The Investment Column: New fields boost David S Smith

David S Smith has come a long way in the past five years since new management came into the business and transformed it from a company almost wholly dependent on paper making to a better balanced paper, packaging and office supplies distribution group.

Albeit from a low base, sales and profits have soared during that time and the share price, just 120p in August 1992 rose steadily to a high of 332p last summer. Since then, however, it has stagnated as the market looked beyond the rescue phase and questioned where the next stage of growth would come from.

Yesterday the share price closed unchanged at 295p despite a better-than- expected 25 per cent rise in pre-tax profits for the year to April from pounds 99.7m to pounds 124.6m. It was a harsh reaction to a 20 per cent earnings per share increase to 30.3p (25.2p) and a 15 per cent hike in the dividend to 7.5p.

What troubled investors was a curiously cautious statement from Peter Williams, Smith's Canadian chief executive. Trading, he said, had started well this year but he expected progress from packaging and distribution to be more than outweighed by continuing weakness in the paper operation, which has just navigated one of the choppiest periods for waste paper pricing that anyone in the business can remember.

Analysts took that to be a fairly strong hint that profits this year are unlikely to rise above about pounds 120m, although the range went as high as pounds 130m last night, with up to pounds 145m pencilled in for the year to 1998. At yesterday's close that suggests a far from demanding price-earnings ratio of 9.5 to next April.

The problem with the shares would appear to be a poor understanding of how Smith has changed over the past few years - it is still essentially rated as a cyclical paper company and little credit is given for the more reliable, better quality earnings from the other two legs.

BZW, which recently did a sum-of-parts valuation of the three operations, thinks a market p/e for both packaging and distribution and a premium valuation for the paper arm to reflect its exposure to the growing recycled- paper market best reflects Smith's true value and comes to a target about 50p higher than the current price.

Whatever you think of that approach, the fact is that Smith is operating in a long-term growth market, is highly cash generative and has a proven record of investing well to produce a steady improvement in margins.

Gearing is manageable and the benefit of several completed investment projects should start to show through in coming years. Good value.