Bond markets around the world have slowly been facing up to the reality that low or negative interest rates are here to stay. The search is on for new ways to generate investment income with acceptable levels of risk. The Africa Report will be running a series of articles in which we analyse African shares that, for some investors, could fit the bill.
Mondi’s financial discipline offers dividend protection as paper outlook worsens
Paper and packing company Mondi fell sharply at the start of August as CEO Peter Oswald said the outlook for the company in the second half was clouded by macroeconomic uncertainty and softer demand.
Previous articles in our series on income investing in African stocks in a world of low or negative interest rates have looked at Grit Real Estate and Anglo American. The articles are not intended as investment advice and readers should do their own research and/or take professional advice before investing.
The decline in the shares has left Mondi with a forecast 2020 dividend yield of 4.7% that is likely to attract investor attention. Cole Hathorn, vice president of equity research at Jefferies in London, says that while Mondi is “definitely not a traditional income stock”, the dividend is “effectively covered” by a strong balance sheet that is “one of the best in the sector”.
Mondi has grown from South African origins into a global paper and packaging company, and trades on the London and Johannesburg stock exchanges. It demerged from its historic parent Anglo American in 2007. Since then, Hathorn argues, the company has pursued a consistent strategy of divesting its higher-cost businesses and securing cheap paper in central and eastern European countries like Russia, Poland and the Czech Republic. The company’s integrated mills and niche product focus, research from Jefferies argues, has created high barriers to entry.
Mondi’s policy is to ensure that its dividend is covered two to three times, providing a margin of safety. Hathorn says the company is near the bottom of that range now, meaning that a short-term increase in the dividend is unlikely.
- Still, “they have the balance sheet to grow or maintain dividend cover,” Hathorn says.
- In research in August, Jefferies argues that even supposing a decline in earnings before interest and taxes of 20%, the dividend could be kept unchanged.
In the bag
The virgin paper that Mondi uses is cheaper than recycled paper, which cannot be used for some forms of packaging such as for food. Hathorn sees Mondi as well placed to benefit from consumer demands for sustainability, due to increased demand for paper-based carrier bags as EU the looks to replace or reduce plastic carrier bags.
- Mondi is the market leader in the kraft paper market used to make paper-based shopping and grocery bags.
- On a cautious scenario, Jefferies sees annual growth of about 4% in this niche market.
- Mondi paid a special dividend in 2018, and Hathorn says that they may return more money to shareholders, possibly in the form of share buybacks, if they can’t find suitable acquisition targets.
- The company, he argues, has been historically conservative in terms of M&A, preferring to keep a strong balance sheet in order to be able to make acquisitions during a downturn.
- Debt, the undoing of many an income investment, is moderate at 1.3 times earnings before interest, taxes, depreciation and amortisation, Hathorn says.
The Jefferies bear case recession downside price target for Mondi is £13.50 ($16.6), compared with a current price of £15.50. With only about 3% of sales in the UK, Jefferies argues, Mondi also has the lowest Brexit exposure amongst industry peers.
The bottom line: Paper and packing is a cyclical and volatile sector – but Mondi has shown a commitment to managing its dividends across the cycle.