Mondi and DS Smith: can a merger save these 2 FTSE 100 packaging giants?

Mondi is looking to expand operations by buying up rival DS Smith. But will the combined forces of these two FTSE 100 giants equate to greater profits?

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It looks like major FTSE 100 packaging behemoth Mondi (LSE:MNDI) will finally buy its long-time rival DS Smith (LSE:SMDS).

The two agreed in principle to a £5.14bn all-share deal that could see Mondi absorb DS Smith into its operations. There is no definitive statement yet that the agreement is finalised but wording in reports suggest it’s all but a done deal.

In a joint statement, both firms said they see the merger as an “opportunity to create a pan-European industry leader in paper-based sustainable packaging solutions“.

Packing for the future

The packaging industry enjoyed elevated revenues during COVID due to surging e-commerce and online food orders. However, the recent return to normality has seen revenues decline.

Now, sustainability has become a core driving factor for growth, with many plastic producers looking to create paper alternatives. Soft drink giant Coca-Cola has been working with Mondi to replace some of its plastic packaging with a recyclable fibre-based alternative.

Looking at the wider packaging industry, it has a compound annual growth rate (CAGR) of 3.89%. Consequently, it’s expected to grow from $1.14trn to $1.38trn by 2029. With Mondi viewed as one of five major players in the industry, the merger should help it corner an even larger part of this market.

Putting pen to paper

Mondi has agreed to pay 373p per share of DS Smith – a 33% premium on the 7 March closing price. Mondi shareholders will subsequently own 54% of the merged group.

When (if) the deal finalises, current Mondi CEO Andrew King and Head of Finance Mike Powell will maintain their positions. Whether or not any of this is set in stone is unclear but, apparently, both sides are still evaluating aspects of the outcome.

Interestingly, DS Smith is the older of the two firms, having started life in the UK in 1940. Mondi, on the other hand, was originally a South African company that formed in 1967 out of Anglo-American. It was only listed on the London Stock Exchange as recently as 2007.

Testing integrity

On paper, the merger looks like a solid plan – particularly since both companies could do with a boost.

But will a combination of the two forces help save the day?

Both Mondi and DS Smith have seen share price declines since 2018. Minor price recoveries in 2021 were short-lived and losses have continued since. When news of the merger broke on 7 March, DS Smith jumped 3% while Mondi closed down 0.29%.

One risk factor is that DS Smith is packing £2.7bn of debt, which Mondi will have to take on. 

Sure, DS Smith has £4bn in equity to cover the debt, but it’s far less than Mondi’s £5bn to cover its £1.6bn debt. The combination would bring the merged group’s debt-to-equity (D/E) ratio to 48% – quite a bit more than Mondi’s current 31%.

Eating the competition can be a lucrative business strategy but you end up eating everything that comes with it too. In an uncertain economic environment, you want to make sure you’re eating healthy. 

Besides the debt, analyst forecasts for DS Smith’s annual revenue and earnings growth are low, at 0.8% and 1.1% respectively. 

With that in mind, I think Mondi will need to play its cards right if it hopes to turn this merger into a lucrative venture.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Mark Hartley has no position in any of the shares mentioned. The Motley Fool UK has recommended DS Smith. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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