Sappi Limited (SAP) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen, and welcome to Sappi Limited's Fourth Quarter of 2022 Results Conference Call. [Operator Instructions] Please note that this event is being recorded. I would now like to hand the conference over to the CEO, Mr. Steve Binnie. Please go ahead.

Thank you, operator. Good day, everybody. Thanks for joining us. As always, I'll go through the investor presentation, and I'll call out the page numbers as I move through. And I'm going to start on Page 3, which is some of the highlights for the year. And I'm very proud to report that it was a record year for Sappi. We generated $1.339 billion of EBITDA, by far, the best year that we've ever had. And on top of that, each of our regions all delivered record profitability. And I think that's a reflection of the strong performance across the group and great work done by our people. And we're very proud to be reporting these numbers. The -- just some of the highlights. The strong global paper markets and dissolving pulp enabled us to increase our selling prices, which offset sharply rising costs. In the product segments, graphic paper generated EBITDA of $650 million. That's obviously a record in that product segment. Obviously, a strong bounce back from the lows of COVID, and we were able to take advantage of the tight markets. A lot of supply had come out there to generate this EBITDA. Packaging and specialities, as you know, we've been making a series of investments over the last few years, and this is a business we want to continue to grow, up once again by 68% to a new record. We successfully completed the commissioning of the Saiccor expansion project in the year, and that's now ramping up nicely. The net debt -- sorry, the net debt reduced by $780 million, from about just over $1.9 billion to just over $1.1 billion. And as you know, that's been an important strategic priority for us. And very happy to be announcing the resumption of dividends, first time for -- since 2018 at USD 0.15 per share. So all in all, a great year for the group. Turning to Page 4. The quarter also record quarter. All regions delivering excellent results. We had record profitability from Sappi North America, record profitability from our South African business. Europe, it was the second highest ever, just a little bit off the highs of the previous quarter, only because of the fact that costs continue to rise, but still a very good quarter. So all around a great achievement. Healthy graphic paper margins at 17.9%. A little bit lower than the prior quarter, but that's because of the ongoing higher costs that are referred to, but still very, very good. And packaging and specialties continued to grow 37% up year-on-year. A little bit off the prior quarter, similar to graphics, once again, because of higher cost and constrained inventories because the earlier part of the year was just so good. And then pulp, the pulp segment bounced back very strongly and delivered EBITDA of 61% year-on-year. And I'll talk about that a little bit more. Obviously, cost inflation continues to be a challenge for us, particularly energy and particularly in our European business because that's most exposed to that. Slide 5 has our EBITDA progression, and we're very proud of this. It's our ninth consecutive quarterly growth, shows the great turnaround of the business. And reflects all the great work done across the group. Slide 6 has the EBITDA bridge. We have the -- and that's from Q4 '21 to Q4 '22. And the big story, as you know, we had higher costs -- sorry, I'm just going to pause a second, there's getting a lot of noise on the line. Okay. I'll carry on. The high costs were across the board. We see energy, chemicals, pulp, across the board. But we were able to offset the impact of that from the -- by putting through higher selling prices. And you can see that there was margin improvement there. We also had additional sales volumes in the quarter. Just reflecting our cost growth in a different way on Slide 7, which has the -- it was indexed off Q1 of 2020, and you can see across the board. Energy costs more than doubled and overall payable cost per ton up some 40%, so significant pressures, which we've been able to mitigate. Slide 8 just shows the relative split of the variable costs. The big themes are energy has increased substantially, now just under 20%. Delivery costs rising. Pulp relatively lower against 2019. But bear in mind, it was already at elevated levels. Slide 9 has the product contribution split between 2017 and 2020. Tells a big story. Obviously, in the current year, graphic papers EBITDA was elevated because of the tight market situation. We wouldn't expect that to continue, particularly in light of the molds that we're selling and the conversions that we're going to be doing. In time, that will come down further. Sales volumes, a significant progress. In terms of graphic paper, you see, was 68%, now 53%. After we sell the 3 mills, that drops to, I think it's 45%. And obviously, as we convert capacity, that will come down further. And you all know that's one of our stated strategy is to reduce exposure there and optimize our graphic paper business. Slide 10 has our net debt progression. Obviously, coming off the highs of the COVID period down to just over $1.1 billion. Thrilled with that progress. It's the lowest debt number of Sappi in more than 20 years, and it fundamentally repositions the business for the future, creates opportunities for us, and it puts us in a more flexible place to offset the impact of any potential economic downturns out there. We committed in the results announcement to targeting net debt at approximately $1 billion. We can be below that in this financial year. Slide 11 has our net -- sorry, our debt maturity profile. And the only real maturity is our securitization structure in Europe, which matures in 2024. We will refinance that in the current year. We don't anticipate any problems. On the left-hand side, you can see we're sitting with significant cash balances. Just post the year-end, we did buy back some of our European debt to the value of approximately $206 billion. We made a -- we obviously made a gain on that and we continue to have significant cash balances. Slide 12 has the cash flow, strong cash generation from operations, free cash flow, post CapEx, big number and overall net cash generated of $500 million. CapEx this year is $430 million. You can see in the footnote that there's a breakdown there, approximately $70 million for our investment in the Somerset PM2 conversion. Sustainability projects amount to $60 million, and that's something that we've talked about for a number of calls now. And we have about $20 million of CapEx that was a spillover from '22 into 2023. Turning to some of the macro challenges that we face. It's a slide we've showed you recently in recent quarters, on global ocean freight. What we are seeing is that the challenges are easing somewhat. We've seen slightly better reliability from the shipping lines and spot prices have begun or have been coming down over the last few months. So that pressure point is easing somewhat. Slide 14 shows the elevated pulp prices. You can see they're still very high, come off a little bit in certain categories, but broadly still high. And obviously, that's an input cost, mainly for our European business. And then Slide 15, the energy situation. This is the graph on natural gas. Again, one we've shared with you in recent quarters, still very volatile. It's come back in recent weeks. That's obviously going to relieve some of the pressure, but it's still very volatile and still remains at elevated levels relative to historical norms. Obviously, we have had a hedging strategy in place, which has mitigated some of that impact, and it's reduced those cost impacts for us. Turning to the segments, and I'll run through these fairly quickly. But Page 17 has the pulp, and a nice bounce back in the current quarter. Obviously, higher selling prices. We've seen improved logistics, and that's easing -- helping to ease the backlog somewhat. And we see normalized production as well coming through. Just to point out that there is weaker sentiment in the textile value chain. I think we've got a slide on Page 52, which I'm not going to talk to, but it does show you the high retail inventories that are out there. That's going to put a little bit of pressure on demand for -- ultimately for dissolving pulp and viscose and alternative fibers. And we've seen that happening over the last few weeks. And that's one of the reasons that pulp prices have dropped -- dissolving pulp prices have dropped. Slide 18 has the packaging and specialties, continues to be a growth business for us. We were a victim of our own success, to be honest. We had low inventory levels going into the quarter in North America and South Africa because we were fully sold out. We also had an extended shut in Ngodwana We were upgrading the -- we're doing a quality upgrade on the machine there. That's also impacted in the quarter itself in Europe. We had escalating quarters -- sorry, escalating costs which eroded the margins a little bit. And then on Slide 19, the graphics. Obviously, tight market conditions able to -- enable us to offset cost inflation and deliver the kind of record margins that you see reflected on the slide. And then regional businesses, Page 20. Europe, firstly, excellent quarter, EBITDA of $130 million. We did continue to see higher costs. Remember, energy prices were rising throughout the quarter, but it wasn't only energy. It was across the board. We continue to outperform the market, taking market share. Volumes were good. But as I said earlier, margins impacted because of the fact that costs actually rose at a faster pace than selling prices in the quarter. Slide 21 has the North American business, another record quarter, success across the board. We still see relatively tight markets in the U.S. and graphic paper markets have -- those have supported higher selling prices in graphic paper markets and customer demand for paperboard remains very strong, exceeding our capacity. And that is one of the driving -- and is the main driving force for why we announced the investment that we're making, which I'll talk a little bit more about. In the pulp segment, obviously boosted by higher selling prices. And then in South Africa, strong quarter, big recovery, improved performance from the pulp business. We've seen supply chain easing somewhat, although obviously, we all know that in recent weeks. There was a strike at Transnet, which occurred after the quarter, at the year-end, which did put a renewed pressure in the current quarter. In terms of the -- across the business, selling prices were achieved -- selling price increases were achieved to offset cost inflation. And interestingly, all the favorable -- all the paper businesses in domestic South Africa had favorable conditions. Turning to Slide 23. It's a slide that we -- I've shared with you previously, but we obviously continue to update. And it just highlights the 4 pillars of our Thrive25 strategy. I don't intend going through every bullet here, just to call out a few key factors. Firstly, in terms of driving operational excellence, it's focused on maximizing production and you saw the success of that during the course of the year, getting cost advantages. We're very proud of our safety performance this year. It was another record for Sappi, actually. We had 0 fatalities and our lowest-ever injury -- injuries in the business. So we're particularly proud about that. Enhancing trust during the year, we announced our science-based targets. Those were validated. And based on that, we estimate approximately $70 million a year of CapEx spend over the next few years. And then a focus on growing our business. We had a few smaller projects, which we talked about previously. We've been increasing labeling at Gratkorn. We did a little bit of an investment there and we would expect that to ramp up further over the course of the next couple of years. We had debottlenecking at Somerset PM1, give us a few more volumes. And then obviously, we announced the sale of the 3 mills because we want to reduce our exposure to graphic paper. And in terms of sustaining our financial health, I've talked about this, but we've set ourselves a debt target of approximately $1 billion, and we are confident of achieving that. Slide 24 is an addition, and it's a very important slide, which we thought we would share with you. It's something that we use internally. It's our capital allocation priorities. And once again, I'm not going to run through everything, but just briefly highlight some of the major factors. I think firstly, obviously, we have regulatory environment that we operate in. We have to comply with those regulations, legislation. We've committed to science-based targets in the '23 year, it's $60 million. I know I said $70 million on the prior slide, but that's an average. $60 million in the '23 year. We have to maintain our machines and our equipment to ensure they're world class. That approximately cost us $250 million, so that has to come first. We have set ourselves that debt target of $1 billion, and we want to keep it at those levels or below. And thereafter, we look for profit improvement opportunities. We're selling the mills and I'll talk about it on a different slide. We've had various projects in recent years and that lower our cost base and enable us to optimize our assets. Those approximately add up to $50 million. Thereafter, we believe that it was the appropriate time to return money to our shareholders, and that's why we've committed to a dividend of $0.15, and we are committing to an ongoing dividend program. And that's why we've resumed dividends because we're confident that we can do that. Thereafter, then we can look at expansion opportunities. And in the current year, we've got $70 million linked to the Somerset expansion conversion project. And then ultimately, we continue to look for other avenues and other products that can deliver growth for us in the future. Turning to Slide 25. It's just one slide on the sale of the 3 mills just to remind you, it's about 1.2 million tons of capacity. It's in grids that were noncore to our business. We're getting out of uncoated. We're getting out of mechanical paper, at our Maastricht Mill, certain grades that we made there were getting out of as well. And so we -- strategically, we -- this is very core to our Thrive25 strategy to reduce our dependency on lower-margin graphic categories. The deal overall $270 million, we expect it to be completed early sometime in Q2. The cash flows will flow. Part of the deal was receivables. Those will be progressively collected and that will go into 2023. The graphs at the bottom, I think I've referred to already, but you can see it does lower our graphics to 45%. And obviously, with the conversion of -- and I may refer to it here, but with the conversion of Somerset, that's going to lower further and get closer to 30% in the next few years. Very excited -- Page 26, we're very excited about this project. It's on the back of the strong demand for packaging and boxboard that we have in our North American business. We have -- we've been limited by our current capacity, and we've had our customers pushing us for more volumes. This makes a lot of sense because it will move us away into a growing segment that will continue to grow with a strong push because of the replacement of plastics with paper for packaging solutions, it will give us additional volumes. It will give us a great return. The -- and quite frankly, we are very confident we could fill this machine tomorrow. The CapEx is $418 million spent over 3 years, $70 million in the current year. The balance spread over equally across '24 and '25. And very importantly, it will be funded from free cash flow. We've taken this into account as we look at our cash flow generation in the next 3 years, and this is an important priority and why we were confident about targeting the $1 billion day. Sustainability remains a core of our business. Slide 28 just incorporates our targets. And as I said earlier, safety has been great. We're very proud of our achievements on broad-based black economic empowerment. We are a Level 1 contributor, that's the highest level. Great work done there. We're doing -- making great progress on gender diversity. And obviously, the return on capital employed with the great results was very strong. On Page 29, we missed a couple of the targets on water and energy efficiency, but that's linked to the floods that we had in KwaZulu-Natal, and that caused some disruption in our South African operations. But we're confident now that, that's normalizing and we can get back to being on target. Slide 30. As you know, during the year, we announced our science-based targets that's been validated. We commit to reducing our carbon emissions by 41.5% by 2030. That's been scientifically determined. And the numbers that I quoted to you earlier are all aligned to achieving these targets that we set out here. Slide 32 turns to the outlook. And there's no doubt that there are a number of macroeconomic challenges on the horizon. We know that interest rates are rising, inflation is going to have a big impact on the postings of consumers. And we have seen a downstream demand for graphic paper, particularly in Europe and globally dissolving pulp weakening. And so that is a risk factor. Packaging, more resilient. It is a more resilient business and should withstand those economic downturns. Rising costs remains a risk for us in the year ahead. Some raw materials, however, have started to come off in recent weeks. Natural gas has come down in Europe quite significantly, but it still remains at the elevated levels. And we started to see paper pulp prices come off. And then in South Africa, specifically, lots of you will know this, but obviously, we've been negatively impacted by a big municipal electrical substation outage in KwaZulu-Natal. It hit the whole urban area and it brought down our 3 mills, unfortunately, for a few days. And then we had the Transnet strike. That won't -- that shouldn't affect overall year volumes, but it poses a risk as we look at volumes in Q1, and it might cause some spillover into Q2 as the port normalizes post the strike. Somerset shut is in the current quarter, same as last year. So if you're looking at volumes quarter-on-quarter, in other words, Q4 versus Q1, just -- this is just something to bear in mind. But it was there in the prior year. The CapEx for the year is $430 million, as I said, which obviously incorporates a portion of the Somerset conversion project. So overall, notwithstanding those inflationary cost pressures and the weakening demand in those segments that are referred to, we do anticipate that EBITDA for the first quarter of 2023 will be above that of the equivalent quarter of 2022. Okay. Operator, that's me gone through the deck. I'll take it back to -- I'll hand it back to you for questions.

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

At great numbers. Just a question on -- you've announced PM2 now that's a pretty call. Just -- if I can just ask you a little bit about what comes next. So you've obviously got a chalkboard of possible projects out there. We don't have the visibility into what's possible. But what conversion projects do you have available in the U.S. and Europe after this PM2 conversion is done?

Yes. Thanks, Brian. Two projects we're excited about at the moment. Firstly, on the Gratkorn labels, it's on the smaller machine at Gratkorn. And in the current year, we made about approximately 50,000 tons on that machine on labels. Our goal over the next 2 or 3 years is to get that up to 200,000 tons. So that will take another 150,000 tons out of graphics approximately, obviously, and will move us further into a growth segment, which will give us higher margins. So that's one that's very relevant to us. And in the U.S., obviously, our big project is Somerset. But even at Cloquet, we have opportunities to ramp up further on certain packaging and specialty grades. And as we look at the volumes there, there's at least 50,000 tons that we can redirect away from package -- graphics into specialties. And again, that's with relatively limited CapEx. So those are the 2 big ones. In South Africa, longer term, we remain very excited about the packaging opportunities. You know this, we all know this, there's a shortage of packaging in South Africa to support the food industry, and that's something in time that we remain very excited and committed to hopefully boosting one day. It's not on the immediate horizon, but certainly a very exciting project. The other thing I would say as a group and particularly in Europe, we're more exposed to energy volatility and pulp volatility. And pulp integration remains an important priority for us. So we continue to look for smaller opportunity integration.

That's awesome. And then if I may just ask another question. The 3 mills that you sold, congrats on getting them across the line. But how much did they make in the way of EBITDA in the last -- or in FY '22?

It's a tricky question, Brian, because there's a lot of fixed costs that get allocated to the mills, and they will be moving across with the operations. The best way to think about it is in terms of the overall EBITDA for the region, we're selling about 1/3 of the volumes. And this is a lower margin than the rest of the mill. On a normalized basis, these mills deliver about $50 million EBITDA. They obviously made more in the current year. But with the anticipated lower EBITDA in the year ahead, it wouldn't be at those elevated levels. And that's why we point you towards the $50 million. So take $50 million off a normalized level of EBITDA from Europe.

The next question comes from James Twyman of Prescient.

Yes. My first question is just in terms of the U.S. conversion, PM2. What sort of IRR are you anticipating there? And the reason I'm asking particularly is because obviously, you've done PM1, so you've got an idea about what the IRR from that was, which should give you, I suppose, a fairly good idea about what could be achievable from this one. And then secondly, relating to that, $480 million, it's a lot of money for a conversion. How would that compare with the cost of a brand-new plant? Those are my first questions today.

Yes. Look, on the first question, you're right. We've got a lot of visibility. And just to remind you that the PM1 conversion, the IRR returns were in the high teens. So it was a very successful project for us. The Somerset project is a great project for us, and in fact, it's going to deliver us returns above 20%. And the reason that is, and relative to PM1 is it's not just a conversion. This is an expansion project. It's going to give us 235,000 additional tons of packaging. And that's a very exciting opportunity for us. And that basically answers your second question. It's -- you can't compare it with -- as you recall, PM1 cost us -- I think it was $220 million at the time. So this is an expansion. And if you look at -- James, if you look at some of the peer announcements that are out there, and I'm not going to name names, this is very competitive, if you take into account the conversion and the additional 235,000 tons. So this is a very, very good project and we're very excited about the returns. And as I said earlier, the demand is already there today.

Okay. And then the second question I had was in terms of this $1 billion debt level, is this a sort of planned ceiling for debt? Or is it a general area you want to be around? In other words, could debt go significantly above that if you do a deal, for example?

Look, we're focused on that number. Obviously, we've announced the dividend. We've announced the investment in Somerset. We wouldn't give you that number if we weren't confident that we could achieve it. And in the '23 financial year, if you do the numbers, you'll see that we're going to come in under those levels. Clearly, it's size of our current asset base, and we don't anticipate that changing in the short term. So we think it's a very appropriate level and it's something that we're confident of achieving. Operator? Operator, are you still there? We dropped.

I can ask another question while we're waiting, if you want?

James, so you can still hear us. The operator is obviously gone. Okay. All right. Go ahead, James. You've got the floor, right?

Yes. Okay. Good. So in terms of PM1 in the U.S. ...

One of the -- James, sorry. One of my colleagues in the room is going to try and contact the operator because I don't know where she is.

I'm back, sir. Apologies for that.

Okay. Carry on, James. You've got another question.

Yes. Okay. Well, in that case, I'll go to -- in Europe, obviously, very strong profitability in the quarter, but you did call out speciality not being strong or maybe being weak. Could you just talk about the margins there in specialty? I mean, are they -- even though it was weaker, are they still high? Are they average or below in terms of are there more price increases so to come there to offset some of the cost increases?

All right. I'll give you an initial answer and I'm going to allow Marco some time just to talk about the general state of the market. But what I would say to you is, just to remind you, that this business is -- a lot of it's contractual based. And as you know, we've been going through a period over the last year or so of playing catch up. And we kind of caught up in the last quarter. But then unfortunately, guess and other prices continue to rise. So a lot of our contracts mature in the middle of the year. So once again, we've kind of fallen behind. It's -- and it's something that we need to focus on. Underlying demand for most of our categories continues to be good. It's purely a margin squeeze because remember, during the quarter, natural gas just shot up and pulp prices were still very high. But I'll let Marco talk about the general state of the market.

Thank you, Steve. I think you summarized it well. The market is more resilient probably than the rapid market. Although certain segments, you see have a bit of softening, particularly dye sublimation and containerboards, which are first indicators of where the macroeconomic trend is going. But all the other segments, be it label, flexible packaging, functional paper, the more food packaging related segments, are still doing very well. Steve was alluding to the fact that the costs have played an important role last quarter as well. Just remember that our specialty mills are not fully integrated. So pulp is playing an important role. And obviously, the gas volatility has played its part as well. But overall, these markets are still very, very attractive.

Thanks, Marco, and thanks, James. I'll go back to the operator and get somebody else to ask questions.

The next question comes from Sean Ungerer of Chronux Research.

I've got a couple of questions. I think I'll start off with DP, if you don't mind. Just in terms of the realized DP price in a quarter versus the [indiscernible], I don't know if my own numbers are incorrect, but I was sitting at about a 15% discount. I don't know if you could comment on that, please?

Yes, it's a good point. But what are related to, Sean, is that we still had a significant amount of lag. And remember, it still runs one quarter -- well, in this case, it would have been 2 quarters in arrears. So I think it was over 100,000 tons -- 186,000 tons, which was still priced 2 quarters in arrears. And then -- so if you do the math on that -- and obviously, as you know, the price -- the discount rate does get higher as you get up to 1,100. So it's certainly not a 15% discount to spot prices. The difference relates to The difference relates to the to the delay in those shipments.

Okay. Got you. And as you move into Q1, I guess, what sort of discount [indiscernible]?

Look, it should normalize. And also, obviously, you're going to benefit from the same thing that I think there was a spillover of approximately 90,000 tons at the end of the quarter. So -- but there's probably benefit from it. So you're going to see a lower discount in this quarter. Yes.

Okay. Got you. And then just in terms of the impact from the Transnet issues and electricity or power issues, how do we sort of think about that versus, I guess, the backlog of volumes in previous quarters? Is there sufficient inventory to sort of cover that? Or I don't know if you gave any potential numbers around that.

Yes. I'll let Alex talk in more detail, but just a couple of highlights. In terms of the outage, the Eskom outage -- not Eskom, the municipal outage, it was about 10,000 tons across the [indiscernible], mainly dissolving pulp. So that puts it in perspective. In terms of the Transnet strike, well, firstly, we're hoping to catch up a lot of that backlog that I referred to the [ 90,000 ]. Most of it, we are hopeful that we will catch up. However, it does look like about 20,000 tons would have been impacted by delays because of the Transnet strike. But I'll let Alex talk in a little bit more detail.

Yes. Thanks, Steve. And -- yes, it is roughly 20,000 tons, and it's effectively just a delay. Obviously, for every day that you have the strike, it costs you about 10 days to work down that delay. And then it has a little bit of a cost impact because you've got rehandling and store region there. And maybe just on that note, the Transnet -- the early bridges that are still washed away on the South Coast is putting more trucks on the road, and that obviously has a bit of a cost impact as well. But that hopefully is resolved by April.

And then -- I don't know, I just got a few more questions on DP, if you don't mind. Just in terms of how we should think basically about the shut this quarter or the quarters coming up? That would be useful. And then linked to the cycle expansion, is there any sort of cash cost saving guidance that we should be aware of? Or -- is there any?

On the second one, first, the -- look, obviously, there's a lot of moving parts, Sean. Chemical prices have been rising fast. Caustic, which obviously is an important raw material for us in the cooking process, that started coming down, but it's not shot up once again. So that's going to put further pressure on cost. In terms of the DP business, specifically, in terms of shut, no major shuts in this quarter. And the only big one is in Somerset. Some smaller ones later in the year, Alex, but nothing major there, right?

Nothing. No.

No. There you go. [indiscernible] is not this year. Yes.

That's right.

So that's the only one, Sean.

Okay. Excellent. And just to conclude on the DP, I guess, sort of heading into 2023, I think there's a consensus, too, is that demand should be weaker. So I'm just trying to tie that into how you sort of see that in the demand for your DP given that's been pretty high in 2022?

Yes. Look, you know that there's global pressures here. It's not unique to the viscose fiber. It's across all the fibers. And really, the retailers have allowed their inventories to build up quite significantly. And that's had a knock-on effect across -- right across the value chain. So there's a strong destocking now underway to reverse that trend. And I guess that gives me some confidence that in time, it will reverse itself. But for the next few months, we are going to have the headwind of a destocking. What it means for Sappi, obviously, a high proportion of our volumes is contracted. But we are seeing across all viscose producers and I'm sure you've seen some of the results across all viscose producers, they are operating at lower operating rates and it has reduced global demand for dissolving pulp. But I'm hopeful and optimistic that it's short-lived. Mohamed, is there anything more you want to add on just generally on the market?

Yes, Steve, I think you've covered it, all the stuff, pretty well. The only thing I would add is that we have seen through October, an improvement in the China VSF operating rates. It had dipped to about 52% in September. And as of early this morning, it's now sitting at around 68%. So we've seen some improvement come through in October.

Okay. Great. And then just on paper front, sorry, did you guide on the EBITDA impact from the Somerset [ target ]? I think it was maybe like $20 million in Q1 '21. Is this going to be a similar amount?

Yes. Yes, the reason -- because I know some people compare it quarter-on-quarter. If you are doing that for the North American business, you've just got to take that -- I think it was $18 million. You just got to take that into account. $20 million. Yes.

Okay. And then just your comments around the sort of pressure in the [indiscernible] markets both in North America and Europe. I mean, could you maybe just sort of run us through your sort of thinking and assumptions how do you think the year is going to last, obviously, excluding the impact of the European zone, because I mean that will rack volumes in your product, 20%. But outside of that, how should we sort of be thinking about the structural decline again? Or what have you handled then?

Yes. Well, firstly, on North America, let's address that because it's easier. Markets still remain tight. They may not be as strong as they were 6 months ago or 3 months ago. But remember, that was from a very, very high point. Operating rates are still very high in the industry, and we're still pretty confident in North America. Europe, yes, there has been a softening. It's probably not unlike what's happening in the dissolving pulp market. And we are seeing high levels of inventory across the value chain. And we've seen lower order activity in recent weeks. And broadly, maybe let me talk longer term and then specifically to '23. I mean, broadly, we continue to believe that demand will decline 5% or 6% per annum. At the moment, as we stand, order activity is lower than those levels. However, we are pretty confident that it relates to an inventory adjustment. And -- it may have an impact in Q2. But ultimately, for the year as a whole, it's likely to be better than what we're experiencing at the moment. But at the moment, yes, order activity is low. And maybe I'll allow Marco to go into more detail there.

Yes. The situation we're currently in graphics was partly to be expected. It's a destocking situation that is not abnormal what was exceptional and unprecedented was the demand that we saw in the last 12 months, basically a result of capacity being taken out, and post-COVID, additional activity. That has resulted in over ordering and overstocking, and that is what we see happening right now on the graphic side. Is it something to get overly worried about? No. But it has an effect on the current order intake and therefore, on the seemingly softening of the market. It is twofold destocking and a slightly softer market than 12 months ago.

Excellent. And then just one more for Glen, if you don't mind. Glen, just in terms of the effective tax rate versus cash taxes paid, it was obviously quite low in 2022. Maybe you could probably give a little bit of color around that and sort of linked to cash flows on net working capital, there's a quite a large outflow in 2022 to [ $2 million to $3 million ]. How should we sort of be thinking about that in '23? I'm assuming there'll be a fairly sizable return of cash flow from that.

Yes. So -- yes, first of all, as far as the tax is concerned, there was an outflow of just over $20 million. We anticipate that that's going to double going into 2023 and that's obviously a function of the increased profitability. And then in terms of the working capital outflows, we manage our working capital as a percentage of sales because you would note, it's a function of the operations. And for the year, we came in at just over 9%. We did not anticipate we're going to manage it between 9% and 9.5% going forward. So at this point in time, that's why I can give you, but we don't see a further large outflow.

Yes, that's not going to be repeated. And obviously, and we've referred earlier to potentially lower volumes in Europe. Obviously, if that were to happen, then you would have a reversal of working capital.

[Operator Instructions] Can we go back to Sean for further questions?

Okay. Your call, operator. If there's no one else asking questions, yes.

Sean, your line is open.

Awesome. And then just going back to energy costs in Europe, are you prepared to give us a sort of headwind that you guys saw in Q4 versus the tone we're going to see in Q1 now?

Look, broadly, what I would say is that our energy costs in Europe for the current -- for 2023 are hedged. In other words fixed price, at about 63% at obviously substantially lower levels than the current spot prices. Just to recap on what happened last year. We saw Q1 and Q2, obviously, prices rising. And then in the latter part of the year, Q3 and Q4, at significantly high levels. So at current spot prices, you're seeing a situation where Q1 and Q2 was less but Q3 and Q4 were more. Broadly, the way we are thinking about it is that based on our estimates and where current spot prices would be that if you take the year as a whole, we're looking at about 20% to 25% higher than the prior year for Europe's energy costs. And that takes into account our 68% hedging. Clearly, if energy prices come off, then that would change.

Excellent, Steve. And then just going to CapEx, just one based on that [indiscernible], so you're looking at sort of to extend business and the sustainability CapEx. And then if you do sort of equally rated load up on the Somerset expansion, you are starting to looking around 500, 520 for FY '24 and '25. Is that correct?

Yes, that's right. Clearly, we haven't finalized the math and finalized all our budgets for those years. But broadly speaking, if you look at the CapEx, let us talk something, $70 million roughly in the current year and then roughly $175 million over the 2 remaining years. So that would be an additional $100 million CapEx in each of those years.

Awesome. And then just last one from my side. If you sort of look at the capacity of the per grade over the next sort of 3 to 4 years, it's not long until I think packaging and specialties will easily or materially surpass DP. Is there any sort of reading into that in terms of how we should think about growth, I think beyond that? I mean, is there any [ pathway to that ] or that just is what it is?

Specifically in dissolving pulp, you mean?

What I'm just saying like if you look at the [indiscernible] the packaging specialties with the announced conversion plus the [ hiccups ] in Europe is going to be well ahead of DP capacity.

Yes. Look, if I look at '27 based on our plans, we are -- we're talking approximate numbers. We're talking approximately 30% volumes in graphics, 25% in pulp and over 40% in the packaging and speciality grades. Those are the kind of numbers we're targeting.

Okay. But I'm just saying in terms of capital allocation for this, is there a stronger preference for...

Our biggest area and our #1 priority is in the packaging and specialities segment. That's why we've committed to the projects that we have, the Somerset, the Gratkorn, what we're doing at Cloquet, stuff we're doing in South Africa, that is our #1 priority. Dissolving pulp, obviously, there can be smaller debottlenecking type opportunities. But at this stage we don't anticipate -- at this stage any additional dissolving pulp -- any big dissolving pulp capacity.

The next question comes from Tim Clark of SBG Securities.

Firstly, congrats on the results. It was a really strong result. So well done. Just a couple of sort of quite sort of administrative questions for me. The first one is just on your disclosures of discontinued operations. I wondered why you didn't strip out the European graphics sale, just to give us a better idea of what the sort of historic kind of profitability looks like excluding those operations. [ Mandy ] with selling Russia gave us that sort of disclosure. And then the second question is, in the release, it didn't look like you were committing to a specific dividend payment level. But then on that slide that you spoke about using internally, it sort of spoke of 3x cover. Should we be thinking of sort of a 3x cover scenario as most likely going forward, given the sort of the trajectory of commitment that you made with growth right at the bottom, shareholder returns above that? And then just my last question is just on graphics paper. Like, there's a sort of conversion process going on and closure prices as demand declines. I wonder if there's a point at which you think that we reach that uncertain of the machines and certain of the operations, there's just not going to be any need to ever remove those because there'll always be some underlying demand. And I wonder if you could give us a sense of how much of total sales volume you think that is. You've gone down sort of to the [ 45 million ] post the sale, and that continues down with the conversions.

Yes. Okay. The first question, I'll let Glen explain why we didn't treat it as a discontinued operation.

All right. So as you rightly pointed out, we've identified it as assets held for sale. It's not a discontinued operation because it doesn't take up a large section of what we consider to be our segmental reporting. So there was no requirement for us to separately identify the operations on the income statement, but just to identify the assets held for sale. We did in our notice on the divestment, give you an indication of what the average earnings is, which Steve has already spoken to about. And we're looking at about the EUR 50 million mark. So that should give you an indication of what the profitability is.

Yes. Basically, it's relative to materiality times. I know you referred to [ Mandy ] and their Russian operation. For us, this is not that material, and that's why the accounting treatment, the technical treatment is the way that we've reflected it. In terms of the dividend cover, yes, that's a long-term target to get to 3x. It's not something that we would be striving to do immediately. The fact that we've committed to this $0.15 in the current year is clearly a starting point. And in time, we want to ramp that up. In terms of the graphic conversion, look, this is -- it's an ongoing process. The assets that we have left in our graphics business, we believe are world-class assets. They are competitive and they -- has been reflected in the last year, and I guess that's what you're alluding to. In terms of tight market balance, they can generate significant cash flows and make very good margins for us. So we just have to be proactive. We have to assess the situation. And that's what -- really what we've done with the Somerset conversion. We -- once again, we expect demand to decline over the next 2 or 3 years at 5%, 6% -- 5% per annum. And based on our numbers and the sizable opportunity to grow our packaging business, it made a lot of sense to do that. It's difficult to say what is the end point because we'll have to assess markets as we go forward. But -- the numbers that I shared earlier on the call about the split of our volumes, that is -- that's our best estimate of where we think the business will be come 2027. But if you look at the remaining assets that are in graphics, in North America, we've got a great machine at Somerset, PM3. We've got great machines at Cloquet. In Europe, we've got Grakon, a very big machine, the best machine in Europe. We've got machines that are Ehingen operations, Lanaken, all of those are world-class assets. And -- in that time frame, we think can deliver good returns. And that's why we focus on optimizing graphic paper.

The next question is a follow-up from James Twyman of Prescient.

Yes. Just a few quick ones. But firstly, on the European business, since the last quarter, we've seen the gas price fall sharply and specialty prices potentially moving up. So if we're not going to see profits rise quite substantially, we've got to see, I would guess, prices coming off in the next few months. But I'm not seeing that at the moment. What are you seeing in terms of prices? Are they remaining at these current levels?

James, it's a good question. And our focus at the moment is because we know that the costs are at elevated levels. So based on that, we are striving to hold our selling prices as much as possible. And that is the focus of attention. The margins, we're trying to protect the margins from what we described earlier, you can hear that there's some volume concerns related to the weaker demand, but we will strive to maintain our margins as long as we can.

And then you mentioned your debottlenecking PM1. What sort of size is that? And then also -- are you considering giving authorization for a share buyback at your AGM?

On the first one, it was an additional 30,000, but Mike, that was in the numbers already or it will be in the numbers this year. Yes. James, it will be in the numbers this year. On 2, in our annual report, we are going to put a resolution to have a general buyback of 10% of the authorization. Operator, we're going to have to end the call there because I've got some journalist calls now. So if we can close it off there, okay?

That does conclude the question-and-answer session.

Okay. Thank you very much to everybody for joining us, and we look forward to discussing the results at the end of Q1. Thank you very much.

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