Morning Equity Briefing
Smurfit Kappa Group
(SKG ID)
Positive price and volume trends continue in Q3; debt reduction remains the main focus from strong cash flow generation; stock looks cheap
Barry Dixon
| Closing Price: | 720c | Rating: | Outperform | 30/06/09 |
FACTS: SKG management hosted a sell-side meeting in London during which it gave an update on market conditions. Positive corrugated box volume demand trends have continued in Q3 at the same pace as in Q2 with growth of 3-4%. Demand growth is broadly based across Europe, with Spain and Ireland the only markets continuing to show weakness. Corrugated prices also continue to rise with 15% expected by year-end, up from 9.6% at the end of Q2 and in line with our forecasts. Testliner and kraftliner price increases will be implemented in September/October (as previously announced), which will drive a further 5% box price increase in Q1 2011 – again in line with our forecasts. Management's focus remains on debt pay-down with the aim to reduce leverage levels to circa 3 times trough EBITDA (€740m in the last cycle), implying net debt of just over €2bn versus €3bn currently.
ANALYSIS: The latest round of containerboard price increases has been driven by a combination of low inventory levels, growing demand and rising input costs (primarily starch and chemicals). Assuming the increases are successful, this will take prices close to the peak prices achieved in late 2007. The spread between the testliner price and that of the main raw material input, OCC remains well off its previous peak – implying that a further €50/tonne increase in containerboard prices is likely over the next 6-12 months which will drive further box price increases in 2011. Every 1% increase in corrugated prices raises SKG's EBITDA by circa €35m. Based on our current EBITDA forecasts of €903m in 2010 and €1184m in 2011, SKG should generate free cash flow of close to €150m this year and potentially up to €400m in 2011. This will result in a rapid reduction in debt levels.
DAVY VIEW: The call on SKG is now down to demand. Supply constraints (no new capacity until 2012 at the earliest), low inventory levels (circa 430,0000 tonnes) and rising input costs (chemicals and starch) are all supportive of further price increases. Demand remains the last element of the story. We are forecasting 4% volume growth for this year and 3% in 2011. If these growth levels are achieved, the stock is very cheap – trading on a 2011 EV/EBITDA of less than 4 times. With rapid debt pay-down, equity accretion is significant. We remain very positive on the outlook for the share price and reiterate our 'outperform' rating and 1200 price target.