Earnings Call: Q1 2019

Apr 26, 2019

Dear audience, welcome to UPM's Quarter 12019 Results Webcast. My name is Yussi Peson, and the CEO of UPM. I'm here with our CFO, Tapio Korpeinen. Hello to everybody. Ladies and gentlemen, let's move into the summary slide of the of the conference call, UPM's good performance continued in Q1, in line with with our expectations. Our sales grew by 7%, driven by higher sales prices in almost all businesses and increased delivery volumes in several businesses. Sales prices, increases continued to outweigh the impact of the higher variable costs as a result, our comparable EBIT increased by 5% to year and was 1000000 during this quarter. We had net cash of 1,000,000 in our balance sheet at the end of Q1, even after 1,000,000 of leases were recognized in our balance sheet, following the adoption of the new IFRS 16 standard. All in all, this the quarter of earnings growth. Furthermore, we look forward to our transformative prospects that are set to provide with us unique opportunities for significant long term earnings growth. But ladies and gentlemen, point, I will hand over to Tapio to analyze more our result. Tapio, please. Once again, here, we have the analysis by driver for the EBIT increase. And on the left hand side, you have the year on year comparison. Sales prices increased in almost all businesses Asian Fine Paper business being the only exception. And the positive earnings impact was larger than the impact of higher variable costs. Delivery volumes made a small positive contribution to the EBIT increase. On the right hand side, you can see the same chart compared sequentially to the fourth quarter in 2018. Our 1st quarter EBIT came down by 1,000,000 as compared the fourth quarter. This decrease was mainly due to a lower fair value increase of the Finnish forest assets. The profitability of the 6 business areas combined was on the same level as in fourth quarter. You can see a clear decrease in fixed costs and a modest increase in variable costs as compared to the 4th quarter. The decrease in fixed cost is mainly seasonal and the increase in variable cost also partly seasonal by nature. The adoption of the IFRS 16 standard had a decreasing impact on variable cost and fixed cost in the first quarter of 2019. And respectively an increasing impact on depreciation. On this page, you can see the comparable EBIT development by business area, biorefining reported another excellent quarter. Our average pulp price in euros was 6% higher year on year or as compared the fourth quarter, compared to 4th quarter, it decreased by 6%. Pulp Biofuels and Timber all enjoyed good customer demand and were able to grow delivery volumes. As we had a operationally successful quarter. Communication Papers had a strong quarter as well. We achieved price increases in all paper grades at the start of the year and comparable EBIT increased both year on year and compared to the fourth quarter last year last year. This was the best Q1 since the business area was formed. And the 2nd best quarter overall despite the continuous decline in market demand. This clearly shows the results of the consistent work to improve cost competitiveness and to adjust capacity to the profitable customer demand. To ensure long term success, we continue this work As the latest news, we announced in April our plan to close down paper machine number 10 at the Plattling Mill in Germany which would reduce our coated magazine paper capacity by 155,000 and tonnes. In Specialty Papers, comparable EBIT decreased clearly from the first quarter last year, But we saw a slight improvement compared to Q4. Here, good demand continued in label paper and release liner businesses. Destocking appears to be over also in Asian fine paper markets, margins are turning, but profitability is still low. Aim to restore profitability in the business area with cost efficiency measures, growth projects in the release liner business and with the product development initiatives. At this point, it is also good to note that our two paper businesses have not yet seen any significant cost relief due to the decreased pulp prices, which has taken already place. There is typically a 2, 3 month lag from a change in pulp market price to a cost change in the 2 paper businesses. Demand growth continued in the self adhesive label markets. Raflatac regained growth momentum in sales and earnings. After the challenging last year. Sales And deliveries grew compared with the very low comparison base that we had in the first quarter of last year. To further improve earnings, we started a fixed cost reduction program in March. Energy had a good quarter supported by electricity sales price. However, our hydro power volumes were still held back by the dry hydrological situation. Plywood maintained healthy margins compensating for the higher wood costs with increased prices. Solid market demand for Plywood products continued in first quarter. Our deliveries decreased from last year due to timing of LNG tanker projects as well as tighter competition in the Birch trading business. These points, we already covered, I believe so. Then let's move to the next slide. And here we see the cash flow, where as you see already mentioned, our operating cash flow increased from last year and reached 1,000,000. Working capital increased seasonally by 111 1,000,000. And then to our outlook our outlook for 2019 is unchanged As we discussed 3 months ago, there still are uncertainties related to the macro environment may have an impact on the economic growth in the different regions and on UPM's product and raw material markets during the year. However, we expect UPM's business performance to continue at a good level in 2019. We expect favorable demand to continue for most of our UPM businesses, while demand decline is expected to continue for communication papers. Pulp prices are expected to be lower and graphic papers prices are expected to be higher as compared to the fourth quarter of 2018. Input costs are expected to stabilize after the significant increases seen during 2018. And finally, fair value increases of forest assets are not expected to contribute materially to comparable EBIT in 2019. And now I'll hand it back over to Youssef for an update on our growth prospects. Not only we have had a very good performance in the past 3 to 5 years, as Tapio was explaining, we have had we have a solid growth prospects for the future. In the coming years, UPM seeks significant growth in 3 focused air I. E. The pulp business or the fiber high value fiber business, specialty packaging materials and molecular bioproducts. These spearheads have 3 all of these 3 have key factors in common. First, they all have an attractive long term growth outlook supported by global megatrends. All of them provide sustainable solution for growing consumer demand. 2nd, these are growth areas that have a clear barrier of entry. And finally, UPM really has unique competitive position and valuable know how an IPR in each. We are growing in the specialty packaging business, raflatac and specialty papers, mainly through focused growth projects that we have been reporting, and they will be shown later. The potential new pulp Mill in Uruguay would be a large growth step for our pulp business, but also for UPM earnings. The molecular businesses biofuels and biochemicals could provide a large new platform for UPM for the coming years and decades. These businesses are all about replacing fossil based fuels and fossil based chemical calls with much more sustainable drop in alternatives. If we can do that in a competitive way the market potential is absolutely huge. Let's go to Uruguay. In Uruguay, the second operation phase for the potential new world class pulp mill is ongoing. The implementation of the investment agreement between us and the government of Uruguay is currently in a very intensive phase. To give you an update, progress a lot of progress has been made in many areas. The port concession in Montevideo has awarded to UPM in March. The mill engineering design tendering and permitting process are proceeding. The free trade zone for the mill has been granted. And when environmental permitting processes for the port and the mill are in the final stages, and the first construction contract for the railway has been signed. However, important conditions stated in our investment agreement are not yet to be fulfilled. Those needs to be fulfilled before we actually we won. If the ongoing 2nd phase is concluded successfully as we think, we will the regular process of analyzing and preparing an investment decision of the pulp mill project. As you can see, our estimate for the duration between 1.5 years to 2 years starting from signing of the investment agreement in November 2017. Let's then move on into The preparation is proceeding in our attractive biomolecular businesses as well. In biochemicals, we are working for making an entry into a chemicals market in a commercial scale. We have now completed the basic engineering of the potential at 150,000 ton biochemicals refinery in Germany. During the process, our project has attracted interest from alternative places and sites, which, from our perspective has been a very good situation. So currently, we are assessing 2 final alternative industrial parks in Germany, 1 in Frankfurt and then in Loynham. To select the optimal setup for the facility. In addition to this site selection, the commercial studies need to be concluded before starting our regular process of analyzing and preparing an investment decision. In biofuels, the Lappeenranta Bio Refinery has been a success in the potential Kotka project, our ambition is to scale up the biofuels business with the next generation, the higher level technology in terms of production, product and feedstock. We have completed environmental impact assessment for the possible 500,000 tonne biofuels refinery in Kotka here in Finland. Development work is still expect it to continue into next year. Page 11 shows our list of focused growth projects. As you can see, most of them are supporting our growth in the specialty packaging businesses, I. E. Raflatac and specialty papers. Ladies and gentlemen, I would like to summarize my presentation by saying that Q1 was the 24th consecutive quarter of earnings growth. We expect our business performance continue at a good level in 2019. We have cost competitive measures, capacity adjustments and focused growth approach underway supporting our performance. And finally, we continue to preparations of our transformative projects, with these projects we are aiming for significant long term earnings growth. Ladies and gentlemen, this was the prepared part of the presentation, dear operator we are you. 2 to cancel. Our first question comes from the line of Lars Kjellberg of Credit Suisse. Please go ahead. Your line is open. I just wanted to start off with the communication paper division, which of course, you are doing quite well. When do we start to get concerned about how seemingly extremely weak demand is. And I guess there's various talks about some of the overseas export volumes starting to decline and some exports coming into Europe. Is that something that you're seeing And how would you expect pricing? I guess that's a difficult question to ask, but conditions generally moving as we head into the second half of the current year? Lars, I guess that this is nothing new. We do have a kind of view that that the markets are going 5% down as a trend line. Some other years are having destocking and then somewhat higher, decline in the markets, the various, we're iterating from the qualities and grades But on the other hand, there are quite many exits as well. If you take LWC, you take fine papers, there will be quite a lot of capacity adjustments coming on. So basically, this is going to be the trend for the coming years that the trend decline is 5% on average. Plus minus. And then we are trying to kind of play the game based on that, keeping our costs down and running our capacity on that level that we are efficient and making good money. And if you just take the page where we have the communication papers long term profitability, even if the declining mark have been occurring last 10 years. Now the profitability last 5 years has been improving. So our game plan is to to keep the profits and play the game based on that fact that we are making solid good return for our shareholders. You certainly are managing that very well. You mentioned Raflatac that had been a bit of a drag last year. And when looking at the your main competitor here at Edison, they saw a sort of moderation in the Q1 and New York acceleration. Why are you seeing the improvement in your business? And what has changed from what you were seeing in 2018? No, but basically, you answered yourself the first quarter of 2018. We lost quite a lot of volumes. And now you're comparing that to quarter 1, 2019 volumes. And therefore, we have been if we are looking, our market share of the business, we are pretty much on that level where we were before end of 2017. So basically, now we are comparing a quarter where we did have a tough quarter which was the Q1 2018. Therefore, our volume report is somewhat not looking more positive. So there's no particular change in the market positive or negative? It's a steady market. No, it is actually it is actually now we are just highlighting again that we actually did have a quite tough quarter in 2018 first quarter of 20 18. And final question for me would be, you have, of course, a host of projects growth projects as you spoke about. Your CapEx levels have been comparatively low and targeting growth CapEx for a little while and you have clearly a very strong balance sheet. When should we see or expect a more material increase in your CapEx and what sort of levels as you start to execute this big project, should we expect? No, that is actually very much related to that. I guess that our I don't guess. I know that our kind of typical CapEx will be on the similar level that it has been year in year out around 1,000,000 to 1,000,000, and that will not change at all. And then when these projects are then kicking in, when the decisions are made, the kind of order of, the kind of priority is that, of course, the Uruguay pulp mill is number 1 in our margin. Then then the biomolecular businesses are coming thereafter. But I do not have a allocation of how much of CapEx will be used this year or next year on the transformative investments. So we will guide you more when those decisions are then made. So the base load is $300,000,000 to $400,000,000 and then we can make our own assessment. Is that what you're saying? Thank you. And our next question comes from the line of Robin Santiverta of please go ahead. Your line is open. I was just wondering about the the biochemicals and the biofuels investment in Kotka, whether those projects have been postponed a bit, when do you expect to make a final decision whether to ahead with these projects or not, is it fair to assume 2020 or will it be later on? I don't think that we do have a guidance for you. I guess that I was trying to, trying to actually in my speech to say that the when it concerns biochemicals, the basic engineering has been done now and now we are in the final stage of in the site. And we have done a lot of commercial studies as well before we are ready to move on. In the biofuel my last sentence was, if I remember correctly, that development work is still expected to continue until next year. And is that, development? Are you ready to comment a bit what in terms of biofuels, what that development work is about this? It is all kind of technology. It is all kind of raw materials, all kind of things. Because, we are not going to make just a similar plan that we have in Lappeenranta. We are having ambition to put a lot of more IPR on and therefore, to make even actually more lucrative, investment in Kotka. Any coke, as I understand, tall oil would only be a small part of the raw material Is that correct? Absolutely. It will be multi feedstock and there will be new technologies implemented as well. Good. Thank you. Then in terms of specialty papers, I mean, defined paper market has been very tough in Asia, especially in China over the past half year. I think Tapio called the market bottomed out or bottoming out at the moment. Are you now seeing increasing prices or is it, is it still stable at the level? And also, what is the pricing outlook in Raflatac? Yes, maybe to comment on the specialty papers part. So there, when it comes to the fine paper market in Asia, there that sort of a destocking phase as we see until it seems to be over and therefore, in a sense, we see sort of volumes moving positively the sort of demand side. Has been good there. And let's say, of course, both in Asia and let's say for the label paper in general, the sort of volume and demand situation has been good as it is. And this sort of a margin squeeze, as you know, came from the fine paper business in Asia. And there has been some, let's say, modest movement on prices upwards, as we also mentioned here already the pulp cost will help, but it's not seen in the bottom line yet. So that is sort of coming. So those are the reasons why we are sort of seeing that turning of the margins for the specialty paper business. And if I comment to Raflatac, you know, I need to one again, disappoint you, we are not commenting any of the future price scenarios and pricing kind of things in this kind of way than talking about the past, but sorry? All right. I understand. I understand. Then. And then just on the pulp market, what is the current dynamics? First of all, what what kind of inventory levels are you running at the moment? What kind of deliveries are you having at the moment, I guess, almost 50% of what 30%, forty percent of your sales is to China. So what is your inventory level and what is your view of your customers' inventories at the moment? UPM doesn't have any kind of change the inventories. We are operating with the customers that are long term long term relationship and therefore, our volumes have been moving quite, quite with the solid pace. If you are only looking at the statistics, as you can see, the statistics of the of the last 2 days, the whole global market is now on one point is it 1.1or1.2percent growth comparing that of first quarter of last year. So basically there's already we are seeing a growth, how strong it will be remains to be seen. Stocks, inventory stocks of the suppliers has been going down 3 days, even if they are still on higher level than that of last year. So basically, that is the situation where we are. UPM is kind of a different player. We don't use third party sales at all. So basically, we have only long term customer relationship where it is based on volumes and then following the market when it comes to pricing. Sure. Thanks. And then just finally on, you have a very strong balance sheet and it's clear you have a clear investment agenda for the next, what, 5 years. But are you looking at M and A potential M and A targets at this stage. My evaluations have, in this industry, come down quite significantly, or it's all focused on organic growth at the at the moment, our focus is clear. It is actually with this period of growth prospects that we have, but of course, the balance sheet is is strong enough for making an M and A if that kind of situation appears. But our focus is clearly on these three areas of specialty packaging materials, high value fiber and molecular businesses. Thank you. Our next question comes from the line of Michael Dupell of UBS. Please go ahead. Your line is open. Thank you. Hello, everybody. A couple of questions here. Just briefly first coming back to Raflatac, your talked about that a bit, but as mentioned, you had a quite strong growth there and the margins went up from Q4 last but still lagging on a year over year basis. So going forward, I know you don't want to comment on pricing and your specific volume, but if you talk about the market growth, what would you expect that to be for the labels business and also in terms of your margins, do you expect to see some further and further recovery there going forward? Of course, it is related to general economy, what the trend growth globally has been, it has been more than the GDP growth, and that we expect to continue for the reasons that are well known in the kind of megatrends, whether it's e commerce or whether it is other things So basically, we see a quite solid growth even if when the GDP goes down, you know, of course, the demand on that particular moment goes down as well. So basically quite positive outlook for the longer term, and that's what we do. On the margin side, we do a lot of things that are related to our costs. So we do run the programs of taking costs down. And thus, the margin improvement is our focus on top of that, what we do on the needs. Okay. And then switching to the to your Plywood business. How would you describe the outlook there, both in terms of demand and pricing? No, no, pricing, unfortunately, we are not commenting the future prices But demand outlook is quite solid at this point of time, but once again repeating that it is not immune to any other megatrends of the world and the global economy. So far, it has been pretty solid. We have a quite good market And we have a good position, especially in some of the segments like the LNG tankers, even if those volumes have been somewhat lower this year, not not because of the kind of global economy, but because of the project, quite solid outlook. Okay. And then on the paper business and European paper prices in particular, do you foresee any changes there when you when you head into the second quarter or is it more or less stable compared to Q1? Can I repeat again? I'm we do not kind of comment any of the future prices, unfortunately. Okay. Then a final question in terms of maintenance cost in the quarter, if you think about Q2 compared to Q1, what kind of delta should we expect to see there? We have now for, as is pointed out, in the quarterly release, we have let's say, the normal maintenance as far as energy business is concerned in Aker lot, but then we have the major maintenance shutdown in one of our pulp mills in Kumi this year. So for the second quarter. So I would say you can sort of expect about 1,000,000 impact overall, in the second quarter. Obviously, in the first quarter, we not have any major maintenance. Our next question comes from the line of Cole Hathorn from Jefferies. Please go ahead. Your line is open. Good morning. Tapio, I wonder if you could just give us a little bit of color on the outlook for the energy business and the impact from the ocular-three? Yes. Well, let's say, to start from the latter part, Olkiluoto III as we have, I think discussed earlier as well. If you look at where the markets are today or where the sort of forward curves in terms of pricing are at the moment, the sort of What you have been asking us earlier is what is the impact for the bottom line of our energy business of Olkiluoto III once it starts up. And the answer has been and still is that it will be, let's say, quite a small or not material impact as such. So therefore, let's say this further delay that TVO announced, which is to be sort of more precisely known in June that as such directly, everything else being equal will not have much of an impact on our, on our sort of bottom line. Whatever it might have has an impact on the market, the market price, then this is a kind of a secondary possible effect, which you have to kind of look at than from the markets, how they react to the news. Otherwise, obviously, let's say what we have seen so far is that the devices have been on a sort of an increasing trend, which also, obviously, is seen in our first quarter result and in our average sales price for the first quarter as compared to the first quarter last year. And In that sense, if you look at the sort of, again, prices going forward in terms of the commodities and particularly, the CO2 price, EUA price that has been let's say, volatile, but more on the sort of bullish side lately. Thank you. Our next question comes from the line of Saul Casadio from M And G. Please go ahead. Your line is open. Hello. Hi. Thanks for taking my question. The question is about the new, sorry, the investment plans in biochemicals and biofuel. And I was wondering if you can help me frame that sort of risk reward profile of these investments. Because you said, I understand that the reward can be huge, but also, the risk, I guess, is high as well, which talking about, if I understand correctly, new technology, new processes. I think I've asked this question in the past in terms of sort of capital allocation to these projects. I'm trying to understand whether given the risks that will profile you, you're willing to play a sort of small chip on these investments? Or maybe that the risk reward profile is not that this project is a nice risk is I think. And so you might be willing to invest more, given financial flexibility you have achieved. So anyway, in general, I'd like to understand a little bit better the risk reward profile and how much capital you're willing to Yes. I guess that it is something that we do all the time and the maybe the best way of explaining how do we think about the risk when Lappeenranta refinery was made to the final decision was made 2012 and the the initiative of the development started 2006. So 6 years later, we made the investment decision of investing 800,000 tonne facility in Lappeenranta, with a new technology to refining crude tall oil, which is a residual or pulp process to make high quality renewable diesel. And then people were asking this question as well what is the risk of not getting into the production and not having the quality or the IPRs are not valid and and we were able to do the mill at time, started to operate it 20 14, 15. The first operating year was challenging, but the next one, we were already on the nominal capacity, which I think that this remarkable achievement quality was already from the beginning there. And then finally 'sixteen, 'seventeen made the commercial optimization. And now the returns of the investments are better than UPM on average. If you take the 2018 return on capital employed or EBIT margin, which are 14 point something. This is turning better today. And therefore, I think that this is maybe the kind of best way of describing, yes, there are, the risks always but the UPM way of dealing with the risk is to prepare ourselves into the position that when we take the step, there are firm step And that's our way of operating. And therefore, like the Uruguay, we have been developing almost 7, 8 years, 7, 8 years should be able to then make a very profitable business. Same happens with the bio chemicals where the first initially was taken in 2010, if I remember correctly. And gradually, we are getting there to be securing the profits And then now with the biofuels, it's much easier with the experience that we have, which is I have to say that they are surprisingly excellent. Those kind of experiences. We have the IPR. We know the technology. We have been able to utilize the bio forest biomass into a product that nobody else has been doing. So basically yes there are always risks that are on technology or in IPR or in product quality. But UPM is making steps that are firm steps and therefore, I regard the more the opportunities rather than the risk, but it's you need to be humble always when you develop this kind of businesses. But for both projects, are we talking about new technologies for both or just for the biochemicals and the biofuel is more like a development of something that is already existing and commercially proven? Exactly, right. You are that by biofuels, we do have a kind of concrete steps and we will implement some of the technology on top of that. It is an improvement, right? You are that respect. And biochemicals is more new set up of technologies, even if the technologies are very technologies. We are not putting too much of unknown technologies. There will be some that will will handle the kind of forest biomass into the products that we do. I say that this is steps when and if we are making breakthroughs on this, the entry barrier is enormous for for many others. Thank you. Our next question comes from the line of Alexander Berglund of Bank of America. Please go ahead. Your line is Thank you very much. Two questions from me. First one on, with regard to Stora Anne's conversion coated woodfree at Oulu, is that anything that you can kind of benefit from a volume point of view or you're already fully sold out a little bit more about that that maybe kind of helps balance the market a bit. And then the second question was I saw kind of news that Metzabore might be considering or Metzabharbor considering building a new pulp mill in in Finland. How do you think about kind of the potential that would have for security of supply of wood in your region? And do you think that going forward you might need to increase your direct ownership or forest or Does it work fine with all more of these kind of long term supply agreements that you have? I guess that I do not have very many comments especially on Oulu conversion, obviously, it will take quite a lot of capacity out of out of the fine paper market, which is, if I remember correctly, it is close to 20% in between 15% 20% of the total market. So basically, yes, that will trigger a higher operating rate for the whole business for time being when the market are going down 5% of the year. So that's something that will definitely be there. In Metza fiber investment plan. I think that that's a concrete plan that has been there. Our pulp mills are in Southern Part of Finland And Western Part of Finland. So basically, we have no operations in Northern Part of Finland after Caianic closure. And therefore, it is not directly on that area, but of course, it is of volumes that are required on the pulpwood as well in Finland. But basically, our position is a bit different on And I think that we are a long term operator and having our own way of dealing with that. Maybe I'll add to your question there. That we do own 500,000 hectares of forest land in Finland. Having said that, given that we here in the Nordic part of the world operate on a different sort of a cycle as far as the growth of forest is concerned than we do in Uruguay. Therefore, you cannot own such vast areas of forest land that you could rely on your own forests for the majority of your wood for an operator of our size. So let's say, with the full ownership that we have and with the sort of partners that we work with, we're quite comfortable in the Finnish market. Thank you. That's very helpful. Thanks. Thank you. And our next question from the line of Nicole Yoss of Kepler Cheuvreux. I wonder if you could basically talk a little bit about the midterm prospects for the pulp market. I mean, when we look on potential pulp projects coming on stream in between 2021 and potentially 2024, there's actually quite a lot of projects and potentially your Uruguay project would end up there in that same time period. Could you I mean, it's a difficult question, but could you elaborate a little bit on how you sort of view this? Very difficult to really elaborate that even if there would be kind of willingness to do so because you don't know what are really the real pulp projects. There are plentiful announced ideas. And then only those that are then realizing will be will be affecting kind of supply side. We do have a quite solid view on the demand side that it will grow as it has been growing quite steadily the trend growing being the trend growth being in between 2% 3%. It's absolutely something that we believe on. But then supply side is something that you have a lot of ideas and then then only those that are having a financial kind of solid or grounds to be then implemented will be implemented. And there, they, I do not have any better visibility than you have. I would only add to that that we don't need to be the only power project out there. Certainly, there will others that will come as well, but we believe that the supply side for wood raw material will, as it has in the past, determine how many of these projects will actually move ahead in which time schedule. And so from that point of view, even if there will be projects other than ours, we still believe that the demand supply balance will be will be healthy. Thank you. As there are no further questions, I'll hand back to our speakers for the closing comments. Ladies and gentlemen. Thank you for joining us today and have a nice weekend.