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Why DS Smith could smash the FTSE 100 once again this year

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Manufacturing cardboard boxes and other packaging products might not be the most exciting business in the world, but for DS Smith (LSE: SMDS) it is a lucrative one. Indeed, over the past six years, this company has grown into one of the UK’s largest businesses, earning itself a place in the FTSE 100 as net profit has increased at a compound annual rate of 23% since 2012. 

The surging demand for packaging products, a result of the boom in demand for online shopping (the company is Amazon’s sole provider of cardboard boxes in England), has been just one of the key drivers behind DS’s growth. Management is also aggressively pursuing a strategy of buying up growth through acquisitions — a strategy that has worked exceptionally well. And today, the firm has announced another substantial M&A deal. 

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Consolidating industry 

DS is offering to buy Spanish firm Europac in a deal worth €1.9bn. Last year, the target generated revenues of €868m and is still 40% owned by its founding family, who appear to support the merger. Commenting on today’s offer, CEO of Europac José Miguel Isidro Rincón said: “In my capacity as shareholder, I believe that the offer submitted by DS Smith… would deliver important operating and commercial synergies for both companies.

In total, DS estimates there are synergies of €50m to be had by combining the two groups, and it will give the firm a substantial foothold in Spain, Europe’s third-largest market for packaging.

Management intends to fund the buyout with a £1bn fundraise from investors and €740m of new debt. The purchase price is a relatively conservative 8.4 times earnings before interest, tax, depreciation and amortisation (EBITDA) for the 12 months to March 31 2018, compared to the current valuation of 9 times (based on figures for the six months to 31 October 2017). 

In my opinion, this should turn out to be a sensible deal for the group if DS’s record is anything to go by, and will continue to drive earnings higher in the years ahead. The deal for Europac comes hot on the heels of the announced purchase of  Corrugated Container Corporation announced at the end of last month.

Beating the market 

Before today’s deal was announced, City analysts had been expecting DS to report earnings growth of 34% for 2018 or 34.4p per share giving a valuation of 16.3 times forward earnings. However, now that management has revealed its intentions to buy Europac, I believe that this forecast looks too conservative and, with this being the case, shares in DS look to me to be on track to smash the FTSE 100’s performance once again this year. 

In fact, year-to-date the stock is already up 12% compared to the index’s gain of 1.4% excluding dividends. Over the last five years, the performance gap is even greater with shares in DS returning 147% compared to the FTSE 100’s paltry gain of 23% excluding income distributions.

Put simply, as long as DS continues on its current course it looks as if its market-beating performance will continue. 

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Rupert Hargreaves owns no share 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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