Sappi Limited (SAP) Earnings Call Transcript & Summary

Hello, and welcome to the Sappi Q2 2024 Results Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand you over to Steve Binnie, CEO. Please go ahead.

Thank you, and good day to everyone. Thanks for joining us on the call. As always, I'll move through the investor presentation deck, calling out the page numbers as I move along. I'm going to start on Page 3, which is some of the key highlights for the quarter. We generated EBITDA of $183 million, which included a small fair value adjustment of $3 million. I'm pleased to say, obviously, that these earnings were 10% up on the prior year and also a progressive improvement on the last quarter and ahead of expectations that we had given 3 months ago. So pleased with that result. Contributors to the success, firstly on the Pulp segment, improved profitability there, and I'll talk a little bit more about that. We saw modest recovery in global paper markets, obviously, still a little bit slow, and we did take some curtailment, but it is progressively improving, and once again, we do have slides on that. The other contributor to profitability improvement was a substantial reduction in costs, mainly fixed cost, 9% year-on-year. And clearly, a big chunk of that related to the closure of the 2 mills in Europe. And I'm pleased to say that those closures were completed in the quarter. Moving to Slide 4, the product contribution split. On the left is earnings, and it has been pretty volatile in the last couple of years with COVID and the recovery and then the macroeconomic situation. So a little bit up and down. But broadly, the story remains and you see that on the right in terms of sales volumes that we progressively reduce our contribution from graphic papers and increase, obviously, in the packaging side. The big project that we have underway at the moment to add capacity and convert Somerset in the U.S., that's going to extend it even further. And obviously, we set ourselves a goal of getting the contribution from -- revenue contribution from graphics to below 30% by 2027. So we're on that journey. Then turning to Slide 5, the EBITDA bridge. We've done it quarter-on-quarter because we thought that would be more meaningful just to highlight the key variables. And as I said earlier, the 2 big contributors on the positive side are the sales volume increase, and you'll see that across the segments. So progressive improvement and then the substantial savings in fixed costs coming through. The big red bar on the right is the fair value adjustment. And it's quarter-on-quarter. So it was still positive, but obviously lower than the prior quarter. Slide 6 has the cost inflation developments. And what we've seen in the last couple of quarters is a little bit of upward movement in some of the categories, obviously, predominantly wood and pulp. And we would expect that to continue in the next few months and quarters ahead. Albeit in this quarter, we did have some decreases, lower energy prices coming through and chemicals were also negative, but I would expect that to turn upwards as we move to the next quarter. Slide 7 has the net debt evolution. And obviously, we closed the mills in the quarter, so there was the cash outflow related to that, and that's the reason for the jump. When we look forward to the rest of the year, we do expect to be cash positive. Typically always, as you know, the Q4 is our big cash generative quarter, and that's going to be the same this year. So we're obviously at the peak now, so that's good. Slide 8 has the debt maturity profile. And once again, it tells a good story. The only maturity in the next 2 years that's reflected here. You can see that $159 million in the 2024 year, which relates to a South African volume for ZAR 1.5 billion, I'm pleased to say, obviously, that that's being refinanced in April. So that's gone out as well. The '26 Eurobond, as you know, we bought some back a little while ago. So we're only down to EUR 240 million and we continue to monitor that and we'll pick the right time to optimize the refinance there. Moving to Slide 9. Cash flow and CapEx. And on the right -- sorry, on the left, the cash flow, you can see the positive cash from operations and free cash flow. The negative obviously, and this is a year-to-date number. The negative relates to the closure costs for the 2 mills. Obviously, we've got a dividend that came through earlier in the year and then the CapEx for the expansion conversion project mainly at Somerset. At Slide 10, we have the capital allocation. It's a slide you've seen before and just once again, reemphasizes our priorities. And obviously, the immediate and the most necessary capital allocation comes with regulatory and we have some sustainability commitments. We, on profit improvement, continue to look at optimizing our asset portfolio, and that's why we closed the mills. The project at Gratkorn to convert the 1 machine to labels, that's underway. And once again, that will reduce effectively a machine conversion because it comes out of graphics into the labels and will boost profitability. The dividend, we obviously declared one at the end of last year and was paid this year, and we are committed to keeping the dividend [ growing ] and then ultimately, on the gross side, the project that I've referred to earlier. Turning to the segment -- the segments. And firstly, Pulp, which is on 12. To summarize Pulp, pretty good quarter. Demand is good, and interestingly, supply is tight. There's a little bit of capacity that's come out of the marketplace, so that helps. Obviously, downstream fiber prices have been a little bit weak and viscose prices under a bit of pressure. But net-net, it's positive. We also were able to take costs out and that helped with the improved profitability. And you can see DP prices jumped from 880 to 940 today as we talk. Slide 13 has the Packaging and Specialty Papers segment, and a mixed performance. Overall volumes improved, which is obviously encouraging, margins up a little bit. The mixed performance, if we take each of the regions, North America looking good. We've seen strong recovery in demand. Orders are good. The machine capacity is full again. And the outlook is pretty positive. In the middle, you've got the South Africa business, whereby the demand -- the underlying demand is strong. And however, there was some excess inventories downstream, which are working their way through the system. But the outlook is very positive and we're looking good there. Europe, obviously, where more of the challenges lay and is linked to the economic situation in Europe. A little bit of, in 1 or 2 of the categories, some positive signs, but generally, Europe continues to remain challenging. Then on Slide 14 is the graphics. And we see a gradual recovery. Clearly, we don't anticipate it getting back to where it was in 2022 when we made record profits. But it's progressively getting a little bit better. Obviously, with the closure of the 2 mills now, we've shifted that production to our remaining mills, coated woodfree mills, and I'm pleased to say that, that's gone successfully. And we are pretty full now, in fact, we are full at those coated woodfree machines. The year-on-year profitability improvement comes from the better sales volumes and obviously, the cost savings that we implemented, which I talked about earlier. Then on Slide 15, just very briefly on the regions, the overall story improvement generally in sales volumes, selling prices holding up better and pretty stable. You'll obviously -- some of you would have seen we have announced some price increases in certain of the markets and that should help mitigate some of the cost pressures that are beginning to creep in. And all in all, North America and South Africa, good margins. Europe obviously taking a little bit longer to come back. And you see that again on Slide 16, the margin growth -- although Europe was obviously under pressure from a volume because of the good costs, at least margins were up a bit and volumes slightly ahead and expected to continue that trend. And then the North American, higher volumes linked to the improved performance or demand. And on the back of that higher volumes, at least we were able to keep our margins -- EBITDA margins stable. And then in South Africa, margins improving on strong underlying demand. Slide 17, has our Thrive strategy and the 4 pillars. Again, this is not a new slide we do update it, but it just reinforces the focus areas for us across the 4 pillars: operational excellence, which obviously focuses on safety, on costs, on efficiency. And I think the success there is demonstrated by the cost that we've been able to take out of the business. Enhancing trust, we continue to have a strong certification, competitive positioning. We do have some sustainability CapEx commitments, and that's not changed. It's what we've talked about previously. In terms of growing our business, we've obviously got the 2 conversions underway at the moment at Gratkorn and the bigger one at Somerset and those are on track and help with our strategy to continue to transform the business. And then in terms of the financial health, as I said, I mentioned earlier, we do have -- we did have a cash outlay related to the closure. That's not a surprise, the closure of those mills. But we are committed to getting our debt back down to the [ $1 billion ] and below. Obviously, we've got to finish the project at Somerset, which will be complete next year. We haven't committed to any other big CapEx at this stage. And on the next page, you do see the couple of pictures on the Somerset conversion and expansion. Pleased to say, it's going well. It's on track, in budget, and we're very excited by that and we will obviously start up in the second half of next year, in April next year, next financial year. Slide 19, number of awards and certificates and the likes. And we're obviously proud of this and we remain committed to our environmental and sustainability commitments. And I think we do a great job there. Turning to the outlook, and I'll move to Page 21. Firstly, on the demand side, generally, it continues to improve. DP is healthy. It's -- as I said at the beginning of the call, there are certain negative factors, but they are far outweighed by the positives and the market is tight and we're feeling good there. The graphics will continue to slowly recover, but not getting back to 2022 levels. Obviously, in Europe now, we've filled our machines for coated woodfree, in the U.S., we're converting the machine, so that will help. And then in the Packaging segment, I talked a little bit in detail earlier. U.S. and South Africa looking good and Europe, we expect further improvement as we move forward. The restructuring program that we've done, as I said, to increase our operating rates and when combined with those fixed cost savings will improve our competitive position. And then in the U.S., we've got the conversion. Slide 22, pulp market prices from a cost perspective now. The pulp -- paper pulp prices have started rising and you saw in that earlier slide. So that's clearly a risk. But as I said, we have announced some price increases -- selling price increases, in the quarter, we have 2 shots, Somerset, which is an 18-month shut, it's scheduled. And then we've got a [indiscernible] cycle, which once again is scheduled. The combined impact of those 2 on profitability. If you're looking at quarter-on-quarter growth Q2 versus Q3 is about $30 million. The CapEx, same as we've been talking about $500 million, including the biggest project being the Somerset at $154 million. We were very specific on our plantation fair value price guidance adjustment, and it will be a negative in Q3 and a small negative. And that relates to the way that the model works and different discount rates and there's higher fuel costs, which get embedded into the valuation, and that's why it's negative. The wood prices in South Africa have not risen in recent months. So all in all, the underlying profit and demand in our business, we expect to continue to improve. But obviously, when you deduct the shuts quarter-on-quarter, it means that the third quarter will be below the second quarter. But as I said, the underlying business continues to improve. And then obviously comparing it to the prior year, substantially better. So that's the end of the presentation, operator. So I'm going to put it back to you for questions.

[Operator Instructions] First question comes from James Twyman of Prescient.

I've got a few questions, if I may. The first one is, you're trying to raise prices in Europe, obviously, because of the rise in pulp costs and that's clear for coated paper, but it is always more difficult to do that in specialties. Can you talk about what you are trying to do there and whether you think you can achieve anything there? And secondly, you did mention a few times that you benefited from cost savings in South Africa. Could you just talk about what it is that you've done there and what sort of scale you're talking about?

All right. I'll start and obviously on the European question, I'll let Marco elaborate further. And similarly, on the costs in South Africa, I'll pass to Alex to elaborate further. In Europe, look, we're starting to get price increases across all our categories, not just graphics, on the specialities as well. What we're finding with the market situation, and as I said, Marco will elaborate further, what I'm finding is that, on the graphics side, the prices have been holding up pretty well. And, I guess, because -- I'm not guessing, possibly that's because the operating rates are low and margins are pretty thin. So the various players have been holding their prices. And now with a little bit of cost increased pressure, a number of players have announced selling price increases. On the specialty side, we have seen prices come down in recent quarters. And a lot of that's linked now to the general weakness in the market. Nevertheless, obviously, that same cost pressure is starting to come through and we are trying to implement selling price increases as are other players as well. So, the market conditions are, as I said, slightly better than they were recently. So the ability to try and achieve price increases has become still tough, right, but it's become slightly easier. Marco, maybe you want to talk more about that?

Yes. And your summary is very accurate. If I just divide it between the efforts that we're doing on the graphics side and specialty side, and starting with graphics, James, we already had 1 wave of price increases in the first calendar quarter. However, we're pulling that through as the costs have started to increase, particularly on the pulp site, and we see that coming in the next coming months. So we need to anticipate with further price rises on the graphic side. As Steve rightly said, we feel a bit more comfortable with the capacity utilization that has improved for us, for the industry after the 2 mill closures that have taken place and that are completed this quarter. So that's on the graphic side. On the packaging and specialty side, it's somewhat of a mixed bag, also internally in our portfolio in Europe. There's some segments that see a recovery and link to that, we see some successful increases. And there -- let's face it, there are others that still are hampered by the macroeconomic situation or a lack of sufficient capacity utilization as not a lot of capacity has come out of the packaging and specialty side or conversions have not taken place from 2 other grades to the extent that it would help us enough. So on the packaging fatalities, certainly a challenge. Graphics, we had a first step, we're preparing ourselves for the next step as the pulp prices are starting to rise in the next coming quarters.

And then, just as I said, Alex will expand further on the cost side, but across the board in a number of the categories, and 1 of them I touched on earlier was the wood side that we haven't seen increases. Those have been relatively flat, but there's other cost saving opportunities. And to -- here's Alex.

And, James, a couple of areas, energy and obviously with a much better operation at cycle and the stability there, we do benefit from power generation there. We've seen some savings on the chemical, the pulping chemical sides, just better negotiations, obviously, the volumes that we buy as well has helped. And then on the logistics side, we're actually making good progress to address the logistics infrastructure challenges. We've managed to get more of our coal back onto rail and we've had very good opportunities with Transnet, the state-owned logistics provider in terms of better rates to bring timber back into the mall.

[Operator Instructions] Your next question comes from Brian Morgan of RMB Morgan Stanley.

If I may just carry on with this European packaging business, just looking at the volumes today, your volumes are down back to levels and they have been for the last 5 quarters, back to levels as they were in the lockdown in 2020. And I'm just wondering when you think it would be time to start thinking about rationalizing some capacity in that business. You're talking about some lines where you've seen no signs of recovery yet. Would that not be areas where you could potentially take capacity out?

No, I don't think at this early stage, Brian. We do anticipate that there will be a recovery. And you're right, it is back at those levels. And funny enough, the reason has changed, right? Because initially, it was a stocking issue or an excess inventory issue and that shifted now to being the macro situation. We still believe that the categories -- the key categories that we're in, that there will be meaningful recovery. It's taking longer and we want to give it more time. Marco, do you want to...

Yes, Steve, you highlighted the most important points. If I may, Brian, maybe 1 additional point that has not helped over the last 12 to 18 months was the uncertainty around European regulation. And you might have heard of the packaging and packaging waste regulation or the single-use plastic regulation, but particularly the first one has only been decided effectively by the commission in March, but it has lingered on for a very long time, putting the industry in a bit of an uncertainty when it came to demand, but also additional capacities or additional investments, sorry. So, the European regulation, as we see it right now, has reached the next stage. There's more clarity and that will add to what Steve already said that are confident in some of these segments now picking up is growing.

If I may just follow up there? What sort of demand tailwind would you expect PPWR to provide to your packaging volumes?

Well, it will get -- I think you need to see it the other way around. It has hindered the traditional demand growth that goes for these type of packaging material of between, call it, 2% and 4%, and that turned negative the last couple of months. And therefore, we're confident that it will ultimately normalize and go back to its traditional growth rates.

[Operator Instructions] The next question comes from Patrick Mann at Bank of America.

I just wanted to ask about the lags with the pulp price. Is there a difference between the revenue and the cost lag? So effectively, with pulp prices increasing now, is it sort of beneficial to the margins and then later they squeeze or other way around? Or do they come through -- does it come through at roughly the same time? That's the first question.