I wrote about DS Smith (LSE: SMDS) shares earlier this month, highlighting that I’d buy the stock. I still would, especially now the company is in the limelight for one key reason.
There are rumours that Mondi, the paper and packaging group, is considering a takeover of DS Smith. I think it’s worth taking another look at the stock.
The potential takeover
I believe a Mondi takeover of DS Smith would make sense. Both companies offer similar services. And the quickest way to grow a company can be to buy similar businesses.
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This way not only is the firm growing its revenue, but there’s the potential to increase profitability by cutting duplicate costs. Otherwise known as improving revenue and cost synergies. With a Mondi takeover of DS Smith, I reckon this is exactly that.
I should stress that a deal is, at present, only speculation. As yet, neither company has confirmed the rumours. But naturally, the possible transaction has led to DS Smith shares rising today. Talks around such a takeover could still be at a very early stage and there’s no guarantee they will lead to a transaction.
Mondi, which released its full-year results today, has recently been acquiring companies. In January, it agreed to acquire a 90.38% stake in Olmuksan, a leading Turkish corrugated packaging player. I think this could be a sign of things to come. Mondi could be in the market to acquire rival businesses in order to grow. I guess only time will tell if a DS Smith’s takeover goes through.
DS Smith’s business
I wouldn’t buy DS Smith shares purely on takeover speculation. Yet as a long-term investor, I think the company has some great qualities on its own.
It has weathered the coronavirus crisis well due to its high exposure to two key areas: fast-moving consumer goods (FMCG) and e-commerce companies. FMCG companies typically sell their goods to supermarkets and through online channels. Throughout the pandemic, supermarkets have remained open and e-commerce businesses have been ultra-busy.
Despite these tailwinds, the business has still been affected negatively by Covid-19. It manufactures corrugated thick-paper and falling European paper prices have hurt revenue. But the company has nonetheless decided to resume its income payments with a 4p interim dividend. To me, this is encouraging and I think that if the recovery continues, the company may be able to resume the full dividend too.
The risks
DS Smith is a cyclical business, which means that it’s dependent on how the wider economy is doing. This means that if the economy is suffering, DS Smith shares are likely to suffer.
There’s no guarantee on the dividend. If conditions turn bad again, management could decide to suspend the dividend. DS Smith is dependent on paper prices too. If lockdowns persist, there could be a fall in paper prices, which could impact revenue.
Growth drivers
Even without any Mondi takeover, what I really like about DS Smith shares are the long-term growth drivers. I think the shift to online shopping, not to mention sustainable packaging, should help it. With a price-to-earnings (P/E) ratio of 12, it remains reasonably priced, even after its latest rise.
I believe the company is in a good position to capitalise these trends. Hence I’d buy DS Smith shares in my diversified portfolio regardless of takeover speculation.
