Smith (ds) Share Discussion Threads

[moorsie2] 09/12/2019 10:28

FINANCIAL ANALYSTS: DS Smith - Reiterating Buy rating as earnings are still growing despite challenging market [VRP]


NEW YORK, 6 December 2019 (Viewpoint) - excerpt from Vertical Research Partners

Continued EPS Growth Should Drive Share Price Appreciation – On Thursday morning, DS Smith released its first-half fiscal 2020 (for the fiscal year ending on April 30th 2020) financial results. EPS was slightly lower than expected, but still grew by 4.6% y/y (when including the Plastics business that is now classified under discontinued operations) despite a challenging environment. SMDS has been consistently growing its adjusted EPS on an annual basis for almost a decade now, even during cyclical downturns in the European containerboard market. It has achieved this growth by utilizing its underlevered balance sheet and achieving strong corrugated box volume growth. While we do expect F2H20 EPS to come in marginally below the F1H19 level, this is primarily due to the sale of the Plastics division (which should be completed by calendar year-end), without which our EPS estimate would point to marginal growth y/y. Furthermore, we project SMDS’ streak of full-fiscal year adjusted EPS growth will continue unabated. More specifically, we project F2020, F2021, and F2022 EPS growth of 1.8%, 1.9%, and 6.7%, respectively. While these numbers are not groundbreaking, they compare positively to our projections for the other four containerboard names we cover – all of which are expected to experience varying degrees of earnings pressure during calendar 2019 and 2020. As such, we remain confident that SMDS’ stock should move higher as investors appreciate the company’s earnings resilience and the global containerboard market improves.

Results Slightly Below Expectations… – SMDS reported F1H20 adjusted EPS from continuing operations of £0.17 vs our headline £0.18 estimate, but the actual delta is quite smaller. More specifically, SMDS’ adjusted EPS from continuing operations was 17.3p vs our 17.6p estimate, while our 18.0p “all in” estimate including the earnings contribution of the Plastics division compares to SMDS’ 17.8p. (Note that this small miss vs our estimate is smaller when including Plastics as we previously assumed the sale would have been completed in August while the business ended up contributing for the full half-year period). Operating profitability was actually in-line. Adjusted EBITA (not EBITDA, but EBITA) was £251 million vs our £246 million estimate, driven by lower depreciation. The company’s EBITDA of £498 million was £5 million below our £503 million estimate. EBITA in North America was well below our estimate. Due to re-segmenting, we have no clear picture as to which European segments (which are now three vs four previously) missed/topped our forecasts. However, we believe that SMDS missed us in Northern Europe (along with North America), with results in Western Europe and Eastern Europe were better than expected. We believe the North American softness was due mainly to SMDS’s export exposure.

… With Significant Benefits from its Short Board Position – Revenues of £3.188 billion were 1% below our estimate, and just £115 million above their year-ago level despite a £297 million top-line contribution from Europac. Said differently, like-for-like revenues would have declined by 6%. The top-line pressure was driven by (1) lower pricing and volumes for open market board and recyclable products sales and (2) slightly lower box pricing, partially offset by a 0.7% growth in corrugated box volumes (which was less than half our assumed growth rate). Offsetting this top-line pressure were stronger margins. SMDS’ EBITDA margin of 15.6% was 280bps above its year-ago level and in line with our estimate. This sharp margin expansion was driven by the Europac acquisition (which was a structurally-higher margin business) and lower input costs, including externally purchased containerboard and OCC. In the company’s EBITA bridge, pricing was a ~£130 million headwind, offset by £130 million in lower costs. But when it comes to the bottom-line, much of the pricing headwind which was attributed to lower board and recycled fiber prices was offset by the company short board position – as these two items are interlinked. As a reminder, SMDS should be ~85% backwards integrated (meaning it relies on purchased board for 15% of its fiber needs). Hence, all else being equal, lower board prices are actually a net positive for SMDS. (Of course, normally a material change in board prices would lead to a similar change in box prices – which ultimately drive SMDS’s profits – and in a scenario where box/board prices move in lockstep an inflationary environment is better for SMDS). These benefits were also evidenced on the segment performance. The short-board Southern Europe and Eastern Europe divisions experienced margin expansion y/y, while the long-board Northern Europe division saw a 230bps margin contraction. In the US, were the company is ~60% forward integrated (i.e., it sells around 40% of its board externally), margins shrank by 740bps due to the decline in export pricing.

Box Prices Holding Up – We understand that during 1H20 SMDS experienced a ~2% price decline, consistent with our assumptions. Overall pricing was a 4.5% headwind to revenues, but according to management ~£80 million of the £101 million headwind was due to lower paper and recycled fiber prices. Going forward, prices should decline further reflecting the continuously declining containerboard prices. As we wrote in our October 10th report (here), we assume ~5% box price erosion from the late-2018 peak in Europe. Despite containerboard prices continuing to decline, we have not changed this assumption yet. We note that the topline price pressure for SMDS however will be more significant due to lower pricing for other products, such as containerboard.

Slightly Trimming Estimates – We are slightly lowering our earning’s estimates for SMDS, primarily reflecting lower organic volume growth and lower board/recycled fiber pricing and sales volumes (which also translates into more modest revenue contribution from Europac). Our F2020 EBITDA estimate is reduced by £26 million, to £990 million, with £21 million of this reduction coming in the back-half of F2020. Our F2020 EPS forecast remains at £0.35. Note that with the re-segmenting of the company’s divisions, the segment comparability vs our prior set of estimates is limited. However, we did lower materially our earnings forecast for North America, and believe that Northern Europe is also doing worse than expected – while Western Europe is seeing a larger-than-expected benefit from positive price/cost (with lower input costs for OCC and purchased containerboard not fully flowing through box prices). We expect conditions for the North America business to improve with higher volumes as the new box plant in Lebanon, IN ramps up and as the export market recovers. That, along with additional synergies from the Europac acquisition, should drive modest earning’s upside for F2021 (which starts in less than five months). Our F2021 and F2022 EBITDA estimates are lower by ~1% each, to £1.007 billion and £1.057 billion, respectively. Our F2021 EPS is lowered by one pence, to £0.35, although it is still almost 2% higher than our F2020 forecast. Our F2022 adjusted EPS estimate remains unchanged at £0.38.

Chip Dillon, Vertical Research Partners

[jeffian] 08/12/2019 17:57

I agree that a fundamental re-rating is unlikely until the picture becomes clearer, but I'm happy to pocket a 4.4% divi yield while waiting.

[marksp2011] 08/12/2019 15:10

97peter

i dont expect any great action here until they can demonstrate they are in control of the business. Debt is down and cash flow up

Might be wrong :)

[97peter] 07/12/2019 15:56

Time to invest before this shoots over 400 and then onto 450 territory in 2020 to divi payment in April. Interim I know, but with plastic company sold by then and debt down, plus new Tory majority of 30 to Tories, this will leap like other UK shares!!

[dr_smith] 05/12/2019 16:17

Thank-you GabsterX, readng your reply and re-reading, your earlier detailed post, the comment originates from sales volume not sales £, so like volumes at lower price translates into lower t/o. Makes sense to me now. :-)

Dave (middle name Russell not a Doc ;-) )

[gabsterx] 05/12/2019 15:49

Marksp, yes it's almost as if everything is neatly packaged (pun intended) to look good on the outside but when you start digging you see weakness in key metrics.

Dr Smith, it would make sense however if the cost goes down on a commodity like paper then it goes down for everyone. So all the companies race the prices down which drops revenues even on stable volumes.

Edit: Just found this, they were not kidding about the paper prices! They are at 10 year lows..

[martindjzz] 05/12/2019 15:48

In there webcast the rise in net debt was explained by the inclusion of lease obligations for the first time per new IFRS 16 requirement. The multiple remains at 2.3x EBITDA using a consistent basis of calculation.

[dr_smith] 05/12/2019 15:29

GabsterX:
> and that prices of paper had gone down by 20%
Haven't seen webcast but reading your post, tone is apologetic for uncontrollable raw material costs, but paper cost "down" is a good thing to increase margin, so don't understand the comment?

[marksp2011] 05/12/2019 15:11

Gabster
I think that is the issue with the numbers.
they are chock full of adjustments and "underlying" and reported profit increases but
underneath all that

Debt rose - not big but going the wrong way
FCF generation fell - not big but down
There are obvious issues in North Europe and the US - no hiding those - big numbers.
Some of the other areas have grown well.

Overall it looks like adding Europac has let the ship stay where it was as the original business has faltered. These results should have been a big fanfare on how the market was wrong to underestimate SMDS but they havent done that. the allegation was that they had overpaid and at the wrong time in the cycle. i don't think these results have proved the maysayers wrong

[gabsterx] 05/12/2019 14:51

Did anyone watch the webcast? One of the analysts highlighted that the results ex. Europac (ie organic growth) was negative, there were some evasive answers by the CFO rambling about the addition of Europac making 'mathematical' sense and that prices of paper had gone down by 20% so what did he expect.. Not very convincing.

They did give a strong guidance for H2 growth though and underlying fundamentals are still sound, I'll be adding some more shares of it drops below 350p.

[moorsie2] 05/12/2019 14:19

Market really destroying this half year result news. Management needs to reflect and consider a way forward

[martindjzz] 05/12/2019 10:42

Been holding since mid 2015 and am slightly underwater versus my average acquisition cost with divis producing an overall positive return for me. Having listened to the half year webcast this morning I am optimistic about better times ahead.

[marksp2011] 05/12/2019 08:35

I would strongly recommend reading Note 3 to the accounts

[gabsterx] 05/12/2019 08:13

Market does not seem to like it, probably read through the lines that organic growth was weak and masked by Europac performance.. Don't mind the correction as I've been waiting to add some more shares to my position.

[martinthebrave] 05/12/2019 07:50

SMDS A bit to do in H2 but looks okay to me. Plastics division sale to complete before year end, 30% PBT growth & pretty positive outlook "we anticipate an acceleration of volume growth in the second half of the year which, together with the resilience of our business model, supports our expectation of further growth in the year". I do hold these though as they seem to be in a nice space.

[marksp2011] 05/12/2019 07:40

That is a really mixed bag.

Revenue was flat and times look tough in N Europe and the US

Debt leverage is 2.3x
Debt is up a bit and FCF is down again.

The market will either see these as in line or, will react to the deteriorating cash position which is one of the "negatives" often quoted about the company versus the competition.

Your guess is as good as mine as to what the reaction will be but I would wait for it all to calm down before buying anything.

Then again, I could be wrong. I thought Galliford would sell the construction bit and concentrate on building houses. How wrong can one man be :)

[gabsterx] 05/12/2019 07:38

Solid results, however not looking good in North America where rapid growth was expected. Got hammered both on top line and even more on profits.

Also this: "For the half year period, revenues increased by 3% (4% on a reported basis), principally reflecting the contribution from Europac and volume growth in corrugated boxes."

I was not able to find how much Europac contributed to revenue.. I think we would have seen a decline in sales without the Europac boost.

[togglebrush] 05/12/2019 07:13

Interims out Revenue (+4%), Profits before Tax (+30%),
Divi 5.4p (+4%) XD 14 Apr Paid 1st May

[riggerbeautz] 05/12/2019 07:12

Those results look good to a new investor, be interested what everyone makes of them.

[jeffian] 04/12/2019 10:57

Maybe, maybe not. I think macro-economic issues rule at the moment - Brexit, trade wars, banking system worries - so good results do not necessarily get their immediate rewards. This is one of my bigger holdings as a result of transferring part of my ill-gotten gains from RPC and for me it is just a question of leaving it there and collecting the divis with the aim of long-term growth, not short-term gains.

[97peter] 03/12/2019 22:11

Should be good figures with turnover and acquisitions and sales all sorted and doing well. Then Friday and or Monday we should see SMDS back over 400p.

[moorsie2] 03/12/2019 17:21

Sector has had a horrible two days. Lets hope management impress with dazzling numbers and story on Thursday