Around a year ago, FTSE 100 packaging provider Smurfit Kappa (LSE: SKG) wasn’t exactly having a ball on the markets. Its share price was 31% lower than the average level for the year when I wrote about it. As scary as that might have looked to investors or potential investors, it eventually turns out that it was probably the best time to buy the share. Sitting in 2019 at almost the same time, the price has run up by almost 50%.
This shouldn’t come as a surprise really. It’s a financially sound company with multi-national operations and company management was optimistic about its prospects for the next year. So far, so good. The issue on my mind now, as always, is whether the company’s prospects look as bright for 2020.
Addressing the concerns
Two potential points of concern had arisen when I was first writing about it – first, whether it would be able to maintain its margins in an environment of softer prices and cost pressures and second, whether it’s taking on more debt to fund its expansion drive with acquisitions.
As far as margins are concerned, the latest trading update has happy news with a 140bps reported improvement in EBITDA margin along with growth in EBITDA and revenues for the first nine months of the year.
With respect to the second question, its net debt levels are definitely elevated both in absolute terms and as a proportion of EBITDA. Debt/EBITDA has risen to 2.2x, for the first half of 2019 up from 2.1x last year. Is this necessarily a worry though? I’m not sure, particularly since management has made an effort to shed light on the overall picture, which shows that the company has maintained its credit rating and its capital structure is in a stable place too. I would have still been concerned if there was no clarity on this aspect.
Structural demand favourable
Moving forward, SKG has pointed to continued “macro-economic challenges”. Interestingly though, it still expresses confidence, not about the cycle turning or being able to grow despite these challenges, but the fact that there’s seems to be a structural shift in demand in its favour. Tony Smurfit, group CEO, in the latest trading update said: “Consumers are increasingly demanding sustainable packaging solutions and….we are ideally positioned to take advantage of this mega trend.” Elsewhere, the company has mentioned that Brexit-related disruptions can impact its business. But SKG is no longer talking just about business cycles and policy driven disruptions, it’s talking long-term demand.
For these reasons I remain quite positive on it, especially since its price-to-earnings (P/E) ratio is a fairly affordable 10.4x. I suspect it will see some dips in the near future given the run-up in recent days, but this is as good time as any to make a first investment in it, I believe.
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Manika Premsingh has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.