Good afternoon, ladies and gentlemen, and welcome to Sappi Limited's Fourth Quarter of 2022 Results Conference Call. All attendees will be in listen only mode. There will be an opportunity to ask questions when prompted. If you need assistance during the call, please signal an operator by pressing star and then zero. Please note that this event is being recorded. I would now like to hand the conference over to the CEO, Mr. Steve Binnie. Please go ahead.
Thank you, operator. Good day, everybody. Thanks for joining us. As always, I'll go through the investor presentation, and I'll call out the page numbers as I move through. I'm gonna start on page three, which is some of the highlights for the year. I'm very proud to report that it was a record year for Sappi. We generated $1.339 billion of EBITDA, by far the best year that we've ever had. On top of that, each of our regions all delivered record profitability. I think that's a reflection of the strong performance across the group, and great work done by our people. We're very proud to be reporting these numbers. Just some of the highlights.
The strong global paper market and dissolving pulp enabled us to increase our selling prices, which offset sharply rising costs. In the product segments, graphic paper generated EBITDA of $650 million. That's obviously a record in that product segment. Obviously, a strong bounce back from the lows of COVID. We were able to take advantage of the tight markets. A lot of supply had come out there to generate this EBITDA. Packaging and specialities, you know, we've been making a series of investments over the last few years, and this is a business we want to continue to grow. Up once again by 68% to a new record. We successfully completed the commissioning of the Saiccor expansion project in the year.
That's now ramping up nicely. The net debt reduced by $780 million from about just over $1.9 billion to just over $1.1 billion. As you know, that's been an important strategic priority for us. Very happy to be announcing the resumption of dividends, first time since 2018 at $0.15 per share. All in all, a great year for the group. Turning to page four, the quarter, also record quarter. All regions delivering excellent results. We had record profitability from Sappi North America, record profitability from our South African business. Europe, it was the second highest ever. Just a little bit off the highs of the previous quarter, only because of the fact that costs continued to rise.
Still a very good quarter. All around, a great achievement. Healthy graphic paper margins at 17.9%. A little bit lower than the prior quarter, but that's because of the ongoing higher costs that are referred to, but still very, very good. Packaging and specialities continued to grow 37% year-on-year. A little bit off the prior quarter, similar to graphics once again because of higher costs and constrained inventories because the earlier part of the year was just so good. Then pulp, the pulp segment bounced back very strongly and delivered EBITDA of 61% year-on-year. I'll talk about that a little bit more.
Obviously, cost inflation continues to be a challenge for us, particularly energy and particularly in our European business, 'cause that's most exposed to that. Slide five has our EBITDA progression, and we're very proud of this. It's our ninth consecutive quarterly growth. Shows the great turnaround of the business and reflects all the great work done across the group. Slide six has the EBITDA bridge. That's from Q4 2021 to Q4 2022. The big stories, as you know, we had higher costs. Sorry, I'm just gonna pause a second. There's a lot of noise on the line. Okay. I'll carry on. The high costs were across the board. We see energy, chemicals, pulp across the board.
We were able to offset the impact of that by putting through higher selling prices. You can see that there was margin improvement there. We also had additional sales volumes in the quarter. Just reflecting our cost growth in a different way on slide seven, which is indexed to Q1 of 2020, and you can see that across the board. Energy costs more than doubled, and overall variable costs per ton up some 40%. Significant pressures which we've been able to mitigate. Slide eight just shows the relative split of the variable costs. The big themes are energy has increased substantially, now just under 20%. Delivery costs rising. Pulp, relatively lower against 2019, but bear in mind that it was already at elevated levels.
Slide nine has the product contribution split. Between 2017 and 2020 tells a big story. Obviously, in the current year, graphic paper EBITDA was elevated because of the tight market situation. We wouldn't expect that to continue, particularly in light of the mills that we're selling and the conversions that we're gonna be doing. In time, that will come down further. Sales volumes, significant progress in terms of graphic paper. You see was 68%, now 53%. After we sell the three mills, it drops to, I think it's 45%. Obviously, you know, as we convert capacity, that will come down further. You all know that's one of our stated strategy is to reduce exposure there and optimize our graphic paper business.
Slide 10 has our net debt progression, obviously coming off the highs of the COVID period, down to just over $1.1 billion. Thrilled with that progress. It's the lowest debt number of Sappi in more than 20 years, and it fundamentally repositions the business for the future, creates opportunities for us, and it puts us in a more flexible place to offset the impact of any potential economic downturns out there. We committed in the results announcement to targeting net debt at approximately $1 billion. We can be below that in this financial year. Slide 11 has our debt maturity profile. The only real maturity is our securitization structure in Europe, which matures in 2024. We will refinance that in the current year. We don't anticipate any problems.
On the left-hand side, you can see we're sitting with significant cash balances. Just post the year end, we did buy back some of our European debt to the value of approximately $206 million. We obviously made a gain on that. We continued to have significant cash balances. Slide 12 has the cash flow. Strong cash generation from operations, free cash flow post CapEx, big number, and overall net cash generated of $500 million. CapEx this year is $430 million. You can see in the footnote that there's a breakdown there. Approximately $70 million for our investment in the Somerset PM2 conversion.
Sustainability projects amount to $60 million, and that's something that we've talked about for a number of calls now. We have about $20 million of CapEx that was a spillover from 2022 into 2023. Turning to some of the macro challenges that we face, it's a slide we've showed you recently in recent quarters on global ocean freight. What we are seeing is that the challenges are easing somewhat. We've seen slightly better reliability from the shipping lines, and spot prices have begun or have been coming down over the last few months. That pressure point is easing somewhat. Slide 14 shows the elevated pulp prices. You can see they're still very high. Come off a little bit in certain categories, but broadly still high.
Obviously that's an input cost, mainly for our European business. Slide 15, the energy situation. This is the graph on natural gas. Again, one we've shared with you in recent quarters. Still very volatile. It's come back in recent weeks. That's obviously gonna relieve some of the pressure, but it's still very volatile. Still remains at elevated levels relative to historical norms. Obviously, we have had a hedging strategy in place which has mitigated some of that impact, and it's reduced those cost impacts for us. Turning to the segments, and I'll run through these fairly quickly, but page 17 has the pulp, and nice bounce back in the current quarter. Obviously, higher selling prices. We've seen improved logistics, and you know, that's easing.
Helping to ease the backlog somewhat, and we've seen normalized production as well, coming through. Just to point out that there is weaker sentiment in the textile value chain. I think we've got a slide on page 52, which I'm not gonna talk to, but it does show you the high retail inventories that are out there. That's gonna put a little bit of pressure on demand for, ultimately for, dissolving pulp, and viscose and alternative fibers. We've seen that happening over the last few weeks, and that's one of the reasons that pulp prices have dropped, dissolving pulp prices have dropped. Slide 18 has the packaging and specialities. Continues to be a growth business for us. We were a victim of our own success, to be honest.
We had low inventory levels going into the quarter in North America and South Africa because we were fully sold out. We also had an extended shut in Ngodwana. You know, we were upgrading the. We were doing a quality upgrade on the machine there, and that also impacted in the quarter itself. In Europe, we had escalating costs which eroded the margins a little bit. In slide 19, the graphics, obviously tight market conditions enabled us to offset cost inflation and deliver the kind of record margins that you see reflected on the slide. Regional businesses, page 20. Europe, firstly. Excellent quarter. EBITDA of $130 million. We did continue to see higher costs.
Remember, energy prices were rising throughout the quarter, but it wasn't only energy, it was across the board. We continued to outperform the market, taking market share. Volumes were good, but as I said earlier, margins are impacted because the fact that costs actually rose at a faster pace than selling prices in the quarter. Slide 21 has the North American business. Another record quarter. Success across the board. We still see relatively tight markets in the U.S. and graphic paper markets. Those have supported higher selling prices in graphic paper markets and customer demand for paperboard remains very strong, exceeding our capacity, and that is one of the driving forces and is the main driving force for why we announced the investment that we're making, which I'll talk a little bit more about.
In the pulp segment, obviously boosted by higher selling prices. Then in South Africa, strong quarter, big recovery, improved performance from the pulp business. We've seen supply chain easing somewhat, although obviously we all know that in recent weeks there was a strike at Transnet which occurred after the quarter, at the year-end, which did put a renewed pressure in the current quarter. In terms of across the business, selling prices were achieved, selling price increases were achieved to offset cost inflation. Interestingly, all the favorable conditions. Turning to slide 23.
It's a slide that we have shared with you previously, but we obviously continue to update, and it just highlights the four pillars of our Thrive 25 strategy. I don't intend going through every bullet here. Just to call out a few, like a few key factors. Firstly, in terms of driving operational effectiveness, it's focused on maximizing production, and you saw the success of that during the course of the year. Gaining cost advantages. We're very proud of our safety performance this year. It was another record for Sappi, actually. We had zero fatalities and our lowest ever injuries in the business. So we're particularly proud about that. Enhancing trust. During the year, we announced our science-based targets.
Those were validated, and, you know, based on that, we estimate approximately $70 million a year of CapEx spend over the next few years. Then a focus on growing our business. We had a few smaller projects which we talked about previously. We've been increasing labeling at Gratkorn. We did a little bit of an investment there, and we would expect that to ramp up further over the course of the next couple of years. We had debottlenecking at Somerset PM1, give us a few more volumes. Obviously, we announced the sale of the three mills because, you know, we want to reduce our exposure to graphic paper.
In terms of sustaining our financial health, I've talked about this, but we've set ourselves a debt target of approximately $1 billion, and we are confident of achieving that. Slide 24 is an addition, and it's a very important slide, which we thought we would share with you. It's something that we use internally. It's our capital allocation priorities. I. Once again, I'm not gonna run through everything, but just briefly highlight some of the major factors. I mean, first, obviously we have regulatory environment that we operate in. We have to comply with those regulations, legislation. We've committed to science-based targets. In the 2023 year, it's $60 million. I know I said $70 million on the prior slide, but that's an average. $60 million in the 2023 year.
We have to maintain our machines and our equipment to ensure they're world-class. That approximately costs us $250 million, so that has to come first. We have set ourselves that debt target of $1 billion, and we want to keep it at those levels or below. Thereafter, you know, we look for profit improvement opportunities. We're selling the mills and I'll talk about that on a different slide. We've had various projects in recent years, and that lower our cost base and enable us to optimize our assets. Those approximately add up to $50 million.
Thereafter, we believe that it was the appropriate time to return money to our shareholders, and that's why we've committed to a dividend of $0.15, and we are committing to an ongoing dividend program. That's why we've resumed dividends, because we're confident that we can do that. Thereafter, we can look at expansion opportunities. In the current year, we've got $70 million linked to the Somerset expansion conversion project. Ultimately, we continue to look for other avenues and other products that can deliver growth for us in the future. Turning to slide 25. It's just one slide on the sale of the two mills, just to remind you. It's about 1.2 million tons of capacity. It's in grades that were non-core to our business. We're getting out of uncoated.
We're getting out of mechanical paper. At our Maastricht mill, certain grades that we made there, we're getting out of as well. We strategically, this is very core to our Thrive25 strategy to reduce our dependency on lower margin graphic categories. The deal overall, $270 million. We expect it to be completed early sometime in Q2. The cash flows will flow. Part of the deal was receivables. Those will be progressively collected, and that will go into 2023. The graphs at the bottom, I think I've referred to already, but you can see it does lower our graphics to 45%. Obviously, with the conversion of
I may refer to it here, but with the conversion of Somerset, that's gonna lower further and get closer to 30% in the next few years. Very excited. Page 26. We're very excited about this project. It's on the back of the strong demand for packaging and boxboard that we have in our North American business. We've been limited by our current capacity, and we've had our customers pushing us for more volumes. This makes a lot of sense because it will move us away into a growing segment that will continue to grow with a strong push because of the replacement of plastics with paper for packaging solutions. It will give us additional volumes. It will give us a great return.
Quite frankly, you know, we are very confident we could sell this machine tomorrow. The CapEx is $480 million spread over three years, $70 million in the current year. The balance spread over equally across 2024 and 2025. Very importantly, it will be funded from free cash flow. We've taken this into account as we look at our cash flow generation in the next three years, and this is an important priority and why we were confident about targeting the billion-dollar debt. Sustainability remains as a core of our business. Slide 28 just incorporates our targets. As I said earlier, safety's been great. We're very proud of our achievements on black economic empowerment. We're a level one contributor. That's the highest level. Great work done there.
We're making great progress on gender diversity, and obviously, the return on capital employed with the great results was very strong. On page 29, we missed a couple of the targets on water and energy efficiency, but that's linked to the floods that we had in KwaZulu-Natal, and that caused some disruption in our South African operations. We're confident now that that's normalizing, and we can get back to being on target. Slide 30. As you know, during the year, we announced our science-based targets. That's been validated. We commit to reducing our carbon emissions by 41.5% by 2030. That's been scientifically determined. The numbers that I quoted to you earlier are all aligned to achieving these targets that we set out here. Slide 32 turns to the outlook.
There's no doubt that there are a number of macroeconomic challenges on the horizon. We know that interest rates are rising. Inflation is gonna have a big impact on the purse strings of consumers. We have seen a downstream demand for graphic paper, particularly in Europe and global dissolving pulp weakening. That is a risk factor. Packaging, more resilient. It is a more resilient business and should withstand those economic downturns. Rising costs remains a risk for us in the year ahead. Some raw materials, however, have started to come off in recent weeks. Natural gas has come down in Europe quite significantly, but it still remains at elevated levels. We started to see paper pulp prices come off.
In South Africa specifically, lots of you will know this, but obviously, we've been negatively impacted by a big municipal electrical substation outage in KwaZulu-Natal. It hit the whole Durban area, and it brought down our three mills, unfortunately, for a few days. We had the Transnet strike. That shouldn't affect overall year volumes, but it poses a risk as we look at volumes in Q1, and it might cause some spillover into Q2 as the port normalizes post the strike. Somerset shut is in the current quarter, same as last year. If you're looking at volumes quarter-over-quarter, in other words, Q4 versus Q1, it's just something to bear in mind. It was there in the prior year.
The CapEx for the year is $430 million, as I said, which obviously incorporates a portion of the Somerset conversion project. Overall, notwithstanding those inflationary cost pressures and the weakening demand in those segments that are referred to, we do anticipate that the EBITDA for the first quarter of 2023 will be above that of the equivalent quarter of 2022. Okay, operator, that's me gone through the deck. I'll hand it back to you for questions.
Thank you, sir. Ladies and gentlemen, we will now be conducting a question- and- answer session. If you'd like to ask a question, please press star then one on your telephone keypad or the keypad on your screen. A confirmation tone will indicate that your line is in the question queue. You may press star two to exit the question queue. The first question comes from Brian Morgan of RMB Morgan Stanley.
Hi, guys. Thanks very much for the call and congrats in regards to the numbers. Just a question on. You've announced PM2 now, that's very cool. If I can just ask you a little bit about what comes next. You know, you've obviously got a chalkboard of possible projects out there. You know, we don't have the visibility into what's possible. What conversion projects do you have available in the U.S. and Europe after this PM2 conversion is done?
Yeah, thanks, Brian. Two projects we're excited about at the moment. Firstly, on the Gratkorn labels. You know, it's on the smaller machine at Gratkorn. In the current year, we've made about approximately 50,000 tons on that machine on labels. Our goal over the next two or three years is to get that up to 200,000 tons. That will take another 150,000 tons out of graphics, approximately, obviously. And will move us further into a growth segment, which will give us higher margins. That's one that's very relevant to us. In the U.S., obviously our big project is Somerset, but even at Cloquet, we have opportunities to ramp up further on certain packaging and specialty grades.
You know, as we look at the volumes there's at least 50,000 tons that we can redirect away from packaging, graphics into specialties. Again, that's with relatively limited CapEx. Those are the two big ones. In South Africa, longer term, we remain very excited about the packaging opportunities. You know this, we all know this, that there's a shortage of packaging in South Africa to support the fruit industry, and that's something in time that we remain very excited and committed to hopefully boosting one day. It's not on the immediate horizon, but certainly a very exciting project.
The other thing that I would say as a group, and particularly in Europe, you know, we're more exposed to energy volatility and pulp volatility. You know, pulp integration remains an important priority for us. We continue to look for smaller opportunities integration.
That's awesome. Thanks, Steve. If I may just ask another question. The three mills that you sold, congrats on getting them across the line. How much did they make in the way of EBITDA in the last or in the FY 2022?
It's a tricky question, Brian, because there's a lot of fixed costs that get allocated to the mills and that they will be moving across with the operations. The best way to think about it is in terms of the overall EBITDA for the region, we're selling about a third of the volumes, and this is lower margin than the rest of the mills. On a normalized basis, these mills deliver about EUR 50 million EBITDA. They obviously made more in the current year, but you know, with the anticipated lower EBITDA in the year ahead, it wouldn't be at those elevated levels. That's why we point you towards the EUR 50 million. Take EUR 50 million off a normalized level of EBITDA from Europe.
Okay, that's great. Thank you.
The next question comes from James Twyman of Prescient.
Yes, thank you. My first question is just in terms of the U.S. conversion, PM 2, what sort of IRR are you anticipating there? The reason I'm asking particularly is because obviously you've done PM 1, so you've got an idea about what the IRR from that was, which should give you, I suppose, a fairly good idea about what could be achievable from this one. Secondly, relating to that, $480 million, it's a lot of money for a conversion. How would that compare with the cost of a brand new plant? Those are my first questions, thanks.
Yeah. Look, on the first question, you're right. We've got a lot of visibility. Just to remind you the PM1 conversion, the IRR returns were in the high teens. So it was a very successful project for us. The Somerset project is a great project for us, and in fact, is gonna deliver us returns above 20%. The reason that is, relative to PM1, is it's not just a conversion. This is an expansion project. It's gonna give us 235,000 additional tons of packaging. That's a very exciting opportunity for us. That basically answers your second question. You can't compare it with PM1. As you recall, PM1 cost us, I think it was $220 at the time.
Yeah.
This is an expansion. If you look at James, if you look at some of the peer announcements that are out there, and I'm not gonna name names, this is very competitive for. If you take into account the conversion and the additional 235,000 tons. This is a very good project, and we're very excited about the returns. As I said earlier, the demand is already there today.
Okay. Thank you very much. The second question I had was, in terms of this billion-dollar debt level, is this a sort of planned ceiling for debt, or is it a general area you want to be around? In other words, could debt go significantly above that if you do a deal, for example?
Look, we're focused on that number. Obviously, we've announced the dividend, we've announced the investment in Somerset. We wouldn't give you that number if we weren't confident that we could achieve it. In the 2023 financial year, you know, if you do the numbers, you'll see that we're gonna come in under those levels. Clearly, it's sized off our current asset base and, you know, we don't anticipate that changing in the short term. We think it's a very appropriate level, and it's something that we're confident of achieving.
In terms of in Europe, obviously very strong profitability in the quarter, but you did call out specialty not being strong or maybe being weak. Could you just talk about the margins there in specialty? I mean, even though it was weak, are they still high? Are they average? Are they low? You know, in terms of are there more price increases sort of to come there to offset some of these cost increases?
All right. I'll give you an initial answer, and I'm gonna allow Marco some time just to talk about the general state of the market. What I would say to you is just to remind you that this business is a lot of it's contractual based. As you know, we've been going through a period over the last year or so of playing catch-up. You know, we kind of caught up in the last quarter, but then unfortunately, gas and other prices continued to rise. A lot of our contracts mature in the middle of the year. Once again, we've kind of fallen behind. It's something that we need to focus on. Underlying demand for most of our categories continues to be good.
It's purely a margin squeeze. Because remember, during the quarter, natural gas just shot up, and pulp prices were still very high. I'll let Marco talk about the general state of the market.
Yeah, thank you, Steve. I think you summarized it well. The market is more resilient probably than the graphic market. Although certain segments you see have a bit of softening, particularly dye sublimation and containerboard, which are first indicators of where the macroeconomic trend is going. All the other segments, be it label, flexible packaging, functional paper, the more food packaging related segments are still doing very well. Steve was alluding to the fact that the costs have played an important role last quarter as well. Just remember that our specialty mills are not fully integrated.
Pulp is playing an important role, and obviously the gas volatility has played its part as well. Overall, these markets are still very attractive.
Thanks, Marco. Thanks, James. I'll go back to the operator and get somebody else to ask questions.
The next question comes from Sean Ungerer of Chronux Research.
Good afternoon to you. Thanks for the time. I've got a couple of questions. I think that I'll start off with DP, if you don't mind. Just in terms of the realized DP price in the quarter versus the CCF lag price. I don't know if my numbers are incorrect, but I was sitting at about 15% discount. I don't know if you could comment on that, please.
It's a good point. What it related to, Sean, is that we still had a significant amount of lag. You remember it still runs one quarter. Well, in this case, it would have been two quarters in arrears. I think it was over 100,000 tons. The 186,000 tons, which was still priced two quarters in arrears. If you do the math on that, and obviously as you know, the discount rate does get higher as you get up to 1,100. Certainly not a 15% discount to spot prices. The difference relates to the delay in those shipments.
Okay. Got you. As you move into Q1, I guess, what sort of discount should we be penciling in then?
Look, it should normalize. Also obviously you're gonna benefit from the same thing. I think there was a spillover of approximately 90,000 tons at the end of the quarter. But this time you benefit from it. You're gonna see a lower discount in this quarter, yes.
Okay. Got you. Thanks, Steve. Then just in terms of the impact from the Transnet issues and electricity or power issues, how do we sort of think about that versus, I guess, the backlog of volumes from previous quarters? Is there sufficient inventory to sort of cover that? Or, I don't know if you could give us maybe more tangible numbers around that.
Yeah. I'll let Alex talk in more detail, but just a couple of highlights. In terms of the outage, the Eskom outage, or I'm not. No, not Eskom, the municipal outage, it was about 10,000 tons across the three mills, mainly dissolving pulp. So that puts it in perspective. In terms of the Transnet strike, well, firstly, we're hoping to catch up a lot of that backlog that I referred to the 90. Most of it we are hopeful that we will catch up. However, it does look like about 20,000 tons would have been impacted by delays because of the Transnet strike. I'll let Alex talk in a little bit more detail.
Yeah. Thanks, Steve. It is roughly 20,000 tons and it's effectively just a delay. Obviously for every day that you have the strike, it costs you about 10 days to work down that delay. It has a little bit of a cost impact because you've got rehandling and storage and that. Maybe just on that note, the Transnet railway bridge that was just still washed away on the South Coast is putting more trucks on the road, and that obviously has a bit of a cost impact as well. That hopefully is resolved by April.
Okay. Thanks for the color, guys. I don't know, I've just got a few more questions on DP, if you don't mind. Just in terms of how we should be thinking about the shuts this quarter for the quarters coming up, that would be useful. Linked to the Saiccor expansion, is there any sort of cash cost saving guidance that we should be aware of? Or is there any?
Look, obviously there's a lot of moving parts, Sean. We, you know, chemical prices have been rising fast. You know, caustic, which obviously is an important raw material for us, in the cooking process, that's started coming down but it's now shot up once again. That's gonna put further pressure on costs. In terms of the DP business specifically, in terms of shuts, no major shuts in this quarter. You know, the only big one is in Somerset. Some smaller ones later in the year, Alex, but nothing.
Yeah.
Nothing major there, right?
Nothing significant, no.
No. You've got Tokay and Keith. No, Tokay is not this year. Yeah, that's right. That's the only one, Sean.
Okay. Excellent. Thanks, Steve. Just to conclude on the DP, I guess sort of heading into 2023, I think, you know, the general consensus view is that demand should be weaker. Sort of I'm just trying to tie that into how you sort of see that sort of demand for your DP, given that it's been pretty high in 2022.
Yeah. Look, you know that there's global pressures here. It's not unique to the viscose fiber. It's across all the fibers. Really the retailers, you know, have allowed their inventories to build up quite significantly. That's had a knock-on effect across the value chain. There's a strong destocking now underway to reverse that trend. I guess that gives me some confidence that in time it will reverse itself. For the next few months, we are gonna have the headwind of a destocking. What it means for Sappi, obviously a high proportion of our volumes is contracted.
What we are seeing across all viscose producers, and I'm sure you've seen some of the results. Across all viscose producers, they are operating at lower operating rates and it has reduced global demand for dissolving pulp. I'm hopeful and optimistic that it's short-lived. Mohamed, is there any more you want to add on just generally on the markets?
Yeah, Steve, I think you've covered everything, all the stuff pretty well. The only thing I would add is that, you know, we have seen through October, an improvement in the China VSF operating rates. It had dipped to about 52% in September. As of early this morning, it's now sitting at around 68%. We've seen some improvement come through in October.
Yeah. Yeah.
Okay, great. Thanks, Steve. Then just on the paper front, sorry, did you guide on the EBITDA impact from the Somerset shut? I think it was maybe like $20 million in Q1 2021. Is this gonna be a similar amount?
Yeah. The reason we're, you know, 'cause I know some people, you know, some people compare it quarter-on-quarter. If you are doing that for the North American business, you've just got to take that, I think it was $18 million. You've just got to take that into account.
Okay. Got you.
$20 million. Yep.
Okay. Thanks, Steve. And then just your comments around the sort of pressure in the coated woodfree and coated mechanical markets, both North America and Europe. I mean, could you maybe just sort of run us through your sort of thinking and assumptions, how you think the year is gonna play out, obviously excluding the impact of the European sort of. 'Cause I mean, that'll whack volumes in Europe by like 20%.
Yeah.
Outside of that, how should we sort of be thinking about the structural decline again, or what have you penciled in?
Yeah. Well, firstly in North America, let's address that 'cause it's easier. Markets still remain tight. They may not be as strong as they were six months ago or three months ago, but remember, that was from a very, very high point. Operating rates are still very high in the industry, and we're still pretty confident in North America. Europe, yes, there has been a softening. It's probably not unlike what's happening in the dissolving pulp market. We are seeing high levels of inventory across the value chain, and we've seen lower order activity in recent weeks. Broadly, maybe let me talk longer term and then specifically to 2023.
I mean, broadly, we continue to believe that demand will decline 5%-6% per annum. At the moment, as we stand, order activity is lower than those levels. However, we are pretty confident that it relates to an inventory adjustment. It may have an impact, you know, in Q2, but ultimately for the year as a whole, it's likely to be better than what we're experiencing at the moment. But at the moment, yes, order activity is low, and maybe I'll allow Marco to go into more detail there.
Yeah. The situation we're currently in graphics was partly to be expected. It's a destocking situation that is not abnormal. What was exceptional and unprecedented was the demand that we saw in the last 12 months, basically a result of capacity being taken out and post-COVID additional activity. That has resulted in over-ordering and overstocking, and that is what we see happening right now on the graphic side. Is it something to get overly worried about? No, but it has an effect on the current order intake and therefore on the seemingly softening of the market. It is twofold, destocking and a slightly softer market than 12 months ago.
Excellent. Thanks for color. Just one more for Glen, if you don't mind. Glen, just in terms of the effective tax rate versus cash taxes paid, it was obviously quite low in 2022. Maybe you could provide a little bit of color around that and sort of link to cash flows on net working capital is quite a large outflow in 2022, $270 million. How should we sort of be thinking about then 2023? I'm assuming there'll be a fairly sizable return of cash flow from that. Thanks.
First of all, as far as the tax is concerned, there was an outflow of just over $20 million. We anticipate that that's gonna double going into 2023. That's obviously a function of the increased profitability. In terms of the working capital outflows, we manage our working capital as a percentage of sales 'cause you'd note it's a function of the operations. For the year, we came in at just over 9%. We're gonna manage it-
Between 9% and 9.5%, going forward. At this point in time, that's all I can give you. We don't see a further large outflow.
Yeah, that's not gonna be repeated. Obviously, you know, and we've referred earlier to, you know, potentially lower volumes in Europe. Obviously, if that were to happen, then you would have a reversal of working capital.
Got you. Thanks, guys. I've got two more, then I'll go back into the queue. Thanks.
Okay. Operator?
Thank you. Ladies and gentlemen, just a reminder, if you'd like to ask a question, you're welcome to press star and then one to place yourself in the question queue. Can we go back to Sean for further questions?
Okay. Your call, operator, if there's no one else asking questions here.
Thank you.
Okay.
Sean, your line is open. You can go ahead. Thank you.
Awesome. Thanks, guys. Just going back to energy costs in Europe. Are you prepared to give us a sort of headroom that you guys saw in Q4? This is the tone we're gonna see in Q1 now?
Look, broadly, what I would say is that, our energy costs in Europe for 2023 are hedged, in other words, fixed price at about, 63% at obviously substantially lower levels than the, current spot prices. Just to recap on what happened last year, we saw Q1 and Q2 obviously prices rising, and then in the latter part of the year, Q3 and pre-Q4, at significantly higher levels. At current spot prices, you're seeing a situation where Q1 and Q2 was less, but Q3 and Q4 were more. Broadly, the way we're thinking about it is that, based on our estimates and where current spot prices would be, that if you take the year as a whole, we're looking at about 20%-25% higher than the prior year for Europe's energy costs.
That takes into account our 68% hedging. Clearly, if energy prices come off, then that would change.
Excellent. Thanks, Steve. Then just going to CapEx, initial based on what that one slide said, so are you looking at sort of same business and then sustainability CapEx, and then if you do a sort of equally weighted load up on the Somerset expansion, you're sort of looking around $500-$520 for FY 2024 and 2025. Is that correct?
Yeah. That's right. I mean, clearly, you know, we haven't finalized the math and finalized all our budgets for those years. Broadly speaking, if you look at the CapEx, let's talk some of it. $70 million roughly in the current year and then roughly $175 million over the two remaining years. That would be an additional $100 million CapEx in each of those years.
Awesome. Thanks, Steve. Then just last one from my side. If you sort of look at the capacity output per grade over the next sort of three to four years, it's not long until I think packaging and specialties will easily or materially surpass DP. Is there any sort of reading into that in terms of how we should think about growth, I think, beyond that? I mean, is there any insight into that or that just is what it is? Thanks.
Specifically in dissolving pulp, you mean?
Well, I'm just saying, like if you look three years out.
Yeah.
The packaging specialties with the announced conversion plus the switch out in Europe is gonna be well ahead of DP capacity.
Yeah. Yeah, look, if I look at 2027, based on our plans, we're talking approximate numbers. We're talking approximately 30% volumes in graphics, 25% in pulp, and over 40% in the packaging and specialty grades. Those are the kind of numbers we're targeting.
Okay. Thank you. I'm just saying in terms of capital allocation forward, is there a stronger preference for?
Look, our biggest area and our number one priority is in the packaging and specialities segment. That's why we've committed to the projects that we have, the Somerset, the Gratkorn, what we're doing at Cloquet, stuff we're doing in South Africa. That is our number one priority. Dissolving pulp, obviously there can be smaller debottlenecking type opportunities, but at this stage, we don't anticipate, at this stage, any additional dissolving pulp, any big dissolving pulp capacity.
Awesome. Thanks for the time, guys. Steve.
Thanks.
Thank you. The next question comes from Tim Clark of SBG Securities.
Thanks. Good afternoon. Firstly, congrats on the results. It was a really strong result, so well done. Just a couple of, you know, sort of quite sort of administrative questions from me. The first one is just on your disclosures of discontinued operations. I wondered why you didn't strip out the European graphics sale, just to give us a better idea of what the sort of historic kind of profitability looks like, excluding those operations. You know, Mondi with selling Russia gave us that sort of disclosure. And then the second question is, you know, in the release, it didn't look like you were committing to a specific dividend payment level. On that slide that you spoke about using internally, it sort of spoke of three times cover.
Should we be thinking of, you know, sort of a three times cover scenario as most likely going forward, you know, given the sort of the trajectory of commitment that you made to with growth right at the bottom, shareholder returns above that. Just my last question is just on graphic paper. You know, like there's a sort of conversion process going on and closure process as demand declines. I wonder if there's a point at which you think that we reach that on certain of the machines and certain of the operations, there's just not going to be any need to ever remove those because there'll always be some underlying demand.
I wonder if you could give us a sense of how much of total sales volume you think that is. You've gone down sort of to the 45 post the sale, and that continues down with the conversions. Thank you.
Yeah. Okay. There's various questions. I'll let Glen explain why we didn't treat it as a discontinued operation.
All right. As you rightly pointed out, we've identified it as assets held for sale. It's not a discontinued operation because it doesn't take up a large section of what we consider to be our segmental reporting. There was no requirement for us to separately identify the operations on the income statement, but just to identify the assets held for sale. We did in our notice on the divestment give you an indication of what the average earnings is, which Steve has already spoken to about, and we're looking at about the EUR 50 million mark. That should give you an indication of what the profitability is.
Yeah. Basically, it's relative to materiality, Tim. I know you referred to Mondi and their Russian operation. For us, this is not that material and that's why the accounting treatment, the technical treatment is the way that we've reflected it. In terms of the dividend cover, yeah, that. Look, that's a long-term target to get to 3 x. It's not something that we would be striving to do immediately. The fact that we've committed to this $0.15 in the current year is clearly our starting point and in time, we want to ramp that up. In terms of the graphic conversion, look, this is an ongoing process.
The assets that we have left in our graphics business, we believe are world-class assets. They are competitive, and they, as has been reflected in the last year, and I guess that's what you're alluding to. In times of tight market balance, they can generate significant cash flows and make very good margins for us. We just have to be proactive. We have to assess the situation. That's really what we've done with the Somerset conversion. You know, once again, we expect demand to decline over the next two or three years, you know, at 5%-6% per annum.
You know, based on our numbers, and the sizable opportunity to grow our packaging business, it made a lot of sense to do that. It's difficult to say what is the end point because, you know, we'll have to assess markets as we go forward. The numbers that I shared earlier on the call about the split of our volumes, that is, that's our best estimate of where we think the business will be come 2027. If you look at the remaining assets that are in graphics in North America, we've got a great machine at Somerset, PM3. We've got great machines at Cloquet. In Europe, we've got Gratkorn, a very big machine, the best machine in Europe.
We've got machines at our Ehingen operations, Lanaken. All of those are world-class assets. You know, in that timeframe, we think can deliver good returns, and that's why we focus on optimizing graphic paper.
Thank you.
Thank you. The next question is a follow-up from James Twyman of Prescient.
Yes. Thank you. Just a few quick ones. Firstly, on the European business, since the last quarter, we've seen the gas price fall sharply and specialty prices potentially moving up. If we're not gonna see profits rise quite substantially, we've got to see, I would guess, prices coming off in the next few months. I'm not seeing that at the moment. What are you seeing in terms of prices? Are they remaining at these current levels?
James, it's a good question. You know, our focus at the moment is because we know that the costs are at elevated levels. Based on that, we are striving to hold our selling prices as much as possible. That is the focus of attention. The margins, we're trying to protect the margins. From what we described earlier, you can hear that there's some volume concerns related to the weaker demand. We will strive to maintain our margins as long as we can.
Thanks. You mentioned your de-bottlenecking PM1. What sort of size is that? Also, are you considering giving authorization for a share buyback at your AGM?
You know, on the first one, it was an additional $30,000. Mike, that was in the numbers already, eh? Or it will be in the numbers this year.
Yes.
Yeah. Is it, James? It'll be in the numbers this year. In our annual report, we are gonna put a resolution to have a general buyback of 10%. The authorization.
Okay. Thank you.
Operator, we're gonna have to end the call there 'cause I've got some journalist calls that now. If we can close it off there, okay.
Thank you very much. That does conclude the question and answer session.
Okay, thank you very much, to everybody for joining us, and we look forward to discussing the results at the end of Q1. Thank you very much.
Thank you. Ladies and gentlemen, that concludes today's event. Thank you for joining us. You may now disconnect your lines.