DS Smith Plc - 2018/19 FULL YEAR RESULTS: A year of Significant delivery
• Strong operational performance
◦ Market outperformance - volume growth at 2.4%
◦ Volume growth in all regions through FMCG and e-commerce focus
◦ Continued success of US operations
• Strong financial performance
◦ Record return on sales and upgrade of medium-term target to 10 - 12%
◦ Organic adjusted operating profit growth(8) of 9%
◦ Profit before tax up 35%
◦ Free cash flow up 84%
◦ Robust balance sheet - pro-forma net debt/EBITDA(9) <2.0X
• Strategic delivery
◦ Acquisition of Europac - upgrade to synergies from €50m to €70m
◦ Sale of plastics division agreed
Miles Roberts (photo), Group Chief Executive, commented:
"This strong set of results from DS Smith demonstrates the company's growing scale and strategic progress in key markets. We are continuing to gain market share throughout Europe, particularly among more resilient FMCG customers, and our US business is performing well following our recent acquisition there.
I am very pleased to be able to raise our medium-term return on sales target, up to 10 - 12 per cent, as well as adding to our cost synergy estimate following successful initial progress in integrating Europac, which we acquired during the year. DS Smith is increasingly well-placed to capitalise on rising consumer demand for sustainable corrugated packaging as well as greater convenience from both e-commerce and more traditional retail channels.
The underlying drivers of demand for sustainable corrugated packaging and our differentiated offering give us confidence in ongoing volume and market share growth. We saw some volume weakness in certain export-led markets in the second half of 2018/19, including Germany, but we expect this to improve during the current year. While volatility in the macro-economic environment and input costs remains, our focus on pricing discipline, operating efficiencies and cash flows supports our expectations of further good progress in the coming year."
2018/19 has been another year of good delivery from DS Smith, with substantial progress developing our strategic position in Europe along with further organic growth. We have delivered record return on sales margins of 10.2 per cent alongside continued market share gains and return on capital of 13.6 per cent, in the middle of our target range. We also made the significant acquisition of Europac, which was announced in June 2018 and completed in January 2019. Europac represented an exceptional scale opportunity to enhance our customer offer in Iberia, a key packaging growth region, and strengthen our global supply platform, in particular with the addition of a strategically important kraftliner mill to our assets. Initial integration work has been excellent and I am pleased to announce that we are now able to increase our initial cost synergy target for this acquisition, from €50 million per annum to €70 million per annum, by the end of 2021/22. Our North America operations, comprising Interstate Resources (acquired in August 2017), along with Corrugated Container Corporation (acquired in May 2018), have continued to perform ahead of plan with $33 million of the target $40 million cost synergies now achieved. We have also agreed the disposal of our plastics business for c. £400 million (net), with completion expected by the end of this calendar year.
The success of these acquisitions means that we are now able to look at how we best optimise our paper assets so that we maintain the optimum balance between paper and packaging manufacturing, consistent with our short paper strategy, as well as leveraging further efficiency across the Group.
Strong organic growth
Organic corrugated box volumes have grown 2.4 per cent across the year (excluding Europac), reflecting a strong H1 period and a lower growth rate through H2, due to some weakness in export-led markets, including Germany, as well as some capacity constraints in North America. Once again, all regions have reported growth, with particularly strong regional volumes in the UK and in Central Europe and Italy. Growth once again has been particularly strong from our multinational customers, particularly FMCG, e-commerce and shelf-ready packaging. We have been particularly focused on achieving sales price increases to reflect increasing input costs, resulting in a record return on sales achieved in the year. Our focus is on corrugated packaging, where we see continued market growth, and to be differentiated to succeed in that market. The core market growth drivers of e-commerce, plastic substitution and retail changes are more relevant than ever. In particular, public awareness of the importance of alternatives to plastic packaging has increased substantially over the past 12 months and we have corrugated packaging alternatives that are currently marketed to take advantage of this opportunity. Our differentiators of scale, innovation, end-to-end solutions and partnership approach continue to resonate with customers as we help them to increase their sales, reduce their costs and manage their risks.
For the full year, revenue growth of 12 per cent on a constant currency basis was due to organic growth, the contribution from Europac (which was owned for just over three months of the period) and the incremental four month contribution from Interstate Resources (which was acquired part way through the prior year). Organic growth was driven principally by increases in sales price reflecting rises in underlying costs, plus a contribution from volume growth in corrugated boxes, partially offset by reduced volume in external recycling and paper sales reflecting greater matching of our paper manufacturing with the requirements of our packaging operations.
Adjusted operating profit (continuing operations) increased by 28 per cent on a constant currency basis to £631 million (2017/18: £492 million). This was driven by the significant contribution from acquisitions, including just over three months from Europac, the full year effect of ownership of Interstate Resources, and synergies delivered from the North America business, together with strong organic profit growth. Volume growth together with increases in the sales price due to the lagged pass-through of paper price rises, principally in calendar 2018, offset in part by rising costs, contributed 8.8 per cent growth (£46 million) compared to the prior year. Operating profit increased 29 per cent on a constant currency basis to £427 million.
Adjusted earnings per share for continuing operations increased by 8 per cent on a constant currency basis to 33.3 pence (2017/18: 30.7 pence). Including the earnings per share contribution from discontinued operations i.e. the Plastics division, of 1.7 pence, total adjusted earnings per share was 35.0 pence. This result builds on nine years of consistently strong growth, with the nine year compound annual growth rate for adjusted EPS being 23 per cent. Earnings per share for continuing operations decreased by 8 per cent to 19.7 pence per share, reflecting the benefit of profit growth offset by the increase in number of shares in issue.
The Board considers the dividend to be an important component of shareholder returns and, as such, has a policy to deliver a progressive dividend, where dividend cover is between 2.0 and 2.5 times, through the cycle and having taken into account the future financing requirements of the Group. For the year 2018/19, in accordance with our dividend policy, the Board recommends a final dividend of 11.0 pence per share, which will be paid to all shares on the record date. This, combined with the 2018/19 interim dividend of 5.2 pence, makes a total dividend for the year of 16.2 pence (2017/18: 14.4 pence).
Developing the business
The year 2018/19 has been one of substantial strategic progress. It has been the first full year of ownership of our North America business Interstate Resources, we have acquired Europac in Iberia, and we have also agreed the disposal of our plastics business. These steps together mean that DS Smith will be a fibre-based packaging focused, strategically aligned and financially strengthened business.
Our North America business has performed well ahead of our initial expectations. Integration work has continued through the year such that the majority of the upgraded cost synergy target of $40 million has been achieved, well ahead of schedule. Meanwhile, the customer reaction to our packaging continues to be very good, with a number of customer wins from large multinational groups that we had previously served only in Europe. Our success means that we are now expanding our packaging operations in the region with a new greenfield site in Indiana, substantially increasing our capacity in the region. That site is expected to begin production towards the end of calendar 2019. A one-off impact on divisional profitability of £15 million is expected in 2019/20 relating to start-up losses from this new site.
Europac was acquired on 22 January 2019 and integration work is going very well, with the management team established and positive engagement from employees. We are now announcing an increase to our estimate of cost synergies from Europac from €50 million to €70 million, due to additional synergies from head office cost reductions and paper optimisation.
Optimisation programme in paper
DS Smith has grown substantially over the past nine years with a unique footprint of European capability and operations, and this presents an opportunity to optimise our paper operations.
Our paper assets are managed to support our packaging operations, for example, producing specific paper grades required for our performance packaging, particularly in regions where external supply is scarce. The strategy of DS Smith has consistently been to be 'short' paper, i.e. a net buyer of paper in the market, in order to maintain the consistency of our profitability. The recent acquisitions have resulted in a much improved network of high quality paper mills (in addition to our packaging operations), both geographically and from a product perspective. We have added mills in key locations where there is a shortage of specialist grades, such as the lightweight paper mill of EcoPaper, and significant kraftliner production though the acquisition of Europac. We now plan to optimise our footprint and capability. Taking into account the full operational run-rate of Europac, DS Smith has an annual external corrugated case material (CCM) requirement of around 800 thousand tonnes in Europe. This is equivalent to c. 20 per cent of our total paper requirement, and as such we are c. 80 per cent integrated. Taking into account future growth in packaging, we expect to reduce integration to towards 60 per cent in Europe, in the medium-term. In the US, our strategy has always been to have full security of supply given the differences in market structure in that region. At present we are 'long' c. 275 thousand tonnes CCM per annum in the US and expect to bring this to a balanced position as we continue to build the packaging side of our business, including the new site in Indiana currently under construction.
Upgrading our medium-term margin targets
DS Smith has reported a record return on sales margin in 2018/19 of 10.2 per cent, ahead of our medium-term financial KPI of 8 - 10 per cent. We expect margin to continue to grow in the medium-term due to our value-adding customer proposition, the benefit of contribution from NAPP and Europac, and from a continuous focus on cost and efficiency. As a result, the Board intends to increase the medium-term target for return on sales up to 10 - 12 per cent.
Unless otherwise stated, any commentary and comparable analysis in the operating review is based on constant currency performance.
Our UK corrugated packaging business has performed very well despite the uncertain political and economic backdrop. Overall volumes were very good, driven by both FMCG and e-commerce. Revenue increased reflecting volume gains and price recovery, with the additional revenue dropping through to profit, leading to a 11 per cent increase in adjusted operating profit and a 70 basis points increase in margin.
The Group has considered and planned for the potential impact of Brexit on our business. The UK operations utilise paper manufactured at our Kemsley mill in Kent, UK, in addition to paper from other mills on continental Europe. We also import some other input materials such as starch. The substantial majority of our packaging product is distributed to customers in the UK with our Kemsley mill exporting an element of its production to continental Europe. We have also made plans for contingency levels of spare parts and other essential items for continuous running. As such, while not immune from disruption that might occur in the event of a disorderly Brexit, including the impact of changes in order patterns from customers, we expect disruption to our own operations to be relatively contained.
The Western Europe division has seen like-for-like volume growth ahead of market growth in the period, although volume growth was behind the Group average. While volume growth in France was impacted somewhat by the periods of civil disruption in the country, this was partially offset by good growth in Iberia and very good growth in the Benelux region. The growth in revenue was largely driven by the inclusion of Europac for just over three months, having been acquired on 22 January 2019, in addition to the increase in sales price from recovery of historic paper price rises. The increase in adjusted operating profit relates to the inclusion of Europac as described above and good recovery of operating costs through pricing from the underlying business. Return on sales increased significantly by 110 basis points, broadly in line with the Group margin increase, to 8.0 per cent.
DCH and Northern Europe
Volumes have grown modestly across the region, driven by very good volume growth in Northern Europe, offset by a contraction in Germany and Switzerland due to a focus on price discipline and difficult market conditions. These tough trading conditions related to packaging for export-led industrial customers in Germany, particularly in the second half of 2018/19, where a wider economic slow-down has been seen. Revenues fell 2 per cent due to a reduction in external volumes from paper and recycling and, in addition, reduced pricing from recycling, partially offset by sales price recovery in packaging.
Adjusted operating profit increased by 12 per cent, reflecting the contribution from our paper manufacturing operations in the region. Consequently, return on sales increased to the upper end of our target range at 9.3 per cent.
Central Europe and Italy
Volumes in this region have again been good, slightly ahead of Group growth, with performance in Italy particularly pleasing. Revenue growth of 9 per cent was driven in approximately equal parts due to the inclusion of EcoPaper and EcoPack, and from organic growth in packaging, particularly sales price. EcoPack and EcoPaper were acquired on 6 March 2018 and hence this year was the first full year of inclusion and represented an incremental 10 months contribution.
Adjusted operating profit increased 29 per cent, reflecting a small contribution from the acquired businesses and organic growth from the benefit of drop-through from volume and sales price increases. As a result, return on sales increased by 150 basis points.
The performance of the North America Packaging and Paper division has been very good once again, with margins considerably above that of the Group. Corrugated box volumes have continued to grow, though have been constrained to some degree by our available capacity. We are, at present, part way through the construction of a new packaging site in Indiana which will address this issue, and which is expected to be operational by the end of calendar 2019. Revenue grew 59 per cent principally driven by the incremental four months contribution from the Interstate Resources business, acquired in late August 2017, and from Corrugated Container Corporation, acquired in May 2018. Increases in sales price also contributed to revenue growth. Adjusted operating profit for the division grew by 63 per cent, reflecting both the incremental contribution from the acquired businesses and the benefit of synergies ($23 million) from the Interstate Resources acquisition. Combined with the synergies delivered in 2017/18, this brings the total synergies to $33 million, close to the total of $40 million targeted, substantially earlier than planned.
Our medium-term targets and key performance indicators
We measure our performance according to both our financial and non-financial medium-term targets and key performance indicators.
As set out above, like-for-like corrugated box volumes grew by 2.4 per cent (excluding Europac). This was modestly lower than our target of GDP+1 per cent, with year-on-year GDP growth, weighted by our sales in the markets in which we operate, estimated at 1.9 per cent (source: Eurostat). All regions have again recorded volume growth in the year, with a particularly strong contribution from the UK and Central Europe and Italy regions. Towards the end of the year we have seen some weakness, particularly in industrial customers in export-led markets including Germany, reflecting wider macroeconomic conditions. In addition, the North America business was capacity constrained. Underlying the regional performances has been the strong growth of our pan-European customer base, where we continue to make significant gains with existing customers as we increase our market share with them, further demonstrating the demand for a high quality pan-European supplier of corrugated packaging, operating on a co-ordinated multinational basis.
Adjusted return on sales increased 120 basis points to 10.2 per cent (2017/18: 8.9 per cent), above the top of our target range of 8 to 10 per cent, reflecting our strong commercial offering and the benefit of the sales price increases, partially offset by increased overall input costs.
Adjusted return on average capital employed (ROACE) is 13.6 per cent (2017/18: 13.7 per cent), around the middle of our medium-term target range of 12 to 15 per cent and significantly above our cost of capital, despite the recent significant acquisitions of Interstate Resources in North America and of Europac in Europe, and the exclusion of our plastic packaging business (now discontinued), all of which has a dilutive impact on this ratio. This result reflects a continuous focus on an efficient capital base, in addition to profitability. We have maintained our continual focus on tight capital allocation and management within the business, including capex, which has been closely managed as shown by the year-on-year reduction despite the increased size of the business. ROACE is our primary financial measure of success, and is measured and calculated on a monthly basis.
Net debt as at 30 April 2019 was £2,277 million (30 April 2018: £1,680 million) reflecting the significant acquisitions made in the year of £1,702 million (including debt assumed of £204 million including deposits), less the issue of new equity of £1,006 million net. Cash generated from operations before adjusting items of £774 million was used to invest in net capex of £289 million which included £17 million in relation to Europac, a reduction from £312 million in 2017/18, reflecting our focus on cash management, while still including substantial growth capex. Adjusting items of £93 million primarily related to the acquisition and integration of the new businesses. Net debt/EBITDA (calculated in accordance with our banking covenant requirements) is 2.3 times (2017/18: 2.2 times). This reflects the acquisitions made as well as ongoing tight cash management and control throughout the business and is 0.2 times lower than anticipated at the time of the 2018 rights issue. This ratio excludes the cash required to fulfil the Interstate Resources put option which, if exercised, would take reported leverage to c. 2.5 times. On a pro forma basis, taking into account the disposal of the Plastics business for £400 million (net) and remedy disposals of c. £54 million (as discussed in the financial review), and the relevant adjustment to EBITDA, net debt/EBITDA at 30 April 2019 would have been under 2.0 times. The Group remains fully committed to its investment grade credit rating.
During the year, the Group generated free cash flow of £339 million (2017/18: £184 million), an improvement of 84 per cent. Cash conversion, as defined in our financial KPIs (note 15) was 102 per cent, in line with our target of being at or above 100 per cent.
DS Smith is committed to providing all employees with a safe and productive working environment. We are pleased once again to report improvements in our safety record, with our accident frequency rate (defined as the number of lost time accidents per million hours worked) reducing by a further 23 per cent from 3.0 to 2.3, reflecting our ongoing commitment to best practice in health and safety. The prior year figure of 3.0 is based on the full inclusion of Interstate Resources on a like-for-like basis. We are proud to report that 265 sites achieved our target of zero accidents this year and we continue to strive for zero accidents for the Group as a whole. We did, however, have a tragic accident in our Tallinn plant in the year that resulted in the fatality of a colleague, which overshadows all our performance improvements. Our thoughts are with the family, colleagues and friends of the deceased as we support them and the local authority investigation.
The Group has a challenging target for customer service of 97 per cent on-time, in-full deliveries. In the year we achieved 95 per cent, a further year on year improvement but still below our target. While there has been improvement, management remains dissatisfied with this outcome and is fully committed to delivering the highest standards of service, quality and innovation to all our customers and will continue to challenge ourselves to meet the demanding standards our customers expect.
One key part of the DS Smith strategy is to lead the way in sustainability. Corrugated packaging is a key part of the sustainable economy, providing essential protection to products as they are transported and, at the end of use, it is fully recyclable. Corrugated packaging is also substantially constructed from recycled material, as are many of our plastic packaging products. Our Recycling business works with customers across Europe to improve their recycling operations and overall environmental performance. In calendar year 2018, compared to calendar year 2017, on a restated basis to reflect acquisitions, our CO2 equivalent emissions, relative to production, has reduced by 6 per cent, a good step towards our overall goal of 30 per cent reduction (compared to 2015) by 2030. We have also become a global partner of the Ellen MacArthur Foundation, a leading environmental charity focused on sustainability, in line with our corporate purpose.
The underlying drivers of demand for sustainable corrugated packaging and our differentiated offering give us confidence in ongoing volume and market share growth. We saw some volume weakness in certain export-led markets, including Germany, but we expect this to improve during the current year. While volatility in the macro-economic environment and input costs remains, our focus on pricing discipline, operating efficiencies and cash flows supports our expectations of further good progress in the coming year.
(DS Smith Plc)