Half-year Report

6 December 2018

DS Smith Plc - 2018/19 HALF YEAR RESULTS

Increased margins driving strong growth

Highlights

·     Successful and differentiated business model

o  Return on sales margin +120 bps

o  Good organic volume growth⁽²⁾ of 3.2%

o  Excellent cost recovery reflects business mix and strength of business model

o  Growth from FMCG and e-commerce leadership

o  US acquisition fully integrated and delivering well ahead of acquisition case

·     Strong balance sheet

o  Increase in cash flow from operating activities from continuing operations

o  Net debt / EBITDA⁽⁶⁾ (excluding rights issue proceeds) fallen to 2.1x

o  Refinancing complete - new long-term facility

o  Plastics strategic review making good progress

·     Europac acquisition completion expected around calendar year end

o  Reported performance to Q3 2018 in line with expectations

o  Integration planning well advanced

·     Compelling commercial differentiation and structural drivers for growth

o  E-commerce, sustainable packaging, dynamic retail changes

o  DS Smith innovation-led solutions for multinational customers

·     Good momentum into H2

1. 

"We are very pleased with the progress we have made over the last six months. We have strong momentum in the market, delivering good top line growth and substantially increased profit levels.  We continue to win market share through our strong FMCG presence and our leadership in both e-commerce and sustainable packaging.   DS Smith is extremely well positioned to capitalise on these ongoing growth trends and we are confident about the future prospects for the business."

Miles Roberts, Group Chief Executive

Sustainable delivery against medium term targets

See notes to the financial tables below

Enquiries

DS Smith Plc                                                                    +44 (0)20 7756 1800

Investors

Hugo Fisher, Group Communications Director

Rachel Stevens, Investor Relations Director

Media

Greg Dawson, Corporate Affairs Director

Brunswick                                                                      +44 (0)20 7404 5959

Dan Roberts

Christina Clark

Presentation and dial-in details

A presentation to investors and analysts will be held at 9:00am today at the London Stock Exchange, 10 Paternoster Square, London EC4M 7LS. The event is available by webcast by clicking here or by registering via the link on our website https://www.dssmith.com/investors/results-and-presentations. Alternatively, dial-in access for the presentation is available with details as follows: +44 (0) 20 3003 2666 (standard access) or 0808 109 0700 (UK Toll Free) Password: DS Smith. The slides accompanying the presentation will be available on our website shortly before the start of the presentation, as well as on the webcast.

The webcast will remain available for replay, accessed via our website per the link above, and a replay is available for 7 days on +44 (0) 20 8196 1998, pin 4655414#.

Notes to the financial tables

The Group uses certain key non-GAAP measures in order to provide an additional view of the Group's overall performance and position, eliminating significant items that may obscure understanding of the key trends and position. These measures are used internally to evaluate business performance, as a key constituent of the Group's planning process, as well as comprising targets against which compensation is determined.  Reporting of non-GAAP measures alongside reported measures is considered useful to enable investors to understand how management evaluates performance and value creation internally, enabling them to track the Group's adjusted performance and the key business drivers which underpin it. Note 15 explains the use of non-GAAP performance measures.

(1)        Before adjusting items and amortisation of intangible assets.

(2)        Corrugated box volumes, adjusted for working days, on a like-for-like basis

(3)        GDP growth (year-on-year) for the countries in which DS Smith operates, weighted by our sales by country = 2.1%. Source: Eurostat (14 Nov 2018)

(4)        Operating profit before adjusting items and amortisation of intangible assets as a percentage of revenue, as re-stated under IFRS15

(5)        Operating profit for the prior 12 month period before adjusting items and amortisation of intangible assets as a percentage of the average monthly capital employed over the previous 12 month period. Average capital employed includes property, plant and equipment, intangible assets (including goodwill), working capital, provisions, capital debtors/creditors and assets/liabilities held for sale

(6)        Net debt at average exchange rates over Group operating profit before depreciation, adjusting items and amortisation of intangible assets for the previous 12 month period, calculated in accordance with banking covenants

(7)        Free cash flow before tax, net interest, growth capital expenditure and pension payments as a percentage of operating profit before adjusting items and amortisation of intangible assets

(8)        Organic volume growth, cash conversion and return on sales given for the 6 months to 31 October 2018, ROACE and net debt / EBITDA given for the 12 months to 31 October 2018

(9)        2017/18 EPS and interim DPS have been restated to reflect the bonus element of the July 2018 rights issue as required by IAS 33 earnings per share

(10)      References to continuing operations excludes the plastics division, which is now treated as discontinued

Cautionary statement: This announcement contains certain forward-looking statements with respect to the operations, performance and financial condition of the Group.  By their nature, these statements involve uncertainty since future events and circumstances can cause results and developments to differ materially from those anticipated.  The forward-looking statements reflect knowledge and information available at the date of preparation of this announcement and DS Smith Plc undertakes no obligation to update these forward-looking statements. Nothing in this statement should be construed as a profit forecast.

Unless otherwise stated, all commentary and comparable analysis in the overview and operating review is based on constant currency performance. Organic volume growth means corrugated box volume growth, on a like-for-like basis.

Overview

In the half year to 31 October 2018, DS Smith has delivered good growth and a 120 bps increase in return on sales. In addition, we have seen continuing excellent performance from Interstate Resources, which is now substantially integrated within DS Smith, and we expect to complete our acquisition of Europac in the coming month, for which preparatory integration work is substantially complete. There were strong profit growth contributions both organically and from acquisitions and adjusted operating profit grew at 32% with adjusted EPS increasing by 9% including the impact of the recent rights issue.

Performance for 6 months to 31 October 2018

Unless otherwise noted, this commentary relates to the continuing operations of the Group, on a constant currency basis.

The organic volume growth of 3.2%, ahead of our target of GDP+1%, builds on the very strong growth in the comparable prior period, and was achieved despite corrugated box prices rising to fully recover the higher price of paper. Growth is due to both market share gains, with very good volumes once again from our multi-national customers, reflecting our strong competitive position and our innovative packaging solutions across Europe and the US.

For the half year period, revenues increased on a constant currency basis by 16%, principally reflecting the full recovery of paper prices through box selling price rises, the contribution from acquired businesses, particularly North America, and volume growth in corrugated boxes. Group revenues also increased on a reported basis by 15%, with the organic growth contribution being 6%.

Return on sales for the period was 9.9%, up 120 basis points on the comparable prior period, and now at the top of our target range of 8 - 10%. This reflects the benefit of a strong business model, focussed on value-added packaging, together with strong returns and synergies from acquisitions and continued operational leverage from another year of good volume growth. The comparable prior period was adversely influenced by the headwind of rising input costs which have now been recovered as anticipated. Adjusted operating profit was up 32% on a constant currency basis, with the organic growth contribution being 11%.

Return on average capital employed remained level at 13.9%, which, whilst still in the upper half of our target range of 12 - 15 %, now reflects the reclassification of the plastics division into discontinued operations. It also includes the full effect of 12 months from Interstate Resources.

Balance Sheet

Net debt / EBITDA decreased from 2.2x at 30 April 2018 to 0.8x at 31 October 2018, as net debt reduced by £1,032 million to £648 million, reflecting the combination of free cash flow of £209 million and the c.£1 billion proceeds from the June 2018 rights issue, which is held as restricted cash pending completion of the acquisition of Europac. Excluding the impact of rights issue proceeds, net debt / EBITDA would have been 2.1x, a reduction from 2.2x at the last balance sheet date, reflecting the growth of the business in combination with our focus on tight balance sheet management. We estimate that, following completion of the Europac acquisition, net debt / EBITDA at 30 April 2019 will be less than 2.3x, a reduction to our previous estimate at the time of the announcement of the acquisition of being under 2.5x at that date. This improvement in our estimate reflects ongoing efforts to reduce working capital, tighter control of capital expenditure, reduced acquisition activity and demonstrates our commitment to bring net debt on or below our medium term targets following the Europac acquisition. The above estimates do not reflect any disposal proceeds from either the Plastics division or the Europac anti-trust remedies. 

Underlying cash flow from the business continued to be good, with a further working capital inflow of £28 million generated during the period. On 29 November 2018 we signed a £1.4bn five year revolving credit facility ("RCF") with our banking group to replace our existing £800m RCF and to ensure liquidity for the five years following the Europac acquisition. Covenants are consistent with our existing facilities and calculated in exactly the same way as previously reported.

Operating Review

Unless otherwise noted, the commentary below refers to changes on a constant currency basis.

UK

*Adjusted, before amortisation and adjusting items

In the UK revenues increased 4% to £577 million (H1 2017/18: £553 million) while adjusted operating profit has increased 7% to £59 million (H1 2017/18: £55 million). Corrugated box volumes in the period were strong, reflecting continued success with large FMCG customers, and a sustained leading position in e-commerce which is being replicated in other European regions.  Margin in the region is above the top of the Group target range, reflecting the mix of our business, our leading recycling operations and good recovery of the paper price rises.

Western Europe

*Adjusted, before amortisation and adjusting items

In Western Europe organic corrugated box volumes were in line with the Group average, reflecting a good performance in the French and Iberian businesses, and particularly strong volumes in the Benelux region (having been weak in the comparable period). Revenue increased by 8% driven by underlying volume growth and increases in box prices, to mitigate the input price rises in the period. Adjusted operating profit grew by only 5%, principally reflecting the lower proportion of paper manufacturing in the region than the Group as a whole.

DCH and Northern Europe

*Adjusted, before amortisation and adjusting items

DCH and Northern Europe has seen volume growth across the region, with a particularly positive contribution from our FMCG customers in Northern Europe. Revenue increased by 1%, and adjusted operating profit grew 31% reflecting the lagged recovery of input costs in the packaging business, offset by the contribution from our paper mills in the region. 

Central Europe and Italy

*Adjusted, before amortisation and adjusting items

Organic corrugated box volumes in Central Europe and Italy have grown around the Group average, reflecting in particular a very good performance from Italy, significantly driven by e-commerce. Revenues increased by 15%, reflecting the contributions from Ecopaper and Ecopack, which were acquired in March this year and as such contributed an incremental six months to this half year period. Revenues also reflect volume growth and the benefit of box price rises. Adjusted operating profit increased 19%, reflecting again the contribution from the Ecopaper and Ecopack businesses and the recovery of input costs.

North America

Corrugated box volumes in the period have shown continued good growth with particular strength in innovative packaging solutions for food and other FMCG customers.  Revenues have grown strongly, principally reflecting the inclusion of Interstate Resources for the full six months compared to the comparable period of just over two months and a strong organic growth performance during the period. The recently acquired packaging business, Corrugated Container Corp, is also included in the period. Revenues have been driven by good trading conditions for the paper operations in the region and the benefit of integration with the wider DS Smith platform. Profit performance is considerably ahead of that in 2017, again principally reflecting the additional circa four months of trading included and the positive pricing dynamics in the market. As highlighted at our capital markets day earlier this autumn, we are delighted that customers are now beginning to develop their business with us both in Europe and the US and the access to our innovation is delivering results for customers in both regions.

Strategic Review of Plastics division

Following the initial review of the Plastics business, the Board has concluded that it is an attractive asset with good growth prospects, and we are now exploring opportunities for a potential sale of the division. As such, the plastics division is now being treated as discontinued.

The plastics business has continued to trade well with revenues up 2%, while there has been some impact to short term profitability due to the impact of higher polymer prices and the normal lag in recovery through prices. 

Outlook

The outlook remains positive as we begin our second half with good momentum. The recovery of paper price increases that has been ongoing over the past 12 - 18 months is now completed. Our short-paper business model is robust and designed to deliver good returns throughout the paper cycle, and we have a clear trajectory to reduce net debt / EBITDA into line with our medium term target of less than or equal to 2.0x. The growth drivers for packaging, such as e-commerce, sustainable packaging and the more sophisticated requirements of customers and retailers remain, continuing the long-term trend of structural growth.

We continue to see exciting opportunities for the business and accordingly the Board remains confident about the outlook for DS Smith.

Financial Review

Unless otherwise noted, this commentary relates to the continuing operations of the Group, on a constant currency basis.

Group reported revenue for the half year to 31 October 2018 increased by 15% to £3,073 million (H1 2017/18: £2,663 million), reflecting acquisitions (£247 million), sales price growth and volume. Organic growth was 6%. The sales price increase principally reflected the recovery by the packaging business of rising paper prices, which is now complete. Good volumes in packaging contributed £48 million to revenue in the period, with some negative volume (£26 million) principally due to China-related sales of recyclate. On a constant currency basis, revenue also increased by 16%.

Operating profit of £201 million increased versus the prior year (H1 2017/18: £157 million) principally due to the contribution from acquisitions, partially offset by higher amortisation of £53 million (H1 2017/18: £40 million), again due to the acquisitions and the impact of the guaranteed minimum pension ("GMP") equalisation charge.

Adjusted operating profit increased 32% to £304 million (H1 2017/18: £231 million), with a £1 million headwind from currency translation. On a constant currency basis, adjusted operating profit growth was also 32%, benefitting from a £32 million contribution from acquisitions, principally the additional months of ownership for the North America businesses. The profit drop-through from higher volumes (£15 million) reflects the net impact of corrugated box volumes, partially offset by the reduction in recycling volumes. The benefit of higher pricing and sales mix (£156 million), as described above, was balanced against rising costs (£141 million), which principally relate to the increased price of paper.

Free cash flow (being EBITDA plus the cash flow effect of working capital, pension payments, capital expenditure (net of proceeds, tax and interest)) was £209 million (H1 2017/18: £162 million), driven by EBITDA of £393 million and a further positive contribution from working capital of £28 million, partially offset by capital expenditure, tax and interest payments. Net debt movement for the period was £1,032 million at 31 October 2018 principally reflecting the £1,002 million raised via a rights issue in July 2018 to fund the acquisition of Europac, such funds being held as restricted cash. The acquisition is expected to complete in the coming month. In addition, free cash flow was offset by acquisitions of £41 million (for Corrugated Container Corp, in the US, including borrowings acquired), restructuring and integration costs of £37 million and dividends of £53 million.

Capital expenditure net of disposal proceeds was £118 million in the period (H1 2017/18: £115 million) with c. £270 million expected to be spent in the full financial year (2017/18: £329m), excluding the impact of Europac.

Amortisation for the period was £53 million (H1 2017/18: £40 million), with c. £100 million expected for the full financial year, continuing operations (excluding any amortisation relating to Europac). Depreciation for the period was £89 million (H1 2017/18: £76 million), with the charge for the full financial year expected to be c. £185 - £190 million for continuing operations, excluding the depreciation charge from Europac. 

Technical guidance inclusive of Europac will be published following the completion of that acquisition. Capex and depreciation for Europac are expected at the outset to be broadly in line with those items historically reported by Europac.

Return on average capital employed of 13.9% for the 12 month period to 31 October 2018 (12 months to 31 October 2017: 13.9%) represents a consistent performance and remains in the upper half of our target range, despite the initially dilutive impact of recently acquired businesses. This return on average capital employed, for continuing operations, compares to the prior year figure of 14.6% prior to the exclusion of the plastics division. 

Adjusting items before tax of £58 million were incurred in the period (H1 2017/18: £39 million), including £15 million for GMP equalisation, £11 million relating to acquisition costs, £8 million of acquisition-related financing costs, and £24 million to integration and other restructuring initiatives. Within this last item, £14 million relates to centralisation and optimisation IT projects, resulting primarily from the Group's expansion activities. GMP equalisation is a non-cash cost relating to a change in legal interpretation of pension rights accrued between 1990 and 1997. Total operating cost adjusting items for the year, excluding those relating to Europac and GMP equalisation, are expected to be less than £45 million, a reduction versus prior guidance.

Net adjusted financing costs before adjusting items were £36 million (H1 2017/18: £27 million), reflecting the increase in debt over the period due to consideration paid for acquisitions. Adjusting finance costs of £8 million relate to costs incurred on the acquisition of Europac and the unwind of the discount of the Interstate Resources redemption liability. The pension interest charge for the period was £1 million, similar to last year, with a charge of £4 million expected for the full year. The interest charge for the year as a whole is expected to be around £66 million, inclusive of the pension interest charge and excluding the impact of the Europac acquisition. 

Profit before tax was higher at £162 million (H1 2017/18: £128 million), through higher operating profit, offset by higher interest, GMP equalisation and benefiting slightly from improved share of results of associates. Adjusted profit before tax of £220 million (H1 2017/18: £167 million) was higher through the growth in adjusted operating profit.

Tax on adjusted profits has been charged at a rate on continuing operations before amortisation and adjusting items of 23%.

Unadjusted profit after tax for continuing operations was £122 million (H1 2017/18: £98 million). Profit for the period was £130 million (H1 2017/18: £107 million).

Earnings per share for continuing operations before amortisation and adjusting items increased 9% to 16.5 pence (H1 2017/18: 15.2 pence), reflecting the growth in operating profit, partially offset in the period by the equity issue in July 2018 to raise funds for the Europac acquisition, which is expected to complete in the coming month. Total unadjusted earnings per share for continuing operations were 9.5 pence (H1 2017/18: 9.1 pence) due to higher profit from operations, together with the issues of equity noted above.

Financial position

Total equity increased to £3,231 million at 31 October 2018 from £2,110 million at 30 April 2018 due to the equity issue of £1,002 million, retained profits of £130 million, and foreign currency translation gains of £71 million, offset by actuarial losses on employee benefits of £24 million and dividends of £53 million.

Net debt at 31 October 2018 was £648 million (30 April 2018: £1,680 million), representing 0.8x EBITDA for the prior 12 month period, calculated on the basis of a full year contribution from acquired businesses. Expenditure on acquisitions was £37 million and borrowings of £4 million were also assumed. £1,002 million was raised by the issue of equity, principally in a rights issue as discussed above.

On 29 November 2018 the Group signed a £1.4 billion, five year extendable revolving credit facility with its banking group. Covenants and calculation of covenants are consistent with the existing covenants and reported leverage. This facility replaces a £800 million revolving credit facility maturing in 2020 and the Europac Bridge facility and provides liquidity for the Group for the next 5 years, further reinforcing the Group's strong financial position and liquidity profile.

The Group has for many years sold without recourse certain trade receivables and on realisation the receivable is de-recognised and proceeds are presented within operating cash flows in accordance with IFRS. These arrangements have systematically reduced early payment discounts and have thus provided the Group with more economic alternatives. The facilities available are committed for three years and are not relied upon by the Group for liquidity and not included in leverage calculations by our banks. Balances have slightly reduced, at £550 million (30 April 2018: £559 million), representing a decrease also as a proportion of turnover. The cost of these facilities are approximately £7 million per annum, included in finance charges. Should these arrangements be systematically replaced over the next three years with alternative payment arrangements then it is estimated that this could, at an extreme, cost the Group an additional £9 million - £10 million full year charge.

Dividend

The Board considers the dividend to be an important component of shareholder returns. In considering dividends the Board will be mindful of the Group's leverage, earnings growth potential and future expansion plans. As first set out in December 2010, our policy is that dividends will be progressive and, in the medium term, dividend cover should be on average 2.0x to 2.5x through the cycle.

The Board declares an interim dividend for this half year of 5.2 pence per share (H1 2017/18: 4.6 pence per share). This represents an increase of 14%, demonstrating the confidence of the Board in the outlook for the Group. The dividend will be paid on 1 May 2019 to ordinary shareholders on the register at the close of business on 5 April 2019.

Risks and uncertainties

The Board has considered the principal risks and uncertainties affecting the Group in the second half of the year. The principal risks and uncertainties discussed in the Business Review on pages 40 to 45 of the 2018 Annual Report, available on the Group's website at www.dssmith.com, remain relevant.

In summary, the Group's key risks and uncertainties are:

·     Acquisition strategy;

·     Eurozone and macroeconomic markets;

·     Paper supply;

·     Capital markets and liquidity;

·     Concentration and consolidation of markets;

·     Governance and compliance;

·     Changes in shopping habits;

·     Talent barriers;

·     Digital vulnerabilities;

·     Changes in fibre technology;

·     Sustainability promise; and

·     Strategic process change.

Going concern

The Group's recent trading and forecasts, after taking account of reasonably foreseeable changes in trading performance, shows that the Group is able to operate within its current debt facilities. At 31 October 2018 there was significant headroom on the Group's committed debt facilities of c. £800 million, which has subsequently been further increased through the new RCF agreement as described earlier. As a consequence, the Board believes that the Group is well placed to manage its business risks (as summarised above) successfully despite the uncertainties inherent in the current economic outlook. After making enquiries, the Board has formed a judgement that there is a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. For this reason, the going concern basis has been adopted in preparing the interim financial statements.

Responsibility statement

We confirm that to the best of our knowledge:

(a)      the condensed set of financial statements, prepared in accordance with IAS 34 "Interim Financial Reporting" as adopted by the European Union, gives a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole;

(b)      the interim management report includes a fair review of the information required by DTR 4.2.7R (indication on important events during the first six months and description of principal risks and uncertainties for the remaining six months of the year); and

(c)      the interim management report includes a fair review of the information required by DTR4.2.8R (disclosure of related parties' transactions and changes therein).

5 December 2018