Sappi Limited (SAP) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the Sappi Financial Results Announcement Q2 2023 Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Steve Binnie. Please go ahead.

Good day, everybody, and thanks for joining us. As always, I'll go through the investor presentation and calling out the page numbers as I move along, and then we'll come back to everybody for questions. So starting on Page 3, some of the highlights for the quarter. Firstly, EBITDA of $167 million. Obviously, that's below the prior year and last year -- last quarter's levels. And the reason for that is primarily a major destocking that's underway amongst our customers. We are facing a challenging global economy and significantly weaker paper markets. At the same time, global pulp market came under pressure. Whilst that's good for our paper business because obviously, it's an input cost, the pulp that we do sell, particularly out of our Matane BCTMP mill, those prices came down. I am pleased to say though that paper selling prices remained relatively stable, and I was -- that was something I was talking about in the last quarter. We've seen that continue. In spite of the lower demand volumes, we've been able to keep them stable, but profitability was negatively impacted by this reduced sales volume. We had to take commercial downtime to match sales with demand and -- sorry, production with demand and ensure we didn't have a working capital liability. And then we still had year-on-year cost inflation, albeit that costs are beginning to come down. Net debt decreased by $568 million during the quarter -- sorry, year-on-year, and that's reflective of all the great work that we're doing to keep a tight control on our balance sheet. And as a result, our net debt-to-EBITDA leverage ratio is 1x, and we're particularly proud of that. Moving to Slide 4, our product contribution split. On the left-hand side is the EBITDA profits. And obviously, in recent times, with COVID and then followed by the big bounce that we had in the current year with the destocking that's underway, it's a little bit volatile. But in time, we obviously believe that we will continue to grow in the packaging and pulp spaces relative to graphics. And you do see that on the right-hand side. And this tells a big story in terms of the evolution of our sales volume over the years across the segments, with packaging growing nicely and graphics coming down as we've made the investments and conversions. And that's something that will continue as we move down the path of our Thrive25 strategy. Moving to Slide 5, the earnings bridge. And there's a few broad stories, which I've already touched on, but just to recap. Firstly, the lower sales volumes linked to the destocking cycle obviously impacted volumes year-on-year. Over the course of the last year or so, we've obviously been pushing up our selling prices to mitigate the impact of the higher costs, and you see that in the big green box and then the costs themselves being a negative. All in all, contributing towards the lower EBITDA. In summary, we've managed to maintain our margins, but obviously, the lower volume has contributed towards the year-on-year decline. Moving to Slide 6. I think it tells a great story. We focused on our debt, and we continue to be so. We've set ourselves a target to get below $1 billion of debt, and we remain on that path. Just to call out that in the current year, the dollar has weakened against the euro. And as you know, we've got a lot of debt denominated in euros. So from a dollar perspective, that has impact -- that's increased the net debt year-to-date by about $112 million. But I'm pleased to say that we continue to generate cash in the quarter despite the fact that earnings was less. Moving to Slide 7. Our debt maturity profile, and that continues to be favorable and comfortable for us. We have a few smaller debts maturing in the next couple of years. And just to call them out to you, the $78 million that we have in '23 and the $84 million that we have in '24. Those are some of our South African bonds. And those are coming close to maturity. And then the $90 million that you see in 2024 is some debt that we took out when we converted the PM1 at Somerset a few years back, and that's getting close to maturity. And obviously, we'll repay that. We've got big cash reserves, and we will use those cash reserves for that. Slide 8 is our CapEx and cash flow. We continue to do good work on the cash flow in spite of the fact that, obviously, profits are lower, as I referred to. Free cash flow, you can see in the year-to-date, $303 million. Obviously, that's prior to CapEx, but still shows our strong cash generation. On the right-hand side, we've pulled down our CapEx a little bit. Obviously, with the lower profitability, we sharpened our pencils a little bit, focused on some of the stuff that we're doing. It was previously $430 million. We brought it down to $410 million. Just to remind you that the dollar has weakened. So the euro CapEx if you get converted would have been worth more. So we're doing what we can to pull down CapEx a little bit, but not on our bigger initiatives that we'll speak a little bit more about as we move through. Turning to Slide 9, and we talked about capital allocation in the last quarter, and we will continue to do so. This shows our priorities across the various categories. And there's a lot on the slide. So I'm only going to focus on a few little things. But firstly, sustainability is obviously important for us. We've committed to science-based targets incorporated into the $410 million for this year is $60 million for sustainability initiatives, and that's something that we've talked to you about in the past. The free cash flow, we're proud of the $303 million that I referred to. I mean, we continue to make good progress towards the $1 billion -- getting below the $1 billion. In terms of profit improvement, a number of smaller initiatives, the big Rockstar barrier coating project also has been completed. We're ramping up there and very excited about the prospects for that. We recently completed a smaller project at Somerset on the original PM1 conversion. That gives us about 30,000 extra tonnes, and that's now complete and obviously will give us more volume. And then something else I talked about last quarter is we are -- got a project underway that will give us wet-strength label capabilities at our Gratkorn Mill on the smallest machine at Gratkorn. But ultimately, that will help us move that machine entirely away from graphics towards -- mainly towards labeling, which sits in our packaging and specialties segment. Obviously, we're disappointed that the sale of the European mills that we had announced did not occur. We tried our best. But ultimately, we wanted to protect the value for our shareholders. And the deal does not happen. And we will continue to look for alternatives with those assets, and that is work in progress. On shareholder returns, we annualized a nice healthy return, and that's something that we obviously measure ourselves against very closely to ensure that we are adding value. We've given a dividend back earlier this year, $85 million. And during -- well, just after the quarter end, we did buy back some shares to the value of about $23 million, 9.2 million shares. We firmly believe the share price is undervalued, and we think it's a good use of our capital to create value for our shareholders. And we will continue to look at this opportunistically. Obviously, aware of the profitability of the business and our other priorities for our cash. And then on the growth side, we've obviously got this very exciting project for the conversion of our PM2 machine at Somerset. We're at Somerset at the moment. We've been visiting the mill. The project is on track, and we're very excited about what that's going to create -- the value that that's going to create for us as a business. Slide 10. Just on the cost side, we have -- we've obviously seen a significant adjustment over the last couple of years. It's -- that pressure is now easing. The full benefits haven't been realized yet, obviously, because you do have some in stock and the likes, and you got to work your way through that. But this is something that will give us some relief with the short-term demand pressures on our paper products. Slide 11 has the paper pulp prices, and you can see they've come off dramatically. Now that's obviously good for our paper business because it's an input cost, but obviously, when we do sell pulp like in the BCTMP from Matane, that has an impact on the margins for that segment. Slide 12 is our -- just evident it's the gas prices, and we all know that it's been highly volatile and peaked last year. It's come down substantially, which will obviously ease pressure for us. But as you know, we've hedged a significant portion of our costs at a low level, a low price level. So we were -- we're in a pretty good situation there. Moving to Slide 14 and the various product segments. Pulp, year-on-year, the volumes were down a little bit, but that was at the beginning of the quarter, and we picked up very nicely as it progressed. Pricing improved, market conditions have improved generally, obviously, linked to the opening up of China following their COVID restrictions, retail sales for clothing, not as bad as maybe some, including ourselves, thought that we're going to be. So that's positive. And stocks are starting to come downstream. So we think the prospects are looking better. In recent days and weeks, we've seen viscose prices pick up a little bit, cotton prices as well. So I think, all in all, more positive in this segment. In the packaging segment, on Page 15, major impact from the elevated downstream inventories. We've seen this across the board in all the regions and our customers are working through that. But we are positive. It's difficult to pinpoint when the destocking will be complete, but we are still very positive about the underlying demand for these categories. In addition to that, in South Africa, we did have -- and some of you may remember this, we did have some floods in the Mpumalanga region in South Africa, where our Ngodwana Mill is located, and that did impact on production. And also it's fair to say we had a couple of little hiccups post the recent upgrade that we did on the containerboard machine, but that seems to be steadying out as we move forward. And then moving to graphic papers on Slide 16. Similar situation, markets were weak, predominantly related to the destocking that's underway and that forced us to take production curtailment as expected. And like the packaging segment, I -- it's difficult to pinpoint exactly when the destocking will be complete, but we do anticipate later in the year, there will be a recovery. And obviously, that will reduce the need for curtailment. Moving to Slide 17, which is our regional segments. And I -- a lot of the themes are the same so I'm not going to call out each one. But just generally, obviously, volumes down year-on-year linked to the weaker markets. However, we were able to keep our prices stable, which offset the impact of higher costs. Margin is down, but linked to lower volumes, as I said earlier. And then on Slide 18, you see that graphically. So margin is down. But as I say, hopefully, recovery later in the year. Interestingly, South Africa year-on-year is an improvement in margins. So the South African business is still in a good place. Then moving to Slide 19, which is our strategy. Thrive25, we've shared with this with you many times. So I'm not going to go through in detail, just to call a few key things. Firstly, on the operational excellence. You know that safety comes before all else. We're doing a lot of great work there. Our injuries in the workplace is coming down, and we're improving across all the regions. We continue to look for cost advantages. And I think with raw material prices coming down the way they are, that is going to create some opportunities for us, and we continue to focus on pulp integration. Enhancing trust, we are -- we have a strong leadership position because of certification of our wood. We believe that gives us a competitive advantage, and we continue to look for opportunities there to improve further. We've committed to the science-based targets. We are on track. It's embedded in the CapEx numbers that I've shared with you. And we're confident that we can achieve those objectives that we set ourselves. In terms of growing the business, a couple of these projects I've touched on. But from a smaller perspective, the label upgrade at Gratkorn, we're excited about. And obviously, as I said, we're here at Somerset and very excited about that machine conversion. And then ultimately, the sustaining of our financial health, committed to our $1 billion debt target. We're on track to do that. In spite of the fact that the sale of those European assets didn't happen, we are committed to getting below those levels. We are committed to reducing our exposure to graphic paper moving forward. Turning to Slide 20. Sustainability is at the core of our business. It's embedded in our Thrive25 strategy. We will make the appropriate investments to achieve our targets. And as I say, embedded in everything that we do in the business and as part of our business purposes. Slide 21, there's a lot on this slide, lots of the awards that we've won. But just to call out one in particular that's happened recently, we recently got our EcoVadis platinum ranking reconfirmed, very proud of that. It's across all 3 regions, and it demonstrates how important sustainability and governance around that is for us as an organization. So turning to the outlook, and I'm on Page 23. It's fair to say that the short-term paper markets are difficult. We are still going through a destocking. Initially, we obviously thought that it would start to recover earlier in Q3. It now looks like the destocking will continue throughout Q3, and we are anticipating a bounce back in our fourth quarter of the year when that destocking is complete. The cost reductions that we're seeing in our raw materials will relieve some of the pressure. And -- but as I said to you earlier, that will -- we've just got to work through some inventory. So it takes a couple of months for that to start to flow. It's important to emphasize that we never lose sight of our long-term strategy. Yes, we are navigating through some short-term challenges, but we remain committed to reducing exposure to graphics and investing for growth in renewable packaging, dissolving pulp and biomaterials. And as I said earlier, being very disciplined with our balance sheet, keeping the debt below that $1 billion level. CapEx will be slightly lower, as I said, $410 million. So taking that all into account and just to remind you that the third quarter is seasonally the weakest in terms of our demand, taking into account the global macroeconomic uncertainties and its impact on consumer sentiment, the weak paper markets, we do anticipate that the third quarter of '23 will be below this quarter that we've just reported on. So operator, that's me gone through the deck. I'm going to hand it to you now for questions.

[Operator Instructions] Our first question comes from the line of Brian Morgan of Morgan Stanley.

Just a question on specialties. I've been a little bit surprised about how cyclical that this whole business has proven to be, especially in this quarter. And I was wondering if you could just break it down a little bit more for us in terms of what you see in there. If you could just touch on perhaps the order book there. What subcategories of specialties you're seeing particular weakness and which ones are stronger than you would have expected? Perhaps just a bit more color would be great.

Thanks, Brian. I'll answer initially, and then I'm going to hand over to each of the 3 regional guys, just to give you a little bit of color on what's happening in their respective region. I don't think it's -- Brian, I don't think it's cyclical. It's -- this is very much linked to the destocking. When we've spoken to our customers, it's clear that with the supply chain challenges last year, with the shortage of paper last year, there was a significant inventory build across the board. The underlying demand for the product is not as cyclical as the overall numbers would have you believe. And that's across most of the categories. We did have a little bit of production challenges at Ngodwana, and Alex will talk a little bit more about that. But -- so I don't think it's that any product categories are performing worse. We are in constant communication with our customers, and they are giving us feedback that they're working through those inventories. So I'm going to just pass it to each of the regions and then they can just briefly talk, Alex.

Thanks, Steve. Yes, Brian. And certainly in South Africa, as you know, it's linked to agriculture. We have seen that customers have been keeping high inventory levels. And then we've seen that the great season was slightly weaker than expected. And that means customers don't sit with not quite the right grades of product and obviously have to work through that, but we still anticipate a very, very strong citrus season. So I think for the full year, we're not going to see any significant change, and that really explains most of the, what you call, cyclicality in South Africa.

Thanks. Marco?

Yes. Thanks. And Brian, for Europe, very similar to what Steve just commented on. The 2 grades that have been particularly impacted is paperboard in Europe that was a destocking effect very clearly, and we'll probably see some improvement in the next coming quarters. Then containerboard, all to do with the reduction in online shopping, where this is basically one-on-one related in combination with destocking as well. What I would like to call out is one of the segments that was most resilient in Europe was the flexible packaging, where we saw a much smaller decline. And that gives you already a bit of a hint in terms of the resilience of that specific segment. So flexible packaging and combination with functional papers, we're doing better than the other packaging and specialty grades in Europe.

And as part of that, Brian, labels is in there. Mike?

I'd offer that very similar for North America, although our paperboard business is slightly stronger than the C1S or the flexible packaging in North America. But we've seen slight improvements as we've come out of the quarter, but they're very similar in North America.

Thanks, Mike. I think in summary, what we're saying, Brian, is that we very much attribute this to destocking cycle. It doesn't alter how we think about this as a segment, and it doesn't alter how we think about the investments that we're making.

That's super. Can I just do one quick follow-up? Just on Slide 31, you've got your expectations for the year for volumes. Could you just explain -- sorry, I don't want to harp on something small, but labels, just so I've got a better idea of what's going on there. Why is there such a big drop in 2023?