It’s been a little over a year since I first wrote about Smurfit Kappa (OTCPK:SMFKY).(OTCPK:SMFTF) business and took a long position in the company. Mentioned in my article “Smurf Kappa – Rewarding Shareholders, Customers and the Environmentt’I have shown how a well run company in an unpopular sector like paper and packaging can reinvent itself, create solid competitive advantages and reward not only its shareholders but also the environment.
Since then, Smurfit Kappa has nearly doubled in price, has returned around 88% including dividends, and has comfortably outperformed the broader market on both an absolute and risk-adjusted basis (with a beta of 0.8).
This is largely due to the company’s unique competitive advantages and the industry’s continued tailwind in the form of strong demand for sustainable packaging.
culture of innovation
The pandemic also took its toll on Smurfit Kappa’s business, as the drop in carton prices negatively impacted both the company’s sales and EBITDA margin. Despite the unprecedented shock, however, those two metrics fell only marginally, with revenue down 6% from 2019 and the EBITDA margin slipping slightly from 18.2% in 2019 to 17.7% in 2020.
Source: Smurfit Kappa Annual Report 2020
On the one hand, more and more large FMCG companies need more sustainable and recyclable packaging solutions to reduce their carbon footprint, but on the other hand, more innovative solutions are also needed to improve efficiency and adapt to changing consumer behavior. For this reason, the unique positioning of Smurfit Kappa’s paper-based packaging solutions enabled the company to benefit from this temporary drop in demand in 2020.
Source: Smurfit Kappa investor presentation
In recent years, Smurfit Kappa has moved up the value chain by offering:
- more innovative packaging solutionslike Bag-in-Box, which enables customers to reduce their plastic footprint at a time of increasing consumer pressure;
Source: Smurfit Kappa investor presentation
- value-added serviceslike Shelf Smart, which allows customers selling through brick-and-mortar retailers to improve their in-store positioning;
- supply chain services which are essential for improving efficiency in logistics and packaging for companies selling through both physical and e-commerce channels;
The impact on business fundamentals
In doing so, Smurfit Kappa has created significant competitive advantages through innovation that have enabled it to attract and retain many of the world’s largest FMCG brands.
Source: Smurfit Kappa investor presentation
As a result, not only did recurring revenue increase, but Smurfit Kappa made its mark in a highly commercialized space. This, in turn, has had a profound impact on margins, which have gradually increased over the past 15 years.
Source: Prepared by the author using data from annual reports
From a valuation perspective, the improvement in gross profitability is by far the most important contributor to the company’s trading multiples. Both price-to-sales and price-to-book ratios show a strong relationship to gross margins on a time-series basis.
Source: Prepared by the author using annual reports and Yahoo!Finance data
In addition to the margin expansion, the steady sales growth also had an impact on the share price development of Smurfit Kappa.
Source: Prepared by the author using data from annual reports
Not a momentum stock yet
Since the beginning of 2014 (one year since the iShares Edge MSCI USA Momentum ETF (MTUM) started trading), Smurfit Kappa’s share price has been in a steady upward trend. What is interesting, however, is that SKG’s correlation with the Momentum ETF declined most of the time during SKG’s rise. This means that the share price increase was driven to a lesser extent by market dynamics.
Source: Prepared by the author using annual reports and Yahoo!Finance data
From the chart above, it can also be deduced that Smurfit Kappa’s share price fell significantly only three times during this period – in Q4 and Q1 2015 and 2016, respectively, in Q4 2018 and in the period February-March 2020. These three were mainly driven by market-wide events that also impacted momentum trading.
Still, the correlation of daily returns between Smurfit Kappa and MTUM was fairly low for most of this period. Even during the recent rally in Smurfit Kappa’s share price, the correlation hit one of its lowest levels ever, suggesting that shareholder returns were primarily driven by the company’s stronger fundamentals.
Conclusion
Smurfit Kappa is one of the world’s largest and most innovative paper packaging companies. As a family-owned company in Europe, the company rarely makes the headlines and stays under the radar of most retail investors. However, the company has strong competitive advantages in its field and is one of the most profitable companies in the industry. Its strong business model also benefits from a secular trend towards more sustainable packaging solutions, which is high on the agenda for both FMCG and e-commerce companies.
