very nicely. In my view the likelihood is high that they will manage to continue to grow it’s business in line with the expected growth rate of 4%.

Dividend

The dividend yield at 8.5% is so high in Greatview that it is worth mentioning separately. This gives confidence that you are not stuck in a value trap, since while you are waiting for a revaluation you will reap a 8.5% dividend. As long as the company does not lower it’s dividend that is. The likelihood for that seems low though. The company has a history of very stable dividend payments, which never has been lowered. This would be the last puzzle piece in totally removing any worries of “China hustle” in this company. Looking at the capacity for the company to pay such high dividends, I would say it depends on the future investment pace. Currently on average some 100 million HKD goes into reinvestment in the business and the rest, some 300 million HKD is paid out in dividends, showing that the company is highly cash generative.. Since the company has plenty of room to take on debt, there should be no problem to continue to pay out a dividend in this size, as long as the business does not deteriorate or a very large investment is done.

Valuation

As with many other companies I find interesting, the history tell a story of multiple contraction, very unusual to find in the western listed companies, slightly less unusual on the Hong Kong exchange. If you look at the share price graph, the companies performance does not look so impressive, to a large extent is due to this multiple contraction, whereas most of the companies listed in Europe/USA has seen the opposite a strong multiple expansion.

Company	P/E	EV/EBITDA
SIG Combibloc	19	15
Greatview	11	6

Looking at these two multiples it’s clear we get to buy Greatview at a significant discount compared with only listed competitor SIG. Especially the EV/EBITDA measure which takes the debt level into account (Greatview is net cash) shows how large the discount is. Is it a reasonable discount? In my view no, SIG has shown a even flatter Revenue growth than Greatview in the past years. Sure analysts expects some 5% growth for the coming years, but that is not an unreasonable expectation on Greatview either. So looking at peers Greatview looks like a solid buy at these levels. What does a DCF show?

Main assumptions for the coming 10 years:

Bear: Negative Revenue growth rate of -2% annually. Operating Margin decreasing from current 17% to 13%

Base : 3% annual Revenue growth rate for 10 years. Operating Margin decreasing from current 17% to 15%

Bull: 8% annual Revenue growth rate for 10 years. Operating Margin stable at 17%.

Valuation DCF

Bear: 2.95 HKD per share

Base: 4.72 HKD per share

Bull: 7.7 HKD per share

Probability of outcomes: Bear: 20%, Base: 70%, Bull: 10%

Valuation target with weighted outcomes: 4.66 HKD per share, which gives a current upside of some 48%. This upside would also put the company at a more reasonable discount to the larger competitor SIG. It is also very comforting that the bear scenario gives a target price close to the current price. The reason for the fairly narrow outcomes of target prices, is because the company is not leveraged and it’s business is fairly stable, so large ranges of revenue increases/decreases is not likely.

Given that the company has no leverage, such a favorable owner situation with the founders leading the company, it’s 8.5% dividend yield, it all gives me confidence to put this holding on at a fairly large weight. I will put this position on at a 6% weight as of last Friday.

Key metric to follow in the future

1. Revenue growth in the two segments
2. Margin development in the two segments
3. Performance of Greatview compared to SIG in the two segments