U.S. Markets close in 1 hr 1 min

Edited Transcript of SMDS.L earnings conference call or presentation 13-Jun-19 8:00am GMT

Full Year 2019 DS Smith PLC Earnings Call

London Jun 24, 2019 (Thomson StreetEvents) -- Edited Transcript of DS Smith PLC earnings conference call or presentation Thursday, June 13, 2019 at 8:00:00am GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Adrian R. T. Marsh

DS Smith Plc - Group Finance Director & Executive Director

* Miles W. Roberts

DS Smith Plc - Group Chief Executive & Executive Director

================================================================================

Conference Call Participants

================================================================================

* Alexander Berglund

BofA Merrill Lynch, Research Division - Analyst

* Alexander Mees

JP Morgan Chase & Co, Research Division - Head of UK Small and Mid Cap Research

* David A. O'Brien

Goodbody Stockbrokers, Research Division - Investment Analyst

* Justin Joseph Jordan

Exane BNP Paribas, Research Division - Analyst

* Robert Chantry

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [1]

--------------------------------------------------------------------------------

Well, firstly, good morning, everybody. I'm Miles Roberts and I'm joined with Adrian Marsh, our Group Finance Director. And firstly, welcome here. Thank you very much for spending the time to come to our presentation for the results for the 12 months the end of April and also an outlook for the coming year.

Then let's get straight into it. A year of real change, development, growth, progress. We've really developed our strategic agenda, really trying to get the right assets in the right places, positioning us for what is an extremely exciting market going forward. With the acquisition of Europac boosting our -- significantly boosting our presence in Iberia, we're very pleased with that initial performance. Just over 3 months, absolutely in line with our expectations.

But of course, we're even more delighted with the synergies. Further upgrade -- a EUR 20 million upgrade, a 40% upgrade in our synergy target from EUR 50 million to EUR 70 million. Outstanding work there. Outstanding support from our customers and all of our new colleagues there.

And secondly, the sale of Plastics being sold for 9.5x last 12 months EBITDA. It will be completed by the end of this year, all on track as we expected.

So strategically, creating a group that's more focused, more agile, ready to take advantages that the market is offering us, as I've just spoken about.

And operationally, we've had our growth at 2.4%. All regions were in growth. E-commerce was very strong. FMCG was also strong consistently throughout the whole year. But we did see some weakness in industrial, particularly in Germany. We believe it's short term, and I'll talk a lot more about that in the second half of the presentation.

In the U.S., we've upgraded the synergy target twice. You probably had a quick look at the results. We're extremely pleased with the delivery of that business. Again, huge support from our customers, our new colleagues showing in the improved margin and the synergy delivery.

And financially, I think if we look at the last year, it's really been a year where we started with some rising input costs and we finished the year with some falling. That puts quite a bit of volatility there, but our pricing discipline has been absolutely excellent, really first rate in recovering everything on the way up and holding it on the way back.

That value orientation in the company is working very well. It's delivered an operating profit organically up 9%; overall, up 28%; a record margin of 10.2%, it was 130 basis points improvement. And on the back of that, we're really delighted to say whilst a few years ago our target range for return on sales was between 6% to 8%, then we're 8% to 10%. We can really see our route now to being between 10% and getting to 12%.

It's not only about the profits. It's also about the cash flow, you see a significant improvement there. Again, as we said, we would an 84% improvement in our free cash flow. And on a pro forma basis, with the disposal of Plastics included, our net debt-to-EBITDA falls below 2x.

So with that, Adrian, I hand over to the financial results.

--------------------------------------------------------------------------------

Adrian R. T. Marsh, DS Smith Plc - Group Finance Director & Executive Director [2]

--------------------------------------------------------------------------------

Thank you, Miles, and good morning, everyone. I'm going to talk you through our results for the year.

As usual, unless otherwise explained, change is referred to on a constant currency basis.

I'll also be talking about the group on a continuing operations basis, so that's excluding Plastics, which is treated as discontinued.

Here are our financial highlights. Revenue is up 12% and operating profit up 28%. I'll take you through bridges for these key line items in a moment. We've achieved a record margin, and Miles will also talk more about this later. This improvement has flowed through to earnings per share up 8% on a constant currency basis. The reason that the EPS growth is lower than profit is that the rights issue took place in July last year, ahead of Europac completing in January of this year. Dividend per share is up 13%, ahead of the EPS growth, recognizing the importance we place on shareholder return. Return on capital performance at 13.6% is in the middle of our target range, reflecting the full dilutive impact of the Interstate acquisition and partially for Europac, the full effect which will be in next year's average capital employed.

Walking through the revenue, this is on our continuing operations excluding Plastics as I've mentioned before. For comparative purposes, I split out the impact of Europac and other acquisitions, essentially, the 4 months we didn't own Interstate and also contribution from EcoPack, EcoPaper and Corrugated Containers in the prior year.

Contribution for organic growth was GBP 66 million with a negative balance on other volume, principally from the impact on -- of China on lower recycling sales. The increase from sales price and mix is driven principally from increases in box prices recovering the negative impact of rises in underlying impact -- input costs. Overall, that results in a 3.3% organic rise in revenue.

Turning to EBITA. There is the contribution from acquisitions, as I described already, and the synergies coming through from Interstate Resources as planned. The volume contribution you see here is a net of the positive from packaging, which had a similar drop-through to previous periods, partially offset by the decrease I mentioned in recycling sales. We believe our 9.4% organic growth is a testament to our focus on pricing discipline, and you can see the full benefit of sales price and mix improvements coming through, which more than offset the increased cost we experienced.

The GBP 146 million is a net number comprising higher input costs, of which the substantial element is paper with, as you would expect, some benefit from lower OCC prices and higher paper integration.

Margins by division have improved -- have all improved this year. The U.K., despite the overhang of Brexit, performed very well delivering strong results both in terms of organic growth and delivering on previous restructuring initiatives.

Western European margins remained below the group average due in large part to having less paper capacity. The organic growth was decent and the addition of the Europac assets now provide an excellent springboard for further growth and margin progression.

Within DCH and Northern Europe, Germany was weaker in the second half, and Miles, as he's mentioned, will talk more about that later, but it clearly has had an impact on both group volumes and the overall performance of the country.

Central Europe and Italy continued to deliver good results.

And the U.S. again is a standout region as it's benefited from synergies coming through as well as strong underlying trading.

Whilst the greenfield operation in Lebanon in Indiana will initially be slightly negative on margin this financial year, the financial year we're just entering into, because of the start-up losses, the additional capacity it provides is much needed, and in the full year of operation, we'd expect this to reverse as the facility fully ramps up.

Overall then, we achieved a record margin result and we've taken a decision to stretch our ambition further with an upgrade of our medium-term target to 12%. Following the acquisition of Europac, we decided to simplify European business to drive organic growth and operational efficiencies by amalgamating existing spans of control into 3 new regions: the North covering U.K., Scandinavia, Benelux and Germany; the South, covering France, Spain, Portugal and Italy; and possibly rather unimaginatively, the East, covering from Poland -- or from Austria and Poland all the way down to Turkey. From the half year, we'll be reporting on this basis and will, of course, provide the relative comparatives.

Okay. I pressed the wrong button.

We've consistently delivered on an upgraded expected synergies from our M&A. Europac is no different, and following our detailed post-acquisition work, we're now confident to upgrade our cost synergy target by EUR 20 million to EUR 70 million. The eagle-eyed amongst you may have already flipped to this year's technical guidance and have spotted a small increase on CapEx for Europac, which we've assessed is required to fully deliver this.

Whilst it's still early days at Europac, I can, without equivocation, report that our integration is going very well. The quality of our new colleagues is high and the enthusiasm shown to work together to identify value-creation opportunities has been extremely impressive. Likewise, a significant momentum generated from the Interstate acquisition has remained and the opportunities for further profitable growth are compelling.

We also have a strong track record in driving efficiency in our business and capital allocation. Miles will talk more about our paper strategy going forward in a minute. But in addition to this, we believe we have some significant opportunities with our enlarged business to make some meaningful improvements in our SG&A cost base and also in our asset optimization, driving sustained long-term profitability for the group.

Now we have a quick update on disposals. Both the Plastics and remedy disposals remained fully on track and exactly as expected in terms of value and timing and the proceeds from these will be used for deleveraging, as previously indicated.

Last year, we described our disappointment in our cash flow performance and set out what we would do to improve this. I'm pleased to say that these actions are delivering tangible results with further progress planned for this financial year. EBITDA increased following a good business performance and this was accompanied by strong underlying working capital inflow. You can see that we've also reduced the amount of receivable factored under our 3-year committed facility by around GBP 82 million. The balance last year was GBP 559 million and the comparable this year is now GBP 483 million. In addition, we've acquired a balance of GBP 42 million from Europac, which will be absorbed into our program.

CapEx has come in as guided and was a reduction from last year despite us now being a larger business.

The tax and interest, cash cost is higher principally due to increased profitability, and hence, obviously increased tax.

Overall, we're much happier this year with free cash flow, up 84%, and have plans in place to continue this momentum.

Moving to the cash flow bridge. The picture is dominated obviously by the Europac acquisition and the rights issued to fund it, the other items are as previously described. We ended the year with leverage of 2.3x, which is 0.2x less than we anticipated when we announced the acquisition pretty much a year ago today.

On a pro forma basis, if we take into account the Plastics and remedy disposals, we're at less than 2x. Although, as I always point out, you should consider the Interstate production when looking at implied leverage and we ensure we have the liquidity to cover this should it be exercised, which is an annual option each August. This would add a further 0.2x to our leverage and it's fully considered in our credit rating, which we've just been advised by Standard & Poor's remains at an investment grade and has returned to a stable outlook.

Our gearing then sits at 2.3x based on the balance sheet or less than 2x if you include the Plastics and remedy disposals. We expect to continue de-gearing through ongoing cash flow. Following the Europac acquisition, we refinanced our bank debt and have no meaningful redemptions until 2023. And in danger of repeating myself, we're confident we have meaningful opportunity to reduce working capital, and operational management reward is now directly linked to achieving this.

So overall, it's been a good year, making good progress in relation to our medium-term targets. Volume continues to be ahead of the market, albeit we did see some weakness in half 2 in our industrial section -- sector, particularly in Germany. And as I said, Miles will talk more about that in a minute, that we believe we've meaningful -- we've got clear routes to make further meaningful organic growth.

We're very pleased where margins now are and works will advance to further improve this over the coming years. ROACE is right in the middle of our range despite 2 recent acquisitions, which obviously add goodwill to the calculation, and will improve over time as synergies and scale benefits get delivered.

We've also now taken out Plastics, which had a particularly impressive ROACE, but no longer sat strategically in our business model so we've now recognized a dilutive effect of removing that.

Net debt-to-EBITDA is 2.3x, but following the Plastics and remedy disposal, takes us below 2x on a pro forma basis and our target of below 2x should be fully achievable in the short term.

Here is the usual technical guidance slide. Essentially, the only real change is to reflect a full year of Europac with everything else consistent with the year just ended. As a point of note, a large proportion of those M&A disposal costs you see relate to Plastics and can be assumed to be part of what we've guided to as net proceeds for the Plastics disposals and will obviously be more than offset by the significant exceptional credit on completion. The put option unwinds only cash when the option is exercised and can be assumed to be part of that cash impact to the put option exercise, which I described previously, leaving around about GBP 50 million of cash-adjusting items, which include GBP 18 million of restructuring which have been set aside to refocus on particularly Germany, and to some extent, France.

On IFRS 16 guidance, we'll be adopting IFRS 16 in this current year so we provided some guidance as to the effect. While there are still some moving parts, in summary, there is a very small impact on our ROACE and no impact on our leverage ratios. And the outcome is consistent with adjustments, which S&P have historically made to determine our credit rating. Whilst there will be no impact anyway, it's still worth pointing out that our financial covenants are calculated on a frozen GAAP basis.

So finally, as always, my favorite slide, which sets out our track record and the progress in this year, which continues to add to the upward trajectory in earnings per share and dividend per share.

And so I would now like to hand back to Miles to talk a little bit more about the drivers behind our resilient and growing business.

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [3]

--------------------------------------------------------------------------------

So thank you, Adrian, for taking us through the results. I think you can all see about the progress that's been made not only financially in the strong results but also operationally as well.

So if we just stand back for a while and just think about the last year. It's a year really, as I said, of 2 halves in terms of volatility. We started with very strong increases in the macro environment, but I think over the last 6 months, we've seen the macro environment just quieting down a bit. So we've seen some change there, but the results have shown how we've been able to deal with that.

Fundamentally, over the last year, there's been a huge change, continued progress in the way that everybody is consuming, shoppers are buying, how our customers are thinking about the products they need for the future. It's really been an enormous change here, this whole consciousness of the environment. We've all known about it. But over the last year, it's taken on a completely different perspective with our customers.

Last week, I had a good few hours with one -- with the CEO of our largest customer and all he was talking about was the environment and he was showing how all the blogs on their company are showing pictures of their products -- of their packaging lying on a beach. And underneath, it's got from their consumer saying, is this yours? This is your rubbish, it's got your name on it and I found it in a beach in Indonesia. So what are you doing about it?

So it's not only about a nice to have, this is becoming an imperative for business. We've seen legislation coming up banning the use of single-use plastics around plastic plates, around straws, around cutlery, around single-use plastic cups. That's going across Europe. The U.K. will adopt that, we'll see what happens in the U.K., but I think it will stay aligned with Europe in terms of the environment. So this is starting to affect everything.

And that structural change in the market is sort of really playing to what we've always built our business on over many years about the whole circular economy. So that gives us confidence about the underlying growth, the structural drivers and how we're well positioned. And these are the main drivers.

I'm going to talk more about e-commerce. It's growing all the time. We're hearing constantly about the High Street, about how High Street shops are having to restructure themselves to cope with the reduced footfall. There have been a lot of recent press about this and how -- and reduced rents because High Street isn't as valuable as it used to be because of the growth of e-commerce.

But we're also finding the High Street is also fighting back. Whilst the sales in the High Street may be flat, how does a retailer fight back? Once you've got the consumer in your store, how do you delight them? How do you get more -- how do you increase the value of their shopping basket? What do you do to excite them when over 60% of purchases, in the U.K., it's over 70%, the purchase is chosen at the point-of-sale, that means the packaging.

So we're seeing growth there, we're seeing growth in convenience. We're seeing growth in the discount sector. You've all read about that. This all means new packaging. This all means new requirements. We're talking to a retail -- one of our customers, they have to repack over 60% of their products. The box they leave the factory in has to be put into another box, and that's increasing. So we're seeing big growth there.

And obviously, on sustainability, I've mentioned it already, it's not just about us, it's about how we connect with this wider economy. We're a global partner for the Ellen MacArthur Foundation. It's a foundation we work jointly with some of the world's leading companies here, people like Unilever, like SC Johnson, like Danone, like us, with NGOs because however much we do, we can create the solutions, but we need the infrastructure, we need the awareness of all of our consumers, awareness of government to pick this up. And we're working with them. Joining up the circular economy, we believe not only is it the right thing to do, it's a major boost for our business.

So on that sustainability, when we see our retailers, they're all talking about how they can replace plastics. 81% of our industry uses recycled material. It's not that it can be recycled, it's that 81% is recycled. You've heard in the U.K. government they are talking about legislation. If it's got less than 30%, you're going to have to pay more tax. We're 81%, way ahead of the rest. It's 14 days box-to-box of our products 100% recyclable.

We've recently undertaken a study across Europe looking at the supermarket shelves and about the opportunity to replace plastic with corrugated. And there's an immediate opportunity to replace, with the technology that we have today, 70 billion units of plastics that are currently on supermarket shelves in Europe. That's 140 per person throughout Europe. That's 1.4 million tonnes of plastic. Europe only makes 20 million tonnes of plastic. The problem is it lasts for 5,000 years. So you use it for 5 minutes, you've got it for 5,000 years. And this is the change. This is where we see that opportunity.

And of course, when we come into e-commerce, we have experienced consistently throughout the first and second half year double-digit growth. It's been -- we've seen the shares improving, we see new entrants coming to this market, new customers particularly e-pharma, more on grocery. Whilst we have grown double digit, we have very recently been awarded a further major expansion of our business here by a leading supplier here who looks at the innovation, the quality and the service and we're absolutely delighted to have such a vote of confidence in us, which will be a major boost for our business in the coming year.

And that's partly been enabled by our acquisition into Spain because a lot of that is in the Spanish market. We've now got the capacity and our customers are rewarding us with it.

On innovation. Our 700 designers, but it's these 9 major innovation hubs so we're increasing our spend. Last year has more spend than the previous year, more spend than the previous year. We got some really exciting moves here.

If we look at e-commerce, it is about the void space. But I've talked about e-pharma as well about people having treatments at home. They don't have to go to hospital, they don't have to go to the doctor and wait in a drafty waiting room, catching illnesses from everybody else there. But you treat yourself at home. But of course, the product then has to come to you, maybe it has to be temperature-controlled, may have to be in packaging that is fully recycled, it can be picked up.

So we're seeing not only a real growth in volume there but a real growth in value-added opportunity. It's not just about getting your book delivered home, it's about getting your medicine, that product that you absolutely need in perfect condition and how we can deliver that: properly temperature controlled, properly tracked, traceability is in there, signed for and then linked to how you then have to take that medicine through the app once you've been delivered it and reminding you when you need to take it. Very, very strong, very nice margin and we're delighted the way they work with us. That's on the e-comm innovation.

Barrier technology. How we replace plastics? How we can start to print on our material, on our fiber, make it impervious to the ingress of fat and liquids, et cetera, long-term trends. We're doing very well there.

And of course, how we increase the performance of our packaging so we can take more paper out, we can take more fiber out, use less energy than ever before. It's coming on very nicely and it's all backed up, of course, by our scale because this is what we have thought over the years. Let's not forget that. We've come from just a U.K. company to being the leading company across Europe, serving every market with scale so these innovations can come at pace.

One of the reasons we've had this, say, for example, this major new award on e-commerce is because we can supply absolutely consistently these same solutions right across Europe and the customers want this. They are consolidating their supply chains. We've seen that steadily and that all comes into our FMCG focus.

This is where we were in 2016/'17. You can see about 67% of our business was in FMCG. Very resilient, constantly growing. And 9% in other consumer. So there, we were up towards that 76%. Two years later, we're up to 80%. We can get that to 85% in the medium term, further squeezing that industrial part. It's been a major part of our strategy. Years ago, we were at 60%. We've been driving it and we think we can drive that much further.

Because when we look at our volume growth, if we look at where we were 2.4% for the year, 3.2% first half, that's 1.7% for the second half. And the second half was a low figure compared to where we've been before, there's no doubt about that. But again, it's a story of 2 halves.

When we look at FMCG, well, that grew consistently, half year-on-half year, no change. Consistently well above 4%, doing very nicely the first half and second half with our multinationals. We're actually growing at 7% as they're consolidating their supply. We grew our margins in that as well because of more value-added, a really excellent pricing discipline in there. You have to recover -- when your raw material is going, you have to recover the price. You will always, always, always take a volume hit to get the price even if it means a delay.

And our pricing discipline has been excellent. You saw it in the first half results how we recovered everything. But despite that, we still grew very strongly. I think the issue that we've known about is in the U.S. where we have been capacity constrained. We cannot keep pace with the demand that's put on us and that has held it back. But despite that, we've still grown consistently first half, second half over 4% and we expect further progress in the coming year. It's really exciting.

With industrial customers, the half 1 was flat; the second half was negative, particularly in Germany. As I've said, we've been reducing our exposure here. We've seen some supply chain compression. We think that it's pretty short-lived. We've been very disciplined in pricing. So if you look at our margin analysis, you will have seen despite the fall, the profitability and the margin in Germany in that region has gone up. So it's about value added. We've seen 120 basis points improvement in that margin despite the low volume. It's the right decision and we'll do the same.

So -- but looking forward, we expect the first half of this year certainly to be better than the second half of last year, and we expect the full year of the coming year to be an even further improvement on that as well.

If we look at our margins, you see we put here our margin over many years going back to sort of 2009/'10. We've also put in here a track of our -- some underlying paper prices. We've used this many times. And you've seen really pretty consistent margin progression. We have seen recently some volatility in paper prices, but we think that follows a normal cycle. We don't see anything particularly unusual about that. Indeed, there's quite a bit of stability at the moment.

So that's been the progress on margins. When we look at our drivers of how we improve that, we are seeing the economies of scale coming from our business. We are seeing this increasing value-added proposition for our customers where we're winning that pricing discipline is working well because of the value we're adding, and we're also seeing a contribution from both North America and Europac with the high synergies coming through. We're above 10% last year, and we can see ourselves getting up towards 12%.

Delivering in the U.S. Again, we completed the acquisition back in September of 2017, so this is our first full year. You see the results of it. You see the return on capital in our full first full year of ownership way up into double-digit returns. We are very, very pleased. And we're pleased because of the support we've had from our customers and from all of our new colleagues. The $40 million synergies are absolutely being delivered.

We made a very modest acquisition again, just giving us some more capacity, but as we said, we are capacity constrained. We have not been taking new orders for quite some time so it means the like-for-likes have been more modest, and that's why we need the new factory.

This new factory is -- that's the state of construction as to at the end of last week. This is in Indiana, Indianapolis. It's very close to a number of our customers. They are very excited. It's all on track. It should come onstream in October. It actually adds 1/3 more capacity to our U.S. business. So we think this will give us substantial capacity in that region, and hopefully, provide a footprint for further expansion in the U.S. Construction is going well, the operations as well, but we're preselling the volume and it's getting all the support. So we should see more growth come out of the U.S.

And in Europac, you've seen the initial results. It's exactly what we expected when we made the announcement in -- of the proposed acquisition last June. Basically, the business is pretty much as we expected. We've got some very good paper operations. If we look particularly around the Viana mill in Portugal, it's very good. We've had no paper capacity at all in Iberia. This is now giving us that opportunity.

In terms of the packaging assets, we thought they were poor. They were poor, there's no doubt about that. But we've dealt with all those things before. It's exactly the same as when we bought into Lantero and GoPaca, et cetera, in that region, how we bring those margins back to the group average.

That Western European business has already contributed in our margin analysis. You've seen the margins improve and I have to say we're already seeing quite a turnaround in those packaging assets. And with some of those new awards I've said, I think we're going to see a very strong performance there.

Delighted with the employee engagement, delighted with the customer reaction as well, giving us confidence in those synergies.

But of course, at the time of the acquisition we said, this has given us a bit too much paper. There's no paper in this extreme recently. It's our overall balance. And therefore, we have to reduce that.

We particularly have to reduce it in and around Central Europe where there's excess capacity. That's where a lot of drivers of paper loss are for coming from. So this is pretty much the graph we presented. This is a graph showing our actual position on paper. We've come to about 80% of our package needs provided internally. We need to reduce that towards 60%. We are looking at how we do it through the growth in packaging and optimizing our paper footprint just in and around Germany. We're well advanced on that and we expect to make some good moves, bring it back towards 60% and just rebuilding our short position exactly as we said at the time of the acquisition, really giving us the right assets in the right position.

So our outlook for the current year. We continue to see good structural drivers there for growth. We expect the growth certainly to improve from the second half of last year. We think we can really see where that was and what's happening. We've got very good growth with our FMCG side. We're delighted with the pricing. Our shareholders are entering the year with a strong pricing on our end product. It's essential to get that right, and we feel very pleased with the work that's done. It's only possible because I think our customers recognize the value that we add.

Continued focus on driving the cost and the cash generation, which Adrian has talked about. I think as he said, there are further good opportunities there. We're very convinced of that and we'll see that coming through.

So we expect full year '20 to be a year of good progress for DS Smith. And as we take questions, I'll leave you with our value proposition, which remains the same. Thank you.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [1]

--------------------------------------------------------------------------------

Alex, since you were...

--------------------------------------------------------------------------------

Alexander Berglund, BofA Merrill Lynch, Research Division - Analyst [2]

--------------------------------------------------------------------------------

Alexander Berglund, Bank of America Merrill Lynch. If we can start a bit, it's topical so on box prices. What have you seen so far in your business? Have you seen any reductions? And I know you point to your chart where it kind of showed robustness through the paper cycle. If I think about your margin outlook, the raise from 10% to 12%. Do you believe that you're able to reach that even in an upcoming year, so next year, despite the reduction in paper prices and potentially box prices?

Secondly, on your volume, do you expect to reach your target of 1% above GDP next year?

And then, if I may, just finally, if you could give us a bit more color on the points you made on integration and becoming more short. Is that just a function of you increasing your box volumes over time? Or are you looking also at kind of potentially selling or kind of shutting down some lines to get to that short position?

--------------------------------------------------------------------------------

Adrian R. T. Marsh, DS Smith Plc - Group Finance Director & Executive Director [3]

--------------------------------------------------------------------------------

So in terms of box prices and whether we've seen reductions, as it stands today, box prices have held very stable across our business, so we haven't seen an impact. Clearly, paper prices have come down, pricing announcements that we've seen published show prices going up again on the paper side. So at this stage, we haven't seen a reaction. Clearly, if they went lower and hold lower for a sustained period of time, you inevitably see a response. But at this stage, we see nothing.

In terms of the margin target and the margin guidance, we set our ambition at 12%, that's a medium-term target so I'm not going to sit here today and say my expectation is to achieve that next year or it will be a short-term target. However, we set a floor at 10%. That's where you can -- we now have set the range.

So I'm very confident that we will achieve margins within our target. And clearly, the ambition is to hit stretch. And everything that we're doing around asset optimization, around cost base, around organic growth is designed to deliver to that stretch target.

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [4]

--------------------------------------------------------------------------------

And on the volumes, we do. We have a target. We've consistently delivered against it. I think in the second half of the year, we were behind that. It's one, really one particular issue, it's on industrial. We have seen a softening there. We are reducing our exposure all the time to that. But the FMCG has stayed incredibly strong all the way through. And here's what we're trying to say now, there's a bedrock of demand there, which is going up and all the time our sort of exposure to these, the more cyclical areas, is reducing. Now we're at 80%, would I like it to be 90%? Yes, of course. We continue to do all that. Europac actually boosts that slightly further as well. They've got a good balance there.

So we do think we will be able to be there. We think the first half will be better than the second half, we can see it already. Nothing's for certain, but we feel we can be confident about that and coming back to our target. And that's backed with some of the awards that we can see. But those awards and the growth, as Adrian said, is -- it is on our pricing and we've stayed very, very disciplined to that. There's a lot of poor volume out there that could quite easily come back this year and say, you know what our volume, shut the lights out, get the margins deteriorated. It's about getting both. And there is always a bit of a balance, but you have to get the price right because that's what you set the new year up on.

If you haven't got the price. In fact, we've carried on increasing prices into sort of February. So and Adrian said, we haven't seen this price because we're actually increasing them. It's only over the last couple of months where we haven't been increasing them. As Adrian said, it stayed very stable.

But on the integration point, it's a key part of our model. We've always had this target. It is really around having exposed to that Central European market. I think there are 2 elements in there. There is the element of continuing packaging growth, driving from 80% down towards 60%. But they're also a -- some -- there's another sort of asset, et cetera, having a good -- we're having a good look at and whether that's right for us or whether it isn't as well. It's too early to say. We've been consulting and talking to people, but I think we've got a good opportunity there as well to reduce our exposure through, as we call it, optimizing our paper base.

Alex?

--------------------------------------------------------------------------------

Alexander Mees, JP Morgan Chase & Co, Research Division - Head of UK Small and Mid Cap Research [5]

--------------------------------------------------------------------------------

This is also Alex. This one is at JPMorgan. Two questions. Firstly, just to maybe echo the previous question around the GDP plus 1% target. So I wonder given the focus of the business these days, particularly with the rise of e-commerce, is very much about value-added packaging rather than commodity packaging. Given you're not prepared to chase price, I wonder about your thoughts as to whether this is actually a valid target to be thinking about organic volume growth anymore.

And secondly, just with regard to the upgraded synergies from Europac. I just wondered about the source of this. Is this coming from the packaging side and sorting out that underperforming packaging business? Or are there extra costs you can get out of the paper side of the business?

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [6]

--------------------------------------------------------------------------------

Yes, yes. We -- if we look at our business, the -- what we're seeing in the FMCG is more an absolute level of growth. We've seen the economy being volatile, but we've seen consistent growth in the FMCG side over many years now because of all the factors that I've talked about: sustainability, e-commerce, changing moods, et cetera. It stayed very, very strong. And with the big customers with consolidating, I said we've grown another sort of 7%. That's absolutely typical for us.

So I think looking forward, as that percentage improves, we will move more to an absolute level of growth. We haven't moved there yet because we still have 20% of our business. Okay, it's a modest amount, but it's still 20%. And we said that can vary from sort of plus 5% to minus 5%. We haven't lost share in that market. The market has just been very difficult and that's why we want to reduce our exposure. And you'll see going forward, you'll see further and further sort of compressions of that business, particularly in Europac comes in [forward], you'll see a further compression. So that's when I think we will be able to move more to an absolute -- we should be really between this range, and if GDP goes really up strongly or down strongly, we should remain in that range. We know what we want that to be. As I said, our FMCG has been consistently over 4%. We just need to carry on growing that and I think then we'll come back on that target. And with the synergies, Adrian?

--------------------------------------------------------------------------------

Adrian R. T. Marsh, DS Smith Plc - Group Finance Director & Executive Director [7]

--------------------------------------------------------------------------------

Yes. So with the synergies, Alex, there's a proportion that -- of the upgrade that is simply taking away probabilities. So it's where we originally saw and we're reducing the probability that we had to apply because it was a Class 1. So there's an element of that. Then there's an element that's split probably half and half between packaging and our supply engine and part of it within the supply engine, so our paper -- where our paper capacity sits. Part of that's also interesting enough, a reverse synergy. So there are some aspects of what Europac do that now we've got into understanding. And particularly in Viana, that's extremely helpful within our U.S. business. And something -- and some items within our European recycled as well. So we often find that -- we certainly found it with Interstate as well, but with Europac on -- and we certainly found it with SCA before, there will be things that you can take, and you can reverse back into your organization and you just don't know what they're going to be upfront. So there's an element to that.

And then on the packaging side, there's one plant where we found if we -- that our view -- I mean, it's operating at a level that's nowhere near how we would operate at. We believe if the quality was enhanced, and that's certainly going to require a level of capital investment, which is in our -- published in our guidance, we will really turn that to a profitable operation quite quickly. So it's a split through various things.

We haven't really got -- we haven't really touched in here on the synergy upgrade and revenue synergies. We don't really ever do that. We normally only talk about the cost synergies and how we're upgrading those. So part of it is the probability coming up and then roughly 50-50 of the balance between paper and reverse synergies and operational improvements and on packaging, particularly around one location where we think there's a massive opportunity to turn that profitably, and we know how we'll do it.

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [8]

--------------------------------------------------------------------------------

Yes. And delivery on the synergies in the first few months.

--------------------------------------------------------------------------------

Adrian R. T. Marsh, DS Smith Plc - Group Finance Director & Executive Director [9]

--------------------------------------------------------------------------------

Yes, yes, yes. It's been -- we've had some very good quick wins, some fairly obvious ones as well from how we've managed the overhead quite quickly. We've also, again, another reverse synergy thinking about it. We've taken the Europac shared service center and we've wrapped our operations into that. They had a very good operation in Dueñas in Spain. We've shut down ours pretty much day 1 -- not quite day 1, but within the first 90 days. So the early -- the runs on the board have been coming pretty quickly. It's a good business.

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [10]

--------------------------------------------------------------------------------

Justin.

--------------------------------------------------------------------------------

Adrian R. T. Marsh, DS Smith Plc - Group Finance Director & Executive Director [11]

--------------------------------------------------------------------------------

I don't know if you're waving, making a bid or...

--------------------------------------------------------------------------------

Robert Chantry, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [12]

--------------------------------------------------------------------------------

All right. Rob Chantry, Berenberg. Just a couple of questions from me. Firstly, on volumes, GBP 74 million increase in corrugated volumes on the kind of waterfall chart, but only GBP 7 million kind of growth in EBIT as a result of that, implying quite a low drop-through. I think in the past few years, that drop-through has been 25% to 30%. Can you just talk through why that drop-through is different and how we should think about it going forward?

And then, secondly, U.S. Indiana facility, obviously, a huge project. Lots of CapEx going in, 1/3 of capacity being added. Can you talk about how that should feed through the U.S. numbers in terms of ramp-up? I think there's a comment talking about $15 million-or-so ramp-up costs. But then, clearly, if you've got scope to add 1/3 to the size of the business there, how that maps out in terms of when you expect it to reach efficiency, production, et cetera.

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [13]

--------------------------------------------------------------------------------

Last one again on the drop-through.

--------------------------------------------------------------------------------

Adrian R. T. Marsh, DS Smith Plc - Group Finance Director & Executive Director [14]

--------------------------------------------------------------------------------

Yes, so drop-through, box drop-through will drop through as you'd expect. There is an impact on recycling where the volume -- the revenue from recycling being impacted. In China, that's a much lower contribution business as you'd expect. But the gross box drop-through will be as you would expect, it will be offset by other volumes. We can bridge that for you if you wish, Rob, later.

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [15]

--------------------------------------------------------------------------------

We'll give further bridge after this, but the box volume's all intact. It's just a set of recycler, which has fallen. The other side of that, in turn, is it goes into the paper side. So we can get the benefit there so -- and with Indiana, I said -- we've always said we're starting this in October. There is a ramp-up. We think it will reach breakeven in the very early part of the new financial year when it's been up and running for 6, 7 months. It's all on plan for that. Obviously, we've highlighted to people, this is one of the issues.

It does -- when it's running at full tilt, which won't be for probably 3 years, it could be 3.5, something like that, it does provide a substantial expansion on our existing capabilities.

The reason we're building new is our customers there, to put it bluntly, they want the solutions that they can get in Europe. And for that, you need sort of assets that we have in Europe, whether it's on the ability to really produce performance-based packaging, digital printing, et cetera, all of the CapEx is all in our numbers. It has been. We spent a considerable amount this year, that's in our numbers. It's in the guidance for next year. Actually reduction on underlying CapEx this year despite the new construction. And we think this could give us very good -- enable us to supply the demand that's coming to us in the U.S., in our highest margin business as well. We do have a paper mill there because in the U.S., there isn't really free paper capacity like there is in Europe. So we've got the security of supply. It does mean a ramp-up in our paper production there. But as you can imagine, the margins on all of that feed-through is -- are very strong there -- are very strong, indeed. That's why we're building it.

And as I said in the presentation, the -- we're preselling the volume now. We're already going out and talking to customers. But of course, these are customers we talk before we even decided to build it. These are the customers that said, if you come, we will reward you with this business and they've done that. These are the customers when we said we're going to Iberia, they said we will reward you because there's nobody else who can supply these solutions. So it's a very consistent model, and frankly, we can't wait to bring it onstream.

--------------------------------------------------------------------------------

Justin Joseph Jordan, Exane BNP Paribas, Research Division - Analyst [16]

--------------------------------------------------------------------------------

Justin Jordan from Exane. I've got 3 quick questions, please. Firstly, I guess, on Slide 6, your EBIT bridge. You've got GBP 174 million positive sales price/mix in fiscal '19. I think from memory, GBP 204 million in prior years so that's cumulative GBP 378 million over a 2-year period. Can you just give us some idea if that's basically the impact of 8% to 10% box price increases over that 2-year period? I'm just trying to work out the operational gearing of the box price movement to the business going forward. Appreciate you've got a larger scale with Europac, but it would imply that possibly every 1% in box prices pre any offset is about GBP 45 million of EBIT. Can you just confirm that?

Secondly, on factoring, it's come down. What's the view on factoring versus traditional RCF going forward? Do you have a change in policy going forward?

And thirdly, just on Slide 14, the exceptional cost of GBP 76 million guidance in fiscal '20, that's certainly slightly higher than many of us would have expected. There seems to be an increase in the Europac exceptional cost that you're talking about here. Can you just explain that a little bit, please?

--------------------------------------------------------------------------------

Adrian R. T. Marsh, DS Smith Plc - Group Finance Director & Executive Director [17]

--------------------------------------------------------------------------------

You want to do the one and I do 2 and 3 then?

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [18]

--------------------------------------------------------------------------------

So are you saying -- excuse me, commercially you're at Slide 6, absolutely on the...

--------------------------------------------------------------------------------

Adrian R. T. Marsh, DS Smith Plc - Group Finance Director & Executive Director [19]

--------------------------------------------------------------------------------

I mean the answer is it is substantially in the box price/mix.

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [20]

--------------------------------------------------------------------------------

I mean, look, we can do a further analysis. Sometimes, it's slightly difficult because if you've got a customer who say I want -- I need this price, the price is up, but we're going to introduce a new product as well. Sometimes the absolute split, a lot of it's price but there's a good amount of mix. That's why you're getting the market share gain as well. So we can do a further analysis, but it can be a little bit muted. You've got new product, better price but it's a better product. Is that mix or is it price? Frankly, we're not too bothered we're getting better price for that product.

--------------------------------------------------------------------------------

Justin Joseph Jordan, Exane BNP Paribas, Research Division - Analyst [21]

--------------------------------------------------------------------------------

I guess what I'm getting at really is that, going forward, clearly, you're going to have the benefit of reduced raw material costs in terms of reduced OCC prices. You're going to have a benefit on your 20% short paper in your -- of reduced in cost on, whatever, testliner, kraft you're buying in. But, the big but that everyone's worrying about and the reason why your shares are down 35% in the last 12 months, is the impact of reduced -- subdued volumes and more importantly subdued prices on a Pan-European basis. I'm trying to get a sense of what the impact on that will be on your business.

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [22]

--------------------------------------------------------------------------------

The impact is less than you're suggesting. There are quite a few compensating factors. You're just picking on one factor. So you've actually got the price retention, which is going. We've got the further value add, but of course, there are other input costs as well. So for example, what's happening on OCC in there. So it's not quite that sort of -- the relationship isn't as clear as that.

--------------------------------------------------------------------------------

Justin Joseph Jordan, Exane BNP Paribas, Research Division - Analyst [23]

--------------------------------------------------------------------------------

I guess we'll have to see over the 12 months. Can you help us on the factoring?

--------------------------------------------------------------------------------

Adrian R. T. Marsh, DS Smith Plc - Group Finance Director & Executive Director [24]

--------------------------------------------------------------------------------

Yes. So on factoring, Justin, there's no conscious move from one to the other. What we decided to do when we're talking to a number of investors last year, we said we felt we're very comfortable with it as they are, that they understand it, they understand the economic benefits and the liquidity of it and it's committed and everything. And we said, where do you feel that the right number is, and we said we probably feel it's around about the GBP 500 million, probably starting with a 4, not a 5. And that's what we've done, is we simply moved it to that level, and we've generated that through working capital. We're comfortable where it is. It's well understood by the rating agencies. It's well understood, we believe, by companies that know us well. And we think it's -- actually, we've just shown, you can switch it around relatively easily.

But we're -- don't hold me to a number for the rest of my life now, but we think around about the GBP 400 million to GBP 500 million feels reasonable. It's relative to the quality of receivables that we've got. As the business grows, we might re-reflect on that. But as it stands today, that -- we're comfortable with that and that's where we'll keep it with no -- so if the question is, are we looking to materially take it lower? The answer is no.

In terms of exceptionals, I'll have to come back to you on Europac and guidance. I don't think we're inconsistent with guidance, but can I double check my numbers on that on integration?

--------------------------------------------------------------------------------

Justin Joseph Jordan, Exane BNP Paribas, Research Division - Analyst [25]

--------------------------------------------------------------------------------

Because when you purchased it, you guided to GBP 70 million of exceptionals, of which GBP 30 million was additional CapEx and GBP 40 million was restructuring.

--------------------------------------------------------------------------------

Adrian R. T. Marsh, DS Smith Plc - Group Finance Director & Executive Director [26]

--------------------------------------------------------------------------------

Correct.

--------------------------------------------------------------------------------

Justin Joseph Jordan, Exane BNP Paribas, Research Division - Analyst [27]

--------------------------------------------------------------------------------

How much was the Europac-related restructuring cost expense within the GBP 94 million you've taken in fiscal '19?

--------------------------------------------------------------------------------

Adrian R. T. Marsh, DS Smith Plc - Group Finance Director & Executive Director [28]

--------------------------------------------------------------------------------

Give me 2 seconds and I'll come back to you on that, Justin. I don't think we're out of kilt on guidance, but I don't want to sit here and make a number up, I have it and I'll come back to you on that. But I think we're relatively consistent.

--------------------------------------------------------------------------------

David A. O'Brien, Goodbody Stockbrokers, Research Division - Investment Analyst [29]

--------------------------------------------------------------------------------

David O'Brien from Goodbody. Just a couple from me please. Firstly, it's always positive seeing margin target increase by 200 bps. Can you give us a sense that your 200 basis point improvement, what is actually organic and what is obviously going to be an uplift from acquisitions? And if I look at that margin uplift, what's preventing you from the same type of uplift in your returns on capital?

Secondly, you spoke to stability in pricing on the paper side in Europe. We've seen Mondi, (inaudible) all out and announce price increases. What has stopped you in your tracks in terms of announcing yourselves?

I'm sorry to belabor the point, box pricing, as some of the guys have asked, it's clear that pricing discipline is the center of a lot of the strategy for the next 12 or 24 months. If we sit here this time next year and look at our bridge charts, are you expecting that to be a positive contribution for the full year?

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [30]

--------------------------------------------------------------------------------

So on the margin side, so there are 2 questions in there about the margin, what gives us the confidence, acquisitions, et cetera, and then about the return on capital. The simple thing on return on capital, we're selling some very mature assets like Plastics, which hasn't seen much investment, makes a return on capital of over 30% but it is -- the assets are -- they've -- it's a sort of a long historic asset base and we're replacing them with new assets where we start with the return on capital of 9%.

Now when we buy them, I think you extrapolate up the Europac acquisition. I mean it's only 3 months, but you can see we're making actually initially quite a reasonable rate of return, but it's not where the group has been historically at 14% to 15%. It's purely a function of the mix of assets you have going forward. We don't push above 15% because we think there are opportunities to carry on investing in the company that make very value-adding return on capital that our investors are very happy with that aren't 15%.

For instance, with Europac, we went to them and said we think it will be above cost of capital in the first year. That's fine, but it's not 15%. No, but you're value adding and you're going to be more. That's fine with us.

So we want to keep the company in a range of 12% to 15%. That's what we're seeing. It's purely a function of the age of the asset that you've got and when you bought it and when you've got the goodwill. And many people also have written off a lot of goodwill in the past. We haven't been doing that. It's just come onto the balance sheet, so we're very comfortable with the return.

If you look at the improvement in the margin target, you'll see the forecasts that are out there for return on capital show a similar improvement in terms of the rate of progress. But again, we don't have particular ambition to go above 15%.

Interesting, if you look, therefore, if you're in this range, you go back to the SCA acquisition, we're probably making 17% or 17.5% on that because we start at 9% with Europac and just over 10% in the first full year of ownership with the U.S. But those assets will go on and on and on producing better returns.

In terms of margin uplift, there is a -- I'm sure, if you do the math, you could start to get to say, well, why aren't you going to 13%, et cetera? If you add in all of this, you can get there. But we feel for where we are with the environment that we're currently working in, the 10% to 12%, it does bring synergies. It does bring in the increase in value-added and the operational leverage that comes from the business as we continue to grow. And when you bring them all together, we're comfortable with that range. You can cut it many different ways. We tend to take contingencies over all of these things, contingency this or contingency on the growth and that brings what we think is a material uplift and it's something that's sustainable.

In terms of the paper prices, for what it matter, I mean we never predict the future. I mean anything can really happen here. It's up to us to run the business whatever happens with the paper prices. Interesting, we have seen stability. We're actually raising our prices. Well, we don't make public announcements about it, but our demand is pretty strong. So we're raising prices. What happens in the next 3 or 4 months is anybody's guess, but that's where we are at the moment.

Some of our suppliers have been pushing through increasing prices to us as well, and we can see what's happening and we've been paying them. So it's very, very fluid thing, it's why I said earlier, I think where we are is in sort of a normal cycle, the cycles that we've dealt with. Time will tell, we are not forecasting paper prices. We don't know. It's up to us to manage the business really whatever they are. But at the moment, we're seeing upward pressure.

--------------------------------------------------------------------------------

David A. O'Brien, Goodbody Stockbrokers, Research Division - Investment Analyst [31]

--------------------------------------------------------------------------------

So have you seen probably 60% true or...

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [32]

--------------------------------------------------------------------------------

Sorry?

--------------------------------------------------------------------------------

David A. O'Brien, Goodbody Stockbrokers, Research Division - Investment Analyst [33]

--------------------------------------------------------------------------------

What scale of pricing have you had to absorb?

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [34]

--------------------------------------------------------------------------------

Well, it depends on the exact grade and where it is, et cetera, but typically, it's sort of 40% to 60% is the sort of thing people in the last month have been talking about. I'm not giving that as a prediction. That's just what they've been talking about on the back of actually quite reasonable demand. So stocks are falling. We need this paper. Our customers need it. And we're happy to buy it.

In terms of how these things feed through, as I was speaking with Justin, there are a number of things that affect our overall profitability. One is input cost, we're hard at that. That is there, but there's on many things on input cost, including OCC and other things as well. So there's a whole balance there.

What I said what we are seeing is we've been increasing the prices to sort of about, February, about 40% of our business are what we call on indexed deals. And these indexes start to change on average about 4 months, the large customers, there will be some pressure there but that's 40%. The remaining 60%, a small proportion is what we call fixed, needs to be fixed for 6 months. But the other 40% of the sort of 100%, that's what we call freely negotiated and this is where customers need to come back to us and that gives us an opportunity to discuss about the value that's added, the other issues that we've -- that we deal with, et cetera. And if we are more competitive, given better value than anybody else then we'll keep those prices and those customers, and that's where we are. So it's not some people do ask it's 1% here, it's 1% -- really, it's really just not -- there's -- you've only got 40% of the business that has these sort of indices and even they can be very varied as well on what...

--------------------------------------------------------------------------------

David A. O'Brien, Goodbody Stockbrokers, Research Division - Investment Analyst [35]

--------------------------------------------------------------------------------

Does the customer profile -- so we're dealing with large pan-Europeans, do they tend to be more indexed?

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [36]

--------------------------------------------------------------------------------

They are, yes. The large ones are, yes.

--------------------------------------------------------------------------------

Adrian R. T. Marsh, DS Smith Plc - Group Finance Director & Executive Director [37]

--------------------------------------------------------------------------------

Just to your question, Justin, 22 in the year to do with the financing and 13.7 to call it, 14 to do with integration.

--------------------------------------------------------------------------------

Miles W. Roberts, DS Smith Plc - Group Chief Executive & Executive Director [38]

--------------------------------------------------------------------------------

Well, look, we just -- we are few minutes over. Are there any last questions? Well, look, I'd just like to say thank you once again for your time. We're very pleased with the results and we're looking forward to the coming year. Thank you.