Stock analysis: FTSE 100 Packaging and Paper

Ecommerce is here to stay, and I might have missed the huge initial growth that is now knocking lumps out of UK high street retailers. However, from my recent investment in BBOX, I’m hoping will generate a steady return from businesses seeking to capitalise on ecommerce. Other possible investments into the “infrastructure” of Ecommerce include logistics/ delivery, payments, online security and packaging. I’ll take a look at packaging, as I think this also plays into the theme of the circular economy and attempts to reduce our use of plastics.

There are 3 packaging businesses listed on the FTSE 100:

• Mondi (MNDI)
• Smurfit Kappa (SKG)
• DS Smith (SMDS)

All three produce various types of packaging, mainly of paper and cardboard, and also some plastics.

Without poking around too much in the minutiae of the individual businesses, lets see if crunching a few numbers can give any indication of where to start.

For all financials I’ve taken the last 10yrs published accounts, which for MNDI and SKG are from 2008 to 2017, and from 2009 to 2018 for SMDS, so in the charts below I've just numbered the years to represent the last 10yrs data. Also just to make life awkward, MNDI and SKG report in Euros, and SMDS report in sterling, so I’ve translated everything back into sterling using historical average exchange rates taken from here.

Hindsight

With reference to investing, we're always told that the past is no guide to the future, but, it's one of the few bits of information that we have to work with. So I'm going to use it anyway. First of all, what would have happened if I had invested £1000 into these businesses 10yrs ago:

Mondi, Smurfit Kappa, DS Smith Historical Investment

As we can see an investment in any of these businesses would have generated a nice return, with DS Smith ahead of the other two until the end of 2018 when the prices of all 3 dropped, leaving Mondi slightly ahead (this includes dividends taken as cash rather than reinvested). So in summary, £1000 invested would have done the following:

	Capital increase	Total dividends	Total return
Mondi	£4725	£787	£5512
Smurfit Kappa	£4024	£543	£4567
DS Smith	£3804	£1162	£4966

Even with various assumptions, currency conversions, and general messiness constituting some degree of error this still looks like a fine return to me. What are the chances of it continuing?

Does size matter?
These three are in the FTSE 100 so they are big companies, and since we're told that "elephants don't gallop", size, based on market capitalisation as at 1^st Feb 2019, and some info from the latest annual reports we have the following:

	Market Capitalisation	revenue	employees
Mondi	£6805m	£6221m (€7096m)	26300
DS Smith	£4655m	£5765m	28500
Smurfit Kappa	£5247m	£7506m (€8562m)	46000

Mondi, Smurfit Kappa, DS Smith Revenues

Depending on how you want to think about size, Mondi is worth more, Smurfit Kappa generates higher revenues, Smurfit Kappa also has more employees. Each has a wide geographic diversification, across several continents, but arguably not different enough to use as a factor to differentiate between them.

Efficiency

Combining a couple of those numbers in the table above, we can see that Mondi generates more revenue per employee than the other two which seems much more interesting as some measure of efficiency of the business.

	Market Capitalisation	revenue	employees	% revenue per employee
Mondi	£6805m	£6221m (€7096m)	26300	0.0038%
DS Smith	£4655m	£5765m	28500	0.0035%
Smurfit Kappa	£5247m	£7506m (€8562m)	46000	0.0022%

These businesses require a fair degree of capital expenditure to keep their production plants running, and they require import of raw materials, and partly generate raw materials themselves – from home grown trees. In order to cut through some of that noise I’ve decided to look at just net margin. This seems like quite a nice simply measure – and essentially tells you how much of each pound/ euro is actually profit, in other words, 10% net margin means out of every pound the business makes, 10p is profit.

Mondi, Smurfit Kappa, DS Smith Net Margin

As margin is a proportion of revenue I haven't converted currencies, but the above is interesting, Mondi clearly doing a better job with margins.

What about Return on Capital Employed – another measure of efficiency, this time measuring how effective the businesses are at turning capital into profit, a ROCE of 10% means that for every pound/euro invested, the business makes 10p. 

Mondi, Smurfit Kappa, DS Smith ROCE

As we found looking at margin above, Mondi seems to be more efficient than Smurfit Kappa and DS Smith at generating profits.

Returns

So what cash do these businesses generate, and importantly, as an investor interested in dividends, how much of that cash finds it's way to my bank account. I want my investments to pay dividends, I want those dividends to grow, and to be secure. To start to get a feel for this I’ve looked at the Free Cash Flow (FCF) to Dividend cover, rather than earnings cover. Dividends are paid out of cash left over once all other bills have been paid, bills are paid out of profits, so profits don’t necessarily tell what you need when it comes to understanding if dividends are appropriately secure. To find the FCF cover, FCF is divided by the dividend paid for the year, the magic number is 1, if cover is above this, then the business has made enough cash over the last year to pay the dividend, less than 1 indicates that this is not the case. It is usual to expect higher coverage, which leaves the business cash to invest in itself after paying dividends. Less than 1 isn’t a disaster, but it will mean the business is eating into cash reserves or borrowing to pay the dividend, neither of which is sustainable longer term.

Mondi, Smurfit Kappa, DS Smith FCF Dividend Cover

As we can see DS Smith seems to bounce off of the line showing a coverage of 1 a few times, Smurfit Kappa looks to be dropping alarmingly and also missed a couple of payments in years past too, and Mondi once again looks like it’s doing a pretty good job.

Is it safe?

Each of these businesses has proved a reasonable investment over the past few years, but have generated cash with varying degrees of efficiency. Dividend to FCF has been a little flaky at Smurfit Kappa, but if I wanted to invest I'd want to get a view of the safety of each business through the lens of debt. I've done this by comparing the amount of debt on the balance sheet of each to their Operating Income (EBIT):

Mondi, Smurfit Kappa, DS Smith FCF Debt to Income

In this case Smurfit Kappa has seen it's debt reducing, but not as quickly as Mondi, whereas DS Smith is increasing it's borrowing compared to income.

Summary

So banging through a few numbers leaves me the following conclusions:

• Mondi is a more efficient business judged on a number of measures
• Mondi's dividend looks safer with greater FCF cover
• Mondi has less lower debt compared to it's income

Well that's narrowed things down, Mondi looks like it's worth a bit of investigation, as it looks more likely to generate cash and has less risk associated with debt. Now to the important stuff, crack open the annual report and try to understand their business...