Overview
DS Smith PLC (SMDS) is a London, United Kingdom-headquartered specialist in plastic packaging worldwide and a leading provider of corrugated packaging, with operations in more than 37 countries. From a box making business established by the Smith family in London in the 1940s, the group over the past 80 years has grown dramatically through a series of acquisitions. Today, the company's services and areas of expertise has also expanded considerably, with approximately 32,000 people employed by the group. In December 2017, DS Smith was included in the FTSE100 index.
Being a packaging strategist, the group offers its customers with strategic support across their entire packaging Supply Cycle, operating as a unified company with divisions in the paper, plastics, packaging and recycling. The company is also regarded as the industry benchmark in Supply Cycle strategy and packaging. The company has a recycling business that collects corrugated cardboard and used paper, from which corrugated packaging materials are manufactured in the company's manufacturing facilities.

Key Statistics


Management

Gareth Davis is the Chairman of the Board; he was appointed to the position in January 2012. The Chief Executive Officer of the group is Miles Roberts.

Segments

The company’s packaging business is differentiated in six segments: UK, Western Europe, DCH & Northern Europe, Central Europe & Italy, North America, and Plastics. According to the latest filing, the group generates most of its revenue from Central Europe and Italy, closely followed by Western Europe. Plastic packaging’s products are sold worldwide with manufacturing sites in the US, Europe and the Asia Pacific, while recycling and paper form an integrated part of the company’s global supply chain operations.

Top Shareholders

 
(Source: Thomson Reuters)

Pre-Close Trading Statement

Driven by FMCG-focused customer base and strong position in the e-commerce packaging market, the company experienced growth in the corrugated box volumes and market share gains, with financial performance was in line with its expectations. While certain export-led markets, including Germany, reported some volume weakness, all other regions were in growth, with the UK, Italy and Poland rising more strongly. In the second half of the financial year ending 30 April 2019, group margins are expected to progress further. Moreover, operating cash flow is expected to be stronger.

Key Financial Highlights (H1 FY 2019, in £m)

 
(Source: Company Filings)

Due to market share gains, with very good volumes from multi-national customers, and innovative packaging solutions across Europe and the US, the company reported that organic volume growth was 3.2%, ahead of its target of GDP+1%, and helped the group to deliver good growth with a 120 bps rise in the return on sales to 9.9%.

Reflecting a recovery in paper prices, volume growth in corrugated boxes, and contribution from acquired businesses, the company reported revenue growth (continuing operations excluding plastics) of 16% on a constant currency basis to £3,073m, while revenue, on a reported basis, rose by 15%.

Operating profit surged to £201 millionversus the prior year data (H1 2017/18: £157 million), while adjusting operating profit, on constant currency basis, grew by 32% to £304 million, with the organic growth contribution being 11%, despite headwind from currency translation. The growth was driven by higher volumes and the benefit of higher pricing and sales mix.

While adjusted profit before tax was £220 million, against £167 million reported in 1H 2018, reported profit before tax was £162 million versus £128 million in H1 FY2018, reflecting higher operating profit but was offset by higher interest costs.

Profit in 1H 2019 was £130 millionagainst £107 million reported in the corresponding period of the last year. While unadjusted earnings per share for continuing operations were 9.5 pence, adjusted EPS, driven by the growth in operating profit, increased by 9% to 16.5 pence. Return on average capital employed stood at 13.9% and remained stable and was still in the upper half of the target range.

Net debt at the end of the period was £648 million, representing 0.8x Net Debt/EBITDA, while free cash flow fell to £209 million but proved sufficient to cover dividends. The Board, demonstrating the confidence in the outlook for the group, increased the interim dividend by 14% to 5.2 pence per share. The dividend was paid on May-01-19.

Key Performance Indicators (FY 2018)

On-time, in-full delivery, which indicates the share of the total orders across all businesses that are delivered on-time and in-full, was 93%, against the target of 97%.

Accident Frequency Rate (AFR),which shows the number of lost time accidents (LTAs) per million hours worked, reduced to 2.8 as a result of the proactive measures put in place at mid-year, versus the target of 0.

Like-for-like corrugated volume growth is targeted to be weighted GDP +1%, which the company easily surpassed with corrugated box volumes growth of 5.2 per cent.

Return on sales was 9.2%,within the target range of 8-10%.

Adjusted return on average capital employed (ROACE), which isa key measure of financial success and sustainability of returns,declined to 14.1% but was within the target of 12-15%.

Net debt/EBITDA, which is a key measure of balance sheet strength, was at 2.2x, slightly more than the company’s target of 2.0x.

Cash conversionhelps the company in maintaining a prudent balance sheet and was at 100%, just hitting the target.

Financial Ratios


(Source: Thomson Reuters)

Ratios Commentary

The company's EBITDA and operating margins improved marginallyin the first half of FY 2019, but EBITDA margin was still less than the industry median. Moreover, net margin and ROE of the company were also lower than its peers, indicating a room for improvement. The liquidity ratios improved considerably, with a quick ratio now better than the industry and current ratio roughly in line with the industry. This shows that the company has a higher level of liquid assets than its peers. The leverage position improved in 1H FY 2019 and is now largely comparable to the industry. Though the asset turnover ratio is gradually normalising towards industry median, higher activity ratios indicate a better utilisation of the company's assets.

Valuation Methodology
Method 1:EV/Sales Multiple Approach (NTM)


Method 2: Price/Earnings Approach (NTM)


To compare SMDS with its peers, P/E multiple has been used. The peers are Stora Enso Oyj(NTM P/E was 8.30), Smurfit Kappa Group PLC(NTM P/E was 8.63),RPC Group PLC(NTM P/E was 9.51), Mondi PLC(NTM P/E was 9.86), UPM-Kymmene Oyj(NTM P/E was 10.12), Weir Group PLC(NTM P/E was 13.51) and BillerudKorsnas AB (publ)(NTM P/E was 15.81). The mean of P/E (NTM) of the company’s peers was 10.82x (approx.).

Share Price Commentary

Daily Chart as at June-03-19, before the market closed (Source: Thomson Reuters)

On June 03, 2019, at the time of writing (before the market closed, at 2:10 pm GMT), SMDS shares were trading at GBX 313, down by 0.94 per cent against the previous day closing price. Stock's 52 weeks High and Low is GBX 542.45/GBX 285.83. On the valuation front, the stock was trading at a trailing twelve months PE multiple of 9.4x, against the industry’s median of 13.5x. The company's stock beta was 1.09, reflecting roughly the same volatility as compared to the benchmark index. The outstanding market capitalisation was around £4.33 billion with a dividend yield of 4.75 per cent.

Risks Assessment and Growth Prospects

The group has been financially and strategically strengthened by the disposal of its Plastics division and has significantly enhanced its European operations through the acquisition of Europac.

The company has substantially increased profit levels and has strong momentum in the market and delivered good top line growth, helped by a focus on the stable FMCG market, and enhanced cost and efficiency improvements.

It has also maintained its leadership position in both sustainable packaging and e-commerce. Further, the proliferation of online market at the expense of brick-and-mortar stores offers an immense opportunity for growth from companies like Amazon, which is already a customer of DS Smith.

Though the company has expanded its global footprint through a series of acquisitions, the risk of any venture failing has also risen considerably, which is further accentuated with slowing worldwide economic growth, especially in Eurozone which might lead to weaker consumer demand.

Brexit related uncertainties can increase the interest costs for the company and has led to the curtailment of expansion plans in its home market. The company is also exposed to significant risks from large volatility in paper demand and supply mechanics.

Conclusion

Decent growth in the profit, along with strategically important acquisitions, has well placed the company to capitalise future trends and maintain healthy profitability.
 
Based on decent prospects and supported by valuation done using the above two methods, we have given a “BUY” recommendation at the closing price of GBX 316 (as on 31^st May 2019) with low double-digit upside potential based on 10.82x NTM Price/Earnings (approx.) on FY19E earnings per share (approx.) and 1.10x NTM EV/Sales Value (approx.) on FY19E sales (approx.).
 
 
*The buy recommendation is valid for the current price as covered in the report (as on June-03-19).
*All forecasted figures and Peer information have been taken from Thomson Reuters.

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