DS Smith – further details on the proposed acquisition by Mondi

DS Smith and Mondi have released a joint statement with further details on a proposed acquisition by Mondi.

The proposed deal is to be structured as a combination, with DS Smith shareholders receiving a 46% stake in the enlarged Mondi business. This implies a value of 373p for DS Smith shares. Three Non-Executive Directors of DS Smith are expected to join the enlarged Mondi Group Board.

This is still not a firm offer. Mondi has been granted an extension from the regulator and now has until 5PM on 4 April to make a firm offer.

The shares rose 5.4% in early trading.

Third Quarter Trading Update (6 March 2024)

DS Smith has reported flat like-for-like volumes in corrugated boxes in the third-quarter. Growth in North America and Eastern Europe was offset by weaker performance in Northern Europe.

Focus remains on improving operating efficiency and managing anticipated raw material price increases. Volumes are expected to grow moving forward, but the market remains challenging.

Our view

Deal talk continues to dominate the DS Smith story. A potential all-share offer from Mondi is on the cards and the two businesses have just announced some proposed terms, valuing DS Smith at a 33% premium to when news of talks broke out.

This is still not a firm offer and the two groups are working hard to quantify the potential value released by combining operations. The hardest part of any deal like this will be appeasing both sets of shareholders. Mondi investors won’t want to overpay and for DS Smith, at first glance, an all-share offer is less attractive than a cash buyout.

We continue to see the combination as positive for both parties but await further details.

Back to business. Resilience in tough conditions has allowed DS Smith to mitigate some of the macro-economic headwinds currently faced by its customer base.

The group's a key supplier of cardboard boxes to e-commerce and consumer goods sectors, including 'shelf-ready' options for 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.

Input costs have been falling, but the latest trading update warns container board prices may be nudging back up. While this will need monitoring, it isn't all bad news. The group's robust approach to pricing means that it expects to pass on costs to customers, so operating margins shouldn’t be affected.

We're cautiously optimistic that volumes will continue to improve in the fourth quarter. 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’re also starting to see easier comparable periods acting as a tailwind.

Looking at the balance sheet, despite the 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 5.7%, which looks well covered for now. As always, there can be no guarantees and any takeover would change the picture.

DS Smith is in a good position with exposure to attractive end markets and we continue to like the business. The valuation will now likely be led by developments with the Mondi deal. In these situations, there’s always added risk. And should the deal fall through, sentiment can quickly change.