The Investment column: Paper prices cut Smurfit profits

Jefferson Smurfit, the world's biggest manufacturer of linerboard for packaging, is something of a bellwether for the Western world's economies. Its materials and boxes are central to the shipping of products as diverse as fruit and vegetables, car parts and washing machines around the world. As trade grows, so does demand for Smurfit's products. The problem is that Smurfit is also completely dependent on the paper cycle, which has been vicious over the past 18 months. From $530 a ton at the end of 1995, US prices of kraft liner, a key grade, have slumped to $280.

So there was little surprise yesterday when Ireland's biggest industrial company announced profits slashed by 52 per cent to Irpounds 201m for 1996. Even so, Smurfit remains determinedly optimistic.

Although Dermot Smurfit, deputy chairman, was warning yesterday that 1997 would be another difficult year, he expects that a tightening of capacity later this year will ensure that 1998 should see the start of a sustained upturn for the industry. Support for this view comes from the recent performance of prices in Europe, which in the last few months have recovered half the pounds 60 a tonne fall recorded since the peak last year. Mr Smurfit also takes comfort from the reported decision by International Paper, the big US producer, to buy capacity rather than build it.

But there lies the crux of the problem for Smurfit. While the group has made a mantra of its renunciation of new-build capacity, others have proved more susceptible to the temptation to rush out and start building at the first sign of higher prices. The company itself points out that the 5.9 billion tons of capacity put on by the industry in the last three years is around double that likely to be used by "normal" demand growth. That adds up to a substantial overhang, even before taking account of the estimated 3.5 per cent or so additional plant expected to come on stream this year.

Even if the rest of the industry were to renounce its fixation with investment, Smurfit also has to contend with the uncertain outlook for continental economies, now the biggest part of the business since the pounds 640m takeover of Cellulose du Pin of France in 1994.

That said, Smurfit remains a quality company in an uncertain sector. This year should see it hack out another pounds 30m in cost savings, while good cash flow, admittedly assisted by favourable currency movements, has cut gearing to 34 per cent.

That strength is likely to be used for bolt-ons in places like Germany and developing markets, rather than mopping up the outstanding 53.5 per cent in Jefferson Smurfit Corporation, despite the apparent eagerness of Morgan Stanley to sell its 36 per cent stake. Profits of Irpounds 135m would put the shares, down 4p at 155.5p, on a forward p/e of 19. High enough, even with non-Irish investors holding one-third of the equity.