Financial Times | Cardboard packaging shares revival puts Smurfit Kappa in box seat

Consumer goods groups start to appreciate importance of getting the wrapping right

By John Murray Brown

This article was published by the Financial Times (FT.com) on the 7th Feb 2017

Click here to read on ft.com.

Cardboard boxes are not something that typically excites the average investor. But this week the paper and container business might be about to deliver a pleasing package of headlines that will capture their attention.

With demand for containers improving and expectations of strong results from Europe’s leading packaging group Smurfit Kappa on Wednesday, there are signs of renewed optimism in the sector that could bode well for the broader economy.

These groups may lack the glamour and profile of some of the big car companies and retailers, but the more goods, components and parts they shift in their containers and boxes tends to point to more activity in other industries. The sector is also becoming a little more racy.

“A cardboard box used to be a brown shipping container. It is now an essential part of a company’s marketing,” says Tony Smurfit, chief executive of Smurfit Kappa.

Gerard Moore, analyst at Investec Securities, adds: “Consumer goods companies are starting to see how important it is to have appealing packaging. The progress the industry has made in the last five years has been under-appreciated.”

Significantly, demand is improving despite the cost of the material used to make the boxes increasing. Additionally, the strong dollar exchange rate means that US imports are not a threat for UK and European companies.

And, unlike last year’s price rises, producers are confident the recently announced increases will stick and feed through to improved box prices. This will help boost profit margins.

This optimism has been reflected in the share price performance of the three London-listed companies that dominate the European market.

All currently outperform the overall market. FTSE 100 group Smurfit Kappa is up 26 per cent in the past year, and up 14 per cent in 2017.

Mondi, another FTSE 100 company that also has a Johannesburg listing and reports on February 28, is up more than 50 per cent in the past year — and 8 per cent in the past month. For the same periods, DS Smith, which has an April year end, is up 37 per cent and 9 per cent.

Commenting on Smurfit’s third-quarter numbers, Lars Kjellberg, an analyst at Credit Suisse, says investors expected margins to be hit by Brexit-related turbulence and rising raw material costs.

But he says the shift to more value added products, cost reductions, and well judged acquisitions “have more than offset these headwinds and Smurfit Kappa delivered the fifth consecutive quarter with record quarterly performance”.

Smurfit Kappa currently trades at a discount to both Mondi and DS Smith, but having only joined the FTSE 100 in December, brokers believe that valuation gap will close as more big UK institutions buy the shares.

The reasons for the rebound in the packaging sector are multiple.

For a start, it has been helped by the digital revolution. DS Smith estimates online retailing is just 3 per cent of the packaging market, but contributes around a fifth of the growth, with more than 4.2bn parcels shipped in Europe every year.

Even without the arrival of e-commerce, underlying demand for packaging is growing steadily in Europe at about 2 per cent annually, says Matthias Pfeifenberger, analyst with Deutsche Bank.

This demand remains resilient, with food and drink — rather than items of discretionary spending — accounting for 60-65 per cent of European packaging use.

In the past, attempts to introduce price changes have encouraged smaller independent mill owners — German mills are often said to be the main culprits — to invest or start up mothballed plants, resulting in oversupply and ultimately lower prices again.

Encouragingly this time, manufacturers are showing greater self-discipline and much of the spending has been in acquiring existing plant rather than in additional mill capacity.

Sometimes, this has been through converting old newsprint plant for packaging as the US company International Paper, the world’s largest packaging company by sales, did recently with a factory it bought near Madrid in Spain.

Deutsche Bank’s Mr Pfeifenberger points to the example of Schoellershammer, a small German mill with sales of about €100m, which last month announced investment in new machinery, even as it imposed higher prices on its customers.

“They are raising prices, while raising capacity which is quite unique” he says.

Investec’s Mr Moore said it was particularly significant when Smurfit Kappa, as the largest producer, told the market it would now charge €60 a tonne more for its products. That is, both recycled containerboard and the premium priced kraftliner, which is made from wood pulp.

Analysts think Smurfit Kappa will be the biggest beneficiary of any price improvement — largely because of its integrated business model, producing about 95 per cent of the containerboard that it needs to make the finished box.

DS Smith, by contrast, has to buy in about a third of its supply needs — and hopes to take that figure to 50 per cent in the medium term.

Mondi produces three times more containerboard than it needs, selling the balance to independent box makers across Europe.

“There is a good chance of success,” says Mr Moore. He thinks at least €30 per tonne of the price increase in the container boards and kraftliners will probably feed through to current finished box prices.