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DS Smith - trading resilient but dividend gone

Emilie Stevens, Equity Analyst | 8 April 2020 | A A A
DS Smith - trading resilient but dividend gone

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Smith (DS) Ordinary 10p

Sell: 346.00 | Buy: 346.30 | Change 1.70 (0.49%)
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Since last reporting on 4 March, DS Smith says trading has remained resilient, with COVID-19 having a relatively limited impact to date.

Full year performance is expected to be in line with current guidance.

However, the group says it will inevitably be impacted by any prolonged downturn in global economic activity. In light of this, DS Smith will not pay this year's interim dividend, due to be paid on 1 May. A decision on the full year dividend will be made around the time of full year results in July.

The shares remained broadly flat following the announcement.

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Our view

As almost everything we order online comes in a cardboard box, and as hostility towards plastic packaging grows, we expect demand for DS Smith's products to rise going forwards.

The good news, for now at least, is that coronavirus doesn't really change that. In fact with more and more of us locked down at home, DS Smith is being kept busy, particularly in grocery and e-commerce divisions. It also helps it's seen as a "critical business" in most markets, so its factories remain open - with heightened health and safety measures in place.

Unfortunately, the COVID-19 impact for DS Smith likely lies a little further down the road. As the pandemic takes hold globally, the question for economic recessions has now become more about 'how long' not 'if'.

That's not good news for cyclical businesses, packaging being one of them - who see demand rise when the economy booms, but drop off in recessions. Lower demand means both lower volumes and lower prices. Revenues can go up in smoke as a result, a problem that'll be compounded by a largely fixed cost base.

However, DS Smith does have a couple of traits that should mean it's better placed than some rivals to weather a storm - although that still doesn't mean it will escape a recession unscathed.

The first is a large exposure to consumer goods and food, for which demand tends to hold up rather well when the economy turns. They make up around 70% of DS Smith's sales, offering some shelter compared to competitors more exposed to industrials.

Secondly, DS Smith only makes about 80% of the paper it needs in-house, and wants to cut that even further to around 60%. This means DS Smith gets its raw materials cheaper when paper prices fall in tough times. However, when the industry is booming and paper is more expensive the group's margins get squeezed. The overall effect is, in theory, to make the group less cyclical.

DS Smith is currently chewing through the acquisition of Europac - a French, Spanish and Portuguese packaging group. The deal means there's more debt on the balance sheet than we - and management - would like. The recent sale of the plastics division has helped to reduce debt to around 2 times cash profits - adding to the group's financial resilience, but there's more to do.

In a bid to preserve cash and strengthen the balance sheet further, DS Smith has withdrawn the dividend and stopped any non-essential spending. The group also confirmed access to £1.4bn in undrawn credit. Encouraging actions in our view.

Overall we think DS Smith is built to be a more defensive option with exposure to attractive end markets. Online sales and plastic substitution are structural tailwinds. However, with the full impact of COVID-19 yet to play out, the near term could get tougher for the group.

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Trading update

DS Smith has been classified as a "critical business" in "virtually all" of its markets, which means its factories have remained operational.

Demand for corrugated boxes is said to be good - the group's seen an increase in like-for-like demand since half year results. On a regional basis, the main impact to date has been in Southern Europe, with North Europe seeing less effect and Eastern Europe none. North American trading has remained relatively robust, consistent with the group overall.

DS Smith says the grocery sector has been "very busy" and e-commerce has also been strong in most categories, increasingly so in everyday essentials. The industrial sector has been "heavily affected" but DS Smith says its limited exposure to this market has protected it.

COVID-19 has seen operational costs increase, particularly in relation to employees, logistics and enhanced health and safety measures. However, pricing remains resilient and DS Smith expects a return on sales for the current financial year to be similar to the first half.

DS Smith continues to invest in the maintenance and efficiency of its assets but has stopped all non-essential spending. Executive Directors will be waiving their rights to any annual bonuses in respect to this financial year.

The group has £1.4bn in undrawn credit, and no significant refinancing required until 2023. Net debt to cash profits on 30 April is expected to be around the group's medium target of 2 times.

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