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...

January share purchase no.2: BBOX

My second purchase of January was Tritax Big Box (BBOX). This is a wonderfully dull business - they specialise in the provision of "...very large logistics facilities in the UK".  Having visited a couple of these facilities, I can attest to them being very large indeed. The BBOX IPO was in 2013 and they have seen impressive and pretty consistent growth since, at the time of writing their market cap is over £2bn. Their tenants make up a nice cross section of both UK and international businesses, including Screwfix, M&S, through to Amazon and Unilever.

The ecommerce goldrush is already is full swing (take your pick of stats here), but there's still gold in them hills, and as everyone knows the best way to make money in a goldrush is to sell shovels. Logistics being one type of shovel for the current day.

BBOX is a Real Estate Investment Trust, these are financial vehicles that came into being in the UK in 2006/7. In exchange for following certain rules around their design, these businesses avoid corporation tax and capital gains tax on their property portfolio, and are required to payout 90% of their income to investors. However, since they are paying out most of their cash, when it comes to investing in their business, and going after more properties, they will typically have to raise money through issuing more shares, or borrowing, neither of which is perfect. It's a convenient way of investing in property without all of the usual hassle that typically comes with actually buying property.

Based on their Q3 factsheet, issued in September 2018, the average lease had around 14 years to run, all assets were occupied. Their customers look, like a relative sound set of businesses, but with a couple of exceptions, most notably New Look, which appears to be struggling. Marks & Spencer and Dixons Carphone have also had their difficulties recently. However, apart from those 3, the remainder look like very solid businesses.

I've had my eye on this for while, but the price had moved steadily upwards, not offering a dip to buy into until the summer just past when the price started sliding. It kept sliding all the way to offering a discount of nearly 8% vs. NAV, which considering it had hardly offered any discount in it's history looked pretty tempting. Then just after the January trading update BBOX announced the acquisition of db Symmetry to add to the BBOX asset portfolio. Since the acquisition was viewed as dilutive, the share price took a dip from what I could gather the overall impact of the additional assets would outweigh this.

Now unfortunately I'm no expert on REITS, and I didn't feel as if my screeners, and excel number crunching tools could be applied, but I'm quite comfortable with this. I see it as a fairly defensive investment, that should pay a steady dividend and it adds some diversification to the portfolio too.

Portfolio housekeeping & 2018 performance

Having decided to try to get a bit more serious about my investments I thought the new year should start with some housekeeping. There were a few things irritating me about my record keeping:

• drip feeding money in made it difficult to assess performance
• automatic dividend reinvesting
• tracking costs

Problem 1 - I've unitised the portfolio. There's a great post about this on Monevator, it's a lot easier than I thought and really helps to cut through the noise created by adding in funds.

Problem 2 - As I was lazy I was automatically investing dividend payments. This made keeping track of what I had invested a bit of a headache. Although a case can be made for thinking of this as pound cost averaging in a sense, it was pushing up costs, and purchasing small numbers of shares where on reflection I didn't necessarily want more invested. So that is now cancelled, and I will be reinvesting once a pot of dividends has accumulated.

Problem 3 - I was trying to separate all costs to track them, and to build them into tracking portfolio performance but this was complicated by problem 2. I've now decided to still keep a record of all costs, but I've now built this into the original price of the share. So the original price against which I'll track is price + costs, making life lots easier.

So having spent some time tidying up, getting ducks in a row, the 2018 performance ended up being -1.4%. Not great since objective 1 is to not lose money. However, it compares favourably to the FTSE All Share, I'm taking the Vanguard FTSE All Share Accumulation fund as my initial benchmark (maybe a global tracker would ultimately be more sensible...one thing at a time...), which ended the year -5.4%. A quick look at the monthly movements indicated that my portfolio is more stable, dropping and rising less than the index, which if it continues I'll be happy with.

January share purchase no.1 : MANX

The Alternative Investment Market is home to many weird and wonderful businesses, some of which are household names, and based on market capitalisation would comfortably sit in the FTSE 250, and even make a run at the FTSE 100 – just check out Burford Capital (BUR), Fevertree (FEVR) or ASOS (ASC). It has a lighter regulatory framework to the main market and therefore has greater regulatory wriggle room which could be exploited by badly run businesses, a quick Google search will reveal plenty of examples.

Manx Telecom (MANX) is a telecoms company operating on the Isle of Man (the clue is in the name 😊). They provide fixed line, broadband and mobile telecoms, run a couple of datacentres and are launching a new product to help mobile users with hearing difficulties. They were admitted to the AIM in February 2014.

So the first purchase of the year is a bit leftfield, falling into the speculative part of the portfolio, and therefore was a smaller purchase…

As a speculative investment, I’m not expecting them to meet my standard investment criteria. However, they are appealing for a couple of key points. As the leading comms provider on the Isle of Man there is clearly a “moat” around their business and their core revenues from the residents of the Isle are “sticky” – at least there is going to be a degree of cost involved in switching to an alternative supplier. And their new products, should they prove successful should act as a decent tailwind for the stock. They are a capital intensive business, with more debt than I would like, which is not ideal, but it is defensive in nature.

The share price has been in decline over the past few months and at the time of purchase it looked as if it was finding a bottom (hopefully I’ll not be posting something here in a few months about catching falling knives). Partly as a result of the share price fall, at the time of purchase the dividend yield was around 7%. Anything above 5% gets a big thumbs up, but given the new products, and potential investment required, I wouldn’t be surprised to see the dividend reduced. For 2017 the full dividend per share was 11.4p, adjusted earnings per share was 13.28p and cash flow per share around 10p per share (depending how you calculate it).

Portfolio spread across indices

As you can see the portfolio at the start of the year consists mostly of investments in large FTSE 100 businesses, the next largest chunk is with FTSE 250, and a sprinkling of smaller investments.

portfolio spread across indices

It's ended up like this more or less by accident, but I'm actually pretty happy with this structure. I'm going to aim to have no more than 10% invested in smaller business to hopefully reduce risk and volatility.

I will also be investing in businesses listed overseas, and have my eye on a few US investments. I'm holding off for the moment until the Dollar vs Sterling rate improves, and I also suspect the US markets are likely get a little cheaper throughout the year.

In the meantime geographical diversification is via international businesses listed on the FTSE.

Hello world

So this is an attempt to keep an online diary of investments.

I'll post some background about me at some point, but lets get started.

Porfolio sectors at 1st January 2019: