DS Smith plans expansion amid e-commerce boom

Packaging specialist DS Smith (SMDS) saw its adjusted operating profit slump by more than a third year-on-year in the six months to 31 October, to £230m. While this was partly down to lower box volumes as non-essential businesses closed in the first quarter, the bigger impact came from a decline in box and paper prices. Paper prices have fallen over the past two years, but the group is now seeing an improvement as demand recovers. This should feed through into higher box prices moving forward.

The first quarter saw the biggest hit to volumes, with a 5 per cent reduction in May. Southern Europe was most severely impacted amid the disruption to agricultural and tourist activity, while North America was weighed down by certain states implementing stricter lockdown restrictions. Volumes recovered across the second quarter swinging to more than 5 per cent growth in November.

‘Fast-moving consumer goods’ (FMCG) and e-commerce customers account for around 84 per cent of DS Smith’s box volumes and resilience in the FMCG sector helped offset industrial weakness during the half. Meanwhile the surge in online shopping saw sales to e-commerce clients jump by 30 per cent. The group secured more business from FMCG and e-commerce customers during the half, increasing its market share.

Net debt has remained largely flat from the April year-end position at £2.1bn, although the drop in earnings means that it has risen to 2.4 times cash profits (Ebitda), above the target multiple of 2. Still, a working capital inflow and lower capital expenditure saw free cash flow come in 16 per cent higher than a year earlier at £207m. While the dividend has been reinstated, it is lower than the 5.4p the group had planned to hand shareholders this time last year. It scrapped that payout back in April to help weather the Covid storm.

DS Smith’s shares have struggled this year and have yet to return to pre-pandemic levels.  But its long-term growth story remains intact. The group was already benefitting from the structural shift to online shopping driving demand for more sustainable packaging. Now, it believes the pandemic will produce a permanent step-up in growth for its e-commerce channel. In order to capitalise on this trend, it plans to spend £100m building two new packaging plants, financing the investment through non-core disposals and existing cash flow. The expansion plans are a sign of confidence and alongside the expected bounce back in box pricing, the outlook is positive. Buy.

Last IC View: Hold, 297p, 02 Jul 2020