D.S. Smith (DITHF, DSSMY) has fallen from the start of the year like much of the rest of the market, but hasn’t made much recovery. I think it is a well-run business with continued opportunity for future growth so see the current price as a good entry point. It’s not an outstanding stock but for exposure to packaging with a normally good yield, it’s worth a look.

D. S. Smith: A Proven Packaging Growth Story

D.S. Smith provides packaging, corrugated case material and recycling. So it is firmly focused on a market which is set to grow in line with population and consumption growth, commercial and industrial packaging. I like the simple focus.

Its focus is Europe, with a smaller but growing business in the U.S.

Source: company 2019 annual report

The company has had a good run of growth. Although it is easy to think of packaging as a fairly mature industry, things like Internet shopping have driven up demand for packing materials in recent years. As well as organic growth the company has grown through acquisition, a strategy which persists.

It’s fairly strategic for an operator in what is quite a basic sector, as its simple but powerful strategy illustrates.

Source: company 2019 annual report

Its customer and employee engagement rates are high and I think this helps drive profitability. Doubling profitability is an aggressive strategy but one in which the company has form, as I discuss below in the context of margin growth.

It’s a medium margin business, but as well as revenue growth, the company has generally posted profit growth.

The company continues to grow by acquisition as it helps to consolidate a fragmented industry, which often enables efficiencies to be wrought.

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In fact the company has an excellent record of growing margins. The management deserves credit for an impressive achievement, more than doubling margins.

Source: Q4 Earnings call presentation

In 2017 it entered the corrugated packaging market in the U.S., with the acquisition of Interstate Resources, an east-coast based paper and packaging business with two paper mills and 12 packaging sites and a later add-on acquisition of Corrugated Container Corporation. In 2018, it acquired Europac, a large paper and packaging business operating in Spain, Portugal and France. Its economies of scale and efficiency can already be seen in much improved margins in the southern European business area served by Europac. (The North America number here includes plant startup costs but I also expect margins there to improve over time).

Source: Q4 Earnings call presentation

Despite Bumps in the Road The Growth will Continue

COVID-19 has taken out some demand, especially in the industrial sector, but the overall impact to volumes is limited.

Source: Q4 Earnings call presentation

The company stated that it expects “limited financial impact” in the present financial year, despite dips in volumes and additional costs, which it pegged at £15m.

There are also positive tailwinds in terms of demand. In the consumer goods segment, the increase in mail shipping plays straight into the company’s strengths.

The company has £1.4bn in undrawn facilities, which at a time like this is helpful. It has also been improving its balance sheet although debt/EBITDA remains about 2.1x, so is sizeable.

Source: Q4 Earnings call presentation

D. S. Smith Offers a 6% Yield, but Payouts are on Hold

The dividend cover has been above 2x in recent years and the most recent payout, across 2019, was 16.2p, equivalent to an attractive yield of 6% or so. I think for a FTSE-100 company with a history of dividend growth, 6% is a good payout. It’s also worth noting that the company has been generous in raising its payout almost every year in the past decade.

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2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Dividend (P)

3.2

4.5

5.9

8

10

11.4

12.8

15.2

14.7

16.2

Annual growth

41%

31%

36%

25%

14%

12%

19%

-3%

10%

The company has suspended dividend payouts but said it will resume them when there is “greater clarity”. I expect that it may pay a dividend later in the year, but if not then next year. I wouldn’t invest in the company just for this yield – I think there will be long-term share price growth also as the business continues its growth record – but the yield definitely adds something extra.

After a very good run up over a number of years, in recent years the share price has languished, partly over concerns about sustaining profitable growth and the integration of the U.S. acquisitions. Having fallen this year with the market, it has struggled to climb again. Over the past five years, the packaging company peer Smurfit Kappa (SMFTF, SMFKY) (which I also like) has been a better investment by some distance.

Source: Seeking Alpha

However, I think this points to the fact that now is an attractive entry point. Future prospects remain bright and the shares, at 267p, are 30% down since the start of 2020.

Conclusion: More Growth to Come at D.S. Smith

D.S. Smith is a simple but well-run business with a proven history of growth which has driven the share price and dividends. I expect this to continue in the future once COVID-19 has passed, the economy found a new equilibrium and the U.S. operation is fully bedded in. At 267p, they are a buy and hold.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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