Smith (DS) (SMDS) Ordinary 10p

DS Smith’s full-year revenue fell 16% to £6.8bn, ignoring the effect of exchange rates. Weak demand and lower prices impacted performance. Underlying operating profit fell 18% to £701mn, as expected.

Like-for-like volumes fell 2% over the year, but returned to growth in the final quarter, as customers increased promotional activity and stock levels. Positive trends have continued into the new year, including improved pricing. The benefits of this are expected in the second half.

There was a free cash outflow of £175mn, compared to a £354mn inflow the prior year. Net debt rose from £1.6bn to £2.2bn.

A final dividend of 12p per share was announced, taking the total for the year to 18p.

The shares rose 1.0% following the announcement.

Our view

This was always going to be a challenging set of full-year results for packaging giant DS Smith. The paper and packaging market hasn’t been kind. A mix of lower prices and weaker demand as businesses battle tougher conditions has hit the top line hard.

But input costs have been falling and cost savings have absorbed some of the impact, so operating margins weren’t hit as hard as they could have been.

We're cautiously optimistic that volumes will continue to improve. There are early signs that customers, like Amazon, are back in the market after reducing packaging levels last year to cope with lower end-consumer demand. There have also been positive moves in the pricing landscape, though benefits usually lag and aren’t expected to land until the second half.

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

Looking at the balance sheet, despite the increase in net debt to 2.1x cash profit, it’s just about at a level we're comfortable with. Last year's lack of cash generation was disappointing, but we're hopeful this was a blip rather than a trend. It's something to keep an eye on, though.

For all the operating chat, deal talks have dominated the news recently, and with Mondi out of the race, DS Smith is looking to press on and merge with the US-based International Paper Company.

Medium-term savings of around £413mn certainly look attractive, significantly higher than what investors had been discussing in the early days of deal speculation. There’s a lot of scope to drive efficiency gains, from integrating plants and sharing technology to using the new combined scale to push for better terms with raw material suppliers. To us, the deal makes a lot of sense.

But as ever, it’s not a done deal until shareholders and regulators give the green light. There’s also speculation that International Paper Company could end up the subject of its own takeover offer, so this story may have further twists to come.

DS Smith is in a good position with exposure to attractive end markets, and we continue to like the business. The valuation will likely be led by developments with the International Paper deal. In these situations, there’s always added risk, with upside in the short term likely to be limited by the implied deal price.

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