Good day. Thank you for standing by. Welcome to the Sappi financial results announcement Q2 2023 conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Steve Binnie. Please go ahead.
Good day, everybody, and thanks for joining us. As always, I'll go through the investor presentation and calling out the page numbers as I move along, and then we'll come back to everybody for questions. Starting on page three, some of the highlights for the quarter. Firstly, EBITDA of $167 million. Obviously, that's below the prior year and last year, last quarter's levels. The reason for that is primarily a major destocking that's underway amongst our customers. We are facing a challenging global economy and significantly weaker paper markets. At the same time, global pulp markets came under pressure.
Whilst that's good for our paper business because obviously it's an input cost, the pulp that we do sell, particularly out of our Matane BCTMP mill, those prices came down. I am pleased to say though that paper selling prices remained relatively stable and I was talking about in the last quarter. We've seen that continue. In spite of the lower demand volumes, we've been able to keep them stable. Profitability was negatively impacted by this reduced sales volume. We had to take commercial downtime to match sales with demand and production with demand and ensure we didn't have a working capital liability. Then we still had year-on-year cost inflation, albeit that costs have beginning to come down.
Net debt decreased by $568 million during the quarter. Sorry, year-on-year. And that's reflective of the all the great work that we're doing to keep a tight control on our balance sheet. As a result, our net debt- to- EBITDA leverage ratio is 1 x. And we're particularly proud of that. Moving to slide four. Our product contribution split. On the left-hand side is the EBITDA profits. Obviously, in recent times, we, you know, with COVID and then followed by the big bounce that we had and then, and the current year with the destocking that's underway, it's a little bit volatile.
In time, we obviously believe that we will continue to grow in the packaging and pulp spaces relative to graphics. You do see that on the right-hand side, and this tells a big story in terms of the evolution of our sales volume over the years across the segments, with packaging growing nicely and graphics coming down as we've made the investments and conversions. That's something that will continue as we move down the path of our Thrive25 strategy. Moving to slide five, the earnings bridge. You know, there's a few broad stories which I've already touched on, but just to recap. Firstly, the lower sales volumes linked to the destocking cycle obviously impacted volumes year-over-year.
Over the course of the last year or so, we've obviously been pushing up our selling prices to mitigate the impact of the higher costs, you see that in the big green box. The costs themselves being a negative, all in all, contributing towards the lower EBITDA. In summary, we've managed to maintain our margins, obviously the lower volume has contributed towards the year-over-year decline. Moving to slide six. I think it tells a great story. We focused on our debt, we continue to be so. We've set ourselves a target to get below $1 billion of debt, we remain on that path. Just to call out that in the current year, the dollar has weakened against the euro.
As you know, we've got a lot of debt denominated in euros. From a dollar perspective, that's increased the net debt year -to -date by about $112 million. I'm pleased to say that we continued to generate cash in the quarter, despite the fact that earnings was less. Moving to slide seven, our debt maturity profile. That continues to be favorable and comfortable for us. We have a few smaller debts maturing in the next couple of years. Just to call them out to you, the ZAR 78 million that we have in 2023, and the ZAR 84 million that we have in 2024, those are some of our South African bonds. You know, those are coming close to maturity.
The $90 million that you see in 2024 is some debt that we took out when we converted the PM1 at Somerset a few years back, and that's getting close to maturity, and obviously we'll repay that. We've got big cash reserves, we will use those cash reserves for that. Slide eight is our CapEx and cash flow. We continue to do good work on the cash flow, in spite of the fact that obviously profits are lower, as I referred to. Free cash flow, you can see, in the year -to -date, $303 million. Obviously, that's prior to CapEx, but still shows our strong cash generation. On the right-hand side, we've pulled down our CapEx a little bit.
Obviously, with the lower profitability, we sharpened our pencils a little bit, focused on some of the stuff that we're doing. It was previously $430. We brought it down to $410 just to remind you that the dollar has weakened, so the Europe CapEx, if you had converted, would have been worth more. We're doing what we can to pull down CapEx a little bit, but not on our bigger initiatives that we'll speak a little bit more about as we move through. Turning to slide nine. We talked about capital allocation in the last quarter, and we'll continue to do so. This shows our priorities, across the various categories. It...
There's a lot on the slide, so I'm only gonna focus on a few little things. Firstly, sustainability is obviously important for us. We've committed to Science-Based Targets. Incorporated into the $410 for this year is $60 million for sustainability initiatives. That's something that we've talked to you about in the past. The free cash flow, we're proud of the $303 million that I referred to. I mean, we continue to make good progress towards the $1 billion, getting below the $1 billion. In terms of profit improvement, a number of smaller initiatives, the big RockStar barrier coating project also has been completed. We're ramping up there and very excited about the prospects for that.
We recently completed a smaller project at Somerset on the original PM1 conversion. That gives us about 30,000 extra tons. That's now complete and obviously will give us more volume. Something else I talked about last quarter is we got a project underway that will give us wet strength label capabilities at our Gratkorn mill on a smallish machine at Gratkorn. Ultimately, that will help us move that machine entirely away from graphics towards to mainly towards labeling, which sits in our packaging and specialties segment. Obviously we're disappointed that the sale of the European mills that we had announced did not occur.
We tried our best, but ultimately, we wanted to protect the value for our shareholders and the deal did not happen. We will continue to look for alternatives with those assets and that is work in progress. On shareholder returns, we annualized a nice healthy return, and that's something that we obviously measure ourselves against very closely to ensure that we're adding value. We've given a dividend back earlier this year, $85 million. During... well, just after the quarter end, we did buy back some shares to the value of about $23 million, 9.2 million shares.
We firmly believe the share price is undervalued, and we think it's a good use of our capital to create value for our shareholders. We will continue to look at this opportunistically. Obviously, aware of the profitability of the business and our other priorities for our cash. On the growth side, we've obviously got this very exciting project for the conversion of our PM2 machine at Somerset. We're at Somerset at the moment. We've been visiting the mill. The project is on track, and we're very excited about what that's gonna create, the value that that's gonna create for us as a business.
Slide 10. Just on the cost side, we've obviously seen a significant adjustment over the last couple of years. That pressure is now easing. The full benefits haven't been realized yet, obviously, because, you know, you do have some in stock and the likes, and you go work your way through that. This is something that will give us some relief with the short-term demand pressures on our paper products. Slide 11 has the paper pulp prices, you can see they've come off dramatically. That's obviously good for our paper business because it's an input cost, obviously, when we do sell pulp, like in the BCTMP from Matane, that has an impact on the margins for that segment.
Slide 12, is our just evident. It's the gas prices, and we all know that it's been highly volatile and peaked last year. It's come down substantially, which will obviously ease pressure for us. As you know, we've hedged a significant portion of our costs at a low level, a low price level. We're in a pretty good situation there. Moving to slide 14 and the various product segments, and pulp year-on-year, the volumes were down a little bit, but that was at the beginning of the quarter and we picked up very nicely, you know, as it progressed. Pricing improved.
Market conditions have improved generally, you know, obviously linked to the opening up of China following their COVID restrictions. Retail sales for clothing, not as bad as maybe some, including ourselves, thought they were gonna be, so that's positive. Stocks are starting to come down downstream. We think the prospects are looking better. In recent days and weeks, we've seen viscose prices pick up a little bit, cotton prices as well. I think all in all, more positive in this segment. In the packaging segment on page 15, major impact from the elevated downstream inventories. We've seen this across the board in all the regions, and our customers are working through that. We are positive.
It's difficult to pinpoint when the destocking will be complete, but we are still very positive about the underlying demand for these categories. In addition to that, in South Africa, we did have, and some of you may remember this, we did have some floods in the Mpumalanga region in South Africa, where Ngodwana mill is located, and that did impact on production. Also, it's fair to say we had a couple of little hiccups post the recent upgrade that we did on that containerboard machine, but that seems to be steadying out as we move forward. Moving to graphic papers on slide 16, similar situation.
Markets were weak, predominantly related to the destocking that's underway, and that forced us to take production curtailment as expected. Like, you know, like the packaging segment, it's difficult to pinpoint exactly when the destocking will be complete, but we do anticipate later in the year there will be a recovery, and obviously, that will reduce the need for curtailment. Moving to slide 17, which is our regional segments. A lot of the themes are the same, so I'm not gonna call out each one, but just generally, obviously, volumes down year-on-year linked to the weaker markets. However, we were able to keep our prices stable, which offset the impact of higher costs. Margins down, but linked to lower volumes, as I said earlier.
On slide 18, you see that graphically. Margins down, as I say, hopefully recovery later in the year. Interestingly, South Africa year-over-year is an improvement in margins. The South African business is still in a good place. Moving to slide 19, which is our strategy, Thrive25. We've shared with this with you many times, I'm not gonna go through in detail. Just to call out a few key things. Firstly, on the operational excellence, you know that safety comes before all else. We're doing a lot of great work there. Our injuries in the workplace is coming down, and we're improving across all the regions.
We, we continue to look for cost advantages, and I think with raw material prices coming down the way they are, that is gonna create some opportunities for us. We continue to focus on pulp integration. Enhancing trust, we have a strong leadership position because of our certification of our wood. We, we believe that gives us a competitive advantage, and we continue to look for opportunities there to improve further. We've committed to the Science-Based Targets. We are on track. It's embedded in the CapEx numbers that I've shared with you. You know, we're confident that we can achieve those objectives that we set ourselves. In terms of growing the business, a couple of these projects I've touched on, but from a smaller perspective, the label upgrade at Gratkorn we're excited about.
Obviously, as I said, we're here at Somerset and very excited about that machine conversion. Ultimately the sustaining of our financial health, committed to our $1 billion debt target. We're on track to do that in spite of the fact that the sale of those European assets didn't happen. We are committed to getting below those levels. We are committed to reducing our exposure to graphic paper and moving forward. Turning to slide 20. Sustainability is at the core of our business. It's embedded in our Thrive25 strategy. We will make the appropriate investments to achieve our targets, and as I say, embedded in everything that we do in the business, and as part of our business purposes. Slide 21.
Look, there's a lot on this slide, lots of the awards that we've won, just to call out one in particular that's happened recently. We recently got our EcoVadis platinum ranking reconfirmed. Very proud of that. It's across all three regions, it demonstrates how important sustainability and governance around that is for us as an organization. Turning to the outlook, I'm on page 23. It's fair to say that, you know, the short-term paper markets are difficult. We are still going through a destocking. Initially we obviously thought that it would start to recover earlier in Q3. It now looks like the destocking will continue throughout Q3.
We're anticipating a bounce back in our fourth quarter of the year when that destocking is complete. The cost reductions that we're seeing in our raw materials will relieve some of the pressure. As I said to you earlier, that will, we've just got to work through some inventory, so it takes a couple of months for that to start to flow. It's important to emphasize that we never lose sight of our long-term strategy. Yes, we are navigating through some short-term challenges, but we remain committed to reducing exposure to graphics and investing for growth in renewable packaging, dissolving pulp and biomaterials. As I said earlier, being very disciplined with our balance sheet, keeping the debt below that billion-dollar level.
CapEx will be slightly lower, as I said, $410 million. Taking that all into account, and just to remind you that the third quarter is seasonally the weakest in terms of our demand. Taking into account the global macroeconomic uncertainties, and its impact on consumer sentiment, the weak paper markets, we do anticipate that the third quarter of 2023 will be below this quarter that we just reported on. Operator, that's me gone through the deck. I'm gonna hand it to you now for questions.
Thank you. As a reminder, to ask a question, you will need to press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by as we complete a Q&A roster. Our first question comes from the line of Brian Morgan of Morgan Stanley. Brian, your line is open.
Hi. Good morning, guys, in Somerset. Just a question on specialties. I've been a little bit surprised about how cyclical that, the rural business has proven to be, especially in this quarter. I was wondering if you could just break it down a little bit more for us, in terms of what you're seeing there, if you could just touch on perhaps the order book there. What subcategories of specialties you're seeing particular weakness, and which ones are stronger than you would have expected? If perhaps just a bit more color would be great.
Thanks, Brian. I'll answer initially, and then I'm gonna hand over to each of the three regional guys just to give you a little bit of color on what's happening in their respective region. I don't think Brian, I don't think it's cyclical. This is very much linked to the destocking. When we've spoken to our customers, it's clear that with the supply chain challenges last year, with the shortage of paper last year, there was a significant inventory build across the board. The underlying demand for the product is not as cyclical as the overall numbers would have you believe. You know, that's, you know, that's across most of the categories.
We did have a little bit of production challenges at Ngodwana. Alex will talk a little bit more about that. I don't think it's that any product categories are performing worse. We are in constant communication with our customers. They are giving us feedback that they're working through those inventories. I'm gonna just pass it to each of the gents, and then they can just briefly talk. Alex?
Thanks, Steve. Yes, Brian, certainly in South Africa, as you know, it's linked to agriculture. We have seen that customers have been keeping high inventory levels. Then, we've seen that the grape season was slightly weaker than expected. That means customers then sit with not quite the right grades of product. They obviously have to work through that. We still anticipate a very, very strong citrus season. I think for the full year we're not going to see any significant change. That really explains most of the, what you call cyclicality in South Africa.
Thanks. Marco?
Yeah, thanks. Brian, for Europe, very similar to what Steve just commented on. The two grades that have been particularly impacted is paperboard in Europe that was a destocking effect very clearly and we'll probably see some improvement in the next coming quarters. Containerboard also do with the reduction in online shopping, where this is basically one-on-one related in combination with destocking as well. What I would like to call out is one of the segments that was most resilient in Europe was the flexible packaging, where we saw a much smaller decline. That gives you already a bit of a hint in terms of the resilience of that specific segment. Flexible packaging in combination with functional papers, were doing better than the other packaging and specialty grades in Europe.
As part of that, Brian, labels is in there. Mike?
I'd offer that very similar for North America, although our paperboard business is slightly stronger than the C1S or the flexible packaging in North America. You know, we've seen slight improvements as we've come out of the quarter. Very similar in North America.
Thanks, Mike. I think in summary, what we're saying, Brian, is that we very much attribute this to a destocking cycle. It doesn't alter how we think about this as a segment and, it doesn't alter how we think about the investments that we're making.
That's super. Thanks, Steve. Can I just do one quick follow-up? Just on slide 31, you've got the, your expectations for the year for volumes. Could you just explain, sorry, I don't wanna harp on something small, but labels, just so I've got a bit better idea of what's going on there. Why is it such a big drop in 2023?
Yeah. It's the same story, Brian. It's just linked to the destocking and our customers, you know, just had too much. You know, Mike touched on it, that it's partially, you know, in the U.S. and it's in Europe as well.
Okay. Cool. Thanks very much, guys.
Thank you. We will now take our next question. Please stand by. Our next question comes from the line of Brent Madel of Absa CIB. Brent, your line is open.
Yeah, thanks very much. If you don't mind, I have three quick questions. Firstly on the mill that we earmarked to be disposed of in Europe. Could you possibly just comment on whether there are options to convert any of those three mills? I assume the rationale or the discussion point will be the costs involved in terms of converting. My second question is just on graphic paper demand. It would appear as though European demand is a lot weaker than U.S. demand. If that is the case, if you could maybe just explain to me why that is the case. Lastly, in the DWP market, your guidance is for short-term DWP supply and demand to be reasonably balanced. Could you possibly just discuss that in context of the additional supply that is due to come into the market? Thanks very much.
Sure. I'll take each of these questions. Mohammed, I'll allow you to elaborate a little bit more on DP just now. Just on your first question. With the three mills, we're gonna continue to evaluate our options. Obviously, we are disappointed that the deal wasn't done. You know, at the time there was other interested parties and we need to, you know, we need to revisit that. We need to talk to them, look at other options. As part of that process, obviously, you know, you evaluate conversions as well. You know, there's some great assets there that could be converted. So we, you know, we take that into account. You know, there's nothing concrete at this stage.
You'll appreciate this. You know, we didn't expect it to end, and this is something that the team will be working on over the next few months. In terms of the graphics in Europe versus the U.S., well, it's quite simply the U.S. economy held up much stronger than Europe. Obviously ultimately the excess inventory that's out there ultimately impacted on the U.S. business as well. You know, and I've said this a few times that, you know, it's very much a destocking. We know that graphic paper does decline each year. We estimate between 5% and 6% a year. Now, with the big stocking that occurred in the 2022 financial year, the demand for graphics actually bounced back to pre-COVID levels.
It shouldn't be surprising that there is a drop in the current year. We're estimating in both regions, about a 20% impact, which ties back to the 5% per annum. If you go back to 2019 pre-COVID, you know, four years have evolved, 4 x 5 gives you the 20%. That's what's in our assumptions. Obviously at the moment, volumes in the respective regions are down close to 40%. What I'm saying to you is that we expect, once the destocking is complete, we expect a 20% recovery and get back to 80% levels, which would be effectively 80% of what it was in 2019. On the DP supply side, we're actually pretty optimistic.
In fact, this is as strong as we've felt for a number of years because there isn't actually any new capacity coming on board that we're aware of over the next few years. This is a market that is very exciting. It's a market that the demand is expected to grow at 5%, 6% per year. You convert that to tonnage, it's about 400,000 tons a year. The mix is very, very favorable for us. Bear in mind, you know, obviously there's a lot of pulp capacity coming on board, but that's hardwood pulp. That's not swing capacity. That's what gives us a high degree of confidence. In the short term, and this is where I'll let Mohammed come in. You know, demand is picking up and there are some supply side issues with our competitors. Over to Mohammed.
Yes. Thank you, Steve. I think just talking about the supply side issues, you know, obviously I can't mention any specific company names, but there have been some public announcements where a DP mill in Chile is down for about four months, where they need to address a dryer issue. That mill has a capacity of about 500,000 tons on an annualized basis. There's a DP mill in Brazil that has been down since June 2022, and that has a capacity of about 170,000 tons. You've got a DP mill in Indonesia that has been down since February this year, and that's about 200,000 tons, and that's related to some wood supply issues.
There's some mills in the U.S., or there is a mill in the U.S. that went down in December. That is still down at the moment. That has a installed capacity of about 160,000 tons. There's quite a lot of supply side issues that's keeping the market tight at the moment. The other thing to add to the supply-demand balance is what we have seen is the operating rates for viscose staple fiber, which is a big end user of dissolving pulp, has lifted quite sharply since early this year, going from about the 50%-55% operating rate in China to today, just over 80%.
A lot of the VSF producers are sitting with very, very low inventories. In fact, in terms of numbers published by CCF, the VSF producer inventory of VSF fiber is below their five-year average. That suggests that the operating rates are likely to stay higher for longer, going into the seasonally slow time, which should be very positive for demand.
Thanks, Mohammed. Brent?
Yeah, thanks very much.
Thank you. We'll now take our next question. Please stand by. Our next question comes from the line of Olwethu Peter from Prescient Securities. Olwethu, your line is open.
Yes, thank you. It's James Twyman. Yes, thank you for the presentation. I've got three questions. First two relate to debt. The Kirkniemi mill is presumably the vast amount of the value in the three mills that you were trying to sell. The best value for that would, I would guess, would be a conversion. How easy is it for that mill to be converted to something like kraftliner, you know, given the type of coal it uses, et cetera, et cetera, in terms of whether that's a realistic proposition. Secondly, how does your share buyback, which is obviously welcome, relate to your plan to reduce your debt down to $1 billion? Presumably, if you keep doing that, it's going to be...
Get increasingly tough to get to that target. The second question was, containerboard prices in South Africa went up, I think, around 20% at least this year. You mentioned on the in the release that margins fell despite that. I was running, you know, what sort of scale of cost increases we've seen in South Africa, given you do produce most of your own wood. That's it for me. Thank you.
Thanks, James. Yeah, look, Kirkniemi converting to kraftliner, that could be an option. I do want to stress to you that we are focused on. Our number one priority at the moment is the Somerset machine. That would be our highest priority. We will look at options with Kirkniemi. You are right. Most of the value in those three mills sits in Kirkniemi. It's a great mill. It's not something we would be looking to immediately convert. Theoretically, it could be converted to what you the kraftliner that you suggest. On the share buyback, look our most important priority is to get that debt level below $1 billion.
We did think, with the share price coming under pressure, we felt that it made sense to opportunistically buy some shares. You know, we'll continue to monitor the situation, but never losing sight of our commitment to get the debt under $1 billion. On the containerboard side, I'll let Alex elaborate further, but just to remind you that the volumes were also impacted.
Thanks, Steve. James, yeah, a couple of things. We did have some production issues which obviously affected it. The heavy rains, which meant we, you know, we couldn't run all the volumes and that affected overhead costs. I think from a cost side, the biggest driver is timber prices. We're still seeing continuous increase in timber prices. Energy, you know, we do use coal in the mill. Because of the Transnet issues in terms of rail, we had to transport a lot of that coal by road, and that does increase costs significantly. From an energy perspective, finally also just transport costs, if you think about fuel prices, that kind of thing. I do think they're flattening out now. We will see a better outlook.
That's it.
Thank you very much indeed. Thank you, guys.
Thank you. As a reminder, to ask a question, you will need to press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by. Okay, there are no further questions. I will now hand the line back to Steve Binnie for closing remarks.
Okay, thank you very much. Thanks to everyone for joining us today. We look forward to discussing our results at the end of Q3. Thank you very much. Good day.
This concludes today's conference call. Thank you for participating. You may now disconnect.