Sappi Limited (SAP) Earnings Call Transcript & Summary

Good day and thank you for standing by. Welcome to the Sappi Q3 2026 Results Conference 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, CEO, Steve Binney. Please go ahead.

Thank you, operator. Good day to everyone. Thanks for joining. As always, move through the investor presentation calling out page numbers as we move through. And just quickly starting on Page 2, I just draw your attention to the comments on forward-looking statements. Moving to Page 3, which is really just a high-level summary of the quarter. It's fair to say that we still have challenging market conditions with volatile economic macro factors taking place, which has had an impact on a number of our costs, which is obviously impacted on the margins and also selling prices for our products. On top of that, we continue to feel the impact of the strong rand against the U.S. dollar. On the positive side, we -- I'm pleased with the progress that we're making in North America as we increase our sales volumes in -- on the packaging side, on the SBS side specifically. Just as a reminder that the quarter did contain the Ngodwana shut, the annual maintenance shut, which had an impact of $22 million. So all in all, a tough quarter, but we are beginning to see some green shoots and positive momentum on selling prices, and I'll talk a little bit more about that. But overall, an EBITDA of $53 million, which was in line with the guidance that we put out a couple of weeks ago, the revised guidance that we put out a couple of weeks ago. Slide 4 just 2 of the major drivers of performance is a slide we've shared before. But the DWP price and the rand-dollar exchange rate do have a significant impact. And as I've said previously, normally, they move in opposite directions, unfortunately, both working against us at the same time. And just to highlight the sensitivity there, when you're selling 1.2 million tonnes plus of DWP a year, a 1% change can have a vast impact. And then on the rand-dollar exchange rate, it's $4 million for every $0.10. And yes, just to remind, I know everybody knows this, but 2, 3 years ago, it was above ZAR 18 to the dollar, now closer to ZAR 16. So a vast impact on the South African business and obviously good profitability. Moving to Slide 5, just to the more recent movements in dissolving pulp. It was down year-on-year, but we have seen positive momentum coming through in the quarter. The overall DWP price has risen by ZAR 53. A lot of that's not been felt yet in the in the numbers that we report because there is a little bit of a lag impact. So much of that benefit will be felt in the Q4 numbers, the current quarter that we're in. What is driving those higher prices for dissolving pulp? Well, firstly, on the fiber side, we have seen an increase in various prices of fiber. So that supports a price increase for the raw material, dissolving pulp. We've also seen costs going up, specifically on the fiber pricing, the polyester fiber, as you would imagine, is closely linked to petrochemical costs, that's supporting higher prices. BSF operating rates continue to be good and inventories continue to be low. So all of those things helped. On the negative side, obviously, we -- paper pulp prices continue to be relatively low and the uncertainty caused by the war going on in the Middle East. Then Slide 6 one very pleasing aspect of our results has been the increased volumes coming through from our North American business. As you know, we made that investment. We were confident in that market. We believe that we could grow the volumes, and we're doing that. We're delivering that. We're gaining market share. And we've recorded record volumes in the quarter, and there's more to come. We continue to build our customer base. The machine, the new machine, Somerset PM2, as you would imagine, as you ramp up the efficiencies of the machine get better. There's still more to come, and we're pleased with the progress. Also pleased that there has been price increases now coming through. The first one -- the first round of price increases is now substantially been reflected in the industry data. I think there'll be more to come. And then as many would be aware, there's been a second round of price increases announced very recently. The benefits of these price increases are not in the numbers yet. Some of it will be felt in Q4 and some of that into Q1 of next year. So all in all, feeling good about the progress, volumes rising, selling prices rising, gaining market share. Then turning to Slide 7, the graphic paper. market. It's our traditional business. On the last call, 3 months ago, we did spend some time talking about the increases that we had announced. The U.S., that market is tighter following our conversion, and we were able to implement a price increase there. In Europe, we announced 2. The first one was successful. The second one less so. It became -- we felt that we needed to push for it because of the higher cost, but it was more difficult to execute on the second one. And so the graphs that you see only really reflect the first one. Europe is more difficult because there is excess capacity, as you know, and we've talked about that many times. The earnings bridge on Page 8, I'm not going to go into detail, but the big story here is that we are -- we're seeing the lower selling prices coming through. And bear in mind, this is a year-on-year comparison. So year-on-year across many of our product categories, they are less. They are improving quarter-on-quarter, but year-on-year we were less. And then the currency conversion having a significant impact. Offsetting some of that is a lot of great work that we're doing on costs, and I'll talk a little bit more about that in a future slide. Just Page 9, on costs generally, we have seen headwinds, right? The wood costs in Europe, North America being going up, not in South Africa, but certainly in those regions. But the big drivers of higher costs have been chemicals and delivery costs and a lot of that's linked to the war in the Middle East. We -- and we specifically -- at the bottom of the slide, we quote some of the specific raw materials that have gone up. And we do have a slide specifically on sulphur, which is the biggest one. Other costs like pulp, relatively stable, which have helped. And the proactive work that we're doing on taking costs out of our business have been able to mitigate some of this impact. So Slide 10, we thought it would be useful to share with you, this is the sulphur price. And you can see a commodity that was below $200 a tonne. It's jumped all the way up to close to $1,200. Just to put it in context for you, we quantified its impact. This is a year-on-year impact for the '26 financial year, $350 million just on that one raw material. So you can see it's a vast impact. And hopefully, when the markets normalize, there will be a potential reduction in these costs. Having said that, we are not resting on that, and we are looking at alternatives to mitigate much of this impact or some of this impact. Similarly, on Page 11, the logistics costs, the war has caused higher shipping costs, higher diesel costs. specifically on delivery itself, we estimate this year will be $106 million, but that's only on the direct delivery cost of the South African business. It doesn't include the forestry, the logistics. It doesn't include the other regions. But just -- I know there's been a lot of focus on -- specifically on South Africa, and we thought it would be useful to share that information. Slide 12 has our net debt to EBITDA and obviously, on the back of lower profitability, it's meant that the leverage ratio has increased. On the debt side, interestingly, you can see we've kept it relatively flat. And I think that's a great effort on the back of the lower profitability. So it shows you that the actions that we're taking are reaping rewards, and you see the benefits flowing through there. Specifically on the leverage covenant, as you know, and we announced last quarter, that's suspended until March '27. We continue to have strong relationships with our banks, and they support the business. They understand the headwinds that we've been facing, and I'm confident they will continue to be supportive into next year as well. Then on Page 13, the debt maturity profile. I think the first important point to highlight is that we have substantial liquidity and reserves on hand and facilities on hand. That's on the left-hand side of the graph. On the right-hand side, the first big material debt refinancing is the 2028 Eurobonds. And that's something we will monitor as we get closer to that maturity period. But otherwise, liquidity looks good despite the lower profitability. Then on Slide 14, just again, highlighting the same ones that I've already raised, a disciplined approach to capital allocation despite the lower profits, only a small outflow of cash. And then as part of that, the CapEx, we're estimating $240 million this year. As I've mentioned previously, we've pulled back on any expansionary CapEx. This is focused on maintenance and essential CapEx. We're not putting our assets at risk. This is what we believe that we can reduce it to and maintain the quality of our assets. Slide 15 is our Thrive strategy. I don't intend going into detail. It is a schedule we've seen many times. The emphasis shifts. And at the moment, with the back to basics focus, our priorities have to be on driving operational excellence, lowering our cost base, improving production and then ultimately sustaining our financial health with the #1 priority to reduce debt. Slide 16 takes us to another level, and we call them our self-help pillars. And I don't intend going through all these bullets, but just to highlight a few. In terms of optimizing our portfolio, Somerset progressing very nicely, and we're excited about the prospects ahead. The work that we've done on the joint venture, and I've got a slide on that, -- but we are confident that, that joint venture will bring substantial synergies, and we were thrilled that the shareholders supported the transaction in the recent vote. We got 98.5% vote. And we were pleased with that, and we believe that this is the right course of action for our European business. We've been putting through selling price increases across all our key segments. It takes time. And yes, some of it is to offset higher costs, but market conditions in some of the segments are better, are getting better. And I specifically call out the U.S. SBS market. The disciplined allocation capital guides our principles. A number of these points I've already talked about. The one that we are excited about, and we have been proactive, we've been able to take EUR 120 million of costs out of our business. And I know that doesn't show up in the overall profits because of the other headwinds, but these are real actions that we have taken to mitigate much of that impact of those headwinds. The savings are across the regions and include fixed costs and variable costs. Specifically on Europe, and that -- by the way, the EUR 29 million is in the 129 million. Specifically in Europe, we've done a lot of great work to reduce our fixed cost base. And then deleveraging, I've said it once, I've said it twice, I'll say it many times. Our 1 priority is to reduce debt. It's going to take some time because we need to get the profits back to normalized levels. But with the discipline around capital allocation and the improved profitability that we anticipate in the quarter and the year ahead, we will begin on that path, and we will remain committed to getting our debt back to a manageable or more reasonable levels. Then on Slide 17, again, it's -- there's quite a bit of detail, and I don't intend going through everything. But just on the packaging side, we've got a strong business and a strong platform in North America, great assets and you can see the evidence of our ability to grow the portfolio. In dissolving pulp, leadership position with a strong influence on our profitability, a non-integrated supplier with long-term relationships and well established for increased profitability that we envisage will come in the future. And then graphics, we know that graphics demand is in structural decline. We've been proactive by proposing this joint venture with UPM. We think it will deliver substantial synergies and ultimately preserve flexibility for future upside divestments. And then on the joint venture, Page 18, we've already achieved a number of milestones. The big one, and we've talked about it previously, the big one is to get approval from the competition authorities. And the big one there is Europe. That process is progressing, and we're still feeling good about fulfilling the conditions by the end of 2026. Turning to the segments. Firstly, pulp. Underlying demand is good. I've mentioned it a couple of times. We have been impacted by the lower selling prices year-on-year and the rand-dollar exchange rate. But other shorter-term dynamics have meant that we have seen an increase in price in the quarter. Just it's important to point out the Ngodwana shut was in this quarter as well. So that did have an impact on this segment. And then the next segment is on Page 21, the packaging. We've gone through a tough period. The markets here globally have been tough. excess capacity in Europe. We've had the project that we undertook at Somerset. And then more specifically in this quarter, the South African business was impacted by the shut at Ngodwana. Looking forward, underlying demand for containerboard in South Africa is good. And we were starting to see global containerboard, certainly in North America and a little bit in Europe now starting to come through. Hopefully, that will all be beneficial for pricing in the South African environment. And then we anticipate higher volumes coming through in the North American business. In Graphics, we've got the structural decline. We did take costs out, particularly on the fixed costs, but the rising input costs that I talked about earlier have impacted on margins. The U.S. market is a more resilient or a more imbalanced position following our conversion, and that will boost profitability. And also, seasonally, Q3 is a lower quarter for graphics and normally Q4 is our bigger quarter. Slide 23 has the regions. I don't intend going through that. The big themes coming through here is lower selling prices year-on-year, but starting to rise quarterly, and that's the overriding story with regards to the margins and a great ramp-up in volumes in North America. Then on the outlook, Firstly, demand, I talked a few times, obviously, about dissolving pulp being healthy and packaging ramping up as I referred to. Prices moving slowly in the right direction, which will support profits going forward. But importantly, we're not just sitting back and doing nothing on the cost front. And we've been proactive at taking costs out, and we'll continue to look at opportunities across all our regions. And if you move to Slide 26, we are targeting further operational efficiency improvement and fixed cost reductions. We're going to finish the joint venture, which I talked -- or the proposed joint venture, as I referred to earlier. So taking that all into account, we do have a smaller shut in the quarter at Somerset, but it is smaller. But taking everything into account and the improved conditions, the fact that we don't have a major shut, higher dissolving pulp price coming through. Based on all of that, we -- our guidance for the quarter is that Q4 will be materially above the Q3 numbers. So operator, let me go through the presentation. I'm now going to hand it back to you for questions.

[Operator Instructions] Our first question comes from the line of Sean Ungerer of Chronux Research.

Can you hear me? Just turning to the fourth quarter guidance in terms of being materially up quarter-on-quarter. That's great news. What is your sort of threshold on significant materiality? And I guess there was no specific reference to Q4 last year, where I think the print was about $111 million.

Yes, sure. Look, the market conditions a year ago were very different. So we didn't think it was appropriate to reference it against that. I'm not going to give you a specific number. But what I would highlight to you, if you use the current quarter as a starting point, you don't have Ngodwana shut, you've got a higher DP average price and improved volumes coming through in North America. So when you combine all of that together, that should give you a rough feel of the kind of territory that we're talking. I can't get more specific than that, but it will be materially higher than Q3.

Okay. I appreciate that. And then just in terms of your commentary around normalized profits to sort of bring net debt down. I guess the million-dollar question is when do you anticipate normalized profits again?

Yes. Look, it's too early to call next financial year. But if you do the math and you work backwards, you've got a maintenance CapEx number of around $250 million and an interest bill and a tax bill. It's clear that to begin paying down debt, you have to get close to $500 million of EBITDA, right? So we -- that needs to be the immediate target. It's -- I'm not giving guidance. I'm purely giving you math on debt reduction. So that's our initial target. And I think that market conditions are improving, but it's not clear as we sit here today when we can get to that number.

Okay. Perfect. And then just to North America on the SBS price increases. So just to confirm, in the current quarter, there was no benefit from higher pricing. Is that correct? And then perhaps if you could just -- I know you did mention the further benefit in Q4 and Q1, but are you able to sort of give us any sort of weighting towards those quarters?

Look, there's no benefit in the Q3 numbers, none. The first announcement was $60 a tonne. It's not all come through yet on the RISI numbers. I think it's fair to say that a proportion of that will be realized in Q4 and then the balance in Q1. So some of the contracts are linked and some of them are based on spot pricing. So it takes time to realize. So there's typically a 2- or 3-month lag.

Okay. Got it. And then, Steve, just in terms of the cost base, I appreciate a couple of the slides to explain the sort of cost pressures you have been experiencing across the business. I think the numbers quoted are sort of for the full year impact, right? But just to confirm, I think most of these sort of pressures only started filtering through in the third quarter and obviously are going to read in Q4 with H1 fairly clean? Or is that an incorrect assumption?

Yes. At a high level, and you'll recall our last results announcement, we had a substantial increase in costs in the Q3. And there is incremental increases in Q4 as well. But the jump is not of the same magnitude that we experienced from Q2 to Q3. But there is further cost -- and that's part of our outlook guidance. That's been taken into account. More clearly. Most of that cost increase has been in the second half of the year.

Yes. Okay. Perfect. And then just in terms of shuts for next year, I know you don't want to provide any guidance, but sort of at least on my numbers, the impact on EBITDA is likely to be similar-ish compared to FY '26, whereas obviously '26 was a lot lower than last year. Is that a reasonable assumption at this stage? If you just...

Yes, broadly, that's right. Our North American mills are on an 18-month shut. So you rotate the quarters for those 2. And then in South Africa, broadly in line, right? Yes. Sorry, the team are just reminding me that the Ngodwana shut for next year will only occur in October, Glen. So there will not be an Ngodwana shut in financial year '27.

Yes. Okay. Perfect. That's great. And then just last one, perhaps again. Just in terms of the net working capital for the fourth quarter, normally, we see quite a sizable inflow. How should we be thinking about that for this quarter? Is that sort of in line with last year? Or perhaps you can share some insight?

Yes, Sean, it's Glen here. So you're right, we do usually see a net inflow. We're anticipating a slight outflow this quarter -- this year, and that's really because of the ramp-up that you're seeing in our operations, the increases in prices and we're building into next year for a shut in Turkey.

Our next question comes from the line of Brian Morgan of RMB Morgan Stanley.

Can I just ask on the 2028 bonds. When does that window open? And just chat to us maybe a little bit about your strategy in that regard. Would you be looking to refi those with bonds? Could you do term debt? So just what are you thinking in that regard?

Glen, do you want to take that?

Yes. The -- in terms of the refinancing, we're constantly monitoring the market. We will want to refinance it at least a year before the time. So it's in April 2028. that it matures. The window is a 2-year window prior to that. So we're looking at it, Brian.

At least 2027.

Early 2027.

And Brian, to... Other part of your question, our primary -- we have to get to that refinancing, but our goal would be to refinance it with bonds, yes.

With bonds. Okay. Yes, that's fine. Can you -- can you give us a little bit of color on the SBS market as you see it? And you guys are adding quite a lot of capacity into that market. there's not a lot of capacity coming out of that market. The industry has been able to pass through price increases into a lower operating rate environment. Is demand just that strong? How should we interpret this ability to put through price increases?

Yes. I'll briefly answer, and then I'll let Mike elaborate further. Just Brian, there has been capacity come up. And I don't like naming other competitors, but 2 competitors have taken capacity out this year. In terms of the demand side, we have seen a pickup. But Mike, maybe you want to just go into elaborate further.

Steve, I think you are correct. So 2 competitors have taken assets out of the SBS market in North America. We continue to expect and we continue to see a growth of the 1% to 2%. And in addition to that, there's been another mill that's been down on the West Coast due to failure. And I think all that has had an impact on the market. Our market orders specifically have been continuing to grow and the machine is running well. And now we're working to speed up as we planned. And right now, we've kept all our assets full on SPS.

Okay. Cool. And just to confirm, you've received all your customer approvals now.

I'm not sure the question. Qualification for all of our products. Qualification, yes. Yes. All our base products are going very well, and we've introduced several other products to the market such as an oil and grease resistant and those types of things, which are still in the process of being qualified, but those are new products to the market as opposed to the standard products.

Last question...

Sorry, Brian, just one other comment. I mean typically, in the industry, as you gain new customers, they do want to trial the product on the machine. And so you may be making it for another customer, but they do go through trials. So that happens on all the time.

Yes. Better put, Steve. We do have to qualify with brand new customers, but the majority of that has been accomplished at this stage.

That's cool. And just on DWP, we've seen net paper pulp prices dropped in the last couple of weeks by around $20. Does this sort of cap the upside to DWP in the short run?

Yes. Look, it's an interesting question, Brian, and I'll let Mohamed jump in after I do. Look, there are numerous positives, and I highlighted them earlier. The one negative has been these lower paper pulp prices. But just to reemphasize once again that there are only a limited number of players who can use paper pulp in their viscose manufacturing process. And that kind of puts a cap on it. And similarly, swing capacity on the DWP producer side, there's only so many machines that can do that swing capacity. And a lot of that's already being directed to DWP. So it is a negative factor, but it is somewhat limited in terms of its influence. But Mohamed, maybe you can talk more broadly.

Yes. Steve, I would just add to what you're saying is that the VSF industry in China, in fact, outside of China also, the operating rigs have continued to remain very, very high, low inventory levels. And the value of those very high operating rates, even though we are now in a seasonally slow time means that from a quality perspective, dissolving wood pulp makes it easier for the guys to run harder. So with demand being good for fiber, I think the need for running, let's say, higher quality raw material is also much higher. So that also, I think, continues to create a positive situation for dissolving pulp and also limit the usage of BEK to just the guys that have the technology to actually use BEK.

Our next question comes from the line of James Twyman of Prescient.

The first question is, Steve, the covenants with the banks are until March. Could you give us some idea of sort of when the timing is for extending that and how long you would plan to extend that by? And related to that, how much of your debt would you say is subject to those covenants?

Okay. On the first one, look, we're in constant contact with our banks. We have great relationships with them. We share our estimates with them, and they continue to be very supportive. So in terms of what would happen in '27 after the covenant come back, we would be proactive. We've always been proactive, and we will ensure that we have sufficient flexibility in next year when we come out of that suspension period. And that's what that is an ongoing process, and we're doing that already. In terms of the covenant itself, Glen, it specifically to the RCF, right?

It's linked to the RCF.

So it's the RCF facility and the OeKB loan.