A year after merger of the two packaging giants, observers are wondering when a flotation will take place, writes Arthur Beesley, Senior Business Correspondent.

Packaging giant Smurfit Kappa is not yet turning a profit on the bottom line, but the heavily-indebted business has started to lose its flab.

Four years after Jefferson Smurfit left the stock market and barely 12 months since its mega-merger with Dutch firm Kappa Packaging, some even say the group will be ready for an initial public offering next year.

Group chief executive Gary McGann won't talk flotation, but he is adamant that reforms already in train when Smurfit did the Kappa deal are bearing fruit. Results this week showed €223 million in profits before finance costs and exceptionals in three months to September, up from €210 million in the period to June and €172 million in the period to March.

"In profitability terms we're just about at the level we were last year, at the end of last year. But the momentum, in quarter one, quarter two, quarter three, is up - all the time progressing upwards." The group still had a net loss of €165.78 million in the first nine months of the year, but it has taken the benefit of significant cost reductions as trading conditions improve. Thanks to the closure throughout the industry of plants with the capacity to produce two million tonnes, the sector has been able to increase prices.

In McGann's account, Smurfit is both a contributor to this process and a beneficiary of it.

"We've certainly taken a very significant share of rationalisation into our operations. In two years, we've effectively taken out about 14 per cent of our capacity to the tune of about 600,000 tonnes of mill closures," he says.

"The net effect of that is that the mill systems now have significant pricing power back, but that pricing power is servicing a number of objectives.

"We set out to achieve synergies in the merger of €160 million over three years, with €60 million targeted for 2006. We are on target and probably a little ahead of target on that. So synergies are delivering."

Smurfit Kappa is a vast enterprise, with more than €7 billion in annual sales and operations at 400 locations in 20 European countries and nine in Latin America, as well as in Canada, Singapore, the US and South Africa. The group had 42,800 staff at merger time - now there's closer to 41,000 on the books.

Jefferson Smurfit figures such as McGann, company president Tony Smurfit and chief financial officer Ian Curley are very much in command of the new group, but McGann points out that half of its 70 top managers are from Kappa.

"We merged the number one player and the number three player in Europe to become the significantly number one player," he says.

"At this point in time our focus is, basically, merge the two companies, integrate the two cultures, drive the rationalisation and integration programme, deliver on the synergies, get the prices up, get the margins up, get the cashflow flowing from organic activities."

It is no surprise that the servicing of Smurfit Kappa's €5 billion debt mountain is uppermost in McGann's mind, but the business also has to contend with higher energy prices - to the tune of €70 million this year.

"Before we started this year we basically had to find €70 million," he says. "We're now ahead of the game somewhat, after price increases of 20-25 per cent since November 2005, to recover energy costs and other input costs to start getting some margin back into our business."

So what has changed? "Higher input costs are basically driving some of the smaller fellows to the wall. There have been some bankruptcies," he says. "Secondly, there is capacity to sell the product to the market at a higher price because there wasn't a free availability of cheap tonnes all over the place, which has historically been there."

McGann won't rule out further plant closures but says profit margins in less efficient plant improve as prices rise.

"In this business, supply-demand balance is important. In other words, that we don't have excess tonnage washing around the market is important," he says.

"Pricing is delivering, as is general efficiency and integration of the two systems. So it's progressing as expected, but pricing in a market that has been used to static pricing is difficult to resurrect, so it's been a tough battle, but it's going reasonably well."

Then there's the debt. McGann won't be any more specific than to say the group will lessen the burden, but he notes that it has delivered sequential improvements in pre-exceptional earnings before interest, tax, depreciation and amortisation (ebitda) even while making significant repayments.

"Even in the third quarter, we're paying down debt of €56 million despite the fact that we are spending a serious amount on mill closures and rationalisation.

"Notwithstanding that fact, we're delivering better working capital. That's got to be our focus. The basis that we took the company private was with a view to doing that," he says.

Gone are sideline interests such as the K Club and the Jefferson Smurfit art collection.

"We . . . disposed of any assets that couldn't generate ebitda. Unless they were nailed down and pinned to the wall, they're gone.

"We basically sold non-core business and non-ebitda generating businesses. We managed our working capital probably more efficiently than some companies, but certainly we enhanced and increased the focus on it and delivered quite well."

So what of those persistent suggestions that the merged group will be floated next year?

McGann acknowledges the inevitability of a return to the market but maintains that the timing of such a move is purely a matter for shareholders - Madison Dearborn Partners, Cinven and CVC Capital Partners.

"When you're owned by a private equity company, the chances are that's probably an accurate statement - the only question is when," he says.

He won't say whether a flotation is more or less likely next year, but says his priority is to have the company in a state of readiness to take options as they arise.

"Now I don't know whether the options are going to be available in 2007. What I do know is what we've been doing in 2006 - I'm happy with the progress we're making. I'm happy with the momentum in the business. I'm happy with the industry developments," he says.

"But I'm very clear - we've paid very little debt down. So most of the balance sheet is still structured with a bias to the debt and not an awful lot of transfer from the merger to the equity. Prior to the merger we did - that's how we were in a position to get that merger done. We are a lot better a company - both companies [ are] an awful lot better."