Don’t worry, I do not need to be reminded about the story of King Canute but I think the sell-off in shares in the packaging company DS Smith (SMDS) post its full year results does not make a huge amount of sense – and my instinct is that Mr Market has provided investors with an opportunity to build or instigate a position...
A little over a year ago I said that 'the share still has four quid plus potential and I remain long and strong – a bit like some of its packaging sent in recent weeks by Amazon to me'. We almost got to that level in December last year but 2020 has not been so friendly for the stock, akin to many of the trends overhanging the general market. However, the latest share price fall feels a bit rude. That is with a full year to April 'resilient performance, robust business model' backdrop, which included market share gains, organic profit growth and a reduction in debt (to x2.1 ebitda) even taking into account IFRS adjustments. Despite the inevitably dodgy last month or so, operating profits rose 4% as cost control and synergies from the Europac deal on the Continent helped out. There is no big fire here, evidenced by an improvement in free cash flow too. As we all know though citing historic achievements is only going to cut it so far with the stock market, which intrinsically looks forward.
However, and maybe I am biased but the company’s talk about higher costs and volume declines, wrapped around a general 'overall macro-economic uncertainty' observation feels par for the course when thinking about an industrial cyclical name. Especially when the year-on-year decline in corrugated board volumes (back to that Amazon packaging) has been 4% and change in the April-June period and the dividend postponement for prudence reasons truly does feel like that. It certainly helps when 70%+ of your sales are to the fast moving consumer goods space and now less than 20% to the industrial space, where volume declines in recent months have unsurprisingly been a lot worse. It also helps to have the e-commerce tailwind pushing you structurally along. The company can even cite sustainability and ESG angles to excite woke investors.
Clearly - as per the majority of the market - the numbers over the next year (to end of April 2021) are going to be sequentially down. Naturally, there is currently no guidance but if we take a 20% haircut to operating profitability that puts the shares today at around x11 EV/ebit and still capable of producing a 5%+ free cash flow yield. I can certainly make that work given the e-commerce linkage above and likely further deleveraging. Of course, new lockdowns would not help and there is some exposure to areas such as the United States with more shorter-term challenges, but it is not really a big enough component of revenue to be very, very influential. Similarly you could imagine some horrible cost squeeze, but historically pass-through capabilities in this sector have been reasonable so I am not excessively worried about this. Overall, and naturally I will give it a few days to allow this article to be published and related, a couple of days into next week, if the share is still below three quid, expect me to be supplementing my holding. Corrugated board is much sexier than Mr Market is perceiving it.
Filed under: DS Smith, FastJet, Highland Gold Mining, Shoe Zone, Touchstar, silver, gold
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