Boring investments can sometimes be the best. They are not overly complicated or involved in flashy fair weather industries. It’s easy to see why – businesses that offer essential goods or services are generally better positioned to weather the ups and downs.
Packaging companies fall into this category. Everything we buy in a supermarket is wrapped in something. Baked bean molds are not shipped individually – you need cardboard pallets. When was the last time you had a delivery without cardboard or plastic?
The scale of the demand for packaging worldwide is enormous. It also means that there are a handful of big companies to choose from for investors looking to get in on the action.
This article is not personal advice, if you are unsure whether an investment is right for you, seek advice. All investments go down and up in value, so you might get back less than you invest. Returns are variable and are not a reliable indicator of future income. No dividend is ever guaranteed.
Investing in individual companies is not for everyone. This is because it is a higher risk, your investment depends on the fate of this business. If that company goes bankrupt, you risk losing your entire investment. If you can’t afford to lose your investment, investing in just one company might not be right for you. You should ensure that you fully understand the companies in which you are investing and their specific risks. You should also make sure that any stocks you own are part of a diversified portfolio.
DS Smith’s biggest moneymaker is its cardboard packaging products, but it also dabbles in papermaking (some of which is used in its own products and some of which is sold) and recycling. The group has annual revenues of around £7bn and a pre-tax profit of £378m.
This indicates operating margins of around 6%, which are not the healthiest in the sector, and reflects the difficult cost environment in which the group finds itself. It manufactures much of the paper it needs in-house, but is looking to reduce it to around 60%.
This means that 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 tighten.
More generally, packaging companies are far from immune to soaring input costs, particularly energy. It is therefore pleasing to see that DS Smith is deploying contracts to hedge against unfavorable gas prices.
It is 90% hedged against the price of natural gas for 2023 and around 80% for the following year. This is a notable effort in the industry and provides a real layer of short-term resilience.
Just like the main advantage of DS Smith: its customers. The group’s main customers are blue-chip consumer goods companies (FMCGs). FMCG items, like food, toiletries, or cleaning supplies, are on the shopping list every week. This means that they must also be carried all year round. DS Smith is also heavily exposed to e-commerce, which is another more reliable revenue area.
We also admire DS Smith’s sustainability initiatives. This is an important area of focus for modern investors, which also helps attract and retain sustainability-minded companies.
The group’s net debt level has also decreased and stood at 1.6 times cash profit (EBITDA) at the start of the new year. This helped support the dividend yield of 6.1%, as did the group’s relatively cautious dividend hedging policy. DS Smith aims to have its dividend covered by earnings by 2 to 2.5 times.
DS Smith has an enviable customer base and a proactive approach to weathering the energy crisis. There’s a lot to love and long-term opportunities as far as we’re concerned.
However, we would be remiss not to mention the challenges. The group’s exposure to broader cost inflation and shrinking margins are real hurdles it needs to overcome, which are likely to create short to medium term ups and downs. This is reflected, and more so, in a price-earnings ratio of 7.7, which is 36% below the ten-year average.
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Mondi manufactures and sells packaging and paper products. Its three main product segments are corrugated packaging, engineered materials – which includes elastic stretch films and nonwoven fabrics that go into diapers and other personal care items, and flexible packaging. Among other accolades, Mondi is Europe’s leading producer of paper bags.
Mondi has benefited from the boom in online shopping, accelerated by the pandemic. This is undoubtedly a long-term tailwind. But it’s also something over which Mondi has no control. In fact, what makes Mondi a bit different is its exposure to less developed economies.
Emerging Europe represents more than a third of the group’s annual turnover (by place of production). These areas may increase the risk of ups and downs, but are in our view an opportunity for longer-term growth.
The group is also pushing harder than expected with its environmental initiatives, with recycled materials, reduced waste and reduced emissions truly at the heart of Mondi’s strategy. This is important – investors and customers today may be much more likely to snub a company that doesn’t take these issues seriously.
Mondi’s revenue mix is a little more eclectic than you might imagine. While around half of its customers come from the consumer and retail sectors, the rest of Mondi’s customers are largely from the industrial or construction sectors. This provides a layer of diversification, which means the risk is spread across different markets.
However, it also increases the likelihood of highs and lows. Indeed, the industrial and construction markets tend to fluctuate at the same rate as the economy as a whole.
Along with economic jitters, this is a major factor in why Mondi shares are currently changing hands for 9.2 times expected earnings, well below the ten-year average. While more ups and downs are likely, there could be an opportunity for those willing to take on some short-term risk.
The group’s balance sheet is in good health, with net debt equivalent to 0.8 times the underlying cash profit (EBITDA), as at the end of June. This financial resilience allowed Mondi to pay a dividend.
Mondi is returning to shareholders proceeds from the $1.6 billion sale of its largest Russian factory. There is currently a prospective yield of 4.7% on the offer. However, the yield is likely to fluctuate once this yield is eliminated. And as always, no dividend is ever guaranteed.
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Smurfit Kappa (SK), based in Ireland, is primarily a paper box company. The majority of its operations are integrated. This means that it has a system of its own paper mills that manufacture containerboard, which is then shipped to Smurfit mills, and ultimately converted into corrugated packaging products.
Smurfit holds the title of Europe’s leading box producer. If you’ve ever received flowers from Waitrose, chances are these will come in a Smurfit box.
SK mainly operates in Europe and the Americas – with 13 countries on the list in the latter region, where it also has forests to grow its own timber. It is a model that we admire. €7.8 billion of the group’s €10.1 billion annual turnover comes from all over Europe.
In the first half of the year, underlying revenue increased 32%, reflecting Smurfit’s ability to pass on higher costs to customers. Volumes increased by 2.5% despite higher prices. The group is forced to increase its prices due to a sharp increase in the cost of inputs, particularly energy.
It’s a tricky situation and largely out of the band’s control, but he handles it well.
Thanks to the reduced impact of rising costs and its integrated model, operating margins are 10.6%. It’s not the industry leader, but it’s more competitive than some and allows for some leeway.
The group is comfortable enough to increase the annual dividend by 10%, and the projected dividend looks very well supported by expected earnings. The prospective yield is 4.7%, but remember that no dividend is ever guaranteed.
So what’s the bad news?
Like its peers, broader geopolitical uncertainty and supply chain issues are of concern. The group is exposed to the Food & Beverage and Industrials sectors, which will be more likely to experience short-term ups and downs.
More generally, Smurfit’s particular exposure to Europe potentially exposes it to greater risk in the current economic climate. This is mainly due to current fears of recession and inflation in Europe. Smurfit Kappa has an opportunity for growth, but carries a little more risk.
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Unless otherwise stated, estimates, including forward-looking returns, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Returns are variable and not guaranteed. Past performance is not indicative of the future. Investments go up and down in value, so investors could suffer a loss.
This article is not advice or a recommendation to buy, sell or hold an investment. No opinion is given of the present or future value or price of any investment, and investors should form their own opinion of any proposed investment. This article has not been prepared in accordance with legal requirements intended to promote the independence of investment research and is considered marketing communication. Non-independent research is not subject to FCA rules prohibiting trading prior to research, but HL has controls in place (including trading restrictions, physical and informational barriers) to manage disputes. potential interests presented by such a negotiation. Please see our full non-independent research disclosure for more information.
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