Sappi Limited (SAP) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen, and welcome to Sappi Limited Quarter 4 of 2021 results. [Operator Instructions] Please note that this event is being recorded. I will now hand the conference over to Mr. Steve Binnie. Please go ahead, sir.

Thank you. Good day, everybody. Thanks for joining us for the results call, our year-end and obviously final quarter results. As always, I'll move through the investor presentation, calling out the page numbers as I move through. And I'm going to start on Page 3, which are just some of the highlights for the year. And I think most importantly, obviously, we returned to profitability overall, following the impact of COVID last year. So I'm pleased to say that we did get back to profitability. Other highlights, the Packaging and Specialty segment achieved record profitability. Obviously, justifying the recent years' investments in that segment, and we are excited about the prospects going forward. DP, dissolving pulp was strong. Price is good, market demand strong and we were fully sold out. Graphics recovered, a little bit slower in the early part of the year in Europe, but subsequently picking up there. So relative to pre-COVID levels getting back to encouraging levels, and I'll talk a little bit more about that on the quarter 1. On the other side, obviously in recent times, we've seen the rise of costs coming through. Initially, it was pulp but more recently came in energy, and that negatively impacted margins. And we will talk more about that. And then the other challenge we faced and it's not unique to Sappi or even our industry, but the ongoing global supply chain challenges. And once again, we'll talk about that some more. Liquidity improved significantly during the year, obviously, from our leverage from the worst points in COVID, we continued to improve and the balance sheet is looking stronger. And once again, we'll cover that in a little bit more detail. Moving to Slide 4, which is specifically on the quarter itself. Excellent performance from our North American business. That was broad-based across all the segments, and the business was able to achieve the highest quarterly results in, I think, more than 20 years. So very, very thrilled by that. DP very strong, good prices, and that contributed to improved profitability in this segment. Packaging continued to be good, a little bit down on the prior quarter, but that was a combination of the higher costs mainly in Europe coming through. And remember, we did have the impact of -- in South Africa of the unrest, which we did share with you in the last quarter, obviously, at , we make packaging there. So that impacted volumes there. Graphics now have reached 86% of pre-COVID levels, Q4 2019, which is probably better than we could have hoped for a year ago. And we'll cover that specifically in the regions, but that's enabled us, and certainly in the U.S. to fill our machines. And Europe, things have significantly improved. The one challenge that we did have, obviously, was the supply chain challenges. And we talked about this at the end of the last quarter. And unfortunately, it's meant that we had 100,000 tons which we're not able to deliver during the quarter. Now that's obviously sitting in inventory first. But what I should say is that those are contractual volumes. They're not going into the marketplace. Those are contractual volumes. And the price -- those have been sold. The price is linked to the prior quarter pricing. And although we've lost the benefit in these quarterly numbers, and we show you that that's a $30 million benefit. That is just a timing difference. That will be sold in future quarters. The shipping challenges that we faced, and we talked about this in our last quarterly call, and we gave you guidance at that point in time for what we felt the volumes would be for this quarter, what we found subsequent to that guidance was that the situation deteriorated in Durban specifically. We started to see cancellation of vessels, which we had booked our deliveries on and vessels which we thought were going to be coming, were diverted away from the Durban port because of the significant backlog. And I'll remind you that just prior to that results announcement, we did have the IT outage at Transnet, which impacted on the port. So I do concede that we missed our guidance at that point in time. But I want to point out that was our best estimate and the situation subsequently got much worse. Having said all of that, we are more encouraged where we are today. And it does look like more vessels are now coming back to the Durban port. We've had proactive discussions with the big global shipping lines, and we are more encouraged, which is indicating that maybe the worst is behind us. It's going to take some time, clearly, to catch up the backlog that we have, that 100,000 tons. In the earnings guidance that we've given you, we've assumed that there would be a catch-up, but we will be able to sell the production that we are making because of the improved situation. And in time, as I say, we are encouraged by the improving situation. Moving to Slide 5, just an earnings bridge for the year, and I guess, most of these things we've talked about. But obviously, sales volumes generally up on the prior year, but DP impacted by the backlog that I've just been spending time on. Pricing improving across all our segments, costs going up, initially purchased pulp as we've indicated, delivery costs rising. And then we've grouped together energy, wood and chemicals. Within that, energy and chemicals up, but we did see lower wood costs offsetting some of that. But I will talk a little bit more about energy in a future slide. Moving to Slide 6, just the product contribution split, and we thought it would be useful to show you the evolution from '16 to '21, both on profitability and volumes. And we continue to make progress. We're reducing our exposure to graphite. It's now down to 54% and I would expect that to continue to come down. Packaging, obviously ramping up and will continue to increase. And obviously, from a profitability perspective, packaging, the biggest segment for the year. DP obviously, over the years, we've had a number of smaller projects. And going forward, we'll have the new expansion volumes coming through. Slide 7 shows you the margins by segment, product segment and graphics continues to recover and is looking more favorable as we move forward. Packaging, good margins, lower than the prior quarter, but that is predominantly because of the higher costs that came through in Europe. And I'll remind you that those are periodically priced contracts in the packaging space. We did put through a series of selling price increases, but then the costs rose once again. And we are now implementing or we have been implementing further price increases to offset the higher costs. And then dissolving pulp, recovery of margins, very encouraging lower volumes because of the backlog. Slide 8 has the leverage ratio on the debt side, continuing to come down, and then we would expect that to continue in the year ahead as our earnings to improve, and we generate more cash. And therefore, the absolute debt levels will continue to come down. Slide 9 tells a great story. We managed to refinance our bonds during the year, our securitization also. And we have a very favorable near-term profile and we don't have any major debt maturing. So feeling good about that. On to Slide 10, moving to CapEx. Our guidance for the year ahead is $395 million. That includes $30 million for the Saiccor expansion project that's overrun that we talked about in the last quarter. So if you back that out, the CapEx for the year is $365 million. Included and we did disclose this in the earnings announcement, included in that is, firstly, sustainability project of about $75 million. As you know, we've committed to reducing our carbon footprint and reducing -- well, reducing our carbon emissions and improving our environmental footprint. Just to quote some of the projects that are contributing to that $75 million, the first larger one is at Saiccor. We're looking to eliminate all our use of the calcium and move that across to magnesium. So that consumes some of the CapEx. We have other smaller initiatives in Ngodwana that will continue to improve our environmental footprint. And then in Europe, as you know, there is legislation -- very strict legislation to improve carbon emissions. We have a number of initiatives and specifically at Gratkorn, Kirkniemi and Maastricht -- Maastricht to improve Gratkorn, Kirkniemi and moving from coal to biomass. And Maastricht, we're moving to an e-boiler there as well. So that is going to help us. And that will enable us to get closer to our legislative targets and our science-based targets that we've committed to. On top of that, we included in our CapEx is what we called cost optimization and quality improvement projects. We have a project at Ngodwana to improve our quality. As you know, we have a great containerboard business there, and we need to continue to invest [Technical Difficulty] Apologies. I'm told that the sound keeps cutting out. I'm not sure why. Included in the cost optimization initiatives, as I mentioned, there's a quality improvement project at Ngodwana. And then we have a series of smaller cost initiatives, ones that we believe will give us very quick paybacks, 2, 3 years that makes sense, which will help us move down the cost curve and entrench our position. We also have some IT initiatives. We're rolling out a new mill production operating system as well, and that's in that number. Moving to Slide 11. As I talked earlier, one of the challenges we faced is with shipping. And we could have put in many slides that could demonstrate that. This one is from Sea-Intelligence. It's on reliability of ocean freight. And you can see it's dropped dramatically since COVID. And actually during the quarter that we've just been in, as I talked about, it actually declined further. What I will say is that we are seeing spot rates for freight now starting to come down. So there are positive signs which I talked about earlier. So we are feeling a little bit more encouraged about the situation for our deliveries. Slide 12. As the paper pulp prices, and there's a few numbers there reflected, we've got the European pulp prices, which we can see still remain elevated, and as you know, we're a big pulp buyer in Europe. We buy close to 800,000 tons. So that does continue to impact our business. However, in China, we have seen pulp prices across the board decline. That's partially linked to the energy, the energy capacity constraints that the Chinese government has placed on Chinese industries, and that has had an impact. Certainly not benefiting from that at the moment because, obviously, European prices still remain high. Moving to Slide 13. In recent weeks and in the last month or 2, we've seen a big surge in natural gas prices and energy prices across the board in Europe. You saw the big surge and you can see it in the graph subsequently declining. But as we look at our energy costs for Q1, we are estimating that the costs, the impact of all of this, mainly in Europe, but it's not just Europe, but mainly in Europe, is about $70 million in absolute terms. However, we have implemented, and this is public knowledge, we have implemented an energy surcharge in Europe of EUR 100 a ton to offset that impact. It was announced 2 or 3 weeks back. It is on all delivery subsequent in the last couple of weeks. And that has been successful for us. It has not had an impact on the demand for our paper, but it has offset the impact of those higher costs that I've just referred to. And therefore, we do not believe that in our Q1 earnings that we will have a margin squeeze because of the higher energy costs. We've been able to offset that, and we are encouraged by the way that it has unfolded and the way we've been able to implement the higher or the surcharge. Obviously, at the same time, we continued to announce selling price increases as well. Moving to Slide 15, and that is on our product segments. Firstly, dissolving pulp. Prices still strong during the quarter remained above 1,000, come back a little bit in recent weeks, linked to the energy constraint placed in China and the fact that viscose producers had to reduce their operations, so there was less demand for dissolving pulp. But generally, the market is good. Obviously, our segment impacted by the backlog that I referred to. Viscose prices dropped during the quarter, but what we've seen since that energy surcharge or that energy constraint has been put in place, is that viscose prices actually have dropped -- have increased quite significantly. We're also going to have the additional volumes coming through from our expansion project. We have all but complete that project. Most of the equipment has been handed over now to the mill. The last step is the boiler itself. The team are doing their final tests, and that will be completed in the next week or 2, and then we'll be ready to operate and ramp up from that point. So it's good to get that behind us. And obviously, we're going to see the benefit of the volumes coming through as we move through the year. In terms of longer term, we are encouraged by the dissolving pulp markets. There is additional capacity coming on board, but we believe that the demand is more than enough to offset that. Strategically, as we look forward, we anticipate that our level of contracting will come down a little bit, down to 72%, but we're confident of being able to place that into the Chinese and other spot markets. Slide 16 has the dissolving pulp indicators, strong recovery in retail textile demand, and you can see that flowing through. The graph on the right just shows you what I was talking about earlier, DP coming down, but now a big surge in viscose prices. So that, we believe, will be positive for DP prices moving forward. The Packaging segment on Slide 17. Great year, record profitability, margins good, very strong demand in North America and South Africa; Europe, a little bit more mixed. But as the European economy has recovered, we're starting to see a more broad-based recovery. Obviously, profitability, as I indicated, impacted in the quarter by the higher costs. But with that surcharge that I referred to earlier was across all our paper grades, so it was equally applicable to our packaging business, packaging and specialties in Europe. Slide 18 has the North American SBS market. We thought that would be useful. You could see the impact through COVID. You did see a lowering of production, subsequent recovery. Shipments continue to be pretty strong, and we've seen significantly rising selling prices, obviously, to offset the higher costs that are coming through there. But markets are good, markets are tight. Slide 19 is graphics, and I think it's fair to say that the recovery in graphics has exceeded our expectations. And if you look at the market overall, 88% of pre-COVID levels, and if you think about that, that's over a 2-year period. I don't think any of us could have anticipated that we could have got back to 88%. But within Sappi, our coated wood is even better than that, and we've been able to gain market share. Overall, volumes in the segment reached 86% in Q4. And as I say, profitability impacted by costs but we have been implementing selling price increases to offset that impact. Slide 20 just shows you the respective markets in U.S. and Europe and the recovery in volumes. So we're feeling encouraged because both markets now are tight and in balance. And that will enable us to implement the selling price increases that we've announced to offset higher costs. Turning to the regions, Europe and much of this I've said, so I'm not going to repeat. But early part of the year impacted by volumes, volume subsequently recovering. Coated woodfree for us is 99% of 2019. So you can see that demonstrates the tightness of the market that I referred to and why we are more encouraged as we move forward. Costs rising, but we have been implementing selling price increases. North America, fantastic year. Across the board, highest quarterly earnings in more than 20 years, all the segments full, our machines are full, margins good, improving. We're feeling very good about our North American business. Yes, we've got higher costs, but we've been able to implement higher selling prices to offset that. In South Africa, we're also very encouraged. Yes, we have challenges, but DP markets still remain strong. Our paper business is good, containerboard specifically, strong demand, and we are encouraged that we can, the situation with the backlog. And I'm going to remind you again, that margin is not lost. It's just delayed from the overspill. On Slide 24, our cash management, tremendous work done across the year, refinancing our bonds, improving the liquidity situation. And that will continue to come down in the year ahead as our profits grow. So the leverage ratio will continue to decline. CapEx, I've spent time already on. And on the procurement side, some nice savings there, and we will continue to look for opportunities. Slide 25, I don't intend spending a lot of time on because we've talked about it previously, but our -- the 4 pillars of our strategy, we will continue to look for opportunities to grow in the higher margin segments. We are going to reduce our exposure to graphics as we move forward. But we are going to redirect that towards packaging grades, and there are opportunities to do that in Europe and in the U.S. The financial health, I've spent time on, it's improved significantly. Our job continues to be to drive operational excellence, and we'll look for opportunities to save on the procurement side. Those cost optimization numbers that I referred to earlier on CapEx, that's what that's all about. It's about driving operational excellence, lowering us down the cost curve and generating further savings as we move forward. And then enhancing trust, we're very excited about the work that we're doing to reduce our environmental footprint. We've committed to science-based targets. And I'll talk a little bit more about that in the slide ahead as we move forward. Slide 26 has our -- just summarizes what I'm saying. '22 -- sorry, the financial year '22 further reduction in debt, get that profitability back up again, continue to look for opportunities. We're not going to commit to any big projects to improve -- to increase our exposure yet, but we continue to evaluate opportunities. And we think there's lots of exciting opportunities in the packaging space. Slide 27, we rolled out a new -- with our Thrive25 strategy, we rolled out a new sustainability strategy, and that's across the group and is being embedded in everything that we're doing. And what we've done in the next couple of slides is just, it's a scorecard that we keep internally. We have set ourselves targets, which I'm not going to talk through all of them, but just to highlight a couple briefly, and I'm on Slide 28. Firstly, safety, which obviously comes first for Sappi. We missed our targets for the year. But underneath that, some great work being done. South Africa, where traditionally, we've had our most biggest challenges, we recorded further improvement. And in fact, we got a record best-ever performance. The U.S. in the final quarter had 0 injuries. So very pleased with that. The reason we missed our target is in Europe, a couple of mills did not achieve their targets, and that's something that we're focusing on, and we'll continue to spend a lot of time so that we can continue to improve. Another highlight for us is our achievement as a Level 1 contributor in terms of broad-based black economic empowerment, a lot of great work being done there across the board. And whether it's from procurement or it's from an employee perspective, lots of good work to -- went behind that to achieve the level 1 level. Obviously, we missed our return on capital employed targets that we've set ourselves. That's on the back of the lower profitability from COVID. But as we move forward, we believe we will continue to make improvement. On Slide 29, a number of targets there to improve our environmental footprint. The one did miss out on slightly was our water usage, but that was impacted by the civil unrest and the coal commissioning that we have to do ahead of the -- going live with the Saiccor expansion. But we did achieve our targets across submissions and landfill and biodiversity. So very pleased with the progress there. So turning to the outlook then, Page 31, DP strong, albeit that there is some short-term pressure in the Chinese market linked to the energy constraints. But hopefully, that will start to be over and then we'll benefit from the higher viscose prices that are coming through. Packaging, good, strong demand. Graphics now has recovered strongly. The markets are back in balance. We've been able to put through selling price increases, the energy surcharge that I talked about, logistics problems, hopefully over the worst. We do have the Somerset coal mill outage during the quarter. That's been done now. It's behind us, but it does have a $22 million impact -- It's a cold shut, so it's more than prior years, but it's good now that that's behind us, and the mill is operating back up to full capacity there. So all in all, we're feeling good about the quarter ahead, and we anticipate further improvement in EBITDA relative to the numbers we have just reported to. Operator, that's me completed. I'm going to hand it back to you for questions. Apologies if there was breaking up as I was talking, but hopefully, most of that came across, and I hand it to you for questions.

[Operator Instructions] The first question comes from Brian Morgan of RMB Morgan Stanley. .

If I may ask 3 questions, just on the 100,000 tons of DWP that's sitting in inventory at the moment. I get that it's all contractual sales, and that's fine. I understand what that means. But just in terms of what do you think your customers have done to mitigate not having the volumes of that. Do you think they've drawn down on their inventories? Have they hit the spot market to get those tons or they're just taking reduced operating rates? And then when that tonnage does eventually come to the market, first of all, when do you think it could come? Is it a December quarter issue? Is it a March quarter issue? And what impact do you think that, that might have on the market at that point, given that it is in a big chunk of global supply if it does come on, all in one go?

Okay. Do you want as you give me the other 2 questions? Or do you want me to?

If you could deal with that one, then go from there.

All right. I'll let Mohamed elaborate a little bit further, but it's actually a combination of all those things. Their inventory levels have dropped significantly. They did slow operating rates down a little bit, and they did have to go into markets to get some of the additional volumes. In terms of when will it come back, I don't think there's going to be any meaningful improvement in the current quarter in terms of catching up with the backlog. We do feel that we can sell the current production volumes but in terms of reducing the backlog, we don't anticipate any meaningful improvement. There could be some, but not anything materially. So we would expect that to be spread over the next couple of quarters. This logistical problem is a worldwide phenomenon. So it's not going to be solved overnight. So it's going to progressively improve. I remind you once again that we do get -- it is contracted, and we do get the lag pricing. So that's not lost contribution. In terms of that suddenly coming on to the market, it is contractual. So it's not going to suddenly slide the market. The markets are very tight. Customers are pushing hard for volumes, maybe not the Chinese customers. You've got to separate the Chinese market from the rest of the market. And outside of China, markets are extremely tight, and everybody wants more volume. The DP price that you see quoted is obviously the Chinese price, and that's linked to this energy issue at the moment in China. Ultimately, when we do catch up with those volumes, they will be sold to our contractual customers along with our current year's production.

Okay, cool. Can I ask then on the energy surcharge, et cetera, we saw about a EUR 50 a ton price increase from RISI for November. I assume that the price index that we look at doesn't have the surcharge back into it, is that right?

I think so, but Mark will just confirm that?

Yes, there is a separation between market prices and this exceptional and temporary energy surcharge. So market prices would not include that surcharge.

Okay. So in our modeling, we should just build in an extra EUR 100 a ton into our prices. Are you achieving that across your full graphic purpose let or only a portion of it?

Yes. No, that's -- sorry, Steve, go ahead.

Go ahead, Mark. Go ahead.

No, that's across the entirety of our portfolio and also the entirety of the geographical destinations.

And then you spoke about demand elasticity. You referred to demand elasticity. We did see, back in 2018, we did see these epic falls in volumes as a result of price increases. You're not concerned about that this time, are you?

Marco, let me just start with that, and then I'll cede to you. Just one clarification, Brian, on the first one. Remember, the surcharge was only implemented towards the end of October. So it's not the full volumes quarters. It's not the fuel quarterly volumes, okay? We do anticipate that we'll offset that absolute increase in energy costs that I referred to. I think that's important to point out. Marco can elaborate further. But just from my perspective, we've seen no impact on demand for our product in the short term. It's very difficult to project what it might mean in the longer term. And I guess there is a risk that significant rises in selling prices could soften demand for product in the long term. But at the moment, demand is strong and markets are tight. Marco, I don't know if you want to add to that?

Yes, maybe very shortly, Steve. There is indeed, there is a tightness in the market right now, which is partly probably speculative for or at least driven by very long lead times and this disturbance on supply chains. Underlying, we feel that the advertising market after the -- at the end of the lockdowns in Europe has come back stronger than what we anticipated. So there's certainly a healthy underlying demand, but there is an additional speculative element. To your question on what it will longer term do to the demand for print media, difficult to say right now. We're early days. We're calculating in our models with the natural substitution rate, as we've seen it before, where there is a leakage towards online and digital media that will most likely continue. But there is certainly a residual market that currently seems to be very resilient.

Sorry, can I ask just a follow-up question on that, if I may. To what extent do you think we might be seeing overordering by customers? Is that a risk or not?

Brian, we're not seeing that. There's been a resurgence. And clearly, there was a bit of backlog because of the COVID and the dampened demand at that point in time. But as Marco has indicated, advertising has bounced back very strongly along with the rest of the economy. So as things currently stand, our orders are very strong. And yes, there's a little bit of -- there's maybe a bit of excess demand, but we are encouraged as we look out on our order book over the next few months.

The next question comes from Sean Ungerer of Chronux Research.

Just a follow-up question in terms of the commentary on the markets being tight. So I mean you just sort of unpack that tying it into the sort of commercial downtime taken in the quarter as well as I think there was an impairment on one of the coated mechanical machines in Europe.

I think that would be part of it. Obviously, capacity has come out. There was a curtailment that took place during the difficult period. So that would have an impact. But once again, just repeat what I said just now, if we look forward in the underlying demand at the moment, it is strong. A lot of capacity came out of the marketplace. So with volumes or market demand recovering, you can see the numbers, close to 90% of 2019 levels. That is a very healthy recovery when you take into account all the capacity that's come out of the marketplace.

Okay. Great. And then just going back to DWP specifically on how we should think about volumes and how you're going to run the machines this year. So I mean, if you look at whatever the final number for your FY '21 was in terms of per DWP, do you mind building a sort of bridge for us how we should think about '22 because obviously, '21, you had oxygen impact in . You've obviously had 40,000 tons impact from the Saiccor expansion. And then I think, obviously, the 100,000 now, and I think it's probably about another 20,000 tons in Q3 that was split between the U.S. and . I mean if you look at obviously, the expansion is up and running now. So that will obviously add positively to volumes and then I don't know what sort of impact there will be from the sort of calcium and magnesium line conversion. So maybe you could just fill the simplistic bridge for me to understand, please.

I mean, obviously, there's a lot of noise on doing a bridge because obviously, you had the oxygen outage in early part of the year. Then you had the riots and all that stuff. So if I could approach it from the other side, from a capacity perspective. And if you look at the mills, obviously, you have Ngodwana, which is a 250,000 mill. Saiccor, pre the expansion, 780,000 tons. And then you have Cloquet, which is swing. But as quite a high proportion of the mill. And you'll appreciate, I can't give you the exact number because we have to buy pulp and so on and so forth for our paper business. But a high proportion of our Cloquet mill will be focused on DP. I think it's more than 75% on DP. On top of that, you have the expansion. Obviously, it starts now or in the next week or so, in the next couple of weeks. It doesn't all come on board immediately. There is a progressive ramp-up. So you have to, it is 110,000 tons in total, but you're going to have to progressively increase that. It's difficult to give an exact number, but Alex, perhaps about half of that over the course of the year conservatively.

Steve, remind me if you take all the issues we had plus the additional capacity, we're probably in the region of 100,000 tons more.

Yes, yes. But that includes other challenges. I'm coming at it from the other side. And then obviously, you've got the 100,000 tons of backlog. As I've indicated to you, that will catch up progressively as we move through the course of the year. it's hard to say now. All of it will be eliminated by September next year, but I do think we can make a substantial dent by the end of the year.

Just to confirm, I mean, is there any expected impact from the calcium, magnesium mine conversion?

No, we don't anticipate any significant impact, no.

Okay. Great. And then just sort of just think about the year ahead now. Maybe you can just remind us in terms of canned maintenance throughout the quarters across the lines if you don't mind.

Can we drive what?

Do you mind just running through the planned maintenance for DWP lines this year, just so you got a clear line of sight on this.

Yes, the DWP annual shuts. Just give us a sec because we want to pull out the schedule. Just give me 1 second.

No worries.

And Alex will jump in as well. Yes, this is just the first quarter. Alex, I don't have the full year in front of me. But okay. So Saiccor is planned for when, Alex?

April. April, May.

April, May. And in Ngodwana is third quarter. So Ngodwana, third quarter. Saiccor, second quarter. And Cloquet, Mike?

Cloquet is in April.

April. Yes.

Okay. Great. And then, sorry, just going back to graphic paper, and I think it's...

Obviously, the numbers I've given you in terms of capacity takes into account those shuts.

Yes, of course, yes. Okay, great. And sorry, going back to graphic paper. I mean maybe you can just sort of update on your sort of, I guess, medium term, long-term assumptions on demand or if that's changed at all, specifically in Europe. So I think we're pretty comfortable with North America at this stage.

Sorry, you just broke up at the start of your question. In which segment is that?

In terms of your underlying demand assumptions in Europe, in terms of structural decline, has that changed at all? Or what is that sort of number sitting out?

Based on -- our initial thoughts on this was that COVID would cause a haircut of about 20%. And then we were going to subsequently resume a 5% roughly decline. Things have subsequently transpired to be better than that. And you have the numbers are -- market numbers are actually 90%. A little bit of that, yes, maybe a catch-up in terms of demand. But in terms of the way we are looking forward, we are presuming that the 5% to 6% decline will resume as we go through '22 and beyond. But what I will say is that if you look at operating rates certainly in the U.S., they're at theoretically 100%. And now if even in Europe with the capacity that's come out, those are now healthy and in the 90s as well.

Perfect. And just 2 more quick ones. Just in terms of the opportunities around sales specialty packaging in Europe, I mean it looks like pretty decent volume growth suggested in one of the slides. And then you obviously alluded to the U.S. now as well. Maybe you could expand a little bit more next. It looks like it's a bit of paperboard in the U.S. and perhaps at the more containerboard where that's coming out of Europe. Where is that? .

Yes. I think let's take each of the regions. First, in the U.S., obviously, now we're substantially full now on our Somerset machine that we converted. We look for optimization opportunities and hopefully being able to improve margins further. But essentially, that machine is full. There's a little bit of opportunity on the other machine at Somerset and our Cloquet mill, but it's not big capacities. In Europe, obviously we've got some opportunities, and I'll let Marco talk further. But we do have opportunities, obviously, at Maastricht, first and foremost, because we've talked about that. But what Marco and the team are doing is looking for opportunities to redirect some of the capacity on our graphics machines to certain packaging grades and specialty grades that would not involve a lot of CapEx. And Marco, very briefly, maybe you just want to give examples. Obviously, Ehingen is one of them, but you maybe just want to briefly talk about that.

Yes. Thanks, Steve. Apart from the full specialty mills, it is indeed so that we're looking at ways to create hybrid mills. And that is Maastricht that Steve already spoke about. It's Ehingen for the containerboard grades that we have there, which is taking more and more capacity out of the Ehingen graphic portfolio. And recently, we have announced to the market as well our commercial plans for further label paper production in Gratkorn, which looks very promising indeed.

Okay. Great. And then, Glen, just in terms of, I think, sort of working capital in Q1, I think historically, it's been about a $80 million, $100 million outflow, how to sort of be thinking about that? And then I guess just a follow on to that final question, I mean when should we sort of see CapEx dropping off in the years to come because I think at least from my perspective, I'm sort of hoping to see it coming a little bit lower this year, and that's great.

Yes. Just in terms of quarter one year, you're right, that is a cash outflow. It will be a bit more than that just because of the timing of our year-end -- quarter end rather, which is going to be the 2nd of January. So we'll have some more creditors' payments in there. but you're in the ballpark there. Overall, you're talking about the CapEx. So we've given the guidance as far as this year is concerned. We'll provide guidance later in terms of after that. But the focus, and I'll come back to what Steve said earlier is initially to get the balance sheet stronger and get the gearing lower.

Maybe just to add to the CapEx. Obviously, we've got our maintenance CapEx. And then clearly, over the next few years, there are going to be sustainability investments that we have to make, both from a legislative point of view and to achieve our environmental targets that we've set ourselves. You can see that, that number in the current year is $80 million. The other initiatives, so if you're talking maintenance just under the $200 million, you add in the environmental stuff, you're getting to about $280 million. The risk to get you up to the $360 million that I referred to is discretionary. And some of it is linked to those smaller cost initiatives that I've referred to, some of it's linked. Marco talked about doing stuff at Gratkorn and Ehingen and various other mills. These are not big projects. They're small projects, but they're discretionary. So if we look beyond '22, we haven't committed to any big projects. We monitor the situation and then we make a decision whether it makes sense to invest. And based on how events are unfolding and based on our positive outlook for '22, we felt that we could spend a little bit on these cost initiatives, and that's why we added it to the CapEx. And we'll monitor beyond '22. But at the moment, we haven't committed to anything beyond that.

The next question comes from Wade Napier of Avior Capital Markets.

Just a couple of questions on my side. Maybe the first one for Glen on the balance sheet, I appreciate the sort of leverage ratio is coming down as you're starting to sort of move past the worst of the impacts of COVID and some of those very low EBITDA numbers. How do you think about the balance sheet in terms of absolute net debt levels and when you would potentially start thinking about more discretionary capital or the dividend resumption, et cetera. So I mean, do you sort of have a number in mind? Or are we sort of thinking below net debt-to-EBITDA still below 2x, something along those lines? . Second question from me is really in South Africa and load shedding. Has that sort of impacted you? Can you just remind us what your sort of relationship with Eskom is like and whether you have seen impact there? And then maybe a final question for me on the North American business. I think congratulations is in order there, I think it was a fantastic result. But I mean, what are the downside risks to North America? Because it sounds largely positive for the time being. And I mean, you and I both know that North America is not a 20% margin business. So I mean, how do you sort of think about this North American performance out of the next 12 months or so?

Okay. Thanks for the questions. Glen will talk about the absolute debt level targets and our leverage levels. I'm going to hand to Alex who can share our strategy around load shedding across our mills. And then I'll briefly talk about North America, but I'm going to hand over to Mike just to talk about some of those downside risks.

Thanks, Wade, for that. Our focus is more on the leverage ratio as opposed to the absolute number. And that long-term target of getting towards the 2x net debt to EBITDA is over the cycle because of the fact that we're in a cyclical business, so it will go above, slightly below and move around that. But our focus is to have it over the cycle, get closer to the 2x net debt to EBITDA. So we don't -- it's less of a focus on the absolute number and more of a focus on the leverage target.

Thanks, Glen. Alex, load shedding?

Thanks, Steve. As you're aware, we've got generation capacity at our 3 largest mills in South Africa. So we are able to manage this with Eskom. We haven't had a significant impact. But when it comes to the crunch, what we do is we prioritize and we do the load shedding at the mills where we have the lowest margin, in this case, [ Fortress ], Stanger and [ Lumarte ].

And that enables us, Alex will tell you that Ngodwana is long. So we're okay. And Saiccor is a bit short, but we prioritize Saiccor to the detriment of our less profitable mills.

And we would sell later to the grid from Ngodwana.

Correct. And then on North America, business is in a good place and operating rates are very healthy. You had close to 100%. So that should even with a decline in graphic paper, which we've already talked about 5%, 6% over the next couple of years, even at those levels, operating rates should continue to be healthy. But I'll hand it over to Mike just to talk about some of what he sees as downside risks and how we're offsetting those.

Sure, Steve. Thanks. I guess from my perspective, you're asking for a bit of an opinion here. Obviously, things have been strong. The machines are full at this point. the risk as I see them, are really focused around the logistics, particularly how it impacts our graphics business with imports. If the international logistics issues were quickly resolved, that could potentially weigh on graphics with imports. Other concerns would be around variable cost inflation continuing at extreme rates and potentially impacted materials or additional logistics costs. So I think those are the concerns as I see them right now in North America.

Wade, does that help? .

[Operator Instructions] The next question comes from James Twyman of Pristine Securities.

You've talked about Europe quite a bit. On the round, taking everything that you've said in terms of price increases and the surcharge, it sort of implies you're saying that you should be breaking even or starting to make some money this quarter. I just wanted to check whether if these surcharge increases have come through, whether that is the case? Second, I just wanted to ask in terms of this Saiccor impact of the expansion, whether there's a positive impact from...

Sorry, James.

Yes?

Sorry, James. I'm not sure if your sound is coming through clear to the speakers.

Yes, it's fine. James, carry on.

Please go ahead. Apologies for the interruption.

Okay. No -- So with Saiccor, what sort of impact do you think there'll be? Because obviously, when you ramp it up, there is an impact on the rest of the plant. So when should we start expecting a bit of a profitable impact? And then my third question was lending is bringing its capacity on in sort of Q2. That capacity will either offset some of your production or it will be sold into the spot market hopefully by you maybe. But could you just talk around what the impact you see of that capacity when it comes on because it will come on in lumps. It may not be all right away, but it will come on into some fairly chunky lumps. So that was it for me.

Okay. Just coming back to Europe. Your first question, the surcharge, bear in mind the surcharge is to offset the energy costs. And you've heard from us that we're confident that it will do that. Obviously, other prices have been rising over the course of the year. And our team have been announcing and implementing selling price increases that will offset that impact. So what I will say to you is that the market is tight at the moment, and that's why we are more confident about being able to execute on selling out price increases. If we get them through, then the margin deterioration that you have, we've experienced over the last year can begin to recover. When exactly that will be, that's difficult to pinpoint, but we are more optimistic about the outlook. The Saiccor expansion, I think you asked me, when does the profits from the Saiccor expansion start to flow? Is that right, James?

Yes. Because you've obviously got disruptions that come along as well and these things don't always stop perfectly. No, no, sure. There's a ramp-up, and that's why we were conservative about the ramp-up. Clearly, once we get the quality, and we're confident that we will get the quality pulp through, there is a process of ramping up. And ultimately, as that volume flows, it will contribute to the bottom line.

Steve, if I may add, essentially, we'll ramp up from now the end of this month to February in terms of the additional volume. Then we have the calcium to magnesium conversion, which will just then help us on our cost position.

So yes, we got a question earlier that would affect volumes, but it won't affect volumes, but it will improve our cost position, and that's very important. And it improves our environmental footprint. And that's obviously why that was part of the business case. In terms of lending, you saw a slide earlier where we talked about where we expect our contractual volumes to go, and we have indicated 72% overall contractual volumes. So we are not concerned about that volume coming on to the market, and we're confident that we will be able to place that tons elsewhere.

Okay. So in conclusion, on Europe, it sounds as though you probably won't be back to breakeven this quarter, but hopefully next quarter. And in terms of the Saiccor expansion hopefully, profits Q3.

James, when you say breakeven, what line are you looking at?

Very much EBIT, EBIT level.

Yes. Look, obviously, we're focusing on EBITDA. I can't get too specific that you'll appreciate, right? But what we are saying is that the energy surcharge will offset the energy -- higher energy costs. We're seeing that. Secondly, we're saying that the markets are tighter. And therefore, we are growing in confidence in our ability to execute on the selling price increases that we've already announced, which will help offset the margin erosion we experienced in the last year.

And just in terms of the Lenzing thing, so you will be selling less to Lenzing, but you'll be selling more on the spot market. Did you anticipate helping Lenzing sell its volumes to.

James, I can't get too specific. This is our customers. So all I'm going to say to you is that we're going to reduce our contractual volumes to 72. We're happy with that, and we're confident about being able to place the rest of the volumes into the spot market.

The next question comes from Mikael Doepel of UBS.

I'd like to start off by asking a question around the DWP markets. If you could just talk a bit about the current dynamics you see there overall in that market right now? I mean, how are the VSF prices trending as we sit here today? What are the inventory levels there? Where are the DWP prices as of today and so on and so forth? That would be great.

Okay. I'm going to let Mohamed elaborate a little bit further. But broadly speaking, global markets are great. China, a little bit tougher, obviously, impacted by this energy constraint, and it's meant that viscose producers are not able to operate at full capacity, and that has lowered their demand. I'll let Mohamed go into more detail.

Thank you, Steve. Just specifically in terms of China, as a result of the energy constraints, what we have seen is the operating rates for VSF in China came down to around 50%. That in turn resulted in lower VSF inventories and lifted the VSF prices. Over the last week or 2, there has been some easing of the energy constraint. And what we have seen as a result of that, the operating rates have now lifted a little bit more, going from about 50% to 60%, and the inventory levels are still staying down at around 20, 22 days versus the sort of 30-day level that it was at before the energy constraints were imposed. I think with the VSF industry at the moment, you also have a market inside of China and outside of China. Outside of China, and as you know, we have a big position with buyers of dissolving pulp outside of China. Their markets are very, very tough -- very, very strong. So you're seeing very, very high operating rates. You're seeing very, very strong demand. And a big part of that is being driven by the fact that a lot of the retailers are also shifting now their demand from China to places like India to Indonesia, Thailand. And then there's a big demand coming through from Turkey, which is placing a high demand for fiber from European producers of viscose. So outside of China, very strong. Inside of China right now, somewhat restricted by the energy constraint as well as the logistics issues.

Thanks, Mohamed. Mikael, over to you.

And just to follow up on that, I guess, on the DWP pricing, you mentioned the 940, I think, in the release in October. Just to remind us, I mean, what was the average price in October and in September? And where is the current spot price?

Through the quarter, the results we announced, it was above $1,000 a ton throughout the quarter. So a healthy price did come down for the reasons that Mohamad described, and I think today's CCF is 938.

That's correct.

So still at the -- basically the 940, 938 is today's price. Viscose prices are obviously high. And if those operating rates in China can continue to pick up, then that could be good for DWP prices.

Right. But the VSF prices haven't yet started to increase again, I guess.

No, they have significantly. 2 months ago -- go ahead, Mohamed.

Yes. The prices did go up by over, I think, 20%. And from the time the energy constraints were imposed. It went up to about in terms of renminbi levels to about RMB 14,400. It has started to come off a little bit in the last couple of days as the operating rates have picked up. But at the same time, I would add, you've got cotton prices still moving upwards. You've got oil prices driving the polyester prices upwards. And you haven't, I think, seen the impact of those higher prices flowing into the VSF prices. But it's a lot higher than what it was in September and early October.

Right. Right, right. Okay, that's fair. I was just looking for that most recent price moment. Good. And then just switching gears a bit to the European coated fine paper market in particular. Now we have seen quite significant price increases across you could say publication paper grades in Europe, both in October and November if we look at the spot prices provided by, for example, RISI. When we look at the coating fine in particular, though, I think the improvement have been much more slower there on that side. So I was wondering what's the reason for that? And what are your expectations for the price gains towards the end of this year and into early 2022? I appreciate your surcharges, but that's, I guess, a separate topic.

Yes. I will let Mohamed -- Marco talk in more detail. But obviously, we've been going through announcing a series of price increases. I think when you were comparing, I think where you're comparing it to coated mechanical paper when you were talking coated woodfree there because you said it was less than...

Yes, well, I said publication purpose basically comparing to magazine papers and newsprint which are up double digits

Yes. I'll let Marco talk further. But what we did see is even more capacity coming out of the publication paper space, and those prices did pick up faster. But we have been implementing further price increases on the coated woodfree front. Marco, do you want to just talk about that?

Yes. Just one addition to that, Steve, is that we started earlier on the wood recoated side. So if you take the longer period, call it the last 6 to 12 months -- 6 to 9 months you will end up relatively similar levels. The first mechanical coated price increase was half year. And as Steve rightly said, the market has become very tight after the capacity closure announcements. So there have been a substantial additional increase has followed. But over the longer term, Mikael, the increases are pretty similar. We just started earlier with woodfree coated or later, if you want, with mechanical.

That's a fair point. And going forward, I mean have you announced further price increase towards the end of the year or early 2022 for any of your grades? .

Yes, there has been further announcements during this quarter, but also, as Steve already alluded with the markets where they are and the need for margin improvement or the stop for further deterioration, there will be further increases, yes.

We have a follow-up question from Brian Morgan of RMB Morgan Stanley.

Just sorry, 2 more things, if I may. Do you have updated guidance on the calcium conversion in terms of what that does to unit costs? That's the one question. And the other question is just give us an update on your discussions around that dam at Somerset that we spoke about a couple of months ago.

Okay. Specifically on the calcium conversion and the lowering of the cost, we haven't got -- we haven't made those numbers public yet, but when we complete the project, we'll give an indication.

Maybe just to remind you, what it means is we can recover both the chemicals and the energy on those volumes and rather than having to put that out to waste.

And then on the second one, Mike, do you want to just talk about that issue of the dam at Somerset?

Sure, Steve. As far as the dam is owned by another entity and they're in the process of repermitting that. They have restarted that process. We have received written commitments by the local authorities and the governor supporting the operation and the continued support to have that dam in place. That process of the permitting could be up to another year. We don't see that as an issue, and it's something we're monitoring at this point.

[Operator Instructions] The next follow-up comes from James Twyman of Prescient Securities.

I know we'll be running short of time, but just 2 quick ones for me. Firstly, the 20% growth in packaging volumes this year is obviously very high. Could you sort of give some idea of the split between the divisions, whether it's higher in South Africa and the U.S. and less in Europe? And secondly, the U.S. prices are obviously high now. I don't know whether imports are starting to pick up now. But is there a potential for a further rise in prices? Or do you think that's pretty much done now? And that was it for me.

On the packaging growth, it was predominant -- it was mainly in the U.S., as you would expect. That was where most of the volumes came through. Obviously, in South Africa, we've got our capacity, and we're limited by our capacity that we have in that space. So it was mainly in the U.S. James, on the second one, I lost you again on the -- which one was the selling price increases?

Yes. Just in the U.S., obviously you've achieved a lot whether there's the potential for more increases or whether you think you've pretty much done there now?

Look, I think that's going to be guided by our costs. Our costs obviously, you heard from Mike earlier that that's one of the things that we have to offset that impact. And we will continue to do that. So if costs continue to rise, we need to address that. We are encouraged, obviously, because the markets are tight. So we'll monitor the situation as we move forward. . Okay. Operator, I think that's time up. So I just want to take the opportunity to thank everybody for joining us on the call today and look forward to discussing our results at the end of Q1 in 3 months' time. So thank you.

Thank you very much, sir. Ladies and gentlemen, that concludes today's event. Thank you for joining us. You may now disconnect your lines.