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DS Smith - volumes and prices offsetting higher costs

Sophie Lund-Yates, Equity Analyst | 7 September 2021 | A A A
DS Smith - volumes and prices offsetting higher costs

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Smith (DS) Ordinary 10p

Sell: 372.20 | Buy: 372.50 | Change -0.30 (-0.08%)
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Box volumes since the start of May have grown ''very strongly'' compared to the same time last year, and are also up on pre-pandemic levels. Growth has been seen across all sectors, but was especially strong in the US and southern Europe, and among large international consumer goods customers.

There have been ''notable'' increases in input costs, including energy and transportation, resulting in higher paper prices. These increases are being offset by the strong demand, with prices charged to customers increasing.

The construction of new manufacturing sites in Italy and Poland is going to plan, and both should be operational by the final quarter of the year.

The shares rose 1.4% following the announcement.

View the latest DS Smith share price and how to deal

Our View

DS Smith is a cyclical business, meaning its fortunes wax and wane with the wider economy. So it's no surprise profits took a nosedive over the past year. Things could have been worse, were it not for the group's 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 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. Those two groups make up over 80% of DS Smith's business.

Demand in these segments should remain strong - consumers are keen to shift away from plastic packaging and reliance on e-commerce is a trend that's here to stay. But whether the increased volumes will bring in profits is another matter.

The big question mark for DS Smith is costs. The group 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. Right now, the latter best describes the current environment.

Input costs are on the rise, and to cope, DS Smith is increasing its own packaging price. This strategy is offsetting those higher costs. There's a tipping point though, at which higher prices could start to erode volume growth.

Plus, the balance sheet is carrying a little more debt than is ideal, following the acquisition of Europac - a French, Spanish and Portuguese packaging group. There's comfortable breathing room before the group's in danger of breaching the financial terms set by its lenders, net debt was still 2.2x cash profits at the last count- beyond management's target. While this isn't a huge red flag, it's something to keep an eye on.

That brings us to the group's dividend, which is back on the table after a Covid-related pause last year. As long as pricing can keep pace with rising costs, the prospective 3.4% yield looks reasonable. However, as we saw last year - no dividend is ever guaranteed.

Overall, we think DS Smith is in a strong position with exposure to attractive end markets. However, the share price valuation is a little above the long-term average. That means there's lots of confidence from the market about the group's prospects, but any missteps could create near-term volatility.

DS Smith key facts

  • Price/earnings ratio: 14.1
  • Ten year average Price/earnings ratio: 12.0
  • Prospective dividend yield (next 12 months): 3.4%

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.

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Full year results (22 June 2021)

Full year revenue fell 1% to £6bn, ignoring the effect of exchange rates. Rising costs due to Covid, sharp volume declines in the first quarter and reduced box pricing in the first half meant underlying profits were down 24% to £502m.

Volumes are continuing to recover in the new financial year. There is still some cost inflation, but these expenses should be offset by increased packaging prices.

The group announced a final dividend of 8.1p, taking the total for the year to 12.1p.

Corrugated box volumes rose 3.5% for the year, reflecting a 1% decline in the first half and growth of 8.5% in the second half.

Revenue in Northern Europe increased 1% to £2.4bn, driven by strong corrugated box volume growth. However, this was more than offset by a "significant impact" from higher input costs and pricing declines. The division was particularly affected by reduced in-store retail activity during lockdowns. As a result, underlying profits fell 37% to £138m.

A decline in average selling prices offset volume growth in Southern Europe, meaning revenue declined 4% to £2.2bn. Underlying profits were down 30% to £223m, reflecting pandemic-related challenges in tourism and agriculture.

Revenue in Eastern Europe rose 2% to £909m, reflecting strong volume growth. Declines in both Paper and Packing operations meant underlying profits fell 10% to £78m.

North America revenue fell 5% to £541m, largely because of increased internal use of paper. The group said the recovery in volumes has been "pleasing". Underlying profits were up 70% due to favourable pricing and the ramp up of the group's new Indiana packaging plant.

Free cash flow rose from £354m to £486m, helped by reduced capital expenditure due to the pandemic.

DS Smith's net debt position improved from £1.9bn at the end of April 2020, to £1.6bn, or 2.2 times profits at the same time this year. This is beyond management's medium-term goal of 2.0 times.

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 Refinitiv. 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.