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Smurfit Kappa is one of a handful of Dividend-paying companies from the Republic of Ireland. They have a long history stretching back to 1934 making cardboard boxes for the Irish Market. Acquired by Jefferson Smurfit in 1938 the company soon expanded to the USA. Jefferson Smurfit was first listed on the Irish Stock exchange in 1964.
Smurfit Kappa as we know it today was formed in 2005 when Jefferson Smurfit merged with Kappa Packaging – a Netherlands-based company founded in 1974. They have global headquarters in Dublin and regional headquarters in Amsterdam and Miami.
Smurfit Kappa have paid a dividend since 2006, but did cut the dividend for 3 years during the great recession.
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Operating Segments
Smurfit Kappa is a packaging company that serves companies like Danone and P & G. They offer consumer, retail, industrial, eCommerce, heavy-duty corrugated, as well as composite cardboard tubes, and bags and sacks; and bag-in-box, a single-use packaging system that comprises films, accessories, bags, taps, and boxes. In addition, the company offers recycling solutions to cardboard and paper products, as well as operates as a finance company.
It operates in two segments, Europe and the Americas.
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Europe
Europe is the largest of the two segments and accounts for over 75% of the revenue. The Europe segment is highly integrated. It includes a system of mills and plants that primarily produce a full line of containerboard that is converted into corrugated containers.
Smurfit Kappa currently has facilities in 23 European countries, This includes 22 mills, 193 converting plants and 29 production facilities. They have also completed acquisitions in Bulgaria and Serbia which will further help with the integration into south eastern Europe.
Even during Covid-19, Smurfit Kappa performed strongly during the first half of 2020. They have an EBITA of €575 million with a margin of 17.6%. Their flat box volumes have maintained during the first half of the year. They have completed a successful start up in Austria to increase the sustainability and efficiency of their leading kraftliner mill.
The Future Energy Plant project was part of an ongoing investment programme by the Smurfit Kappa Group to implement a series of transformative sustainable innovations. Efficient energy plants play a major role in the production of paper.
Laurent Sellier – COO Smurfit Kappa
Americas
The Americas segment accounts for the remaining 25% of revenue. This segment includes a number of Latin countries and the United States.
Similar to Europe this segment is also highly integrated and they have 12 paper mills in Argentina, Brazil,Columbia, Mexico and the United States. The mills are supported by 22 recovered fibre facilities and forestry operations and 12 converting plants.
Throughout the first half of 2020, the three main countries – Columbia, Mexico and United States performed strongly. This has been mainly due to the groups unique Pan-American offering and the increased focus on sustainable packaging solutions.
Smurfit Kapa Company Growth
Smurfit Kappa has a market cap of €9.7 Billion and a book per share value of €12.14. Its price-to-book ratio stands at 3.2.
Over the last 10 years revenue has increased from $6.67 Billion to $9.04 Billion as of 2019. This gives a CAGR of 3.09%. Over the last 5 years, the revenue grew at a compounded annual growth rate of 2.22%.
Earnings per share have increased at a much better rate from €0.23 in 2010 to €2.01 in 2019. There was a negative EPS in 2018. This was due to a higher charge for exceptional items which incurred a loss of €646 million
Free Cash flow has also grown considerably from 56 million in 2010 to 531 million in 2019.
The total debt/equity is 123% which is not a major concern for me but they have quite a high ratio of Goodwill/Equity. This means that the company is buying other companies at a price above market value. The 10 year average Goodwill/Equity is above 90% as the company has been Quite active in Acquiring companies over the last 10 years.
Smurfit Kappa Dividend
SK3 has paid a dividend from the year it was formed as we know it in 2005. However they did cut the dividend for 2 years in 2009. As a dividend growth Investor, it is is important to see how companies handles a crisis and again in April 2019 the company announced it would cut its final dividend. This is not uncommon for a European company.
The refreshing part for me was in July when Smurfit Kappa understood the extent of the coronavirus related damage they reinstated the dividend. It paid 80.9 euro cents per share in September 2020 as an interim dividend. This was a 12% yoy increase.
I like the chairman’s statement where he reaffirms that dividend remains a central component to deliver value to shareholders. Usually, I would see a dividend cut as a negative sign, but this sequence of events shows the CEO has the companies best interest but also the shareholders.
Payout Ratio
The Payout Ratio is a good indicator of the sustainability of dividends. I have discussed the different methods for calculating the Payout Ratio here.
As is the norm with European companies, They like to keep their payout ratio around the 50% mark. The EPS payout Ratio is currently at 54% while the FCF payout ratio is 45%
Smurfit Kappa Dividend Growth
Part of my Investment thesis is to invest in companies that show a good history of increasing dividends but also show good potential to continue to raise them. Companies that generate sustainable earnings growth often make the best dividend companies, as it is easier to lift the dividend when earnings are rising.
I described earlier that revenue, earnings and Free cash flow are all growing. The dividends have also grown at 24.64% CAGR over the last 9 years and 9.88% over the last 5 years which is in line with their free cash flow.
Would I buy this company?
Please see my disclaimer before reading on. These are my thoughts and are not to be used as investment advice. I am simply outlining my thought process when deciding if I should buy a company or not. Please do your own due diligence and check all data for your self.
This will be broken into 6 different sections with the maximum points per section are outlined below.
| Section | Max Points |
| Financial Strength & Future Proof | 25 |
| Management Quality | 15 |
| Dividend Quality | 20 |
| Valuation | 20 |
| Story of the Stock | 15 |
| Momentum (TA) | 5 |
| Total | 100 |
Financial Strength and Future Proof
When starting to analyze a companies’ financial position, I start with the income statement. I generally look through 10 years of statements where I am interested in the average growth of Revenue, net Income, and Earnings per share. Basically, I m looking to see there is a demand for a companies products, they generate profit after costs and taxes and their earnings are growing.
Revenue, Earnings, and Free cash flow have all been growing which is a good sign.
I also note the net profit margin and operating profit margin, over the last 10 years to ensure they are at least maintaining their margins.
n 2019 the Operating margin was 11.5% which is higher than the 10 year average of 8.8%. The Gross margin was 33% which is higher than the 10 year average of 30%. The net profit margin is 4.91% which is slightly lower than the industry average.
While I’m on the income statement I like to compare profitability ratios against the industry. For US companies I like to use Ready ratios. For Smurfit Kappa I found the comparisons on Investing.com
Balance Sheet
The next step is to analyze the balance sheet. The first step is to check how much assets and liabilities a company has and to calculate the book value, or shareholder equity.
Some of the assets may be listed as “goodwill”. If goodwill and other intangible assets are excluded from total assets when calculating shareholder equity, then you get the tangible book value.
When a company acquires another company and pays a price that is higher than the tangible book value of that company, they’ll incur a loss on their balance sheet and income statement. To avoid this problem, the acquiring company can put the difference between the purchase price and tangible book value of the acquired company on their balance sheet as “goodwill”. Whenever you see an increased amount of goodwill over a number of years you can assume the company can be buying other businesses. depending on the business they bought this can be seen as a good thing.
Acquisitions
Below is the Goodwill on the balance sheet over the last 7 years from 2013.
Below are a list of Acquisitions since 2016
- July 2018, Smurfit Kappa announced the completion of the acquisition of Reparenco, a paper and recycling business in the Netherlands. In December 2018, Smurfit Kappa announced the strategic acquisition of the Papcart and Caradec packaging plants in France
- August 2017, Smurfit Kappa expands its European operations with acquisition in Russia with the acquisition of Soyuz, a corrugated packaging company based in Moscow.
- Smurfit Kappa in 2016 acquired two integrated paper-based packaging businesses, Industria de Embalagens Santana and Paema Embalagens, based in Brazil, for approximately €186 million
Debt
At the end of 2019, Smurfit Kappa had a D/E ratio of 1.22, which is lower than the industry average of 1.52. This means the company has €1.22 of debt for every €1 of equity. This is a perfectly acceptable debt ratio for me.
Interest coverage is over 6.13 which is greater than the 3:1 ratio that I look for. Moody’s assigned a credit rating of Ba1 to SK3 which is not an investment-grade rating but they are likely to fulfill obligations in uncertainty.
Is the Balance sheet healthy
According to the 2019 reported balance sheet, Smurfit Kappa had liabilities of €2.2b due within 12 months, and liabilities of €3.2b due beyond 12 months. The net debt divided by EBITDA is how many years it would take a company to pay back its debt. Assuming that the net debt and EBITDA were held constant. At the time of writing the debt is 2.23 times EBITDA. This along with the Interest coverage above 3 is a good indicator for a solid balance sheet.
Cash Flow Statement
Operating cash flow shows how much cash a company received from operating, after expenses. For me it is good to compare this with the net Income. I am looking for the operating cash flow to be healthy and larger than net income.
Free cash flow, is the real cash profit and for me is one of the most important metrics. I like to see a company that has free cash flow equal to at least 65% of net income over the last 10 years. This ensures they have plenty of cash to keep paying us shareholders dividends. In 2019 Free cash flow was 111% of net income. The 10-year average is 90%.
Cash flow has been strong and stable over the last 10 years and grown over 10% a year on average.
Dividend Quality
At current prices, and a current yield of 2.71% I have estimated that it will take roughly 15 years to reach a YoC of over 10%. The scoring metric that I use awards 5 points if it takes under 12 years to reach a YoC of 10% and 3 points in it take under 15 years.
The current yield is greater than the SP500 by over 171% which is just under what I require to give full marks.
The dividend growth rate has been strong with 9.88% DGI over the last 5 years and 24.64% over the last 10 years.
Valuation
PE ratio
Looking at the current TTM PE ratio, SK3 would look overvalued at 21.53 times earnings. Historically the average pe ratio has been 13.85 x earnings which would give a fair value of €27.70. This would make them overvalued from a PE point of view
Dividend Discount Model
Using my multistage discount model the current estimated price is €28.45. I like to use a 10% margin of error which makes Smurfit Kappa 41% overvalued.
Discounted Cash Flow
Using a discounted cash flow model with a discount rate of 7% the fair value for SK3 was €61.45
Taking the average of all 3 methods the estimated fair value of Smurfit Kappa is €39.20 which makes them slightly overvalued at current prices.
Story of the Stock
In this section, I look at the market place in general, is it stable, can the company continue to grow? Do they Innovate and how efficient is there organisation. I also look at the overall share count, Are they reducing this over the last 5 years?
“we are increasingly excited by our future prospects and the structural growth drivers of our business including e-commerce and sustainable packaging as well as our innovative ability to capitalise on these opportunities”.
Tony Smurfit CEO
While the company has not been immune to the COVID19 pandemic, the better than expected figures points to a bright future. Smurfit Kappa Management have backed this up by reinstating the dividend. Smurfit Kappa continues to generate strong cash flows and has a nice healthy balance sheet behind it.
Large scale
It helps that they have a global and diversified product line. This can certainly help with mitigating the risk during downturns. The company is the largest producer of corrugated packaging and containerboard in Europe and is the only large scale pan-Americas player.
Last year several US packaging companies announced the first increase in containerboard since 2018. This increase was in response to very strong box shipment data which grew 4% the 3rd Quarter of 202 which led to declining inventories. As such, Smurfit increase recycled containerboard prices by €50 per tonne from 1 October which could help grow earnings.
The companies global diversification , size and expertise gives it an edge to meet increasing customer demand. An example of this was shown in the first half results presentation 2020 where they mention eBay requested 5 million boxes to be delivered in 10 days. It is hard to see another company to be able to deal with this request on such short notice.
For those ESG investors, Smurfit Kappa is a leading company in sustainability rankings and publishes sustainability reports annually. Smurfit aims to help customers create efficiencies and reduce their carbon footprint by using sustainable paper resources and eliminating single use plastics.
Future growth can be driven from e-commerce and corrugated packaging as a sustainable, bio-degradable solution.
Recommendation
My Scoring recommendations are as follows
| Recommendation | Score |
| Strong Buy | 90 – 100 |
| Buy | 71 – 90 |
| Hold | 51 – 70 |
| Sell | 31 – 50 |
| Strong Sell | 0 – 30 |
In total, Smurfit Kappa scored 67 out 100 which makes them a hold. I find them fairly valued from my valuations and I like to add a 10% buffer as there is always assumptions made when doing a DDM or DCF. If the Yield rises above 3% again I might initiate a small position to keep me interested in tracking the company. Smurfit Kappa dividend is safe for now and the rise in eCommerce will certainly help them but they have shown that in terms of uncertainty they will cut the dividend first.
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