Shares in FTSE 100 paper and packaging producer DS Smith (LSE: SMDS) have jumped in value this morning after reports emerged that its blue-chip peer, Mondi (LSE: MNDI), was considering a multi-billion pound offer for the business.
Buying UK shares based on merger rumours is never a good idea. Nine times out of 10, the stories turn out to have no substance. As such, jumping on the bandwagon could lead to significant losses for investors who end up buying at high levels.
Instead of investing based on rumours, I like to look at the long-term potential of businesses. I think high-quality companies will always be attractive investments, whether or not they’re subject of a potential takeover offer or rumour. With that in mind, I’ve been taking a closer look at both of these FTSE 100 UK shares to see whether or not they’re worth buying, based on long-term potential.
FTSE 100 group
One of the main reasons I like these two businesses is that the e-commerce industry is booming. Last year, online transactions jumped to around 40% of the UK retail market. The pandemic was responsible for most of this growth. The online share of the market did drop back when the economy started to reopen. However, it’s remained significantly above pre-pandemic levels.
I think this bodes incredibly well for the future of the paper and packaging industry.
That said, one of the challenges these FTSE 100 companies face is costs. While both organisations produce some of their own materials, such as wood pulp for cardboard packaging, for the most part, they’re reliant on market forces. This means they can’t control the cost of essential commodities used in the manufacturing process. As a result, if material costs rise, profit margins will fall.
What’s more, the paper and packaging market is highly fragmented and commoditised. Anyone can produce cardboard boxes. DS Smith and Mondi are some of the most prominent players in the market, but if a company such as Amazon decided it would take over the sector, there’s nothing these firms could do.
Therefore, these FTSE 100 firms face significant risks. An amalgamation would get rid of some of these issues. Based on current market values, the enlarged group could be worth as much as £14bn. That would give it significant economies of scale and clout with suppliers.
Nevertheless, as noted above, buying a stock on merger rumours alone is never a good idea.
Improving outlook
Mondi has noted it foresees price rises for its paper and packaging products due to increased demand. I think this shows the company’s potential to grow as the e-commerce market booms.
With that in mind, I’d buy this FTSE 100 stock today as part of a diversified basket of UK shares, although I’d avoid its smaller peer DS Smith. I think Mondi’s size should help it mitigate some of the risks outlined above.
