Mondi far from boxed in

The rush from plastic to paper this trend has fuelled has fed through to the likes of packaging and paper group Mondi (MNDI), which saw underlying operating profits rise by a quarter to €630m (£558m) over its first half. The group has been well placed to reap the rewards thanks to its business's global reach and vertically integrated operations – it produces about a quarter of the wood it uses as well as operating pulping mills and manufacturing a diverse range of paper and packaging products. The rise in online shopping is another source of structural growth for the business. Yet the company's share price has collapsed by 19 per cent in just under six months.

A key reason for this souring of sentiment has been a decline in containerboard (corrugated cardboard) prices. While the latest industry data from intelligence agency RISI from November puts the decline at only 3 per cent, or €20 per tonne, the agency is forecasting that the decline could extent to 5 per cent (€30 per tonne) this year. But others think things could get a whole lot worse due to the potential for a global economic slowdown coupled with potential industry overcapacity. Given the high fixed costs associated with pulping mills and containerboard manufacture, it is not surprising some investors have taken fright. 

However, there are reasons to think the market has marked Mondi's shares down too far. Based on the two-fifths of the company's cash profits (Ebitda) that come from containerboard, broker Jefferies estimates that even if prices fell by €100 per tonne, compared with its expectation of a €40 per tonne fall, its forecast for Mondi's 2019 earnings per share (EPS) would only drop by 8 per cent from 188p to 174p.

True, Mondi’s exposure to industrials is a noteworthy bear point for anyone who fears a global economic slowdown on the back of a pullback in Chinese spending and the Sino-US trade war. During the financial crisis, the group's operating margins shrank by three-fifths between 2007 and 2009. However, an overhaul of the operation between 2007 and 2012 means Mondi looks far higher quality and more resilient business now than it did then. Over four-fifths of its production is in the lowest half of the industry's 'cost curve', while just over half is in the bottom quarter. Meanwhile, ongoing investment – both organic and acquisitive – has led to an impressive record of growth in sales, profit, operating margin and return on capital employed (ROCE) – see table. The current year should benefit from €415m spent on acquisitions, which includes the €363m acquisition of Finnish paper and pulp mill Powerflute, and €750m of planned capital expenditure this year could add between €40m and €50m to earnings before interest, tax, depreciation and amortisation (Ebitda).

And aside from containerboard, other key businesses face strong market conditions. The company is pushing through price rises for kraft paper (super-strong packing paper) thanks to the move away from plastics. The group's industrial bags business is also performing well, and paper prices are rising ahead of input costs. Meanwhile, the consumer packaging division, which has some exposure to plastic packaging, should benefit from restructuring and recently completed investments. 

The balance sheet also provides comfort. As well as forking out for acquisitions and capital projects, management has handed back cash with a €484m special dividend last year. This underlines management's confidence in the financial position and the resilience of cash flows. Even after this largess, net debt still only stood at 1.5 times Ebitda at the end of the first half.