From humble beginnings as a box-maker in Rathmines, Dublin in 1934, Smurfit Kappa Group plc is now Europe’s leading corrugated packaging company and one of the largest paper-based package production companies in the world. Smurfit Kappa Group has circa 45,000 employees across 35 countries, 12 in the Americas and 23 in Europe.

Following on from strong H122 results, we still consider the stock to be materially undervalued. The market appears to be paying more attention to macro-economic factors than management’s guidance that it can mitigate against those factors not only to drive top line growth in the challenging environment but also maintain margins despite an increasing input cost environment.

Much stronger than expected H122 numbers.

In late July, Smurfit Kappa issued materially stronger than expected H122 results and noted that the first half performance has set a strong foundation for the remainder of 2022 and beyond. The company has reported an 85% increase in adjusted earnings per share, 19% ahead of consensus, from a 50% increase in EBITDA, 18% ahead of market expectations and 36% increase in revenue, 4% ahead of forecasts. The company declared a 31.6c interim dividend per share against 29.3c in H121 and 30.5c forecast for H122. Management noted that the strong performance was a result of many actions taken over several years, including significant customer-focused investments to meet growth, providing the most innovative and sustainable paper-based packaging in the marketplace and selective acquisitions ensuring security of supply to customers. In H122, the company noted that it overcame many challenges including sharply increasing input costs, logistics and supply chain constraints, COVID-19 disruption and the impact of the war in Ukraine.

Running the H122 numbers and management commentary on future progress into our model, drives a 13% and 8% increase to our FY22 and FY23 earnings forecasts, respectively. This is driven by an 11% and 8% increase in EBITDA in the coming two years and 12% increase in both our FY22 and FY23 revenue forecasts (not guaranteed). For FY22 we are now looking for Smurfit Kappa to report a 44% increase in earnings to 360.2c from a 22% increase in EBITDA to €2.07bn and similar increase in revenue to €12.33bn, broadly in line with consensus.

Capital allocation in focus

The €648m raised through a share placement in November 2020 followed by the acquisition of a state-of the-art 600,000 tonne containerboard mill called Verzuolo in Northern Italy for €360m completed in October 2021, plus an additional €53m spent on bolt-on acquisitions in FY21 left the balance sheet in a strong position at the end of 2021 (ND/EBITDA at 1.7x). In FY22 to date, the company has been less active, only completing two deals for a total consideration of €40m, reflecting their bolt-on nature. The company reported ND/EBITDA at 1.6x at the end of the six-month period. On returns to shareholders, while the interim dividend was increased by 8% there was no indication of management considering any share buybacks. This is not surprising as buybacks have not been a feature of capital allocation for over five years. The primary allocation is to capex, followed by dividends and then acquisitions. Stretching the balance sheet to 2.5x ND/EBITDA could release over €3bn for further corporate activity, which if deployed on acquisitions could, in theory, add over 20% to FY23 earnings. A €400m spend (circa the FY21 acquisition spend) could add a more realistic 3% to FY23 earnings.

The US European sector price movement disconnect appears unwarranted

While US packaging companies’ share prices have remained resilient (up 1%) European companies have been much weaker (down 22%), we presume on the relative concerns investors have over the European versus US markets. Even following the small rally over the past two weeks, Smurfit Kappa has been particularly weak, down 30% year-to-date. We believe this to be unjustified, given its relative position in the paper and packaging markets as demonstrated by the strength of its H122 numbers. In geographic terms it is strongly European-centric with only 23% of revenue generated outside of Europe but we believe that this should not be seen as an overhang. At 8.6x FY22 P/E and 5.3x EV/EBITDA, Smurfit Kappa is currently trading at 19% discount to its peers and over 25% discount to its 10-year averages.

Ian Hunter is a Senior Research Analyst at Cantor Fitzgerald.