Smurfit Kappa discount from 'temporary' margin squeeze attracts Goldman

Goldman Sachs recommended clients 'buy' Smurfitt Kappa on Monday after the shares fell by around 7% over the past month to open an attractive entry point, while Jefferies also rated the Irish packaging company highly.

Smurfit remained Goldman's top-pick in the European paper and packaging space, as although the market has become increasingly concerned about a margin squeeze, this "is temporary in our view" as box prices are expected to increase in the second half to enable margins to recover quickly.

Smurfit trades at an 26% discount to peers on a ratio of enterprise value to adjusted operating profits (EV/EBITDA), despite offering a 10.5% free cash flow yield, which is significantly above the 5.6% average for packaging peers.

Rivals DS Smith and Mondi are both rated 'neutral' by Goldman.

"A key risk to our packaging view is increased uncertainty in Europe related to the upcoming elections. Packaging is closely linked to economic growth and could come under pressure if uncertainty increases," Goldman said.

Analysts trimmed their London target price to 2,425p from 2,500p.

Jefferies, meanwhile, explained that the margin squeeze on Smurfit was from rising old corrugated containers (OCC) prices but that China's “National Sword” program aimed at improving quality of imported materials has led to imported Chinese old corrugated containers (OCC) prices falling 15%-20% over past month and hence European OCC prices easing 3% in the past fortnight.

EU containerboard prices have continued to grind higher despite easing OCC prices, but while this reduces raw material headwind for Europe’s largest OCC buyers, Smurfit Kappa & DS Smith, easing OCC "might taint second round EU containerboard price hopes and box price hikes", Jefferies said.

Smurfit's quarterly results, the first of the peer group, are likely to provide an update on current price negotiations.

Jefferies, which has a 'buy' rating and a €23.4 target price on Smurfit, said it expected to see benefits from higher kraftliner given a net long position for both.

However analysts believe investors will focus on European testliner and kraftliner price hikes and the feed-through to higher box prices in the second half.