Cardboard boxes are essentially commodities, and while global supply chains are still problematic, one box maker still looks very interesting - Smurfit Kappa (LSE:SKG, Financial). This company is vertically integrated, meaning it handles multiple stages of the manufacturing process. That is to say, it does everything from growing trees to making paper, converting paper into cardboard boxes and recycling.
Smurfit sources most of the materials for its packaging factories from its own paper mills. This provides protection against material cost inflation. It also provides security supply – a term now in vogue. In contrast, competitor Mondi (LSE:MNDI, Financial) is having problems because part of its supply chain is in Russia. Smurfit Kappa has invested heavily to get further protected via international diversification, buying a containerboard mill in Northern Italy and a corrugated facility in Buenos Aires.
Smurfit still faces some pressures. In 2021, recovered fibre cost the group an extra 440 million Euros ($469 million) compared with 2020. Energy costs were up €235 million. The company proved resilient, though. Revenue was up by 18% in 2021, while profit before tax rose by 22%. Management tackled a 24% increase in cost of sales by increasing its own prices, which was tolerated well in a period of strong final demand.
CEO Tony Smurfit confidently predicted in February that there would be further margin improvement for 2022. Recent events have cooled that view somewhat. In a trading update published recently, Smurfit said Q1 had presented “a number of significant operational challenges.” Input costs have risen sharply and tight markets and supply chains were made worse by the war in Ukraine.
Smurfit highlighted that these challenges are being dealt with through active pricing, but the CEO made no mention of margin improvement.
However, longer term trends give plenty of reason for optimism. In Q1, both revenue and Ebitda added a third compared to the year-ago quarter, and the group’s Ebitda margin was flat at 17%. This good performance was also evident at rival DS Smith (LSE:SMDS, Financial), which noted packaging price increases have “more than offset” input cost increases in the last year and it expects adjusted operating profit to come back after a troublesome 2021.
Demand outlook
The key question is, can packaging demand keep up? Smurfit Kappa was well positioned in the begging of the pandemic as online shopping grew quickly and so did the demand for cardboard. Revenue grew quickly, and shares more than doubled between March 2020 and August 2021. Obviously in more recent times, the e-commerce boom is starting to soften.
That said, Smurfit Kappa is resilient. About 70% of the group’s sales are generated by customers in the fast-moving consumer goods market, which provides revenue stability. Demand from its industrial customers is likely to rise now that industrial production is picking up.
Competitive advantages
Smurfit Kappa’s geographical diversity is also a competitive advantage. With more than 350 production sites in 36 countries worldwide it’s not too exposed to any one place. Most earnings are generated in Europe, but about a quarter of profit is made in the Americas, and Smurfit Kappa is the only large-scale, pan-regional player in South America. Box demand growth in the Americas is strong at 6%, and margins are nearly 20%.
There should be growth in Europe, too, as compared with North America, European packaging is still fragmented. Smaller producers will be hit harder by energy price increases. If prices get too high, their production levels are likely to drop off. This gives Smurfit Kappa an upper hand thanks to its economies of scale and the potential to pick up distressed assets though acquisitions.
The move from plastic packaging to paper and cardboard is also a long-term demand driver. The company has decent eco credentials via its focus on sustainable packaging. Government policies in Europe are pushing more businesses towards paper products. Smurfit Kappa issued €1 billion worth of green bonds last autumn.
Value
Smurfit Kappa's balance sheet situation is decent. The net-debt-to-Ebitda ratio is only at 1.7. A a large proportion of its debt is fixed rate, so near-term interest rate rises won’t hurt too much.
Super fast growth is coming to an end as people in many countries are mostly ignoring Covid. This was shown it the group’s latest update, which showed demand for corrugated boxes grew by only 3.6% in Q1 2022 compared with 8% growth in 2021.
Smurfit Kappa’s stock price has fallen by about 20% since its September peak. Its forward price-earnings ratio is just under 12 based on analysts' estimates of future earnings, which is slightly lower than the five-year average price-earnings ratio of just under 13.
The GF Value chart rates the stock as fairly valued:
The PEG ratio is currently at just 0.8, compared with a five-year average of 2.5. The sector average is 1.1. I think the market is missing something on this stock; it seems the higher growth is making this stock more undervalued than it was in the past.
