DS Smith packaged for growth

As a market leader in a buoyant sector, Smith has managed to consistently generate growth in sales volumes and profit from its core European market. The group makes two-thirds of its profits from the recession-ravaged continent, yet it continues to report growth in each of the regions it serves.

That success has been enhanced by an increasing range of value-added services. For example, Smith distinguishes itself from rivals by offering 'retail ready' packaging, where products are placed in cardboard packages ready to be loaded directly on to supermarket shelves. For retailers, this makes the entire process - from warehouse to shop shelf - easier, quicker and cheaper.

Another offering that's popular, and has enhanced Smith's defensive credentials, is its recycling operations. Aside from designing boxes, the group also collects emptied packages from supermarkets, sends them to its own recycling plants and then recreates them in days, ready for use again. This service has gone down a storm with customers. It's fast, efficient and, crucially, enhances the environmentally-friendly reputation of suppliers. It also stands to reduce the impact of volatile raw-material costs as it means Smith has a better chance of passing on cost increases to customers.

Buying new businesses has also helped diversify Smith's list of services, as well as enabling it to successfully ramp up its exposure to more attractive European markets. Over the past few years, a spate of acquisitions has distanced the group from its previous status as a cyclical UK-dominated paper and packaging business.

A turning point was the acquisition of Swedish rival SCA for £1.4bn in 2012. That deal propelled Smith into the big league by transforming it into the second-largest producer of corrugated sheet. Several acquisitions have since followed, such as the £220m acquisition of south-east European corrugated board packaging maker Duropack in February.

This deal, which is expected to complete at the end of this month, prompted investment bank JPMorgan Cazenove to upgrade its adjusted EPS forecasts for 2015-16 and 2016-17 by 3 per cent and 6 per cent respectively. Duropack offers a number of benefits, including access to seven new countries in eastern Europe, expanding the group's existing operations in Hungary, Slovakia and Austria, and creating cost savings of about €12m (£8.6m) over the next three years.

Associated savings from other acquisitions, coupled with tight cash management, have usefully boosted profits. In Smith's latest results - for the six months to 31 October 2014 - adjusted operating profits climbed a tenth to £176m. With the help of strong organic growth, that meant underlying operating profit margins rose by 130 basis points to 8.9 per cent.

It also meant Smith's bosses have achieved the top end of their target to widen margins to between 7 and 9 per cent by 2014, a goal that was set when they stood at 5.7 per cent in 2012. Moreover, although a weak euro is momentarily threatening to derail that progress - JPMorgan Cazenove reckons every 1¢ fall in the euro skims £1.7m off cash profits - further cost savings and the benefits of a recovering European economy are expected to trigger further profit growth in the coming years.

Equally encouraging is the group's improving cash generation. Average working capital to sales stands at 3.4 per cent, with a £23m inflow from working capital helping to cut net debt by £133m to £694m in this year's first half. Free cash flow, meanwhile, rose 37 per cent to £151m. That helps to fund a growing dividend, while spurring speculation that more acquisitions could be on the way.

As the top five players in the European corrugated industry account for about 40 per cent of the market, there are more opportunities for Smith to build market share. One of the regions it's said to be exploring is Turkey. At the end of last year, management told us it plans to tap into the nation's 75m population and fast economic growth by acquiring a Turkish corrugated packaging business.