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DS Smith - dividend payments return

Sophie Lund-Yates, Equity Analyst | 8 September 2020 | A A A
DS Smith - dividend payments return

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Smith (DS) Ordinary 10p

Sell: 294.70 | Buy: 294.90 | Change 1.50 (0.51%)
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In a brief AGM statement, DS Smith said performance has been in line with expectations, despite the difficult conditions caused by coronavirus.

Corrugated box volumes returned to positive territory following the initial impact of Covid-19, with FMCG and e-commerce business offsetting challenges in industrial sectors. Northern Europe has continued to perform well, while there's been a "pleasing recovery" in other European regions. North America has also reported progress, including attracting new multinational partners at the Indiana plant.

DS Smith said the impact of lockdowns on recycling pricing and costs has started to temper. Which combined with better clarity over the group's outlook, means an interim dividend will be declared.

The shares rose 6.0% following the announcement.

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Our view

It's certainly a good sign that dividends are back on the table. It means management's confident the impacts from coronavirus aren't going to derail plans in the short term. But there are still some things to be mindful of.

DS Smith is a cyclical business, meaning its fortunes wax and wane with the wider economy. While coronavirus had a limited impact on the latest set of results, the economic outlook from here looks very challenging.

Lower demand means both lower volumes of DS Smith's packaging products and lower prices. Revenues can go up in smoke as a result, a problem that'll be compounded by a largely fixed cost base. This is a particular problem for the group's industrial customers, which includes exposure to things like the struggling automotive market.

There are reasons for optimism though, for investors prepared to take a longer-term view. The biggest is the group's significant exposure to consumer goods and groceries, which accounts for roughly 70% of business. These categories are holding the fort while industrial customers struggle.

There's also booming e-commerce sales, and as almost everything we order online comes in a cardboard box, this is a great growth lever to have. A growing dislike of plastic packaging will also work in the group's favour.

And it isn't just the "what", how DS Smith works is attractive too. 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.

The balance sheet is carrying a little more debt than is ideal, following the acquisition of Europac - a French, Spanish and Portuguese packaging group. But there is comfortable breathing room before the group's in danger of breaching the financial terms set by its lenders, so we aren't concerned about financial health at this moment in time.

Re-introducing the dividend won't help bring debt down, putting more pressure on plans to preserve more cash like scrapping non-essential spending.

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

DS Smith key facts

  • Current 12m forward P/E ratio: 10.7
  • 10 year average 12m forward P/E ratio: 11.7
  • Prospective yield: 4.5%

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Full year results - 2 July 2020

Full year revenue fell 2% to £6bn, ignoring the effect of exchange rates. This reflects weak paper pricing in Europe and North America, partially offset by improved corrugated box volumes in Europe. Despite this fall, cost control and the nine-month contribution from Europac after its acquistion, meant underlying operating profit rose 5% to £660m.

The direct impact from Covid-19 on operating profit was around £15m.

Despite lower corrugated box volumes in March and April l because of coronavirus disruption, for the year these rose 0.6%. The improvement was helped by the group's exposure to e-commerce and consumer goods, while industrial demand was weaker.

Revenues in Northern Europe fell 9% to £2.3bn, driven by lower paper prices and the knock on impact on box prices. The group also increased paper integration, which reduced external sales. The region reported lower-than-average corrugated box volumes for the year - there was stronger growth in the UK, but higher exposure to industrials in Germany weighed on performance. The lower paper prices meant underlying operating profit was down 16% to £219m.

Southern Europe however saw revenues rise 10%, reaching £2.2bn and this was primarily driven by the addition of Europac. Volumes for the year improved overall, but Covid-19 disruption meant these were challenged in the final two months of the year. Underlying operating profits were £314m compared to £186m last year. Revenue dipped 3% in Eastern Europe, to £892m although strong packaging price retention meant operating profit rose 17% to £88m.

North America was significantly affected by declines in the US export paper price, while corrugated packaging volumes were flat. Full ramp-up of the new packaging site in Indiana is on track to complete in the next two years. Revenue was down 9% to £604m, and weaker paper margins and costs associated with Indiana meant operating profit fell 65% to £39m.

The group achieved profit margins of 10.9%, which is within the target range and higher than last year's 10.2%.

Higher profitability helped free cash flow increase to £354m from £339m. Net debt reduced slightly to £2.1bn, thanks to the proceeds from the disposal of the plastics division. The group is well within the terms set by its lenders (covenants), with net debt lower than required as a proportion of cash profits.

In the short-term DS Smith expects Covid-19 to negatively affect industrial volumes and increase operating costs, especially those associated with recycled materials.

In response the group will lower spending in a number of areas this financial year. Capital expenditure will be lowered by 20%, non-essential spending deferred and headcount flexed.

Find out more about DS Smith shares, including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.

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