As I am a shareholder of Smurfit Kappa (OTCPK:SMFTF) (OTCPK:SMFKY), I like to keep an eye on the company’s performance on a half-year basis. The first half of 2020 was quite important as I wanted to see how the company was weathering the COVID-19 storm. I originally purchased my position in Smurfit Kappa based on its strong and resilient free cash flow profile and the good coverage of the dividend.
Source: Yahoo Finance
The US listing of Smurfit Kappa is quite illiquid so its two European listings (Dublin and London) usually are the better option. I will refer to Smurfit Kappa’s Irish listing as that provides us with a share price in EUR and as that also is the currency Smurfit Kappa reports its financial results in, it makes it easier to figure out how reasonably Smurfit is valued by the market right now. The ticker symbol in Ireland is SK3, and the average daily volume is approximately 600,000 shares. With 238.5M shares outstanding and a share price of 29.68 EUR, the current market capitalization of Smurfit is approximately 7.08B EUR.
The cash flows remained strong in the first semester
Smurfit Kappa clearly wasn’t immune to the outbreak of the COVID-19 pandemic and the company posted a 9% revenue decrease to 4.2B EUR in the first half of the year, while the EBITDA fell by 13% to 735M EUR.
Source: financial statements
Fortunately, the company was able to cut some expenses which kept the impact of the lower revenue manageable, but we can’t really be too impressed with the operating profit of 450M EUR compared to 558M EUR in the first half of 2019. The lower interest expenses helped Smurfit Kappa and the after tax income of 278M EUR (of which 277M EUR was attributable to the shareholders of Smurfit Kappa) is only 55M EUR lower than in H1 2019. Not bad considering Smurfit Kappa’s revenue came in about 419M EUR lower than in the first half of last year. With an EPS of 1.17 EUR in H1 2020, Smurfit is currently trading at a P/E of around 13. That’s not cheap but as I would expect business to pick up again in the current semester, this actually is a very reasonable result.
My main reason to invest in a company is usually based on the free cash flow performance. Any accountant can make an income statement say what he or she wants, but the cash flow statements usually provide a detailed view on how the company was actually performing.
In the first half of the year, Smurfit Kappa reported an operating cash flow of 512M EUR but we need to make a few adjustments here: the reported result includes a 33M EUR investment in the working capital position but excludes a difference of 9M EUR between taxes due and taxes paid.
Source: financial statements
After taking these two elements into consideration, the operating cash flow was 534M EUR and 500M EUR after including the 35M EUR in lease payments and adding the 1M EUR in interest received.
That’s an excellent result as the total capex in H1 was just 255M EUR, resulting in a free cash flow of 245M EUR. Divided over 238.5M EUR, this represents a free cash flow result of 1.03 EUR per share. That’s indeed slightly lower than the net income, but it does confirm Smurfit Kappa still has a high conversion rate from net income to free cash flow. And considering the H1 operating cash flow came in almost 10% lower than in H1 2019, we can easily assume that without COVID-19, the free cash flow would have been approximately 275M EUR or 1.15 EUR per share.
Smurfit Kappa’s balance sheet remains strong, and the dividend will now exceed 3%
The free cash flow helped Smurfit to keep its balance sheet in good shape. As of the end of June, the company had 639M EUR in cash on the balance sheet while the total amount of gross debt was roughly 3.9B EUR. This means the net debt as of the end of the second quarter was approximately 3.25B EUR. A substantial improvement compared to the net debt of 3.75B EUR a year ago.
Despite the lower EBITDA of 735M EUR, the debt ratio on an annualized basis remains very reasonable at approximately 2.2. If we would use the normalized EBITDA of approximately 1.65B EUR per year, the debt ratio drops to less than 2 and I’m confident we will see a sub-2 debt ratio before too long.
This confirms Smurfit Kappa’s balance sheet is robust and the company should continue to pay its dividend. The company already made a dividend payment of 80.9 cents after the first semester and there’s no reason why Smurfit shouldn’t be able to continue making its annual dividend payments north of 1 EUR. This results in a current dividend yield of over 3.3% at a payout ratio of less than 50%.
Smurfit Kappa doesn’t appear to be cheap on a P/E basis, but even during the COVID-19 pandemic the company continued to report very strong free cash flows. At the current share price, the annualized free cash flow yield is approximately 7% and looking at the normalized cash flows pre-COVID in 2019, the normalized free cash flow yield is almost 8%. That’s more than good enough for me and I continue to hold my position in Smurfit Kappa and will be trying to add on weakness as Smurfit Kappa is one of my preferred names in the packaging industry.
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Disclosure: I am/we are long SMFTF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.