Thank you, Cathy. Good afternoon, everybody, and welcome to Stora Enso's Q2 conference call concerning the results that we published earlier today. We will start with the presentation, and I will hand it over to Jouko, who will start, and Markus then will continue. After that, there is a Q&A session where questions can be answered. Please go ahead.
Thank you, Ulla. Thank you, everybody, for taking the time to be with us today, and welcome to the best second-quarter release review in 10 years. This is our best second quarter in 10 years. Not that I checked, but our people did, and I think it's maybe more curiosity than anything else, but that's the reality. EUR 228 million quarterly operating profit, excluding non-recurring items and fair valuations, an improvement of only 7%, and clearly massively driven by a year-on-year improvement of pricing and mix, but mostly pricing, and then reduced by a few things. One, a compensation that we've been talking about quite a bit, of EUR 128 million, and a year-on-year net negative impact of currency, EUR 48 million. If you look more sequentially, also an impact from a reduced net power balance.
If you can turn to page four, I believe, which is this little graph, an EBIT and EBIT margin excluding non-recurring items, there you see that we continue to climb up the hill, and it is again a solid quarter. We're happy with the performance of the second quarter, I must say, on the balance of it because we believe strongly that also the pricing quality that we'll talk about a bit more in a minute. It didn't happen automatically. It was driven by, besides the early action and capacity reductions, you can take the example of why newsprint pricing is so much better now. Because Stora Enso and only Stora Enso closed three machines last year. We are trying to take credit for the action, and that's what's talking. Short term, there were a few limitations on our earnings performance second quarter, now compared to the first quarter more.
Significant maintenance stop with a negative EUR 37 million impact in Q1, which, yes, and we'll tell you in a minute, it has a positive Q2 to Q3 impact. We had, because of the maintenance specifically being in a couple of our pallet mills and the Imatra integrated pallet mill, we were low on net balance of selling pallets, but very good pricing, obviously. Actually, 66,000 ton reduction from Q1. That will also turn slightly positive in Q2 to Q3. This is important because we see, as you heard, and obviously didn't like too much, a relatively significant increase in uncertainties. If you can please turn to page five, the demand graph, the old graph, updating now for Q2, the historical. The selected grades there, if I can point to you specifically on the quality fine paper where you can see that's the lowest graph at Q2 2011.
That is a worrisome signal to us. Remember, this is not a forecast. The Steffi report in Europe is quality guttery. Demand went down 12% year-on-year in Q2, whereas unquality went down 6%. To us, that is a signal that we better make them ready for maybe a less certain future than all of us, including you, would like. If we then turn to page six, which is the pricing graph, yes, closer quarter for billion earnings improvement on price and mix Q2. As you can see on the examples here on a very broad scale, like I said before, it did not happen automatically, and pretty much independent of the grade, we are trying to take credit for those actions in terms of improving both the demand-supply situation, but also being very determined that price and quality is critical.
Page seven, which then brings us to the outlook, which obviously is less liked by many. I specifically want to say uncertainty. It is not a negative outlook by any means, but it is an outlook that says, yes, there is more uncertainty. Yes, it is driven by also the undecisiveness or the long, long lacking dialogue and discussion on the debt price in Europe. When we look at the markets, specifically country by country, we can see a clear correlation on the weakness in the economically weak countries versus the strong countries. That is why we are giving this outlook. Post-inflation remains at the 4%, and selectively, then we can obviously see already, for example, in RCP, that there is a small turn to the better direction.
I need to highlight also that our closed inflation uses pallets at the gross value, so we put the pallet price increases on the purchase pallet here, not on a net value. That changed the number a bit. The point of the story, no news there. We continue to pursue improved cost and mitigate these issues. Specifically, I want to mention, because the press headlines were what they were, is that we see both the fine paper action in the second quarter, but also the logistics action. Remember, logistics costs a billion of our cost base in terms of improving this cost, but maybe more important, flexibility. That is very good investments from the company. Again, early, as early as possible, even though it has the cost related to it. When we look at Q3, we come up with this approximately in the same range as Q2 2011.
Yes, we get a plus from Q2 Q3 from maintenance, and we get a plus from pallet net sales, not so much pricing. Like we've discussed also in our quarterly report, there is also a negative, and if you want to kind of highlight them, basically, currency will be a negative even sequentially. As we mentioned, a couple of RBAs, we see geographic mix to be unfavorable on the earnings. Short term, the wood product, which is also shown as a red demand arrow year on year, is basically a customer inventory level issue that we see there. Pricing on the same chart, I still think it's very green relatively. We've been able to actually execute price increases in newsprint and magazine, which I think is very good.
If that's the PowerPoint, we have announced price increase in fine paper, but what we've clearly said in the release is because they are scheduled to happen on September 1, it's going to be very limited impact here in this quarter. That's the story. More uncertainty. Am I sure that my maybe conservative view is right? No, but I am pretty sure that if I'm wrong, then it's better to be wrong this way than the other way. I think it's in the interest of our shareholders. Let me turn it over to Markus to talk a bit more about what we've done and are doing for the good of the company. Markus.
Okay. Thanks a lot, Jouko. If I turn to page eight, we have a chart there which looks at our sales per employee per each of the quarters here, which implies what our productivity development has been. From year 2007, we had Q2 sales per employee of EUR 80,000. Now we are slightly over EUR 100,000. Turnover on a run rate basis is close to the same level. In the past four years, we have done a lot of work, as you know. The results start to be visible when we look at this development. The direction is right, but a bit same as with our results. We feel that we have only started this work. We are by no means complete here.
This also gives us a good buffer in case the market would get even more volatile than it is today, and also gives us a good platform for future development. If we turn the page, look at another aspect, the total fixed cost per sales line. The flexibility also has increased. We have been able to reduce our fixed cost from a level of about EUR 0.28 per sold euro in 2007 down to a level which is a bit over €0.24. This is another good cushion if the operating environment turns more negative. I think here as well, we just want to continue, regardless of the circumstances, to develop this flexibility further. On page 10, you see the net debt to EBITDA development. The balance sheet remains strong. Gearing is low, and we have almost EUR 1 billion of cash on our balance sheet.
This even despite the EUR 198 million of the increased dividend payment. We will definitely want to keep this strong balance sheet and good liquidity. I think, again, we just reiterate that any kind of volatility and softness in the market for us against where we are is more of an opportunity than a threat. This really opens for us windows of opportunities. It also has enabled us to be a bit tactical, for example, with regards to wood procurement, where we have increased the working capital to be able to keep the wood price development a little bit on a better level. That brings us to page 11, the inflation. What we have here on the page is, first of all, a column showing what has been the realized cost development on a year-on-year basis.
From Q2 2010 to Q2 of this year, and then the sequential from Q1 to Q2. On this second column, the RCP and pallet cost increases, from our point of view, have been rather modest, and as Jouko was saying, a pallet increase is not a bad thing for us. Overall, things have gone very much as we have been anticipating. We had a sharp increase year on year on the costs, and now the inflation has slowed down. Our forecast and our expectation for Q3 is that the cost inflation will be very, very modest, almost nonexistent from our point of view. There is some variance, of course, between the different items, but it will be very small. Finally, from my point of view, on page 12, we have the pallet price development. On the chart, you can see both the softwood and hardwood pallet.
For us, again, the long position we have is on softwood, and the short position is on the hardwood pallet. One thing I've noticed, and we get a lot of questions about the pallet pricing, is that a very large part of our business is based on the fixed prices and their contractual, long-term, solid business relationships, mostly in Europe. The recent news that we have been seeing also in the press are referring largely to spot prices in overseas markets. From our point of view, what I said first is more of the picture that we see in our end. I give the word back to Jouko.
Thank you, Markus. I'll try to be really quick so we won't take all of your questions out loud. A few, actually, one page. While we're doing all the productivity improvement, fighting inflation, improving price, we are also building the future of the company. Slide 13 basically says that the projects we launched and announced before, Mondi Świecie, the pallet mill, I was in the board call on that 10 days ago, or the ultra-light containerboard machine, the wood-based construction element, Kuko. Everything is on plan. Specifically, maybe the Mondi Świecie is of interest because it's so large. We are on time, and we believe we're right on the other targets as well in terms of the capital spending and so forth. That we think is very important and good news because the action has actually started quite a bit there.
I also want to mention again the microfibrillated cellulose project, a very small investment relatively to our scale. That, unfortunately, has made it small news, even though I think it should be dramatically big news. It is not a technology base. It's an add-on technology to an existing pallet mill. We're doing the pre-commercial, and Imatra have ordered the hardware. We'll do installation starting in September. The beauty of it is this idea protects it and technology we can use in any chemical pallet mill we have in the world. We think it offers significant competitive advantages to us. Finally, not a huge one, but a combined heat and power plant investment in one of our low-cost engineered products, sawmill combinations in the Czech also today. Why is it important? The important thing is that we try to build the transformation of the company as well. Last slide, 14.
We think Q2 was solid, nothing else. We also say that we continue. I know it's a broken record. We will continue and have continued on the cost improvement, productivity improvement path. We try to be always as early as possible. Fine paper announcement, logistics announcements, two examples on a long, long string. The good thing is this daily maintenance sequential impact out, the fixed cost continues to decrease. Still, like I said, investments are moving along per plan. The final word really is when I do not exactly know how the world, how the European economy will work out in the next three months and beyond that, and neither does anybody on this phone, I think, then I think the flexibility we build into the company is going to be a humongously important fact. With that, I was wrong. The last page is for 15.
I'll leave you with that fo r questions. We wake up every morning and say, what do we do differently? Thank you very much.
Okay, we are ready now for the Q&A session.
Thank you. If you'd like to ask a question at this time, please press the star or asterisk key followed by the digit one on your telephone keypad. Please ensure that the mute function on your phone is switched off to allow your signal to reach our equipment. If you find that your question has already been answered, you may remove yourself from the queue by pressing star two. Again, please press star one to ask a question. We'll pause for just a moment to allow everyone to signal. We'll take our first caller today. Our first question comes from [Mikael Jass] of Chevron.
Yes. Hello, everybody. It's [Mikael] here from Stockholm, Chevron. A couple of questions. I missed the beginning of the call, so excuse me if you already covered this, but for the following quarters, how does the maintenance profile look like? The second question is that as you show us that you have multiple productivity improvements ongoing, could you please give us some flavor to what are the big changes aside the fact that you're becoming more flexible in offsetting the cost inflation that you see? Thank you.
Okay. If it's okay, this is Jouko. Hi. Thanks for the questions. I'll start, and I think Markus can give you a little more flavor on the cost inflation battle, so to say. I won't go beyond quarter three. We think we discussed today that there was a total negative impact of EUR 37 million, I think, sequentially Q1 to Q2 on maintenance because there was no maintenance in Q1. Order of magnitude, when we go from Q2 to Q3, about a little half, a little more than half, or EUR 20 million positive impact on from the maintenance point of view, both cost and margin. Why? Because we do have quite a bit of maintenance also in Q3, not as much as in Q2. That will, I think, cover that. The second question, then overall productivity and flexibility, the inflation side is hundreds and hundreds of progress.
If I may use the example of some of the things we've done on the flexibility side, or we are doing, I mean, take example maintenance cost, which is a very significant cost factor in our world. We, I think, as the only one in the industry, outsourced that to a joint venture between us and ABB a couple of years back. Very direct cost savings. ABB also foreseeing efficiency or productivity improvements because of preventive maintenance, predictive maintenance practices that our partner has. Third, as you'd expect, a contract like that, volume sensitivity of cost is significantly less than it is if you're insourced. There are other examples like that. Logistics that we announced in the second quarter, to my liking, our system may have been very good in many respects, but it was, to me, too fixed cost.
One of the major objectives of the restructuring efforts in the logistics area announced in the second quarter is that if and when there are changes, and I don't only mean cyclical demand changes, but I mean moving from market to market, changing product lines, changing production lines to the lowest cost unit, which you've heard me say a million times. I want a logistics pipeline or a supply chain that can deal with that. I think that's one of the industry issues that it's not good enough that you're perfectly perfect when everything is as you planned, but you have to be pretty perfect when everything is different than you planned. Geographic mix, product mix, manufacturing mix, and so forth. Sorry for the long answer. Markus, you want to add something on the inflation action?
Inflation actions, I would just say that, at least from my point of view, the cost fighting and efficiency improvement effort is wider than ever in the company. The 700 programs that we have going on, I think, are taking us to the next level of penetrating all the parts of the company. That also means that we will engage another layer of people in this. I do expect, honestly, that once we kind of get through this step, that means we will have more people who are able to do the changes. A good example of what we are able to do now is the announced plans in fine paper and logistics. We are swifter to react. We have better ability to plan. We have better ability to execute if and when needed. We have the skills to do that, but also in a socially responsible way.
I think, [Mikael], that is, and one thing on the maintenance, I would just say that in Q3, the main stops are Imatra and Heinola. They will be impacting also the consumer board business.
Okay, thank you very much, gentlemen.
We'll take our next question today from Mr. Lars Kjellberg of Credit Suisse.
Good to come back to your comments about pricing. If I recall, we talked about this in the spring. There were clear expectations of more material price increases, and we've heard from one of your competitors, 1%- 2%. Can you tell us a bit, so give your side of this? What do you think? Are we looking at 1%- 2%, or? Is that not a disappointment given how costs have had in the second quarter? Also, if you want to comment on the fine paper, obviously, you have also announced a price increase for September. Given the weakness in demand and, I guess, somewhat easing pallet prices, how do you feel about the possibility of that price increase? The final question, I guess, I think, Markus, you mentioned a window of opportunities from turbulence.
If you want to elaborate a bit about what opportunities you see in a turbulent world.
Okay. I can start with the window of opportunities. I think the Angus isn't together with ARAUCO of the Anza Forest. That was an example of what can be done. We have our clear directions where we want to go, things that we want to develop. There's a lot of potential out there in the world. These windows, when there are such, of course, are relative strengths and become stronger. I hope that clarifies.
You've got nothing specific in mind now. That's obviously in the past, right? You.
We do, but we won't say it loud on the phone. Like we've not said that before when we did the ARAUCO.
Sure. Okay.
Good. On the pricing, I think, if I understood correctly, I wasn't quite sure if you asked a very specific question or generically. Can you help me with that?
No, it's slightly generically, I guess, talking about 1%- 2%. I guess we can see the same comments from RISI where price increases have been more than down from EUR 40- EUR 50 or EUR 10- EUR 20, which is kind of the same direction, I guess.
Yeah. The first short answer is yes, 1%- 2%. The second answer is it's disappointing. I'm never disappointed, but it does mean that we have to be very, very firm in keeping to push the pricing up. Because if you remember, on the other side of the story, the pricing curves I showed in my presentation, there's been a pretty significant pricing improvement overall before this most recent 1 to 2% push. I can assure you we will continue pushing. The fine paper question, I wouldn't want to speculate. This pricing increase in fine paper has been publicly announced. They are to take effect on September 1. How effective they will be, I think it's going to be obviously driven a bit on how the July-August auditable development, so forth and so on. For the time being, we're going to fight for it.
If I may, also, on the consumer packaging, some of your competitors have been very vocal about price increases, which clearly have not succeeded. You've been less vocal there. Why are you taking a different approach? Are you just seeing the market differently than some of your competitors?
First of all, consumer board, and consumer board, as you well know, has very different pricing structures, partnership agreements, depending on the grade and so forth. I would bear to say, without knowing the exact detail, that we've focused at least as much on pricing quality. I actually do hope that we talk less and do more. If we're not very successful in increasing price, we hope we don't. I don't want to communicate through you people, let alone the media, price increases. I always keep saying there are people that you have to talk to your customers and agree with them. Yes, we will talk to you. There's been less of that development to your point.
No. Okay, no, that makes sense. That's all for me. Thank you.
We'll take our next question today from Mathias Carlson of UBS.
Yes. Good afternoon, gentlemen. A couple of questions. First on consolidation. Now, we had the unconditional approval of the UPM-Myllykoski deal. How do you view that? How do you see that deal affecting your own kind of efforts on the consolidation side? I mean, you're already one of your strategic pillars to be in selective grade. How do you look at this deal?
Okay, Mathias. Jouko, thank you for the question. I think you asked actually two questions. What does the UPM-Myllykoski now unconditional by European Union approved deal affect our consolidation efforts? The short answer is not at all for two reasons. One, the deal, as we see it, doesn't do anything to anybody. It is the actions after the deal that will possibly have a positive impact on the selected segments that they're addressing. You obviously need to discuss with UPM, not me. Second, our view then, I guess, is very clearly, and I won't use the word selected basis. That's going to be it. Yes, we're still looking and interested, but on two items, hopefully clarifies our view beyond the history. One, it needs to be value creating to the shareholders for Stora Enso. You don't look at that from an industry point of view, as you can well understand.
Two, on the balance of economy scale benefits being big on a region-wide basis, which is one thesis versus improving your delivered cost to the customers that you happen to serve, as the other thesis being a competitive critical factor. I believe we are very clearly of the view that also consolidation, like most other things we do, has to serve the purpose of improving our delivered customer total cost, basically giving resource cost. We think that is more critical than being the biggest in any given segment in this type of an industry with commodity products, low-value products, and a relatively fragmented customer base. I don't know whether that helped you or confused you.
I mean, basically, what I'm after is that given the way that EU now had defined the publication paper markets, adding together newsprint standard also into newsprint magazine and codifying, does that help you in the consolidation process in any way, the way that now you have defined the market for this grade?
Let me just comment. I think this is the third question. Is it helpful that the European Union has decided to combine paper grade? Yes, for anybody. It doesn't have to do with us because it gives an easier market share definition, obviously, in any deal. Let me just also say that that hasn't exactly been the issue with our consolidation thoughts anyway. If you heard what I said about if you have to select between being very big in a grade, which would lead to very high market shares versus always improving your total cost base also in consolidation, then that's less of a concern, right?
Yeah.
Okay.
Okay. Final question. Final question, which I think is quite important here now, given that what you talked about, code of fine paper markets, and also you've got 1 million tons of market pulp. If now demand for fine paper is coming down, that share might even increase. How do you intend to play this game here now? Given that you're selling so much to the market and pulp prices are rolling over, and you're then shipping market pulp, and given that that has obviously had a negative impact on me if prices are rolling over, you're contributing, so to speak, to the fall in pulp prices. Are you prepared to remove market pulp volumes in order to keep the pulp price high and also then to defend, let's say, higher fine paper price? If pulp price comes down, fine paper price are most likely to drop as well.
How do you play that game there? I guess that's quite important in terms of your own profitability going forward, given that you've had such a massive profit boost from market pulp.
Okay, Matthias. I'm maybe slightly on thin ice here because I'm not so new in the industry, but let's be very clear. My very strong view is that there is now a clear separation between long-fiber pulp and short-fiber pulp. We are a net seller of, call it, 1.2 million tons of long-fiber pulp from our Nordic mills. We are a net buyer of short-fiber pulp. If you talk about fine paper, that's a short-fiber pulp application. Like I said, we're buying short-fiber pulp today because we don't yet have enough capacity of our own. We actually see now that the long-fiber pulp, that's more than in other grades in fine paper. If you look at the most recent price trends, if the Chinese come back from their summer holidays, as I call it, remember we had exactly the same discussion a year ago on the softness of pulp pricing.
That shift stopped in September when the Chinese came back. If that all works out, how do I say? I think I'm a lot less worried than you are. I don't buy a rollover effect, and I specifically don't buy that our long position on long-fiber market pulp would be dramatically impacted right away by the fine paper issue. Sorry for the long answer. Long fiber and long answer.
Okay, thank you very much.
Thank you.
We will take our next question from Markus Ormerod of Morgan Stanley.
Yeah. Hi, Markus Ormerod here from Morgan Stanley. The first question is about taxes and financials in the second half. The tax rate was a lot lower in the second quarter than the first quarter, and also the financial cost went down. What should we expect for the second half? You're talking about the operating profit being the same level. That would be very helpful.
Yeah. Yeah. Okay. Markus here as well. I think, again, I'd guide to the 5% about on the net debt being a good proxy for our net financial items over the long run. There will be volatility between the quarters, but second quarter is a pretty good indication of where the financial items normally would be. Income tax for Q2 was unusually low, and it would normally be higher. The statutory rate should be somewhere around, let's say, around the low 20% and the effective rate somewhere around where we were in the first quarter, roughly.
Okay. Perfect.
Last year, 2010, was a pretty good indication also of our income tax. Around, let's say, the mid-teens is a good proxy. We have the reason because of the volatility that we operate in different jurisdictions, and we have, of course, due to the write-downs and all of that, a lot of tax losses that we are utilizing and so on.
Okay. Okay.
Income and all that. Otherwise, I hope this guides you.
Okay. Perfect. My next question is in industrial packaging, where I was a bit surprised, to be honest, that your margin is actually up quarter on quarter despite raw material costs being quite significantly higher. Could you just explain the reason for that, please?
If we don't look at the quarter on quarter or whatever, there is a positive correlation traditionally between containerboard price, i.e., cost for a corrugated box plant, and the price of the box offering, which is very different than in, say, newsprint. You can automatically assume that it would be all negative on corrugated, I'm sorry, containerboard pricing goes up. That's the best example or answer I can give. Markus, do you have more specifics, or do we leave it at that?
Yeah, I think the bathroom there is good, and prices have been coming up. I'm looking at it.
Okay.
I mean, that's about it. I think that is also for us, it's a fundamentally important thing. That is why also the acquisition of Impact, the growth in the corrugated area, because we have good underlying market dynamics, and there is perpetuability of cost in that business.
Okay. Continuing on industrial packaging, you're talking about growing in the fiber-based packaging and pulp, and that's the core of your strategy. Where do you see yourselves growing? You're still quite small in industrial packaging, especially compared to consumer packaging. Do you want to be a larger player, or are you quite confident where you are? Could you just elaborate a little bit on your thinking there?
Okay. It will take a very long time to answer this because maybe the interesting or the dimensions of interest in packaging is we have to be selective. Packaging for the sake of packaging or saying that fiber-based packaging doesn't do any good to us. What we'd like to do is growth markets. In fact, example, China, India, very interesting. A lot more of that than Western Europe. That's an excellent comparison point. Second, in segments where we can actually also hook up to the global brand orders and so forth. Consumer packaging or consumer corrugation packaging, to me, is clearly more attractive than just from box transport packaging. If we talk about what we call our industrial packaging area, those would be the growth dimensions, both organically and inorganically, if we find more opportunities like Impact and so forth.
Okay. Could you just repeat, please, I'm sure you've said it and I missed it, but could you just repeat, please, why you see EBIT being unchanged compared to Q2 when you see it's only 1%- 2%, but you still see some price increases on both news and on magazine paper, and also you had the reversal of the maintenance cost you had in Q2. Could you just explain again, please?
Yeah. I'll obviously oversimplify from the monster table I have in front of me with many columns and rows. Seriously, basically, yes, we get a positive benefit sequentially from our maintenance, about half the negative of, so call it EUR 20 million. We do get a smaller, about the same amount of benefit sequentially from a higher net pulp sales with the all-time record pricing of long-fiber pulp. Those are the positives. Currency will be, because of also hedging, expiring, and so forth, a negative for us in sequence Q2, Q3. There is, I think I should say, a bit in, for example, wood products because the government uses volume weakness too. We are worried about the combinations to wavering demand in fine paper or specifically coated fine paper. Those would be kind of that's how we walk down then from the yield to the same range as in Q2.
That's the simple variance analysis.
Okay. Perfect. Thank you very much.
We will take our next question from Mr. Ross Gilardi of Merrill Lynch.
Good afternoon. Thanks, guys. Just following up on the Q3 versus Q2. When you're looking for flattish type earnings, are you assuming any further price erosion in pulp and paper pricing, or are you essentially just marking to market where we are now, or we're at the end of June and assuming that holds for the rest of the quarter?
At our, I guess, slice of XZ also, we're basically seeing packaging sequentially flat. We're seeing the 1%- 2% we talked about, the slight price push in the newsprint, the magazine arena. We're saying effect pricing in fine paper flat because of the fact that the price and our price increases come so late in the game in the quarter, which is September 1. Before it really takes off, it's going to be probably the last two weeks of Q3, that's too late. We also say that on wood products, flat development, and that I obviously.
It seems you're like on fine paper, we're already starting to see price erosion creep into the indices over the last month or two. You know, more than one, not huge, but also more than 1%. Is that factored into your Q3 outlook?
How do I say this? Yes and no in a way because, I mean, there are other factors that we obviously think about in qualitative fine paper. I understand from yesterday the final decision on [BidVeris] is done now. Half a million tons going away. There is the balance of the interesting import duties from China to Europe. There are positive and negative factors and so forth. Basically, I stick to what I said and our slide said we expect flat pricing in fine paper sequence Q2, Q3. If it's then 1%, if I'm 1% off there, I'll find the 1% somewhere else.
Yeah. Maybe, Ross, the one thing I'd add here to complete the picture is that we have some geographic mix weakness in a couple of the segments. What Jouko is referring to is actually the prices per market. We have a negative market development, like market split development in some of our businesses. I think the effects are something to note. I'll just emphasize that, as I've been saying in previous calls, we hedged quite significantly long and more than normally the Swedish Krona exposure that we have. When we roll these hedges over that were done at excellent rates, we get some headwind here, which is not totally insignificant from Q2 to Q3.
Okay, great. In terms of strategic priorities, I appreciate that you outlined some of the bigger picture considerations for any acquisition target that you might look at. Can you give us some sense as to where your real prioritization is across the portfolio? You've talked about expanding the packaging business for several years now. You've made this smaller acquisition recently. You're doing this Polish containerboard expansion. Can you give us some granularity in how you're looking at expanding the packaging business in your portfolio versus consolidating the graphic paper market, which is still, whether we like it or not, a very big portion of the portfolio? How are you looking at one versus the other?
If I may, and this may sound, it's not meant to be funny, but it may sound funny, but I don't think it's an either/or. I feel responsible that we will have to get together with our board into a conclusion and action on our paper portfolio, which is better than saying selective paper grades, but actually doing that. I fully understand and respect that we will have to do things there. I don't think it's an alternative to the fact that we have said and are saying that we would like to and are working on growing our fiber-based packaging business. Yes, we've said that for a long time. Yes, we've taken some small actions, you might call it, impact, but I think it's a significant action in about 5- 10 years when you see the growth rate opportunities there and possible add-ons.
We've taken the action now on the lightweight board in Ostrołęka. As you well know, one consideration, as I mentioned here, is no decisions made. I want to be very clear on that. The 93,000-hectare plantation we have uniquely in China, which you know well, in Guangxi, one clear consideration there is that that would serve in the future us as a unique fiber-based packaging integrate for the Chinese market. That obviously is a big thing then and a very unique thing and so forth. In addition to that, yes, we're looking at the M&A horizons and so forth, hopefully with the discipline in terms of sticking to our strategy, which is, like I said before, be selective, meaning don't go for anything that moves in fiber-based packaging. Priority growth markets, not mature markets, priority consumer packaging, brand ownership type of things versus transport packaging. We do that too.
My point is that's just one avenue. I think that's the best I can say that.
In terms of balance sheet targets or financial targets, can you give us some idea of where you'd be willing to go with your leverage?
Okay. To be honest, before Markus answers that, I'm saying no, we're not going to give you an answer. To be honest, right now, I'm very happy that we got such a strong balance sheet. Because of the uncertainties that we've experienced and the turmoil in the past two years, I think it's very good because we're so solid now on balance sheet.
How could?
If I may, just use the example, you know, Mondi Świecie, eight years faster, nobody could have ever done it on our own, would not have happened with a weak balance sheet because if you remember the turmoil we were then. The point I'm trying to make is I don't, I can't give you a ratio for multiple years forward, but I can say that right now, I think we got the firepower. If we get the strategy right and the right targets and the synergies and so forth, our strategy will not be limited by our balance sheet. Mark, do you want to help me?
Yeah. I think the safest target is to keep the year-end below 0.8. That is, of course, clear. As well as the return on capital employed 13%. We are happy to increase the leverage and utilize the balance sheet, which is a bit underutilized at the moment. That has to happen with also appropriate cash flow coverage. I think we will be careful, of course, doing the right things and grabbing the opportunity and then funding that appropriately if and when these opportunities come. The liquidity aspect is, of course, that in these kind of circumstances, we think that the opportunity might come exactly when the market is not necessarily open.
That's why we like having the billion of cash to be able to do M&A, to be able to restructure, to be able to invest when we think it's the best time to do it and not when money is available.
Okay. Lastly, hopefully, this is not a situation that you have to think about, but you know we're seeing some weak data on paper demand and pulp, and maybe the inflection in the pulp is the same as last year. Maybe it isn't. Do you have any flexibility to alter the timing of your containerboard and Uruguay pulp projects if we were to be going into a more significant cyclical downturn right now? Is it your view that these projects are pretty much coming on in 2013 no matter what?
In my four years in this industry, I kind of learned one thing. Never say no matter what because it's changed. Everything's changed three times over. I think right now I can say that we're very focused on time, on target, execution of Mondi Świecie and Ostrołęka. The 1.1 and 0.2 is we also look at, obviously, we look at from a total capital cost point of view. We actually have, I won't give you the number, but for the team in, for example, Mondi Świecie, we know exactly what the cost of one-day delay is because obviously we're tying up capital extremely fast now and so forth. We would never take this on an emotional basis. We would look if there would be a value creation in delays. Right now, the way it looks, we'll speed ahead. Obviously, I don't want to say no matter what.
That would be too silly. It's not the time to make those decisions, no.
Right. Fair enough. Thanks a lot, guys.
Thank you.
Our next question comes from Linus Larsson of SEB Ens kilda.
Yes. Thank you. Good afternoon. Coming back to the bridging of your third quarter guidance and the second quarter results, if you would look at your variable cost development into the third quarter, could you please comment on wood and other input raw materials, please?
Markus can answer. It doesn't matter. Go ahead.
Okay. Like I said before, the variable cost development is going to be very, very small. The inflation quarter on quarter should be almost unnoticeable. The variations are calculated in some millions, plus and minus, per the different cost items. I think that's how we see it, that very flat cost development quarter on quarter. I wouldn't even go into the detail of the different parts there because of this.
That's fine. The FX impact that you mentioned, would you care to quantify that? Q3 on Q2?
Yeah, let's say it's in the ballpark of the other numbers that have been mentioned here, type of thing like the maintenance cost or maintenance impact reduction. We talk about the same scale in the FX.
Very good. If you would say, you say it's overall a flattish EBIT development on the group level. If you would look at various divisions, would you care to say which are up and which are down Q3 on Q2?
Yeah. We don't comment specifically on those. I think that, of course, we give the guidance and the pricing, and we mentioned that some of the maintenances and demand as well. I think you have to build it from that point. I think we give as much guidance as we can.
More than most others, I dare to say.
Sure. No, that's fair enough. Your wood product division was very strong in the second quarter. I think it's the best margin since 2007. If you'd care to comment a bit about what happened in Q2 and what's going to happen. You mentioned there will be some downtime during the third quarter, but market-wise, should we expect any impact from what's happening in Japan and so forth, and any color on Q2 and that particular outlook would be helpful?
Yes. Q2 was very good, this is Jouko, on wood products. If you look at sequentially, quite a significant improvement. Interestingly enough, their material cost was not negative sequentially. They were quite good there. They had a somewhat slight pricing improvement and so forth. Good volume growth, and that then added up. Remember, we're still talking relatively small numbers, to be honest, so it's a little volatile. Looking forward, I think the key issues for them are that, as we said, that on a group level, the variable cost inflation, so to say, it sat for us quite a bit. There is some of it in wood products coming even sequentially, and that's going to hurt them a bit. Japan specifically, it hasn't been as bad as we thought in Q2. I'm not sure it's going to be as good as we thought.
I think three months ago, we were talking there's going to be somewhat negative in Q2 because of everything with JAN in the harvest and so forth. That didn't really hurt us, so to say. I don't see a huge help in Q3 yet either, even though we are one of the few who are certified with the Japanese quality standards and so forth and so on. In summary, they had a great second quarter, but now they are with their customer up there, but the industry customer inventory, so to say, pretty high up. We're facing also a bit of a volume challenge, I'd say, in the third quarter. That's what we showed the Earth the way we showed.
Okay, thank you very much.
Thank you.
We'll take our next question from Harri Taitt onen.
I pretty much tackled already, but maybe if you can comment the roundwood sourcing, if you have sort of implemented any changes in the volumes imported from outside the Nordic countries, such as the Baltics or Russia.
Marcus, you want to think? I can start while we're looking for maybe more data on that.
Basically, the imported wood has grown relatively. We think it's quite important that we use that opportunity just operationally, but also because of the fact that going forward, I actually am, believe it or not, pretty seriously hopeful that the Russian WCO will work out, and there will be a significant benefit directly through the sourcing opportunity we're really used to is from Russia, but maybe even bigger because it will have, when we open up, so to say, one sourcing market for wood in Finland and Russia in the geographic, it will have quite a significant impact on our cost performance on that side. As you may remember, specifically on Solorox, we're at the pain level right now.
I said today in the Finnish press conference that somebody said, "Where's the pain level?" I said, "I'm already hurting today." We need to keep pushing on the imported wood also to control that. That's all right.
Yeah. No, the only comment I'd add to that is that, like I said before, of the year-on-year working capital increase, half of that was on our wood suppliers. That's been a conscious decision to do that and to prepare and try to be in a position where we wouldn't be hurt so much by the pricing development. We are paying a price on that on the working capital side, but that has been deliberate.
We have said today, to be complete, that we are considering, not planning, but we are considering temporary curtailments on sawmilling if the cost-to-price ratio isn't giving us a chance to earn money. You should know that.
Right. Thank you. Just sort of one final confirmation on the FX item side that I understood correctly that the change that you referred to in the third quarter is not one-off type, but it is.
In the Finnish press conference, somebody said, "Where's the pain level?" I said, "I'm already hurting today." We need to keep pushing on the imported wood also to control that. That's all right, I think.
Yeah, no, the only comment I'd add to that is that.
In the Finnish press conference, somebody said, "Where's the pain level?" I said, "I'm already hurting today." We need to keep pushing on the imported wood also to control that. That's all right, I think.
Yeah. No, the only comment I'd add to that is that, like I said before, of the year-on-year working capital increase, half of that was on our wood suppliers. That's been a conscious decision to do that and to prepare and try to be in a position where we wouldn't be hurt so much by the pricing development. We are paying a price on that on the working capital side, but that has been deliberate.
We have said today to be complete that we are considering, not planning, but we are considering temporary curtailments on sawmilling if the cost-to-price ratio isn't giving us a chance to earn money. You should know that.
Thank you. Just sort of one final confirmation on the FX item side. I understood correctly that the change that you referred to in the third quarter is not one-off type, but it's an indication of the new level of, say, profitability at the new rates once the earlier hedges have expired. Is that the case?
Yes. Of course, that is the impact of where the hedges were made. Then again, the underlying spot rates have moved a little bit favorably compared to where we were already at, from our point of view, at the worst time during the previous quarter. The situation, both the spot rates and our rolling hedging levels, continue to change. You shouldn't take that unless you then benchmark exactly the spot rates at a given time.
Yes, understood. Thank you very much.
Good, thank you.
Our next question comes from Mr. Karri Rinta of SHB.
Yes. Thank you, Karri Rinta, Handelsbanken. I have a bit of a more broad question, and it's actually, if I look at the valuation multiples implied by today's share price, it tells me that the markets are pricing in a 30%-40% drop in earnings in 2011 or 2012 and 2013. My question is that with the flexibility that you have built in in the past few years, units that you have closed, things that we have seen in the market, what would need to happen in the economy and sort of in things beyond your control that this would actually become a reality?
Very.
My question?
Yeah. It's an excellent question. I'm struggling to find a way to answer you without giving you multi-year forecasts, which I will not do. I think, is it fair to say, if my reading from today is that the market's actually happy, they saw that we delivered what we promised, the performance was actually pretty solid. They did not like what we said about the other. Certainty.
On the market in the next three months. I think that's how I read, and then the extrapolation to multiple years is done by the market. I don't want to comment on that. I would suggest maybe this. It is important, and this is another sort of story, and I say it everywhere I go, including national TV. The national government and the European Union need to stop talking. They need to get to a conclusion with or without guarantees on the debt crisis because this nervousness, uncertainty, and talking about it forever will hurt Europe beyond belief. We're a very small part of that hurt. That's as far as I'm willing to go because I don't want to give you a multiple-year forecast. You know our targets. We're not going there. We're going the other.
We will continue to go the other way around as we've had now for about 10 quarters. That's our goal. Sorry, it's not a very good answer, but anyway.
If I attempt to follow up, if Lehman Brothers were to happen all over again and you would get identical volume and price impact, how much more better equipped you would be to deal with that kind of a scenario now versus three years ago?
How do I quantify that? We had a graph. If you look at our fixed cost takeout, our productivity, we've taken 11,000 people out. We've done on capacity on pretty much throughout the paper grades. We've done twice our market share of capacity cuts, which also means not that we're trying to be heroes, even though we are, but the more important point is I think we've proven our cost base in the last three, four years, and this is all public information. You can look at that. Stora Enso versus any competitor, we've taken more relative capacity out of against our market share than anybody else. That means that our remaining asset base also is in pretty good shape. Our marginal cost of variable cost is in better shape.
The more recent ambitions of flexibility on maintenance, mill maintenance, logistics, which are in the order of magnitude billion items each, we'd be in hell of a good shape. That's the only answer I can give you. Not that I hope that happening because I'd like to keep climbing on my habit curve, but we're good to go with a billion of cash on balance sheet too.
All right. Thanks a lot.
Thank you.
Our final question today will come from Mr. Marc Hesselink of RBS.
Yes, hello. Two questions left from my side. First, also, you said with more uncertainty in the market currently, if you're looking to the inventory levels of your customers, are you afraid that there will be a lot of destocking because of the fact that they also see the uncertainty coming? Secondly, there's some increase in the working capital. You've said it's because of the wood chips. What do you see the trends here? Do you think this is a level that you can sustain, or will the working capital increase further or just go down? Can you talk about the trends there?
We'll split the question. Markets will take our own working capital and so forth. On the customer inventory levels and the nervousness, yes, it's obviously very clear that if people see the consumer demand at the end and then they tell them not to reduce and they tend to destock and so forth. My seeing it or my view is that I'm not too worried about it right now only because of the fact that I think quite a bit of that has happened. It's immediate demand-driven. The discussion about the European debt crisis has gone on forever. There's no chance. I don't think that drives that. On that side, I'm not too worried about it. Short of the wood products, we specifically disclosed today that there we see very high customer inventories and we think, well, we know they're going to destock pretty much. I'll leave it at that.
Our inventory, our working capital.
Yeah, working capital, we're definitely not happy with the levels where we are. Part of this increase, as I said, a good part of it has been not wood chips, but wood and standing stock overall has increased. Then a bit of adverse development on payables and receivables and inventories. Otherwise, I think we remain even more confident that we have big potential on the working capital side. That's one part of our learning process when we learn to change things. We have still a lot of work to do in changing our supply and demand chains in our whole business. We are still holding a lot of inventories that make no difference for our customer in our total production chain. I think we have to still get a lot more customer-oriented and steer our business from that point of view.
Internally, our level on kind of when we think about the innovation on the working capital side, what we should do, we think further and further out on looking at benchmarks way beyond our business and looking at totally different kind of businesses with totally different kind of approach to that. A long answer, but hopefully gives you more of the spirit of where we are. Not happy.
Okay. Okay. Clear. Do you think you can turn it around already in the next quarter, or is it more a long-term goal?
I'd say that we genuinely have the balance sheet and the liquidity flexibility to be able then to, if we need tactically in the short term, make moves. Of course, the last thing we want is that we would be growing our own product inventories. That's not something we're going to do. Otherwise, I think what we want to keep is a tactical freedom on that side. Over the short term, quarter by quarter, I'm not going to start forecasting that. In the medium term, our ambition definitely is to get the working capital down.
Anything we can do short term, it will be done also because the management, and I'm not talking about us only, but we've incentivized the management also on relative working capital improvements and so forth. We're very focused on that as we should be. The longer-term answer is that we need to re-engineer the supply chain. That's the logistics which we're doing, but also some other parts to be able to give a clearly sustainably lower level which we already see in some of our product line.
Okay, thank you.
Thank you.
That will conclude today's question and answer session. I would now like to turn the floor back to Ms. Paajanen for any additional outlaws and remarks.
Okay. Thank you, everybody. Before I hand this over for Jouko for the final conclusion remarks, I just want to remind that we will be speaking to each other latest then in October 21 when we are out with our Q3 result and know a bit better about the future. Please, Jouko.
Thank you. Thank you, everybody, for being here today. We feel very good about the second quarter. We feel uncertain about the third quarter. We would be very happy if you beat me up in October by saying that I was too conservative in July. Thank you very much, and I wish you all a nice summer. Thank you.