Speculation over Mondi bid for DS Smith

Packaging remains a fragmented industry. And though we have witnessed several high-profile deals in recent years, such as Berry Global’s (BERY) takeover of RPC Group, consolidation within the sector is likely to accelerate due to the rise of e-commerce.

On the day prior to Mondi (MNDI) releasing its full-year figures for 2020, reports emerged that it was mulling a potential £5bn offer for industry rival DS Smith (SMDS). Shares in the latter packager were on the rise following the press reports. The business models differ to a degree, so the question arises as to whether they would be complementary within an enlarged group.

David O’Brien, equity analyst at Goodbody, believes that opposites attract. Given commercial trends, Mondi may well be tempted to combine its containerboard competencies with “an operation with an emphasis on innovation within the corrugated box market”.

The growth of online shopping though 2020 isn’t reflected in Mondi’s financial performance, with underlying operating profit of €925m (£799m) down a quarter on the prior year as average selling prices for pulp and paper grades headed south. There was also the small matter of the pandemic, though swift reaction by management ensured that production interruptions and temporary closures were kept to a minimum.

Cash fixed costs were marginally up through the period, though they were largely offset by cost mitigation programmes. And while operating cashflow contracted by 9 per cent, net debt was down by more than €400m to €1.79bn, or 1.3 times underlying cash profits.

You could argue that Mondi has not seen the e-commerce benefits that have accrued for some of its industry peers over the past 12-months or so. Glasgow-based Macfarlane (MACF), a designer of protective packaging products and labels, has certainly felt the benefits, achieving a 9.6 per cent increase in reported pre-tax profits through 2020, with results ahead of previous expectations.

Bosses at Macfarlane point to “underlying strength in the e-commerce, household essentials and medical sectors”, though this was offset to a degree by weaker demand from sectors most affected by Covid-19, namely “automotive, aerospace, high street retail and hospitality”.

The good news for Mondi shareholders is that the group is seeing positive signs on the pricing front, which is doubly encouraging given strengthening volume growth in corrugated and flexible packaging. We will have to wait before the smoke clears on any DS Smith approach, but it could that improved specialisms, rather than the desire to drive scale benefits, could be the principal driver of any deal. Hold.

Last IC view: Buy, 1,601p, 15 Oct 2020