Excitement is not a word typically associated with corrugated cardboard. However, packaging companies have caught the eye of investors in recent months as online shopping supercharges demand for their boxes. The question is, can these companies sustain high levels of growth, or will rising costs dampen cardboard’s prospects?
Packagers such as DS Smith (SMDS), Macfarlane (MACF) and Smurfit Kappa (SKG) have performed well over multiple lockdowns. Box volumes have swelled as e-commerce shipments increase and rising costs have largely been passed on to customers.
Managers of these companies remain optimistic about their prospects. Eddie Fellows, chief executive of Smurfit Kappa UK and Ireland, said he is confident that e-commerce will sustain further growth in 2022, albeit at a more modest scale.
Fellows' view chimes with a study published by broker Jefferies, which models 1.5 per cent growth in demand for European packagers in 2022, compared with 5-6 per cent in 2021.
Cardboard boxes are getting pricier to produce, however. The cost of the recovered fibre used to make recycled paper has more than doubled, according to DS Smith. Paper, energy and logistics costs are also rising. A study by commodities data group Mintec found that paper prices were still rising in November, despite its broader global packaging index encompassing plastics and metals inputs falling for the first time in 19 months.
This is not necessarily bad news for paper packagers. So far, they have been able to pass extra costs onto their customers by making their products more expensive. Hedging arrangements with suppliers and financial institutions have also supported margins.
It's unclear how long this can last, though. At some point, customers will surely balk at the bill. It is also worth noting that trade receivables form a hefty portion of packagers’ current asset base – and are on the rise. In many cases, trade receivables are growing faster than group revenue. This could spell trouble down the line if clients themselves hit turbulent times.
Some packaging companies have voiced their concerns. DS Smith’s head of strategy, Alex Manisty, warned that the UK paper industry will struggle without more government support, claiming the local energy costs for industry are nearly double the average of Europe. Although natural gas prices have eased in recent weeks – at about 200p per therm, they are less than half of the 450p peak crossed last month – they remain more than treble the level they were trading at 12 months ago.
“If government policy is not more supportive, the UK’s £12bn paper industry could face continued decline and [we] would become even more reliant on imports, which would be a great pity given that we have an abundant source of recovered paper onshore that can be recycled into new finished paper products,” Manisty said.
A surplus of paper could ultimately prove worse for packagers than a tightness of supply. In a report published this month, Jefferies warned that the European market could be oversupplied by 2024-25, and predicted that paper mill operating rates will fall below 90 per cent. This is partly because companies that manufacture graphic paper – which is being squeezed out by digitisation – are increasingly turning to packaging.
Jefferies also noted growing concern among investors about paper imports from the softer North American market, which could further affect supply and demand dynamics.
One solution is consolidation. The European packaging market is still fragmented despite some high profile deals, such as Berry Global’s (US:BERY) takeover of RPC Group in 2019. Oversupply could stimulate more mergers as companies battle to stay competitive.
Packaging products are also likely to become more sophisticated. “The trend is to find fit-for-purpose packaging,” said Macfarlane chief executive Peter Atkinson. “For cost and environmental reasons, finding ways to protect products and minimise the use of packaging is high on the agenda”.
The 'unboxing experience' is also due an Instagram-worthy makeover, as retailers develop their direct-to-consumer strategies.
Indeed, the end consumer is increasingly important to packaging companies – particularly when it comes to green credentials. Paper packagers have a natural advantage over plastic manufacturers following the backlash against single-use plastics and they repeatedly stress the importance of the circular economy.
However, like all energy-intensive sectors, paper is under pressure to decarbonise and this transition could be bumpy. According to DS Smith, the industry “urgently needs” a plausible long-term strategy for green hydrogen, and advice on how to strengthen the low-carbon electricity grid. It has also called for regulatory support for transitional fuels, such as biomass and biogas.
Beyond consolidation and costs, the future of packaging will be dictated by sustainability. As cardboard boxes mount up, the industry’s green credentials – and our own shopping habits – must be prepared for greater scrutiny.
