DS Smith defies rising costs

As Christmas approaches, the number of cardboard boxes in people’s hallways, porches, and cupboards starts to multiply. Last December, however, packaging specialist DS Smith (SMDS) was hit by lower box volumes and a decline in box and paper prices, while it struggled to keep its plants open and operating. This year things are cheerier for the UK’s largest cardboard manufacturer, though, as its financial performance starts to match its long term growth prospects.

The group’s revenue is now well above pre-pandemic levels and profits in the half-year to October rebounded strongly. Its performance has been bolstered by two factors: volume growth and higher prices. Management reported “record” corrugated box volume growth of 9.4 per cent, with particularly strong profit spikes in North America and Southern Europe.

Meanwhile, “significant rises” in the cost of energy, transportation and raw materials were mitigated by raising the price of its products. This strategy seems to have successfully protected margins, although there has been a notable rise in trade and other receivables, which now stand at over £1bn, up from £828m the previous year.

Inflationary cost pressures are not going to go away overnight. However, the group’s balance sheet looks robust: net debt fell £155m to £1.64bn over the past six months, as free cash flow of £188m has driven leverage to 1.9x net debt/Ebitda, just below its medium-term target.

The group’s capital efficiency is also improving, although it is still some way off target. Return on average capital employed, for example, increased from 8.7 per cent to 9.4 per cent, which remains below the goal of 12 to 15 per cent. Cash drag incurred from recent acquisitions and investments, together with Covid disruption are likely to blame. 

It’s the group’s long-term growth story that is most attractive for investors, however. E-commerce is increasingly popular and customers are looking for sustainable options. DS Smith only produces fibre-based corrugated packaging, providing an appealing alternative to plastic products. To make the most of this trend, it has invested in two extra packaging manufacturing sites in Italy and Poland, where operations are due to begin in the final quarter of this financial year. 

This positive growth story is reflected in FactSet consensus EPS estimates of 30.7p for the year to April 2022, rising to 35.8p the following year. At the current price, the market appears to be overlooking these prospects and management confidence, as evidenced by the big dividend hike. Buy.

Last IC View: Buy, 388p, 28 Oct 2021