First quarter trading has been in-line with expectations. Box volumes declined slightly on a like-for-like basis, but are still expected to grow 2% for the full year. The outlook for the year is unchanged.
Nearly all input costs, including energy, have increased significantly, but improved efficiency and the long term hedging programme have "substantially" mitigated this. The group remains 90% hedged against the price of natural gas for 2023 and roughly 80% hedged for the year after.
Cost efficiencies and successful increases in packaging prices have boosted profitability and cash generation. At the same time, the group's mindful of economic uncertainty and is seeing some weakness in its Industrial customers, which is currently being offset by its exposure to fast moving consumer goods (FMCG).
The shares rose 3.0% following the announcement.
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Our View
While most businesses nurse growing inflationary wounds, DS Smith is out there proving that people will pay anything for a product they need. In fact, DS Smith's doing more than coping, the cardboard box maker is thriving in a difficult environment.
The group is a key supplier to ecommerce groups - providing the cardboard boxes that have become a familiar sight outside houses up and down the country, as we shifted to online shopping during lockdown. DS Smith also sells its boxes to consumer goods and food groups. These include many of the ''shelf-ready'' cardboard boxes you'll find in the supermarkets. Those two groups make up over 80% of DS Smith's business.
Demand in these segments has been resilient - consumers are keen to shift away from plastic packaging and reliance on e-commerce is a trend that's here to stay.
Crucially, profits have come along for the ride, where we'd been concerned this wouldn't be the case. Costs are an ongoing point of interest where DS Smith's concerned. It makes much of the paper it needs in-house, and wants to cut that even further to around 60%. This means DS Smith gets its raw materials cheaper when paper prices fall in tough times. However, when the industry is booming and paper is more expensive the group's margins get squeezed. With commodity prices on the rise, this goal likely isn't a priority.
Input costs are on the rise, and to cope, DS Smith is increasing its own packaging price while deploying contracts to protect against unfavourable gas prices. This strategy is currently helping offset those rising costs. Higher packaging prices haven't upset demand so far, insulating the group from inflationary headwinds. However, with the cost-of-living crisis looming large in the background, a slowdown can't be discounted. DS Smith's customers won't be buying more boxes if their existing ones are still sitting on the shelves.
We're pleased to see the group's used some of the cash flowing through the business to lower net debt, bringing it back down to more manageable levels. The balance sheet looks in good shape for now, but softening demand could change that as costs continue to rise.
That brings us to the group's dividend, which is back on the table after a Covid-related pause last year. In light of improving trading, the 6.3% prospective dividend looks to be well-covered. However, this is contingent on price increases continuing to offset rising input costs without denting volumes. This isn't guaranteed.
Overall, we think DS Smith is in a strong position with exposure to attractive end markets. We don't think those strengths are necessarily reflected in the current valuation, but remember this also reflects the ongoing uncertainty.
DS Smith key facts
All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.
Full Year Results (21 June 2022 - Constant Currency)
Ignoring the impact of exchange rates, full year revenue rose 26% to £7.2bn. This was helped by a 5.4% increase in like-for-like corrugated box volumes, thanks to strong demand among fast moving consumer goods and other consumer-related sectors, which make up about 80% of overall volumes.
Price increases offset rising input costs, which meant underlying operating profit was up 29% to £616m, slightly beyond management's guidance.
The group's expecting corrugated box volume growth of 2-4% in the current year, with price increases and cost management offsetting inflationary costs.
A final dividend of 10.2p per share was announced. This brings the total for the year to 15.0p, up 24%.
Revenue in Northern Europe rose 21% to £2.8bn. Strong performance in Germany and Benelux offset declines in the UK, as the region lapped las year's exceptionally strong demand due to the pandemic. Underlying operating profit improved by 5% to £139m as price hikes more than made up for rising input costs.
The return of tourism drove a volume recovery which saw revenue rise 33% to £2.7bn in Southern Europe. Underlying operating profit rose 53% to £324m, helped by higher paper prices. Europac, acquired in 2019, contributed to the improved profitability with return on sales of 12%, in line with management's target.
Rising corrugated box volumes helped revenue in Eastern Europe rise 30% to £1.1bn. However, operating profits were flat at £73m reflecting the lag between higher paper prices and increased packaging pricing.
Packaging volumes were strongest in North America, where revenue rose 14% to £597m. Underlying operating profit improved 31% to £80m, reflecting better paper and packaging prices.
The site in Italy is now fully online and Poland's expected to be operational over the next few weeks. At full capacity, the two will add around 3-4% more packaging capacity and have been 80% pre-sold so far.
DS Smith plans to spend around £500m in capital expenditure, a 20% increase.
Improved profitability meant free cash flow improved by 7% to £519m. This helped net debt fall from £1.8bn to £1.5bn, or 1.6 times underlying cash profits (EBITDA).
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