Trading in the third quarter has been in line with expectations. This reflects continued momentum in FMCG and e-commerce sales, while Northern Europe and North America have "seen the most positive performance". There have been signs of recovery from Industrial customers.
Box volumes have been strong, which has offset higher input costs. Paper costs are increasing, but DS Smith has already started to recover these and expects them to be fully offset.
The group expects results in line with expectations for the full year, and hopes to report cash conversion of over 100%.
The shares were broadly flat in early trading.
DS Smith is a cyclical business, meaning its fortunes wax and wane with the wider economy. Despite that it's weathered the current crisis surprisingly well, and that's thanks to exposure to two key client groups.
The group is a key supplier to ecommerce groups - providing the cardboard boxes that have become a familiar sight outside houses up and down the country as we shifted to online shopping during lockdown. DS Smith also sells around 72% of its boxes to consumer goods and food groups. These include many of the "shelf-ready" cardboard boxes you'll find in the supermarket, and supermarkets have remained open and busy throughout the crisis.
Despite those tailwinds the group hasn't escaped unscathed. Disruption to industrial and hospitality customers has hit volumes and some costs have risen, but falling prices were the real headache. Fortunately, those headwinds have started to reverse, but they won't bounce back to normal straight away.
Given the uncertainty ahead it's good to hear dividends are returning. It means management's confident the impacts from coronavirus aren't going to derail plans in the short term. Investors should remember no dividend is guaranteed, and dividends could be suspended again if conditions sour.
We continue to think the group's longer-term prospects are intact too. E-commerce and consumer goods exposure should remain long term positives. Consumer's growing dislike of plastic packaging should also increase demand over time.
We think DS Smith's business model 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's comfortable breathing room before the group's in danger of breaching the financial terms set by its lenders.
Overall, we think DS Smith is built to be a more defensive option than some of its peers, with exposure to attractive end markets. However, with the full impact of COVID-19 yet to play out, patience is key while waiting for a recovery.
DS Smith key facts
- Price/Earnings ratio: 14.4
- 10 year average Price/Earnings ratio: 11.8
- Prospective dividend yield (next 12 months): 3.5%
All ratios are sourced from Refinitiv. 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.
Half year results (10 December 2020)
DS Smith's half year revenue has fallen 10% at constant exchange rates to £2.9bn. This reflects both lower volumes and pricing which, combined with changes in product mix, fed into a 55% decline in pre-tax profit to £97m.
Trends have been more positive in the second quarter compared to the first, and the group has declared an interim dividend of 4.0p per share. This is a decrease from the cancelled 5.4p dividend due to be paid earlier this year.
First half volumes fell 1.0% year-on-year. This reflects more substantial falls of 4.7% in May, and the situation has improved over the course of the half and volumes were up 3.0% in October.
Revenues in Northern Europe fell 7% to £1.1bn, driven by lower paper and corrugated box prices. Growth was strongest in the UK, the Nordics and Germany, but weakest in the Benelux region where the group is more exposed to hospitality. Lower prices meant underlying operating profit fell 34% to £69m.
Volumes in Southern Europe saw the greatest declines as the region is highly exposed to agriculture and tourism, which was especially poor in Q1. Management says Q2 has seen progressive improvement. Revenue fell 14% to £1.0bn on lower prices and volumes, which fed into a 42% fall in underlying operating profit to £100m. The recently acquired Europac network is now profitable.
Revenue dipped 5% to £438m in Eastern Europe and volumes were in line with the group average. Underlying operating profit fell 20% to £37m as a result of lower prices.
North America was significantly affected by declines in the US export paper price, although prices have now begun to recover. Volumes were also substantially behind the group average. As a result revenue fell 10% to £279m and operating profits 17% to £24m.
Free cash flow rose from £178m to £207m as cost control, working capital management and lower capital spending offset the fall in cash generated by operations. Net debt was broadly flat at £2.1bn.
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