Sappi Limited (SAP) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the Sappi Third Quarter 2021 Results Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Steve Binnie, CEO. Please go ahead.

Thank you. Good day, everybody. Thanks for joining us for the results call. As always, I'll go through the investor presentation, which has been made available to you. I will call out the page numbers as I move through it. I'm going to start on Page 3, which has got some of the highlights for the quarter. All in all, a satisfactory quarter, in line with the expectations, in line with the guidance that we provided. I think we're making good progress year-on-year, EBITDA up 40%. So obviously, we've continued the recovery from the lows of last year. And in terms of the segments themselves -- and we will go into a little bit more detail. But on the pulp side, strong market conditions, good demand and further upward movement in pricing. Paper side muted recovery. Packaging volumes continue to increase, and we would expect to see more of that as we move forward. Graphics seems to be leveling off now at a new level. Obviously, post the declines that we've seen in the last couple of years it seems to be leveling off, albeit that we know that seasonally Q4 is a stronger quarter than Q3. Pleased to say that the sale of the Stockstadt Mill was concluded in the quarter. We had proceeds of USD 49 million. And all in all, the net cash generated for the quarter was $32 million, which is pleasing for us. Slide 4 has the EBITDA -- sorry, the product contribution split. And obviously, this is a longer-term trend line. The big story is obviously on the right-hand side that we continued to reduce exposure to graphics. We're well -- well, we're below 50% now being graphics. And obviously, we've got a couple of projects underway, which will take that even lower. And I've talked about this before. Probably by the time we get to 2027, the target is to get that below 30%. Increasing contributions from our higher growth margin segment. The EBITDA a little bit fluctuations [Technical Difficulty] you can see in times of the macroeconomic conditions, specifically in the quarter. Obviously, on the Packaging side, we had the big Somerset shut, which would have impacted on the contribution from Packaging. Moving to Page 5, the bridge earnings last year relative to this year. I mean, firstly, a recovery in volumes in the -- particularly, obviously, in the Paper segment, which has contributed to that. We did see some negative pricing and mix. The pricing -- mainly in the Packaging segment, where we did see somewhat downward pressure. But in Pulp, as I said, positive. Savings and variable costs coming through, albeit Pulp -- and all of you will know this that paper, pulp prices have been higher in recent quarters, albeit they've just started to come down again. Some fixed cost adjustments relative to last year associated with the shut, and giving us the EBITDA of $151 million that you're seeing quarter-on-quarter. Moving to the input costs, and this is a 3-year trend line. Obviously, off the highs in 2022. We saw declines in costs. But then more recently, pulp rising. And the other category is relatively flat. All in, 2% quarter-on-quarter increase in variable costs. As I said, pulp is leveling off, and, in fact, we're anticipating pulp to start coming down again. But most of that benefit will -- because there's a bit of a time lag, will be felt in the new financial year. Page 7 has our leverage over time and our net debt levels. As I said earlier, positive move in net debt on the quarter. Obviously, we're higher than a year ago because we had to fund the expansion and conversion project at Somerset, and then more recently, we had the closure at Lanaken. So we had to fund those. But a strong focus on getting that debt number back down to close to the $1 billion level. Moving to Slide 8, has our debt maturity profile. Some change, obviously, relative to the last quarter. Perhaps the largest sizable refinancing or maturity is on our 2026 Eurobond. There's only -- there's EUR 240 million outstanding. We obviously continue to monitor. Obviously, when we did issue those bonds, it was at a level of 3.125%. So it's very favorable. So keeping it running a little bit longer does help. And it's not a -- it's a big maturity, but it can be managed. So we will pick the optimal time for that. Then moving to Slide 9, just looking at the cash flow from a generation perspective. Obviously, in the current year, the free cash flow continues to be healthy. Obviously, at the bottom line negative, but that's linked to what I talked about earlier, the CapEx and the closure of Lanaken, and, obviously, we did clear the dividend in the current year. CapEx we've guided down a little bit relative to the last quarter. We brought it down to $480 million. Some of the projects that we were undertaking we've deferred into next year because they don't have an impact on operations. The biggest part of it is Somerset, and that's on track. So under control and no surprises in the number. Page 10. We continue to be disciplined in our capital allocation with a strong focus on getting the debt back close to $1 billion. We've got to see through the Somerset project, which is going well. And thereafter, we haven't committed to any other major CapEx. So we will start generating cash when that project is completed. We obviously reduced exposure to graphics with the 2 mill closures, Stockstadt and Lanaken. On the plus side, we are -- we've made the investments in Gratkorn to give us wet strength label capabilities. That will be finished in September, and the Somerset expansion conversion which will be finished in April next year. The net effect of those 2 is effectively like taking 2 mills, 2 machines out of coated woodfree and obviously pushing us into higher margin, higher growth segments. On top of that, Somerset giving us the extra volume. So there will be growth on the top line associated with that, too. Moving to segmental overview and Page 12, the Pulp segment. Within that, obviously, the main driver is dissolving pulp. As I said, favorable conditions, strong demand, no new supply coming, price is favorable. So we are feeling pretty good about the market conditions there. It's a tight market. Offsetting that, BCTMP. We sell some tons into the BCTMP market from Matane. That market has been tougher, and that's what impacted on the margin. Having said that, just remember when we complete the Saiccor -- sorry, the Somerset conversion, we are going to be supplying additional BCTMP to the Saiccor Mill. So we're going to be less exposed to the external market. We also did have the Matane shut in the quarter, actually, which also impacted on margin. And we had a [Technical Difficulty], which impacted. Moving to Packaging. Obviously, there was a big drop in margin from what we've seen recently. But we had the 18-month extended shut at Somerset, which would have impacted. And then at the same time, we did have some production issues at Somerset, not linked to the shut itself, but those impacted on volumes. They're now behind us, and we're feeling good about the prospects in North America for the fourth quarter. Europe, mixed. Obviously, it's still difficult in Europe. The economy is still challenging. But there are pockets of improvement, and we called out 2 there on the slide, labels and self-adhesive. The labels is good, obviously, because we're getting close to the completion of the project at Gratkorn. In South Africa, generally good. The containerboard demand was a little bit worse than we had thought it was going to be, but underlying demand continues to be strong. Then on Graphics on Page 14. As I said, we have seen recovery from the very lows of last year, but it now feels like it's leveling off. We will have a little bit of seasonal benefit in Q4. But it does look like it's leveling off at around the 500,000 ton mark per quarter. A little bit of macro -- negative macroeconomic factors at play. But I don't think we're going to get much substantial improvements from here. Having said that, obviously, because of Somerset, us taking out that capacity, when we complete the conversion, that will reduce our exposure. Similarly, at Gratkorn. And post us closing the 2 mills earlier this year, we're relatively full there. So the margins actually at 9% are reasonably healthy and at normalized levels. Turning to Page 15, the product segments -- sorry, the geographic segments. Well, firstly, I'm obviously pleased that the volumes are positive in each of the regions year-on-year. But I did call out, obviously, Graphics leveling off now. Selling prices, we did see a little bit of negative pressure in the Packaging segment, and that's what impacted the numbers in the European and North American regions. The margins, South Africa healthy. North America, obviously, impacted by the Somerset shut, but should get back to normal levels. And then as we've called out, the Europeans lagging, but hopefully some improvement will come through as the packaging specialities improve moving forward. And you see all of this graphically on Page 16, so I'm not going to repeat it. But you can see that healthy in South Africa, a little bit down in North America, but recovery coming. And then U.S. still subdued -- sorry, Europe is still subdued. Then on to Slide 17, the Thrive strategy that we have. We shared this with you many times. It doesn't change quarter-by-quarter. We continue to focus across the 4 pillars. On the operational excellence, obviously, very pleased with the progress that we made. And after closing Lanaken and Stockstadt, moving that volumes across, that improves our operating rates in the coated woodfree machines in Europe. And then across each of the regions a strong focus on maximizing production. In South Africa, we continue to look for opportunities to increase our forestry footprint. These are not material acquisitions, but we continue to look for opportunities. And we added a couple of acquisitions and that's in the CapEx numbers that you've seen. The enhancing trust, firstly, pleased that we maintained our level 1B compliance. We think our sustainability positioning puts us in a strong competitive space. And as I've talked about previously, we've probably got about $60 million to $70 million over the next few years to continue to improve on our environmental footprint. The growth of the business, in the short term, it's built around the 2 projects that we've got at Gratkorn and Somerset. And as you heard earlier, those are going well. And then in terms of sustaining our financial health, committed to getting that debt back downwards post the Somerset project. And as I say, we haven't committed any large CapEx beyond that. Slide 18, moving on to sustainability. Very proud that we got another EcoVadis platinum award, across all 3 manufacturing regions getting the highest rating 6 consecutive year, ranks us in the top 1% in our segment. Then moving to the outlook, which is on Slide 20. It's fair to say that there's still challenging macroeconomic conditions out there. Interest rates are high, but, hopefully, they will come off at some point. But there is volatility out there. DP markets, I've talked about a couple of times on the call, still favorable conditions. On the Graphics side, a little bit of seasonal recovery, but as I said, we're probably at the new normalized levels after the recent volatility over the last 2 years. Packaging markets, continuing to improve, feeling very good about North America and South Africa, Europe lagging. But we are seeing certain categories, as I said earlier, showing positive signs. On the cost side, chemical costs, there could be a little bit of inflation coming through. But on the positive side, it does look like pulp prices may have peaked and they are expected to reduce in coming months, which will benefit our Paper business in the new financial year. Slide 21. We continue to focus on margin management, obviously, taking into account our costs and ensuring that we can protect margins. The guidance for Q4 -- well, firstly, we have the plantation fair value adjustment. There was a very recent reduction in wood prices in South Africa, which means you're going to have a negative fair value adjustment in the second -- the fourth quarter, which offsets much of the positive from earlier in the year. Taking that out of it, we anticipate that the EBITDA for the fourth quarter will be above the same quarter of last year. So further progress on our road to recovery and feeling positive about the quarter. Operator, that's me gone through the presentation. I'm going to hand it now back to you for questions.

[Operator Instructions] And now we're going to take our first question, and it comes from the line of James Twyman from Prescient.

Thank you very much for the presentation. I've got 3 short ones, if I may, just to kick off with. The first one is in terms of CapEx, where do you see that in next year? Do you think that will be similar to this year or maybe a bit higher or lower, just given that the Somerset expansion cost is still going to be fairly similar? Secondly, is there any restructuring cash flow in Q4, either positive or negative? I can't see anything substantial seems like to be in Q3 that we've had all coming in Q1. And then are there any further energy credit possibilities? Others have had them? You obviously got a big one in Q1 this last year, but just wondering if there's anything else that you could get there.

Yes. I'll take the first one and Glenn will take the second and third ones. Yes, on the CapEx, you're right, there's a similar number coming through from Somerset next year. So we're still finalizing our budgets. But overall, as I look at it, it's likely to be a similar number to [Technical Difficulty], obviously, predominantly around the Somerset project. Glen?

Good. James, just in terms of the restructuring costs, there will be some minor costs coming through in the fourth quarter, but the bulk of them come through. So it won't be anything substantial. And then in terms of the energy credits, we don't -- we're not -- we don't have any energy credits for the fourth quarter. No.

And it comes from line of Brian Morgan from RMB Morgan Stanley.

With the pulp price cracking in China, can you just talk to us a little bit about how that might feed through into DWP? Do you think there's still some swing capacity?

I'll start, Brian, and Mohamed can add to what I say. I think -- look, on the positive side, the fact that the pulp prices are coming down, as I indicated in the presentation, we think there will be benefits for the paper business to come. On the DP side, so far, no impact, most of the swing capacity has already moved into DP. So we're not anticipating any sizable further moves away from pulp to DP. And as I said, and you would have got a sense of that, as I went through the presentation, the demand is so robust. There is no new supply, and we're still feeling pretty positive. Mohamed, if you want to add to that?

Yes. Steve, the only thing I would add is that more recently there's been some further supply-side reductions. There's a mill that's taken off DP production in Canada. So that's also tightened up supply as well.

Yes -- there's been a disconnect now between the paper pulp and dissolving pulp. And as I said, most of the capacity that would come across has already done so.

And can I ask on paper pulp. Now with Lanaken and Stockstadt closed, what's your net short position in Europe?

We are about 600 million tons, 600,000 in Europe and about 200,000 in the U.S.

And then the last question is with the wood price drop in South Africa, can you just give us an understanding of sort of magnitude of the price drop. And then can we expect that to feed through into any of your costs given that you guys do still buy wood?

Yes. Well, the magnitude of the drop -- Alex, that's public, right? So we don't have to -- we can disclose it. It was ZAR 125 a ton. Yes. So that's public. You're right. And by the way, Brian, you -- it's not just on what you buy from third parties. It's even on your own fair value, right, because you take the fair value knock and then it means that your cost per ton that you apply to the paper and pulp prices comes down as well. So most of that benefit would be felt in the '25 year.

And the next question comes from the line of Brent Madel from ABSA.

2 questions from my side, please. So you've indicated that cotton prices are lower, but the viscose discount cotton remains healthy. Do you have a sense of how much cotton prices would have to fall for viscose prices to rise for it to be more favorable for cotton? That's my first question. My second question is the last few quarters post the closure of some of your European graphic paper capacity, you've been operating close to the 90% level. I just wanted to ask you whether you could give us a sense as you enter Q4, whether that capacity is still operating at around that 90% level? Or has it moderated from those highs?

Yes. Yes. Okay. On the first one, in terms of cotton versus viscose. It's not an exact replica because clearly, they have different functionality. Historically, the 2 prices were very close. In recent times, cotton has sold at and Mohamed, you can jump in here at a quite a significant premium. More recently, it's come backwards. There is a correlation. But because it's a different product with a different process, the actual cost, the manufacturing costs are very, very different. So there's no doubt when the price of 1 moves has a knock-on impact on the other, but Mohamed, I don't know if there's specifically anything that you want to see on the relative movements.

Steve, I would just say its cotton has just proven to be very, very volatile, whereas viscose has tended to be a lot more predictable. And what we've seen as a result of that predictability, the buyers of the fiber have tended to go with the fiber that is more predictable so that they know what the input costs are.

Yes. Okay. And then on the coated woodfree, yes, look, we're still close to the 90% level. We -- the industry interestingly in Europe is less than that. It's about in the mid-70s somewhere. So we are above those levels. And obviously, which means that some of our competitors must be struggling.

All right. If I can just -- if I may ask a follow-up on that, and I think you've given this information before. Can you just give us your idea of what the surplus capacity is of graphic paper in Europe at the moment?

Yes, good -- it's a good question because there's so many swing machines. And whether it's on specialty grades -- some machines have uncoated on together with coated. But it's probably -- we estimate the market demand for coated woodfree in Europe at about 2.5 million tons. And it's currently -- depending on how you allocate the capacity of the competitor, maybe about 700,000 800,000 tons excess.

And the next question comes from the line of [ Fol Cassido ] from [ MNT Plc ].

I have a couple more like a clarification. The first one is an accounting one. In regards to the impact of the fair value adjustments of your presentation on your EBITDA, your post $3 million in the P&L, if I understand correctly. But when I look at your cash flow, there is for the quarter, $31 million negative in the account, suggesting that there's potentially a noncash contribution of $31 million in the quarter. So struggle to reconcile the 2 numbers. If you can explain that, that would be great.

Okay. So we're just finding the $31 million.

It's on page, yes, Page 13 of the report.

That's the combination of your price fair value adjustments and your volume per value adjustments. So we put them all together because they're noncash items. Yes, every year, your trees grow and you have what we call a volume adjustment. So that's obviously noncash as well. And we just called out the price fair value adjustment on the income statement.

And the -- does the volume adjustment flow through the EBITDA as well?

Yes, that's correct. Yes. But bear in mind, you have costs that you incur to grow your trees, your operating costs.

Yes, so the culture costs.

And they're pretty much similar?

Correct. So they more or less set each other off.

Okay. And the second question is on your Slide #4. You mentioned you have a target to reduce the paper contribution below 30% by 2027. I missed whether you were referring to the EBITDA or the volumes?

It's on volumes. We -- at some effects, we have the machine that we're converting is about make about 250,000 tones. So that's obviously coming out of the coated woodfree space. And then at the Gratkorn machine in Austria, we're taking about 200,000 tones up. Yes. Marco.

On graphics volumes, it's more towards 250. Yes. Yes.

So that's on the volume. Obviously, the segments that we're moving to are higher margin segments. So you would have not only the volume adjustment, but you would have the improved margin that would contribute towards the packaging and specialties grade.

The next question comes from line of Lars Kjellberg from Stifel.

Okay. Anyway, so 2 things. Pulp prices, of course, were extremely elevated. And yes, paper prices barely moved, which suggest to call there is competitive pressures out there. Are you seeing any sort of downward price discussions now on account of fairly rapidly falling pulp price in particular on the hardwood side? That's my first question. The other one relates to packaging, obviously, we can track the price indices right for U.S. leach forward, for example. And yes, it's down a bit. But most of the packaging grades, craft paper, containerboard, et cetera, are tracking higher. So what are you seeing in that market that makes the -- your packaging exposure seeing some pricing pressure or other big segments appears to be having the opposite.

Yes. I think on the paper prices for graphic, now we're not seeing significant downward pressure. Bear in mind that obviously, pulp prices in Europe have lagged China. So prices are still relatively high. And -- sorry. Okay. I wasn't sure if you were asking another question there. But no, we're not seeing downward pressure. In the U.S., and Mike go into more detail or elaborate further. But ascending, yes we did see some negative price pressure on the SBS markets in the U.S., not significant, but downward pressure. I think there was -- from a competitive landscape, I think there were some competitors looking to fill their machines. But -- and maybe that's why the direction of the pricing is different from other categories. Having said that, it's not significant downward pressure, and we're feeling good about the market.

Yes. I really think, Steve, you summed that up well. We're not seeing significant price pressure, I wouldn't call it, maybe some minor price pressure last quarter. We're actually feeling good about our Q4, our next quarter.

Lars, do you have any further questions?

Now I was just going to say on the specialty side of the business, are you -- pricing direction that would be helpful. And also a topic that has been quite vibrant on the U.S. side, specifically as the trade publications keeps on talking about European threat of folding box boards coming in, while it looks pretty apparent that given the wood cost in the Nordics, in particular, that would be quite a challenge. But if you -- do you have any color you can share on potential import penetration that could have an impact on your volumes in particular, post Somerset expansion?

Yes. Yes. Look, your first question, I guess, is just a follow-on from what you previously asked. As we say, there is a little bit of downward pressure, but it's not significant. We are feeling good about the market in the U.S. Volumes are good. Our machines are full, and we are feeling positive ahead of the completion of the Somerset project. On the folding boxboard coming out of Europe, look, there's already some of that there. We're not seeing unusually high activity. You're right. The operating costs in Europe does create challenges for them to bring in more. But certainly -- and again, I'm repeating myself, but generally, we are feeling good about the North American market. We're feeling good about signing up customers ahead of the completion of the machine, and we're positive about the outlook.

[Operator Instructions] And the question comes from the line of Brian Morgan from RMB Morgan Stanley.

Can you -- $30 million of maintenance shut in the quarter. What can we expect in the fourth quarter?

Sorry, it was $30 million.

Maintenance side, impact of maintenance side.

Yes, we don't have any big ones sorry, it's a material prime, where are we its very small.

Okay. When is the next -- when would you think the next big quarter of maintenance would come through?

Yes. February, we've got in Ngodwana.

In Ngodwana. Okay. That's good. And then...

And then, obviously, we've got -- and then we've got Cloquet next year.

Okay. And just to confirm, these are on 12-month cycles or 18-month cycles?

Yes, the 2 American ones are 18 months. In Ngodwana with 12. And then cycle -- we don't have one big shot. We've got the 3 lines, and we schedule those at different points in the year. But that 12 months is [Technical Difficulty].

And then can I start ask on Lanaken and Stockstadt. Were you able to carousel all of those volumes? Or is there some volumes you lost?

Yes, most of it, we were able to carousel. There was a little bit of uncoated that we didn't, but we knew that, and we took that out. But on the coated woodfree side went very well and most of the uncoated as well.

And the question comes from the line of James Twyman from Prescient.

So I had a few questions. The first one was if you look at the 9 months volumes, South African volumes were down so far this year, and pulp volumes overall were also down, and the common denominator would be South African pulp. But that should be growing, I would suggest, because of cycle ramping up, but it would be good just to check that, that is the case. The second one was there was a nasty looking fire at Saiccor, last month, which fortunately didn't cause any injuries. Did that lead to a few days of downtime, I'd just be keen to know about that. And then the third one is just what the mechanics are of the Somerset start-up in terms of the extra downtime that is needed to put this all online and when you think that might be and what that might cost? And that then will be everything for me.

Yes. Yes. Okay. Mike will talk about the Somerset -- or changeover as we complete the project. And Alex will just give you a little bit of feedback on the fire. In terms of the DP volumes, yes...

We had a shut at in Ngodwana, which affected the volume.

Yes. And the -- yes.

Which we didn't have in the previous year. And what has really happened is we had an 18-month cycle, and we've actually pulled it back to 12 months just because we're not very comfortable with the long duration. We obviously will be focusing on getting it back longer as we're comfortable with being able to maintain equipment adequately. So it's really a change in the shut timing.

Yes. And I'm just thinking, it's a year-to-date question. I think earlier in the year, we had some challenges at Ngodwana as well, which took a few tons out. But maybe the bigger answer to your question is that the production Saiccor is going well. And we're really happy with the progress that we're making there. Specifically to the fire.

James, maybe just to give you some background, it was a liquid oxygen tankers that caught fire. It looked more spectacular than it was. It does -- this cost us about 5 days of downtime. But for me, what is very, very positive is the recovery. We literally got that mill up as quickly as we could get the equipment replaced, and there was a little bit of damage of equipment. And just to remind you, this was a real -- the best stop in the mill. So it's not there was a controlled stop. So for me, what I take out of that is we really are under control of operating under [indiscernible]. So very positive, but it did cost us some production there.

Thanks, Alex. Mike, on the Somerset.

Yes. So the Somerset outage is scheduled for 70 days of downtime on PM2. We go down the end of January, and we'll start up in April. The startup of the equipment is -- the equipment is almost identical to what we installed on our #1 paper machine. So this isn't a brand-new equipment that we've never run before. We have a ramp rate that is planned over the course of the next 6 months. The most aggressive performance starts in that first month. So we'll ramp up substantially. And we should be at reasonable uptime levels within 3 months and then we'll progressively get better through the course of the next 9 is the way we've planned it.

And obviously, ahead of that, we will be building inventory levels.

Yes. So it's about 50,000 tons, 52,000 tons of what would have been graphics orders. But remember, this machine is going to start up and be 100% packaging at essentially went back to full rate, double that production.

Does that make sense?

Yes. Okay. So it's like a sort of additional maintenance hit, you're going to take some time.

That's the best way to think about it. But obviously, this is going to be a machine expansion that in those 70 days, we will be retooling the entire asset to make a much different grade at a higher production rate.

So net-net, it's positive because of the higher volumes post the completion of the project, if that makes sense.

If I could just do one more little one, which is Lars was asking about coated fine paper prices with the rise in pulp prices, you want to get prices up, which means that the markets are quite weak, which maybe means there's a bit of pressure. But in terms of the specialty market, that's probably a bit different. You haven't managed to get any pricing there really either it looks like. But presumably, can we feel a bit more confident there that you should be able to hold prices when your costs come down there?

Yes. What made it tricky, right, is that the market has been weak. So it's very difficult to get price increases in Europe when the market conditions have in that states. Things are improving. So our ability to hold prices will improve. Obviously, if you look historically, normally when the pulp cycle tons, that's when that's when there's an opportunity to capitalize on the margin benefit. So it's going to be a strong focus of our attention to keep our prices high for as long as possible.

[Operator Instructions] Dear speakers there are no further questions. I would now like to hand the conference over to your speaker, Stephen Binnie for any closing remarks.

No, just to thank everybody for joining us again today, and we look forward to discussing our year-end numbers in 3 months' time. Thank you very much.

This concludes today's conference call. Thank you for participating. You may now all disconnect. Have a nice day.