The Investment Column: Paper prices cut Smurfit's profits

Magnus Grimond
Wednesday 03 September 1997 23:02

Jefferson Smurfit, the world's largest maker of cardboard boxes, has been through the mill (so to speak) over the past two years or so. It is less than 18 months since the paper group was hailing its 1995 profits as the biggest ever made by an Irish company, but even then it was recognising that the seeds of its own nemesis were being sown in the form of collapsing prices in an over-supplied market.

At their bottom earlier this year, prices for boxes had fallen close to a fifth since the beginning of 1996, while paper was down by as much as 25 or 30 per cent. The pain of that is reflected in Smurfit's pre-tax profits to June, which collapsed by 51 per cent to Irpounds 61.2m, but the group is now confident that the worst is over and has duly hoisted the half- way dividend by 10 per cent to Ir1.65p.

Certainly, Kraftliner and recycled paper grades, two key raw materials for Smurfit, have risen by 9 and 15 per cent respectively since earlier this year. The group is confident that a planned 8 per cent rise in European prices will stick after it is implemented at the beginning of October. It is also working hard to put its own house in order, with cost savings already running proportionately well ahead of the Ir35m promised earlier this year.

However, all this will be as naught unless the industry shows more discipline than it has in the past. The last upswing in prices to 1995 prompted a capacity binge amounting to around twice the normal demand growth, according to Smurfit. As ever, the timing proved disastrously wrong and much of it has come on stream since prices peaked.

The Irish group has been a model of restraint in all this, but in a triumph of hope over experience, it is now hoping that big US rivals like Georgia Pacific and International Paper mean what they say when they announce that future capital expenditure will only match depreciation.

This optimism is only part of what has been driving Smurfit's share price, which has leapt from around 150p in April to 210.5p, up 4.5p yesterday. The main propellant has been the soaring share price of the 46 per cent- owned US associate, Jefferson Smurfit Corporation, which has risen from $13 to around $19.50 since the start of the year on takeover hopes.

Expectations that the Irish group will bid for the rest of JSC look wide of the mark, given the price likely to be extracted by Morgan Stanley, the other big shareholder. However, the group revealed that it is looking at the possibility of a merger between JSC and another US paper group, which would help tidy up a messy situation.

Meantime, analysts are expecting Ir120m profits for the full year, putting the shares on a forward price-earnings ratio of 29. That fully discounts the recovery prospects. Avoid for now.

Plenty of riches in Wilson's land bank

Wilson Connolly, the building group, was looking ill-positioned in the housing market 18 months ago. A bias towards the bottom end of the spectrum at a time when first-time buyers were still not in evidence meant the company had to discount heavily to keep up volumes.

But the picture has changed entirely since the housing market started picking up. Although the group shifted only 1,725 houses in the six months to June, 104 fewer than last time, they were sold at much better margins, with the average selling price rising from pounds 61,000 to pounds 64,400. That fed through to a 30 per cent increase in profits to pounds 10.4m, with housing margins jumping from 5.9 to 8.3 per cent.

Although full-year completions at around 4,200 are unlikely to be much different from 1996, the improving momentum of the first half is set to continue.

At close to five years' sales, the land bank is one of the longest in the industry, allowing Wilson to steadily increase the number of its operative sites and be flexible if land costs spiral out of control. Currently, there is little sign of that, with selling prices moving up in line with costs.

Management have done a good job at shifting Wilson out of its ghetto in the one and two-bedroom house market, halving that proportion of the business to under 30 per cent of sales in less than five years. At the same time, the group has broadened its geographic coverage and gradually divested its development activities.

But the jewels lie within the strategic land portfolio. Wilson hit the jackpot with its 900 acres near Dunfermline in Fife, selling the site for the new pounds 2.6bn Hyundai microchip plant and winning permission for 3,200 houses which will have a plot cost of just 8 per cent of average sales prices. Dunfermline chipped in a land sale profit of around pounds 500,000 in the first half and there could be three times as much again in the second if a site sale to Tesco, likely to be worth around pounds 9m, goes through. Over 20 years, the project could produce pounds 300m of gross sales at very attractive margins, and Wilson has another potential gem at its Broadclyst site near Exeter.

Full-year profits of pounds 34.5m would put the shares, down 0.5p at 173.5p, on a forward multiple of 15. Attractive.

Emap titles boost Johnston Press

Investors in Johnston Press, the acquisitive Edinburgh-based regional paper group, have every excuse for looking smug, given the company's share price performance. The shares have risen 27 per cent in three months, as market worries over the ability of advertising revenue to weather this year's interest rate rises evaporated.

Yesterday the shares rose a further 6p to a new 12-month high of 222.5p, as the company revealed pre-tax profits in the first half to June of pounds 19.4m, up from pounds 12.6m before. The increase partly reflected the full impact of the pounds 205m takeover of Emap's regional newspaper titles early last year, which doubled Johnston's size. But as always with Johnston Press, sound management and rigorous cost control have justifiably given it a premium rating.

The Emap deal provided Johnston with the opportunity to sell off non- core assets and the company yesterday hinted at the imminent sale of bookbinding and library book selling businesses. Together they could raise pounds 10m, although this would be unlikely to result in a profit over their book value.

The economic recovery has played its part in the latest good figures, despite the interest rate hikes. Johnston disclosed advertising revenues up 7.7 per cent, beating most forecasts, with recruitment advertising soaring by 24.3 per cent in a buoyant jobs market.

The other good news came from newsprint costs, which the company predicted would stay at similar levels next year. Previously, they had forecast increases of up to 8 per cent. Lower newsprint costs saved the company pounds 2m alone in the first half of 1997.

The improving outlook should raise full-year profits to pounds 37m, compared with pounds 24.1m last year and previous forecasts of pounds 34m. Yesterday's one- third increase in the interim dividend, to 1p, should also be a good guide to the full year. The shares are still attractive as a long-term bet, though as a short-term opportunity they are starting to look fully valued.

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