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Is there profit in packaging? We take a closer look at three packaging industry leaders.

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Boring investments can sometimes be the best ones. They aren’t overly complicated or involved in flashy fair-weather industries. It’s easy to see why – companies that offer essential goods or services are usually better placed to weather ups and downs.

Packaging companies fall into this bracket. Everything we buy in a supermarket comes wrapped in something. Baked bean tins aren’t shipped individually – you need cardboard pallets. When was the last time you had a delivery that didn’t involve cardboard or plastic?

The scale of demand for packaging around the world is huge. That also means there’s a handful of big companies to choose from for investors wanting to get in on the action.

This article isn’t personal advice, if you’re not sure if an investment’s right for you, seek advice. All investments fall as well as rise in value, so you could get back less than you invest. Yields are variable, and are not a reliable indicator of future income. No dividend is ever guaranteed.

Investing in individual companies isn't right for everyone. That's because it's higher risk, your investment depends on the fate of that company. If that company fails, you risk losing your whole investment. If you cannot afford to lose your investment, investing in a single company might not be right for you. You should make sure you understand the companies you're investing in and their specific risks. You should also make sure any shares you own are part of a diversified portfolio.

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DS Smith’s biggest money maker is its cardboard packaging products, but it also dabbles in paper manufacturing (some of which is used in its own products and some of which is sold), and recycling. The group has annual revenues of around £7bn and pre-tax profit of £378m.

That indicates operating margins of around 6%, which aren’t the healthiest in the sector, and reflects the tough cost environment the group’s in. It makes much of the paper it needs in-house, but is seeking to reduce this towards 60%.

This means DS Smith gets its raw materials cheaper when paper prices fall in tough times. However, when the industry is booming and paper is more expensive, the group's margins get squeezed.

More generally, packaging companies are far from immune to soaring input costs, especially energy. It’s therefore pleasing to see that DS Smith is deploying contracts to protect against unfavourable gas prices.

It’s 90% hedged against the price of natural gas for 2023 and roughly 80% hedged for the year after. This a notable effort in the industry and offers a real layer of resilience for the near term.

As does DS Smith’s core advantage – its customer base. The group’s main customers are blue-chip fast moving consumer goods (FMCG) companies. FMCG items, like food, toiletries or cleaning products, are on the shopping list every week. That means they need to be transported all year round too. DS Smith also has large exposure to e-commerce, which is another area of more reliable revenue.

We also admire DS Smith’s sustainability initiatives. This is an important area of focus for modern investors, and also helps to attract and retain businesses who have sustainability on their mind.

The group’s net debt levels have come down too, and stood at 1.6 times cash profits (EBITDA) at the start of the new year. That has helped support the dividend yield of 6.1%, as does the group’s relatively prudent dividend cover policy. DS Smith aims to have its dividend covered by earnings by 2-2.5 times.

DS Smith has an enviable customer base and a proactive approach to navigating the energy crisis. There’s a lot to like and long-term opportunity as far as we’re concerned.

However, we’d be remiss not to mention the challenges. The group’s exposure to wider cost inflation and shrinking margins are genuine road bumps it must clear, which is likely to create some ups and downs in the short to medium term. That’s reflected, and then some, in a price to earnings ratio of 7.7, which is 36% below the ten-year average.

VIEW THE LATEST DS SMITH SHARE PRICE AND HOW TO DEAL

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Mondi makes and sells packaging and paper products. Its three main product segments are corrugated packaging, engineered materials – which includes the stretchable elastic films and non-woven fabrics which go into nappies and other personal care items, and flexible packaging. Among other accolades, Mondi is Europe’s leading paper bag producer.

Mondi has benefitted from the surge in online shopping, which was accelerated by the pandemic. This is no doubt a long-term tailwind. But it’s also something Mondi has no control over. In fact, what makes Mondi a bit different is its exposure to less-developed economies.

Emerging Europe makes up over a third of the group’s annual revenue (by location of production). These areas can increase the risk of ups and downs, but are a longer-term growth opportunity in our opinion.

The group’s also pushing harder than we’d predicted with its environmental initiatives, with recycled materials, reduced wastage, and lower emissions truly at the heart of Mondi’s strategy. This is important – today’s investors and customers can be a lot more inclined to snub a company that isn’t taking these issues seriously.

Mondi’s revenue makeup is a bit more eclectic than you might imagine. While around half its customers are from consumer and retail, the remainder of Mondi’s customers largely come from industrial or construction sectors. This offers a layer of diversification, which means risk is spread across different markets.

However, it also increases the likelihood of ups and downs. That’s because industrial and construction markets tend to ebb and flow at the same rate as the wider economy.

With economic jitters rife, this is a large factor in why Mondi’s shares currently change hands for 9.2 times expected earnings, which is some way below the ten-year average. While more ups and downs are likely, there could be opportunity for those prepared to stomach some short-term risk.

The group’s balance sheet is in good health, with net debt equivalent to 0.8 times underlying cash profits (EBITDA), as at the end of June. That financial resilience has helped underpin Mondi being able to pay a dividend.

Mondi’s returning the proceeds from the $1.6bn sale of its biggest Russian plant to shareholders. There’s currently a prospective yield of 4.7% on offer. However, the yield is likely to fluctuate once that return is out the way. And as ever, no dividend is ever guaranteed.

VIEW THE LATEST MONDI SHARE PRICE AND HOW TO DEAL

Ireland based Smurfit Kappa (SK) is predominantly a paper-based box company. The majority of its operations are integrated. That means it has a system of its own paper mills which make containerboard, which is then shipped to Smurfit’s plants, and finally converted into corrugated packaging products.

Smurfit holds the title of Europe’s leading box producer. If you’ve ever had flowers delivered from Waitrose, chances are these came in a Smurfit box.

SK mostly operates in Europe and the Americas – with 13 countries on the roster in the latter region, where it also owns forests to farm its own timber. This is a model we admire. €7.8bn of the group’s €10.1bn annual revenue comes from all across Europe.

In the first half of the year, underlying revenue rose 32%, which reflects Smurfit’s ability to pass higher costs onto customers. Volumes rose 2.5% despite higher prices. The group’s being forced to up its prices because of a sharp increase in input costs, particularly energy.

This is a tricky situation and is largely outside the group’s control, but it’s handling it well.

Reducing the impact of rising costs, plus its integrated model means operating margins are 10.6%. This isn’t industry leading, but is more competitive than some, and allows for some breathing room.

The group’s comfortable enough to increase the full year dividend by 10%, and the projected dividend looks very well supported by predicted earnings. The prospective yield is 4.7%, but remember no dividend is ever guaranteed.

So, what’s the bad news?

Like its peers, wider geopolitical uncertainty and supply chain issues are a concern. The group has exposure to food and drink and industrial sectors, which will be more likely to see ups and downs in the near term.

More broadly, Smurfit’s particular exposure to Europe potentially puts it at a higher risk in today’s economic climate. That’s mainly because of Europe’s current recession and inflation fears. Smurfit Kappa has growth opportunity, but carries a bit more risk.

VIEW THE LATEST SMURFIT KAPPA SHARE PRICE AND HOW TO DEAL

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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