FTSE 100 constituent DS Smith (LSE: SMDS) is a specialist packaging company. The firm produces paper and corrugated cardboard boxes that have been in high demand for deliveries over the past few months.
But the DS Smith share price has struggled. It has fallen 30% from its year high and the company now trades on a trailing price-to-earnings ratio of just over 8. Why is a company, seemingly in demand, struggling, and does this lower share price offer a good entry point for an investment?
The DS Smith share price is inherently cyclical
There is a correlation between the DS Smith share price and the state of the global economy.
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The coronavirus has resulted in far less demand from industrial customers, and this translates to fewer packaging products and ultimately lower prices.
DS Smith’s fortunes are also tied to the price of the raw materials it uses. The low price of paper has also hit the group’s North American paper manufacturing and export businesses.
In an effort to make itself a less cyclical company, the firm is aiming to produce less of its own paper. It currently manufactures about 80% of the paper it needs but is targeting to reduce this to 60%.
You might think this outsourcing would increase costs. But it means that when the economy is struggling it gets the raw materials cheaper. When times are good, it makes less profit. The aim is to even out earnings.
DS Smith has been resilient through the pandemic. In July financials, revenue fell just 2% and basic earnings per share actually increased 7%. But the firm is clearly looking to the future and foresees a difficult time ahead for the economy.
The company announced it was cancelling the interim dividend and wouldn’t be paying a final dividend to preserve cash. While probably prudent, the DS Smith share price dropped 7% on the day.
I think the future is bright
As you might imagine, corrugated box volumes have been strong particularly in Europe through the pandemic. E-commerce sales are exploding and that is only good news for this packaging specialist. In addition, 70% of business volume for DS Smith is through consumer goods and groceries and these sectors typically weather an economic storm well.
The firm is also on trend in terms of reducing its environmental impact. It is increasing its use of recycled materials and disposing of its plastic packaging business. This sale helped to reduce debt, which had risen slightly higher than my liking following the acquisition of Europac last year (a French, Spanish, and Portuguese packing company).
Historically we are looking at a company that has steadily grown operating profit for a number of years. And I see several long-term trends that will benefit the firm once the economy gets going again.
In my view the DS Smith share price already factors in a very bumpy next 12 months. But after that, I foresee the dividend being reinstated. I think we will then once again be looking at a fantastic income and growth company. I’d buy now while the share price is low.
