DS Smith confirmed yesterday, in response to press speculation, that it had received an early expression of interest from rival Mondi for a potential deal.
No proposal has been received and there's no certainty that a proposal will be made. According to regulation, Mondi has until 7 March to provide further details on whether it intends to make an offer or not.
The shares rose 9.8% on the day.
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Our view
Shares jumped on news that DS Smith has received a very early sign of interest from rival Mondi on a potential deal. There are attractive qualities to a potential combination of the two operations. But we should be clear, there's been no indication of how a deal may be structured nor any confirmation that a proposed deal will actually come to pass.
Investors should continue to focus on the business fundamentals. On that front, selling cardboard boxes might not be the most exciting business model in the world, but DS Smith's resilience in tough conditions has allowed it to mitigate some of the macro-economic headwinds currently faced by its customer base.
The group's a key supplier to e-commerce groups, providing the cardboard boxes that are a familiar sight outside houses up and down the country. 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. Looking further ahead, demand for these segments is benefitting from structural growth drivers - consumers are keen to shift away from plastic packaging, and reliance on e-commerce is a trend that's here to stay.
The global economy isn't exactly firing on all cylinders though which is causing a dent in volumes. While this will need monitoring, it isn't all bad news. Input costs have fallen following a period of prolonged upwards pressure. The group's robust approach to pricing means that while it has passed on some of this benefit to customers, it hasn't been at the expense of operating margins.
We're cautiously optimistic that volumes will rebound in the second half of the year. There are early signs that customers, think Amazon, are back in the market after reducing packaging levels last year to cope with lower levels of end-consumer demand. We should also start to see easier comparable periods acting as a tailwind.
Looking at the balance sheet, despite the recent increase in net debt levels, 1.7x cash profits is still a level we're comfortable with. The lack of cash generation seen in the first half was disappointing but we're hopeful that this was a blip rather than a trend. It's something to keep an eye on though.
There's probably scope for a buyback or bolt-on acquisitions, but the focus is organic growth and efficiency improvements - which makes sense. The forward prospective yield sits at an attractive 5.9%, which looks well covered for now. As always there can be no guarantees.
DS Smith is in a strong position with exposure to attractive end markets. The valuation currently sits a good way below the longer-term average, which we feel offers potential upside. But remember, this also reflects ongoing economic uncertainty so be prepared for further ups and downs.
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.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.
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