Acquisitions can often fail to create shareholder value but packaging firm DS Smith (SMDS) is off to a good start after last June's €1.6 billion purchase of Swedish rival SCA Packaging.
The progress was reflected in a strong set of results for the year to 30 April which saw revenue nearly double to £3.7 billion, pre-tax profits up 51% at £166.2 million and the dividend hiked 36% to 8p – a full 11% ahead of consensus.
The payout hike chimed with a positive outlook statement which indicated the current year had started well and in response the shares gained 5.1% to 252.1p.
The Maidenhead firm, which makes heavy use of recycled materials, upgraded its guidance for cost synergies from the SCA deal by 20% to €120 million. It had initially estimated it would save €75 million a year after three years of ownership before raising that number to €100 million in October. It indicated SCA had achieved a return above the cost of capital in the first 10 months – a full year earlier than expected.
Strong cash generation also enabled the £2.2 billion cap to reduce its net debt to earnings before interest, taxation, depreciation or amortisation (EBITDA) to a targeted ratio of less than two times a full 12 months ahead of schedule. Helpfully the firm has a list of key performance indicators which allow you to judge the business beyond the headline figures. Based on these the company's earnings look high quality with free cash flow of £270.4 million, up 186% year-on-year, translating into a cash conversion ratio of 171%.
Broker JP Morgan Cazenove, which reiterated its overweight rating on the stock and increased its price target from 272p to 277p in response to the prelims, forecasts a free cashflow yield of 11.6% for the current financial year.
Citigroup analyst Hugo Mills, who is also a buyer with a price target of 265p, says: 'DS Smith remains a self help/special situation story with the potential to deliver 50%+ earnings per share growth, underpinned by cost saving and restructuring without any end market recovery.
Finance director Steve Dryden told Shares the group has avoided some of the pitfalls associated with acquisitions because 'this was directly in line with our strategy and we were very clear that the cost synergies would exceed our cost of capital; it has been a very structured integration.'
The combined business is the second largest manufacturer of corrugated products in Europe with a 14% market share. This is a fragmented market; Dryden explains the top three account for just 40%, and he is confident the group can grow the top-line even if economic growth is weak. A target of achieving volumes 1% ahead of GDP was achieved in the April 2013 financial year, with growth of 0.6% ahead of a 0.5% decline in the wider European economy.