Sappi Limited (SAP) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Sappi Limited Q1 2022 results. [Operator Instructions] Please note that this call is being recorded. I'd now like to turn the conference over to Steve Binnie. Please go ahead, sir.

Thank you, and good day to everybody. Thanks for joining us on the call today. As always, I'll move through the investor presentation, calling out the page numbers as I go along. And I'm going to start on Page 3, which is our highlights for the quarter. And we're very pleased to say that this was an excellent quarter for Sappi. The performance exceeded even our own expectations. Markets were strong across all our segments, and we achieved success all our operating regions. So very pleased with those results. The EBITDA was 240 (sic) [ $240 million ], which was well up even from the prior quarter. We did have an additional trading week, which contributed $25 million, but we did have an extended cold mill outage at Somerset, which offset that impact. So it was a real number -- up significantly from the prior quarter when we had the logistical challenges and that backlog was created. In the current quarter, we were able to transport the production that we made. So the problems on the logistics side didn't get worse, but we were not able to reduce the backlog. Packaging continued to be strong, and we saw a big rebound in demand graphic papers. And that enabled us to ensure that we -- all our assets ran full operating capacity, which is the first time in some time. Our debt continued to improve. Our leverage ratio in terms of our debt was down to 2.9x...

Mr. Binnie, this is the operator. Steve, this is the operator, sorry to disturb, but may I just ask if you could please speak up a bit more so? And closer to the mic, as close as possible.

I am sorry?

If you could please speak closer to the mic and a bit more louder, please. Thank you, sir.

Apologies, everybody. We're just having some technical challenges. So I'll move on and I'm now on Slide 4 which is the earnings growth both the prior year and the current year. And firstly, sales volume I talked about on the prior slide, well up on a year ago. And you can see across each of the segments. The selling price is up significantly, pulp a big contributor. Obviously, we benefited from the lag impact on our contractual pricing. And then on top of that, we were able to implement selling price increases across both packaging and graphics, which enabled us to offset higher costs which are represented in the big red bar. And the higher costs were really across the board from pulp, which would have been at elevated levels for the [ 18 ] months. And then all the other raw materials, energy, wood, chemicals and the higher delivery costs as a consequence of the ongoing supply chain challenges, the global one. And that was offset by the higher selling prices enabling us to get to the 240 for the year. Slide 5 has our contribution across the profit segment. Obviously, during COVID that was that deviated from normal because of the different impacts of COVID on the segment we are seeing in the current quarter, obviously, and in the last 6 months or so, a big rebound once again from graphic. Pulp picking up once again, but pleased to say that packaging continues to grow and be a major contributor. On the right-hand side, the sales volumes, about half in graphics, obviously boosted by the rebound in demand that we have experienced recently and in pulp and packaging roughly 1/4 each. Slide 6 has the segmental volumes and EBITDA margin, obviously, a very positive story. Volumes picking in our paper segment, margins picking up as we implemented the selling price increases. And then pulp, good to see volumes back up and the logistical challenges somewhat, although we still have that 100,000 tons which we can sell or deliver later in the year, but margins improving of course for the segment. Slide 7 has the net debt development, 2.8 you see on the far right there. It's slightly different to the 2.9 on the opening page because this is clearly, a balance sheet calculation. It's not in terms of the covenant itself. But nevertheless, moving in the same direction. Debt coming down fast, and the leverage still coming down fast. And with the strong cash generation that we anticipate over the course of the rest of this financial year, we're going to see this come down sharply. Slide 8. As the maturity profile for our debt and you've seen before, a lot of great work being done on the last 18 months or so, refinanced our near-term debt, almost crossing immediate -- that needs to be revised. The next one is this the next material [indiscernible] in '24, but that's a 3-year facility, which we roll over each time. So it's looking good and a clear pathway. Slide 9 is our CapEx. It's unchanged from the prior quarter results under $400 million which contains the balance of the expense on the cycle expense from cost optimization projects of 80 million and the sustainability projects that we talked about last quarter. So, unchanged. Slide 10, we just had -- we included some slides just to replace with the headwinds. And this first one is on ocean freight. On the left-hand side, just to schedule reliability and it's still challenging in global markets. And it does look like it's going to carry on for some time to come and the reliability level is actually getting worse since the last quarter. The right hand side is the cost of containers, [indiscernible] goes back to February '21. And you can see it's doubled in that time. and remains at those elevated levels. If you went back further, these world container indexes have gone up close to 4x. Slide 11 has the pulp prices. This one has Europe and China. And you can see that Europe firstly has remained at undisputed [ levels ] and obviously, we buy a lot of pulp in Europe. In China, which tends to be a lead indicator for much of the global pulp market. We did see declines in paper pulp prices, but more recently, those prices have actually started picking up once again, which actually could be good for DP pricing. Slide 12. As I explained to you in the last quarter, our European business is a big user of natural gas in Europe and impacts on our available cost base. You can see that natural gas pricing has come off the highs. They remain extremely volatile and they're well up on a year ago. So across the board, across a number of our raw material categories, timber in South Africa, chemicals and the like, we are seeing higher costs. But because our markets are strong and all the great work that we've been able to do in our business, we've been able to mitigate that impact. Then turning to Slide 14, moving into our product segments. Firstly, on pulp, DP prices did come down to $905 per ton during the quarter, still at pretty good levels, actually. But they did stabilize towards the end of the quarter, they followed viscose by then. More recent data, the end of the quarter, viscose prices actually started rising again. And in fact, coming out of [indiscernible] viscose prices come quite nicely. The DP prices has gone up today. So it's moving in the right direction. And we are positive about the [indiscernible] did [indiscernible] the BCTMP out of our Matane Mill. BCTMP prices also came off on the back of all the other declines in pulp prices in the Far East, but we've also seen some nice improvement in BCTMP prices in recent weeks as well. So that's looking good. On the 100,000 tons, which we mentioned last quarter, still there, as I say, not getting any worse, but we have been able to secure some additional capacity, break bulk specifically, and we are optimistic that we can start to reduce that backlog in the current quarter and in the rest of the financial year. Slide 15, just a couple of graphs on the dissolving pulp market. On the left, it's just apparel, we could put many different graphs or indicators there for you, just to show the rebound in textile. And apparel sales are strong, starting to recover and the underlying demand for textiles and viscose and ultimately, the dissolving pulp is good. On the right, you see the DP price versus the viscose prices. And after the drop viscose experience, earlier in the quarter, you can see it started rising once again. And in fact, this graph a couple of weeks old. It's actually moved -- the green line has moved up further since it was put together. On packaging, Slide 16, still on another strong quarter, record profits. Markets are robust across all our regions, we've been able to successfully implement selling price increases, focus on product mix optimization, something we promised to you, and that's led to additional benefits. EBITDA up more than double a year ago. South Africa containerboard very, very strong. North America, equally, very strong markets for us. In Europe, specifically in the categories that we list there, particularly strong. But across the board, we're looking at very strong markets at the moment. And then on graphics, the rebound in demand -- I'm on Slide 17. Graphic demand has bounced back and demand is strong. With all the additional capacity that has come out of the marketplace, it's meant that operating rates are full. And we are able to operate all our assets at full operating capacity. Volumes are basically back at the pre-COVID levels. And with that as a backdrop, we've been able to implement selling price increases in Europe and North America to improve our margin and offset costs. Then turning to the regions. Firstly, Europe, we -- a strong recovery, and we're very pleased and from the difficult quarters that we experienced last financial year, a nice rebound, we're seeing strong demand. We've been able to implement selling price increases to offset those higher costs, and you see a significant growth in volumes across all the paper businesses, but we, obviously, do have the headwinds of the higher variable costs. But we've been able to mitigate that impact. Just the one comment I have to make is that on the packaging and speciality margins side, so there are contracts [indiscernible] so there's a little bit of a lag impact as we recover margins in the packaging side as well. So we continue to increase selling prices. And then in North America, another great quarter, another record quarter, more than tripled the prior year in terms of profit. We did have the cold mill outage at Somerset. It was very successful for us, obviously offset by the additional trading week. All the segments doing very well, and we've been able to mitigate and stay ahead of the curve with regards to cost increases. Then in South Africa, a good quarter. We saw higher pricing in all segments. Despite the higher costs, demand for DP continues to be strong, and very strong demand for or containerboard. And that's expected to continue as we move forward. However, we do see variable costs coming through. we've got higher the external timber that you buy and like everywhere else, higher chemical prices and delivery costs. So it does mean that the some pressure on the South African pulp business because you don't pass on those same surcharges that you would see in the paper businesses. Slide 21 has our strategy, and I know there's a lot on this slide, so I won't spend long on it other than to just reemphasize the four segments: The ongoing focus on operational excellence, which include safety, which comes before all else; looking for opportunities to reduce our costs to offset these higher raw material prices that we're experiencing; enhancing trust, that's why we're in business. Great work done on the certification and we have a slide a little bit later, we'll talk about that. One of our strategic advantages is our forestry certification of our wood out of South Africa. And as we talked about last quarter, there was some topic as we reduce our environmental footprint. We look for opportunities to grow and redirect capacity through our growing segments. And we've been very successful about and we'll continue to look for those opportunities. And then ultimately, sustaining our financial health, but the debt situation has improved tremendously, and will continue to come down on the back of the strong customer and higher profit. Slide 22 is one that you've seen before. And just to reemphasize that our focus on the short term is on the balance sheet, strengthening the balance sheet. And ultimately, we do think that there are opportunities to grow beyond this period, but we haven't made any big investments at this stage or material investment. Slide 24 as the sustainability. It's an important part of the way we do business, built into our values and our culture. These are some of the certifications and a number of them you'll have seen before, but I'm pleased to say we're reconfirmed over the last few months. And obviously, as I mentioned before, we have committed to science-based targets out to 2030. And also very pleased to reconfirm that we are a Level 1 BEE contributor, and that's all been certified. Turning to Slide 26, the outlook, and I'm pleased to say that we are optimistic about the prospects for the forthcoming quarter and for the rest of the financial year, all our markets are strong. Demand is good. We're able to put through higher selling prices, does look like DP prices are picking up as well. And I do think that margins in Europe's packaging and specialties business continue -- can continue to improve as well. So feeling good and things look strong across the board. On Slide 27, obviously, we have costs and logistics challenges, but you can see from our experience over the last year that despite these headwinds, we're able to combat them, we're able to mitigate those and deliver higher profits. And with that in mind, looking at all the factors that are out there, we anticipate another improvement of the $240 million that we just achieved. And obviously, that contained an extra week, despite the fact that the ahead of next week will be that absolute number in the second quarter. So we're feeling very optimistic. So operator, I'm going to hand it back to you for questions.

[Operator Instructions] The first question comes from Wade Napier from Avior Capital Markets.

Congratulations on the great set of results. I think very commendable. And thanks for the opportunity, a couple of questions on my side. Can you maybe just give us a sense of historic sort of imports of coated freesheet into the U.S.? You sort of continue to sort of benefit from, I guess, a lack of imports into the U.S. And maybe you can just give us a sense of what they have been historically relative to what they are now and what the sort of potential risk is going forward, if those return? Second question is on graphic paper price increases. We're obviously starting to see those price increases come through and they're becoming quite material. What are your sort of thoughts on the risk of price increases causing sort of an acceleration in demand erosion? This sort of looks familiar to what we sort of saw in 2018 circa 2019. Just some thoughts on that would be great. And then just a question on taxes. What is your expected tax rate over the sort of financial year? I think you tax looked a little bit low this quarter. Maybe you can just give us some guidance there, please?

Okay. Wade, repeat the question. I mean, firstly, on historical imports to the U.S. I've got Mike here with me. Obviously, the logistical challenges that are out there have been a benefit to our U.S. business. And however, we have seen a rebound in imports in recent times, particularly out of Korea. So what I'm going to do, I'm going to hand to Mike and he will speak broadly about the imports of the U.S. market.

So in the U.S., historically, we've had 25% to 30% of the coated freesheet market as imports. Currently, it's running just about 30% overall, down slightly over pre-COVID levels for the overall volume. But we've seen in the last few quarters, some of the demand returning and some imports turn up behind. Just from North America, our assets are full on coated freesheet and there's no additional volume for us to supply.

Wade, your second question was about selling price increases in graphic paper? And could those lead to demand erosion like we experienced back in 2017, 2018? I think the big difference between now and then -- I mean clearly, it's a risk, and there's a shortage of graphic paper in Europe and the U.S., in fact, globally. So there is a risk that, that could impact downstream demand. However, at the moment, there is a significant shortage and that's not what we experienced back in 2017, 2018. So that's why we are much more confident about our ability to execute on these increases. And literally, our customers are looking for more volume across the board, and they're on allocation, and that's why we're very bullish about the short-term outlook. So I do think there will be an impact. However, markets are still very, very tight. And they look like they're going to be that way for some time to come. In the longer term, clearly, if we look out 2 years and beyond, yes, graphic paper will continue to decline. But in the intervening period, we can, with markets as tight -- none of us have seen markets this tight before, it's going to create opportunities for us. Your last question was on taxes -- the tax rate, I'm going to give you to Glen.

Wade, just as far as the taxes are concerned, we -- for two main reasons that is so low. The first one is, are the investment allowances that we get as a result of the Saiccor expansion. And then the second one is the utilization of our assessed losses coming through in North America. And it will continue. We anticipate the rate will stay at that level for the remainder of this year.

The next question comes from James Twyman from Prescient Securities.

Excellent quarter. Congratulations. I've got two questions. The first one is in terms of energy costs, would you say that they peaked? And that this quarter, at the moment looks like energy is going to be at a similar level to last quarter? Or is it slightly higher? And maybe the same for chemicals. And then also the Maastricht Mill, you've said that you're looking to potentially sell that. Very keen if you could talk through the reasons of that and whether you're making any progress on that? And that's it for me.

Sorry, James, you just broke up slightly there on your second question. Was it on Maastricht?

Yes. Just what the reasons are for it and whether you're making any progress on that?

Yes. Okay. On the energy -- apologies, we're just having some technical challenges. On the energy costs, we are anticipating a further increase in Q2. which we're probably looking at another -- and I'm giving you a rough number here, of about another 25% on the energy costs. In absolute terms across the group, that's about [ ZAR 50 million ]. But we have been able to put through selling price increases to offset that impact. And that's already taken into account in the outlook statement that we provided to. You can see that on that graph, we showed earlier, the gas prices have come off a little bit, but they're still relatively high and volatile. Yes, who knows where prices are going to go. But one thing we do know is that, typically, when the Europeans come out of their winter season and into spring, energy prices -- the pressure on the energy prices should come off somewhat. But to the absolute impact of that, we have been able to mitigate. In terms of the last question, I'll briefly answer, and then I'm going to hand you to Marco. Yes, we've talked about before about one of our strategies has been to reduce graphic paper. And we are exploring opportunities to see whether it would make sense for us to consider selling that asset. It's an exploratory stage. And in terms of the legislation in the Netherlands, we have to make certain disclosures. So it's exploring. I'm not going to make any promises, but it's something that we're exploring. And Marco, I'll allow you to speak some more.

Yes. Thanks, Steve. And it is, as you say, it's -- the exploration has started. It has been part of the strategy review that we that we have undergone last year, which has led to a certain conclusion based on the market segments we would like to play and we think we can win. And part of that is the consideration of looking for a buyer for the Maastricht asset. Again, this is in an exploratory phase. The reason that we went out public is that we had to comply with legal requirements, particularly in light of the information to the works council in Maastricht. And that's why we have gone out and made it public. Again, we're in a very early phase to see where this ultimately will lead to.

The next question comes from Brian Morgan from RMB Morgan Stanley.

Two questions from me, if I may. On specialties -- both on specialties. If I just simply take revenue divided by volume to get price realization, it looks as though prices are up or realized prices are up about 30% quarter-on-quarter. And obviously, you did highlight mix changes and product optimization or that sort of stuff. Can you just give us a bit more color on what's going on there? And specifically, where you're seeing that geographically?

Look, it's a combination of mix and price realization. It's predominantly price. And we have seen those kind of levels of price increases in Europe and in the U.S. So that's got a little bit lower because -- and you're aware of this, Brian, we have annual contracts on the packaging side in South Africa. But strong increases in prices in both Europe and North America.

Okay. And then in terms of margins, obviously, a 15% EBITDA margin for specialties across the board. Specifically between Europe and North America becoming quite material there now, is there a big margin differential between the two regions?

Yes. I think we indicated earlier -- I mean, we don't provide that granularity. But what we have indicated earlier is that the European margins are lagging a little bit because we do have some contractual business, 6 months an annual business. So those selling price increases that we've been putting through, and we continue to put through. As those terms mature, that business will start to benefit. So we do think there is further scope for margin improvement in the European business.

[Operator Instructions] The next question comes from Mikael Doepel UBS.

Can I just ask firstly on the DWP backlog that you mentioned, how should we think about the pricing of that backlog? You might have said this previously, but maybe you could remind us of that. So you have 100,000 tons basically in the backlog, which you expect to deliver. The question is at what price, I mean, compared to where the current spot market is? That would be my first question. The second question would be, if you could talk a bit about the overall market dynamics now in DWP in terms of [ swing ] mills, behavior in terms of inventories in the value chain in terms of what you expect up or down in the short term? And then thirdly, just coming back to graphic papers. You mentioned you basically sold out. Does that translate into a continued year-over-year volumes growth for you in the current quarter? Those would be my questions.

Yes. I'll talk about the DWP backlog price, and I'll talk briefly about the DP market dynamics, then I'm going to hand you to Marco -- Mohamed, who will expand further. And then on the graphics volumes, I will talk about those. And then perhaps Marco will elaborate a little bit further as well. Yes, on the backlog -- as we talked at the end of the last quarter -- because of the lag impact of our pricing, we do get the benefit of the earlier quarter. So the 100,000 tons backlog that's there today is not the same 100,000 tons backlog 3 months ago. And that's why the price realization in this quarter relative to where market prices were at that point in time was higher. So that's why DP prices were relatively higher. So similarly, that 100,000 tons, as it's delivered in the current quarter, effectively, is benefiting from the price 2 quarters ago, if that makes sense. Whereas the rest of the volumes would be at last quarter's price. So we do have a benefit there. The DP market dynamics, as I said, I'll talk briefly and then hand to Mohamed. Broadly, viscose prices came under a little bit of pressure. DP followed it downwards, but then it started to stabilize. And more recently, viscose prices have picked up. We've seen cotton prices at 10-year-plus high, the differential between cotton and viscose prices at recent many years high. So those are very, very favorable. And as I said, viscose price is picking up more recently, and DP went up to date, only $5, but it's a sign that it's moving in the right direction. And I'll hand you to Mohamed.

Thank you, Steve. Just if I can start in terms of the industry-specific characteristics, what we are seeing is the VSF operating rates inside of China has lifted quite nicely. And we're now seeing it sit over the 80%. The VSF inventory level, sitting with the VSF producers, certainly going into the Chinese New Year, has dropped to a very low level, below the 17 days and that's below actually the long-term average, which is closer to, say, 20 days. What we did see was that there was a big transfer of VSF inventory moving from the VSF producers to the yarn producers. And that's typically what you see leading into Chinese New Year. And -- but when you look at the yarn producers, stock of VSF yarn, that's sitting at levels which are below the 5-year industry level. And that should, I think, support more spinning of this viscose staple fiber. So the inventory levels are -- in the value chain are looking, I would say, pretty good at the moment and supportive of higher pricing going forward. The one other thing I would say that has changed, cotton has been at a very high level that difference to viscose is at least at a 10-year high, and that should I think, support increased usage of VSF fiber at the margin. And also, we're seeing more recently higher oil prices starting to have an impact on the polyester staple prices, which, again, should be supportive of VSF demand in the near term.

Can I just -- go ahead. I'll take it afterwards.

No, no. Ask your follow-up question.

I just wanted to ask on the cotton. I mean I've seen the spike myself as well, and it's pretty extraordinary. I mean, can we expect that to last really? Or I'm sure that it start to correct down at some point.

That's a hard question. Obviously, a number of global commodities are up significantly, and it's creating an opportunity for us, we believe, on the viscose side. It's very difficult to predict how long cotton prices can remain at these levels, but it's very promising for DP pricing ultimately. It's very difficult for us to predict how long that can carry on for. In terms of your last question was about graphics volumes. And I guess the big story there -- our North American business has been full now for the last year. So the additional volumes that you're going to see coming through in the current year relate to our European business. And as you know, last year, I think we took about 280,000 -- about 280,000 tons of curtailment last year across the 4 quarters have progressively got better. So the opportunity there is if we keep our machines full, we can sell all those volumes.

Mikael do you have any further questions?

I'm good. I'm good. Actually, one follow-up. Just on -- actually not relating to these questions, just a separate question on cost -- the cost side of things. Just two questions there. You mentioned the energy being a bit of a headwind into this quarter, but you're covering that with pricing. Just wondering if there's any other there any other cost -- key cost items that you see moving up on a sequential basis? And then on these energy surcharges you had mentioned, just wondering to what extent have you implemented dose across which products really is the question. And then on that, topic. Is there a mechanism of how you're going to unwind those when the energy costs come down eventually? How does that work?

It was across the board that we implemented those. And it was -- clearly, it was unprecedented. But energy prices costs have remained high. So we continue to have that surcharge. And it's not mechanically tied to a specific metric, if that's what you're asking. So we have to monitor the situation and determine how long it's appropriate for. It's across the board. We've been able to be successful. In terms of the other costs, pulp has been high for some time. And as we've talked about in the presentation, the delivery and shipping costs are high and chemical costs. Overall, as a group, we are looking at probably a 10% quarter-on-quarter rise in variable costs, but we are able to offset. Sorry, just one other thing I wanted to point out just -- and I know you talked about it in your report today. But the 53rd week, we did point out at the end of the last quarter, we did say it was coming. And the impact of the Somerset shut perfectly offset the 53rd week. So it's a real number that you're seeing in our EBITDA.

[Operator Instructions]

Operator, if there's no more questions. I like to take this opportunity to thank everybody for joining us today, and we look forward to discussing good results at the end of the next quarter. Thank you.

Thank you very much, sir. Yes, there are no further questions. Ladies and gentlemen, that does conclude today's conference. Thank you for joining us. You may now disconnect your lines.