Recycling is a crucial weapon in the move towards a greener planet. So this waste paper collector is well-placed from our growing awareness of environmental issues.
DS Smith (SMDS), tipped as a BUY by UBS
Recycling is a crucial weapon in the move towards a greener planet. DS Smith is the UK’s leading collector and recycler of waste paper, from which it also manufactures and sells corrugated products throughout Europe. DS Smith owns seven mills, five in the UK and two in France, generating around 900,000 tons a year of containerboard and other packaging. It also makes plastic bag-in-box and returnable transit containers and is a leading wholesaler of office supplies via its Spicer division.
Importantly, in this cut-throat industry where operating profit (EBITA) margins are around 5%, DS Smith has huge economies of scale and is currently winning the battle against rising raw material costs by passing most of these on to its customers. Last week the board said that “performance had been in line with expectations” and that the group had done well from the recovery of higher input costs and a turnaround at Spicer. It also reported buying the New Thames Paper Mill from M-real Corporation for £67m in cash, which it intends to upgrade. This should strengthen the firm’s long-term competitiveness.
So what do the numbers look like?
After a strong first half, in which organic revenues grew 10%, UBS forecasts sales and underlying earnings per share of £1.9bn and 19.3p respectively for the year ending April 2008. And while net debt is expected to increase to around £250m due to the acquisition, interest payments should still be comfortably covered nine times by adjusted EBITA. DS Smith also has defensive attributes. About 60% of its packaging division makes boxes for the fast-moving consumer goods sector – food, toiletries and drinks. Even in a downturn, people need to eat, drink and wash, giving the firm protection in a more frugal climate.
So far so good, but what do we need to watch out for? The main concern is severe economic slowdown. The group has relatively high fixed costs, especially in its packaging facilities, and is also exposed to rising waste paper, energy and polymer costs – albeit offset by good pricing power with its customers. Another cloud is that rivals Mondi, Hamburger and Progroup are all building more capacity, while a number of other private companies are thought to be doing the same.
Clearly, if the market gets flooded with extra supply then it will be hard for DS Smith to keep lifting its prices – although it’s worth mentioning that there are rumours of capacity closures across the industry. There’s risk here, but the shares are good value on under nine times earnings and yielding 5.4%. Preliminary results are due out on 26 June.
Recommendation: SOLID VALUE at 166p (market capitalisation £660m)
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments