FTSE 100: where next for UK packaging shares?
Packaging companies have suffered the same falls in value as the wider market, but they have been deemed essential whilst countries remain in lockdown to battle the coronavirus.
Most businesses are having a tough time adapting to the disruption caused by the coronavirus, with many unable to stay operational whilst countries remain in lockdown. However, packaging companies have been deemed essential during these uncertain times as more people shop online and more goods are shipped to the doors of homes and businesses.
According to Statista, the number of weekly online orders being made in the UK has soared and is continuing to accelerate. Throughout most of February, when the worst of the outbreak was yet to be recognised outside of Asia, online weekly orders were up between 30% to 40% year-on-year (YoY). In the week to 22 March – the day before the UK officially entered lockdown – online sales jumped 115% YoY, and the most recent data, covering the last week of March, shows orders jumped 200%.
Even the king of online shopping, Amazon, has struggled to cope with the spike in demand as people are forced to order goods online as they are unable to go shopping in bricks-and-mortar stores. And the few physical stores that do remain open, like supermarkets, are still seeing record demand for online groceries.
Considering their markets look likely to prove resilient over the coming months, it is somewhat surprising that all three of the FTSE 100’s packaging stocks – Smurfit Kappa, Mondi and DS Smith – have all seen their share prices fall roughly in line with the wider market since the start of 2020.
One contributing factor will be the fact that all three of them have cancelled dividend payments in response to the coronavirus crisis. Despite the fact that they should remain among the most cash-generative during these testing times, the trio have felt it is prudent to hoard cash and shore up the balance sheet so they can tackle whatever is thrown at them over the short term.
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Smurfit Kappa is the largest packaging stock listed in the UK. It is one of the largest producers of packaging in Europe, operating in 23 countries, and is the only one working across the Americas.
‘We are an integral part of today’s vital supply-chains, whether it is ensuring that retailers remain supplied with food and other basic goods or ensuring that critical pharmaceutical and medical supplies and devices reach hospitals and other health care facilities where they are needed to fight this pandemic,’ said chief executive officer (CEO) Tony Smurfit.
The company said all of its facilities had remained open when it released quarterly results on 15 April, and that demand in the three months to the end of March 2020 had increased. Volumes in Europe and the Americas rose 3% and 3.5%, respectively, but the company still reported lower revenue, tighter margins and a decrease in earnings in what it described as an ‘obviously challenging environment’.
It is worth noting that Smurfit Kappa also has its own forestry and recycling operations that help feed its own supply chain and produce packaging and paper.
Smurfit Kappa said the ‘full extent and effects of the macro and economic risks brought on by COVID-19 are unclear’, but stressed it remains ‘very well positioned both financially and operationally’. Smurfit Kappa should continue generating cash and has over €1.5 billion of liquidity to tap into. It’s next material debt payment isn’t due until 2024.
Still, the company is being precautious by cutting costs and any unnecessary expenditure. For example, the capital expenditure budget for 2020 has been cut from an original sum of €615 million to between €500 million and €550 million, down from the €730 million spent last year. But shareholders are having to contribute too after it clawed back the final dividend for 2019 of 80.9 cents per share that was due to be paid in a few weeks’ time.
‘The group’s performance in the first quarter (Q1) was strong and its balance sheet, liquidity position and cash flow generation continue to give the board confidence in the prospects for our business and its strategic direction.
However, in light of the increased macro uncertainty due to the COVID-19 pandemic, the board believes it is prudent to no longer recommend the previously proposed final dividend of 80.9 cent per share and as a result to withdraw Resolution 3 at the forthcoming annual general meeting (AGM) on 30 April 2020. Beyond the current uncertainty that COVID-19 brings, the board remains committed to providing shareholders with an attractive and progressive dividend stream.
The board will make an assessment of the quantum and timing of a dividend later in the year when the effects of the current COVID-19 pandemic are better understood,’ said Smurfit Kappa.
Mondi is the second-biggest UK-listed packaging provider. It has operations across the world, but they are predominantly concentrated in Europe and North America, and it also boasts its own forestry and recycling operations within its supply chain.
‘Our businesses have generally been designated as providing essential services by governments in the countries in which we operate, allowing the group to play an important role in responding to the COVID-19 pandemic,’ said Mondi on 9 April.
The company said virtually all of its facilities had remained open during the first three months of the year apart from a temporary closure of one paper mill in South Africa and some other interruptions to production at a ‘small number’ of its paper bag converting plants. It warned that while issues with its supply chain have been ‘manageable’ to date, it is suffering longer delays and higher logistical costs.
Mondi said underlying earnings dropped 18% YoY in Q1 of the year, mainly as a result of lower prices, but the result was largely flat from the final three months of 2019.
The company said the ‘potential impacts of COVID-19 remain very unclear and the pace of change means any effect on operations and the group’s financial performance for the year are difficult to predict.’ As a result, it is cutting costs and has also ‘slowed down’ some of its major capital projects.
It said this will mean ‘limited delays to the commissioning of certain of our capital investment projects’ and that annual mill maintenance shutdowns have been postponed until H2 of the year. The capital expenditure budget will now be €600 million this year rather than the original budget of €700 million to €800 million.
Mondi has an equal amount of liquidity as its larger peer at €1.5 billion, having recently raised €750 million by issuing an eight-year Eurobond at the start of April, which it said ‘demonstrated its access to the public bond markets’.
Although Mondi recently struck a deal with its core lenders to postpone the payback date of its €50 million revolving credit facility from July 2021 to July 2022, the company will still have to pay back or refinance its debt sooner than its two peers.
It has a €500 million Eurobond maturing in September 2020. But, beyond those two commitments, its next material debt maturity won’t occur until 2024. Plus, it has more headroom than its rivals with net debt to underlying earnings ratio of 1.3x, compared to Smurfit Kappa at around 2.2x and DS Smith at around 2.0x.
The final dividend for 2019 that was due to be paid in the coming weeks has been postponed, with Mondi stating it was part of ‘proactive measures to manage the current risks’.
Importantly, whilst it remains unclear whether Smurfit Kappa or DS Smith will return the sums they have clawed back from investors at a later date, Mondi is the only one of the three that has said it is postponing – not cancelling – its final dividend payout.
‘The board recognises the importance of dividends to shareholders. While it is its intention to pay a dividend, the board will consider the appropriateness, quantum and timing of an additional interim dividend payment relating to the financial year ended 31 December 2019 when it has a clearer view of the effects of COVID-19 on the business and outlook,’ said Mondi.
DS Smith is the smallest of the trio but it is still a large player in the market with operations in 37 countries. It also has its own recycling operations that are slightly smaller than Smurfit Kappa’s in terms of volumes. Customers include the likes of Tesco, Pets at Home and Mondelez.
‘Some online retailers and food suppliers are experiencing extraordinarily busy periods as more people try out home delivery while social distancing, making packaging a crucial element in these supply chains,’ said the company’s head of strategy Alex Manisty.
The company’s last update was released on 8 April, when it confidently said there had been a ‘relatively limited impact from COVID-19 seen to date’ and that trading had ‘remained resilient’.
‘In virtually all markets in which we operate, governments have classified us as a critical business involved in the supply of packaging to sectors such food and essential products. All our factories are, and have been operational throughout, albeit with further enhanced safety and hygiene standards,’ said DS Smith.
DS Smith said volumes had continued to grow and that its ‘focus’ on the fast moving consumer goods (FMCG) sector had proven beneficial over recent weeks. FMCG includes many grocery items and the firm has been ‘very busy’ in areas such as ambient food, drinks, hygiene, frozen food and dry packaged groceries. It said ecommerce packaging demand had been strong in most categories, but particularly for everyday essentials. ‘These are sectors where we have clear market leading positions with outstanding service and product quality. The industrial sector has however been heavily affected but our more limited exposure has protected us,’ DS Smith explained.
DS Smith looks to be the most bullish as the coronavirus crisis unfolds although it still decided to scrap the final dividend for 2019 that would have hit shareholder’s bank accounts at the start of May.
The company has £1.4 billion in liquidity and should remain cash generative, but said it is ‘conscious that we are operating in an exceptionally uncertain global environment and we will inevitably be impacted by any severe prolonged downturn in global economic activity.’ Fortunately, DS Smith doesn’t have any material debt due until 2023.
DS Smith is due to release annual results covering the year to the end of April 2020 on 2 July. It hopes to have a ‘clearer view’ of effects of coronavirus by then and said it will review the situation with the dividend then.
DS Smith seems more concerned with the economic picture after the coronavirus crisis is over rather than the current disruption it is causing. However, it also sees long-term benefits too. ‘With home delivery during this period a first time experience for many, we can also foresee potential long term structural changes to the market as they continue to rely on the ease and flexibility of having goods delivered directly to their homes even after the lockdown has been lifted, said Manisty.
Where next for packaging stocks?
Packaging companies will remain essential whilst countries remain in lockdown. Although not all areas have proven resilient with, for example, less need for industrial packaging right now, all three of the UK’s blue-chip packagers should be able to capitalise on overall higher demand whilst countries remain in lockdown and people stay at home.
Still, they will have to spend money to adapt to the situation and respond to the disruption being caused to its operations and supply chain. Plus, social distancing will also reduce efficiency for the time being, contributing further to an increase in costs. The challenge will not be meeting increased demand but balancing it with the higher costs the coronavirus pandemic brings.
But the major concern of the sector does not appear to be the short-term issues the virus is causing but the long-term economic effects and the state of play once lockdown measures end. Nobody knows how everything from gross domestic product (GDP) to unemployment to wage growth will perform once lockdown measures are eased and the virus is contained - but it is fair that pessimism is winning over optimism right now. Still, this will be a challenge for all businesses, not just the packaging sector.
All-in-all, packaging companies should remain resilient in the current climate and have the potential to outperform the wider market over the short term. Dividends may be off the table for the foreseeable future but earnings and cashflow should hold up and the trio should be able to restart dividends sooner than other sectors that will take longer to recover.
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