Smurfit's share price in retreat despite record profits


THE Jefferson Smurfit Group management could be forgiven for feel perplexed, if not slightly frustrated, as 1995 drew to a close.

Little more than a year ago, the group completed one of the best" acquisitions in the current round of consolidation in the paper industry with the £680 million purchase of Cellulose du Pin. And for 1995, the group is expected to report pre tax profits of £410 million to £420 million, which would be a record for the company and for the Irish market.

Despite this, the share price is nearly 20 per cent below its level at the beginning of 1995, while the ISEQ (Irish stock market) Index is up over 20 per cent.

The stock, market value of Smurfit is now about £1.6 billion a multiple of only 5.5 times expected after tax profits for 1995. This low rating is not unique to Smurfit. Paper/paper board companies in the US and Europe have experienced a contraction in ratings (as measured by profit multiples on current earnings) during 1995 and the industry average would not be much higher than, for Smurfit.

The reason investors are not prepared to pay up for 1995 earnings is the belief that these profits are not sustainable. Smurfit's current stock market value suggests investors are factoring in a decline in pre tax profits to below £200 million. The key question in appraising the share price prospects is whether this view is too pessimistic.

The paper industry is, of course, highly cyclical and relatively modest swings in the supply/demand balance in the industry can bring about a sharp swing in profits. In container board, Smurfit's major product area, the problem has been weak demand in both the US and Europe and this has been exacerbated by a sharp fall in US exports to China.

The weakness in demand has been attributed to destocking by the end users of container board the purchasers of corrugated boxes following a period of inventory build ups, as product prices were on a sharp upswing.

Many companies in the sector believe will shave run its course by early 1996, after which the price of container board, which has fallen from $530 (£331) a ton to between $450 and $480 (£281-£291) a ton in the US, can resume its upward swing. If we are, in fact, experiencing a pause in an extended up cycle, the potential upward rerating of stocks like Smurfit is very significant indeed.

Our own view is that, for containerboard at least, the current weakness is likely to be more just a pause, in the sense that we do not expect containerboard prices to get back up to $530, let alone re accelerate from this level, over the next six to 12 months. We acknowledge that destocking has to be the big problem on the demand side and fully expect a pick up in demand as we progress through 1996.

However, next year will see significant new capacity coming on stream in the US and, for prices to get back to the previous peak level, demand would need to be much stronger than that suggested by the moderate growth of around 2.5 per cent we expect from the world's economy.

Capacity utilisation levels suggest that liner board prices are likely to be in the range $400 to $450 a ton over the next 18 months. While this would be well below the record highs of mid 1995, it should be borne in mind "that the 1995 peak level was well above analysts consensus expectations coming into 1995 and so, in hindsight, prices overshot on the upside in 1995.

Equally, the £400 million plus profits earned by Smurfit in 1995 well above expectations at the beginning of the year can be viewed as being "supernormal", the context of the current asset

On the basis of the pricing out look for containerboard, Smurfit should be capable of generating annualised profits in the region of £300 million in the softer markets expected in 1996/97. This would still be a very substantial level of profits and well ahead of the sort of out turn factored in to the share price.

Currently, investors are assuming a decline in profits similar in magnitude to the last downturn, which was the most severe in the industry's history.

The short term outlook for the shares may thus be unexciting but cyclical shares will again come into favour. The attraction of Smurfit shares, however, goes beyond the potential for a cyclical rebound the group has never been content to merely "ride the cycle" and the superior returns earned by Smurfit investors over the years have been generated on the back of astute expansion moves.