WHEB Commentary

Ted Franks

Monthly Commentary: March 2018

It is nearing five years since we opened our investment in Smurfit Kappa. Listed in Dublin (and now also London), it is one of the world’s leading packaging companies. The 46,000 Smurfit Kappa employees produce 34,000 cardboard boxes every minute.

Paper-based packaging is an energy-intensive business with a large environmental footprint. But it is very sustainable: over 75% of Smurfit Kappa’s input material is recycled. Around half of its energy comes from renewable sources.

This positive impact was one of the original attractions in 2013. We also admired its sound environmental approach. And we liked its strategy of getting closer to its customers through innovation.

But a major factor then was its attractive valuation. The company had been close to insolvency during the financial crisis. Four years later, financial constraints had largely eased. But the equity markets seemed unable to forget. We were also warned that the packaging market was cyclical and prone to over-capacity. A price to earnings ratio in single-digits reflected these fears.

In the five years since, the packaging market hasn’t grown as we’d hoped. But it has been far more orderly than the naysayers had warned. And in the meantime, Smurfit Kappa applied itself to improving the way it works. By its own calculations, its return on capital employed has grown from a little over 13% to over 15%. Earnings have doubled over the same period as a result.

In one sense, this good work has not gone unrewarded. Smurfit Kappa’s stock has outperformed its local Irish index by 67% since we’ve owned it. And yet, the doubts never seem to have gone away. The stock’s rating has never expanded in the way we thought it deserved.

This under-appreciation has looked particularly odd in the past six months. There has never been greater pressure to reduce the use of plastic for packaging. The amount of plastic entering the ecosystem (and never leaving) is becoming all too clear.

The BBC’s ‘Blue Planet’ documentary series proved to be a landmark in raising awareness. Here in the UK the government has this month proposed a recycling scheme covering single-use plastic bottles. The 5p charge on plastic bags introduced in October 2015 is now estimated to have reduced their use by around 80%.

Cardboard is a sustainable, renewable, bio-degradable alternative to plastic. Better still, it is well-suited to the burgeoning world of e-commerce. Uniform lightweight boxes are strong and easy to handle. These are useful attributes when speed is critical, and automation is increasing.

Eventually the disconnect between prospects and valuation was just too great. On the thirteenth of February, Smurfit Kappa’s largest rival, US company International Paper, made a confidential takeover approach. The premium to the share price then was 30%. The management team swiftly rejected the unsolicited bid, which was made public on the sixth of March. A second bid arrived on the twenty-sixth and was again rejected.

We now await the next move. The suitor has said that it would be willing to pursue a hostile takeover. Whatever the outcome, alternatives to plastic remain a compelling investment opportunity. Even more so, if the rest of the market can’t see it.