Good afternoon, ladies and gentlemen, and welcome to Sappi Limited's Quarter Four of 2021 Results. All attendees will be in listen only mode. There will be an opportunity to ask questions when prompted. If you should need assistance during the call, please signal an operator by pressing star and then zero. Please note that this event is being recorded. I'd now like to hand the conference over to Mr. Stephen Binnie. Please go ahead, sir.
Thank you. Good day, everybody. Thanks for joining us for the results call. Our year-end and obviously final quarter results. As always, I'll move through the investor presentation, calling out the page numbers as I move through. I'm gonna start on page three, which just has some of the highlights for the year. I think most importantly, obviously we return to profitability overall following the impact of COVID last year. I'm pleased to say that we did get back to profitability. Other highlights, the Packaging & Specialties segment achieved record profitability, obviously justifying the recent year's investments in that segment, and we are excited about the prospects going forward. DP, dissolving pulp was strong. Price is good, market demand strong, and we were fully sold out.
Graphics recovered a little bit slower in the early part of the year in Europe, but subsequently picking up there. Relative to pre-COVID levels, getting back to encouraging levels, and I'll talk a little bit more about that on the quarter one. On the other side, obviously in recent times, we've seen the rise of costs coming through. Initially it was pulp, but more recently came energy and that negatively impacted margins. We'll talk more about that. Then the other challenge we faced, and it's not unique to Sappi or even our industry, but the ongoing global supply chain challenges. Once again, we'll talk about that some more. Liquidity improved significantly during the year. Obviously from our leverage from the worst points in COVID.
We continued to improve and the balance sheet is looking stronger. Once again, we'll cover that in a little bit more detail. Moving to slide four, which is specifically on the quarter itself. Excellent performance from our North American business that was broad-based across all the segments. The business was able to achieve the highest quarterly results in, I think, more than 20 years. Very thrilled by that. DP, very strong, good prices. That contributed to improved profitability in the segment. Packaging continued to be good, a little bit down on the prior- quarter, but that was a combination of the higher costs in, mainly in Europe coming through.
Remember, we did have the impact of the unrest in South Africa, which we did share with you in the last quarter. Obviously, at our Tugela Mill we make packaging there, so that impacted volumes there. Graphics now have reached 86% of pre-COVID levels, Q4 2019, which is probably better than we could have hoped for a year ago. We'll cover that specifically in the regions. That's enabled us, certainly in the U.S. to fill our machines, and Europe things have significantly improved. The one challenge that we did have obviously was the supply chain challenges. We talked about this at the end of the last quarter.
Unfortunately, it's meant that we had 100,000 tons, which we were not able to deliver during the quarter. Now that's obviously sitting in inventory. But what I should say is that those are contractual volumes. They were not, they're not going into the marketplace. Those are contractual volumes. The price, those have been sold. The price is linked to the prior- quarter pricing. Although we've lost the benefit in these quarterly numbers, and we show you that's a $30 million benefit, that is just a timing difference. That will be sold in future quarters.
The shipping challenges that we faced, and we talked about this in our last quarterly call, and we gave you guidance at that point in time for what we felt the volumes would be for this quarter. What we found subsequent to that guidance was that the situation deteriorated in Durban specifically. We started to see cancellation of vessels which we had booked our deliveries on. You know, vessels which we thought were gonna be coming were diverted away from the Durban Port because of the significant backlog. I'll remind you that just prior to that results announcement, we did have the IT outage at Transnet, which impacted on the port.
You know, I do concede that we missed our guidance at that point in time, but I want to point out that was our best estimate. The situation subsequently got much worse. Having said all of that, we are more encouraged where we are today. It does look like more vessels are now coming back to the Durban Port. We've had proactive discussions with the big global shipping lines, and we are more encouraged, which is indicating that maybe the worst of it is behind us. It's gonna take some time, clearly, to catch up the backlog that we have, that 100,000 tons. In the earnings guidance that we've given you, we've assumed that there will be no.
There would be a catch up, but we will be able to sell our the production that we are making because of the improved situation. In time, as I say, we are encouraged by the improving situation. Moving to slide five, just an earnings bridge for the year, and I guess most of these things we've talked about. Obviously, sales volumes generally up on the prior- year, but DP impacted by the backlog that I've just been spending time on. Pricing improving across all our segments. Costs going up. Initially purchased pulp as we've indicated. Delivery costs rising. And then we've grouped together energy, wood, and chemicals.
Within that, energy and chemicals up, but we did see lower wood costs offsetting some of that. I will talk a little bit more about energy in a future slide. Moving to slide six. Just a product contribution split, and we thought it would be useful to show you the evolution from 2016- 2021, both on profitability and volumes, you know, we continue to make progress. We're reducing our exposure to graphics. It's now down to 54%, and I would expect that to continue to come down. Packaging obviously ramping up and will continue to increase. Obviously from a profitability perspective, Packaging the biggest segment for the year. DP, obviously over the years, we've had a number of smaller projects and going forward, we'll have the new expansion volumes coming through.
Slide seven shows you the margins by product segment, and Graphics continues to recover and is looking more favorable as we move forward. Packaging good margins lower than the prior quarter, but that is predominantly because of the higher costs that came through in Europe. I'll remind you that those are periodically priced contracts in the packaging space. We did put through a series of selling price increases, but then the cost rose once again, and we're now implementing, or we have been implementing, further price increases to offset the higher costs. Dissolving pulp recovery of margins, very encouraging, lower volumes because of the backlog.
Slide eight has the leverage ratio on the debt side, continuing to come down, and then we would expect that to continue in the year ahead as our earnings to improve, and we generate more cash, and therefore the absolute debt levels will continue to come down. Slide nine tells a great story. We managed to refinance our bonds during the year, our securitization also, and we have a very favorable near-term profile. We don't have any major debt maturing, so feeling good about that. On slide 10, moving to CapEx, our guidance for the year ahead is $395 million. That includes $30 million for the Saiccor expansion project. That's that overrun that we talked about in the last quarter. So if you back that out, the CapEx for the year is $365 million.
We did disclose this in the earnings announcement. Included in that is firstly, sustainability projects of about $75 million. As you know, we've committed to reducing our carbon footprint and reducing our carbon emissions and improving our environmental footprint. Just to quote some of the projects that are contributing to that $75 million, the first larger one is at Saiccor. We're looking to eliminate all our use of the calcium and move that across to magnesium. So that consumes some of the CapEx. We have other smaller initiatives at Ngodwana that will continue to improve our environmental footprint. In Europe, as you know, there is legislation, very strict legislation to improve carbon emissions.
We have a number of initiatives, and specifically at Gratkorn, Kirkniemi, and Maastricht to improve. Gratkorn and Kirkniemi moving from coal to biomass. Maastricht, we're moving to an e-boiler there as well. That is gonna help us, and you know will enable us to get closer to our legislative targets and our science-based targets that we've committed to. On top of that, we included in our CapEx is what we called cost optimization and quality improvement projects. We have a project at Ngodwana to improve our quality. As you know, we have a great containerboard business there, and we need to continue to invest-
The sound apparently is cutting.
Apologies. I'm told that the sound keeps cutting out. I'm not sure why, so I will. Should I talk slower? Okay. I've just received feedback that the sound is cutting out. I'm not sure why, but I'll carry on regardless, and then if we need further clarification on the questions, we'll take them as they come. Included in the cost optimization initiatives, as I mentioned, there's a quality improvement project at Ngodwana. And then we have a series of smaller cost initiatives. Ones that we believe will give us very quick paybacks, two to three years, that make sense, which will help us move down the cost curve and entrench our position. We also have some IT initiatives.
We're rolling out a new mill production operating system as well, and that's in that number. Moving to slide 11. As I talked earlier, one of the challenges we've faced is with shipping. We could have put in many slides that could demonstrate that. This one is from Sea-Intelligence. It's on reliability of ocean freight. You can see it's dropped dramatically since COVID. Actually, during the quarter that we've just been in, as I talked about, it actually declined further. What I will say is that we are seeing spot rates for freight now starting to come down. There are positive signs which I talked about earlier. We are feeling a little bit more encouraged about the situation for our deliveries.
Slide 12 has the paper pulp prices. There's a few numbers there reflected with both. We've got the European pulp prices, which you can see still remain elevated. As you know, we're a big pulp buyer in Europe. We buy close to 800,000 tons, so that does continue to impact our business. However, in China, we have seen pulp prices across the board decline. That's partially linked to the energy capacity constraints that the Chinese government has placed on Chinese industries. That has had an impact. Sappi not benefiting from that at the moment because obviously European prices still remain high. Moving to slide 13.
In recent weeks and in the last month or two, we've seen a big surge in natural gas prices and energy prices across the board in Europe. You saw the big surge, and you can see it in the graph subsequently declining. As we look at our energy costs for Q1, we are estimating that the impact of all of this, mainly in Europe, but it's not just Europe, but mainly in Europe, is about $70 million in absolute terms. However, we have implemented, and this is public knowledge, we have implemented an energy surcharge in Europe of EUR 100 a ton, to offset that impact. It was announced two or three weeks back. It is on all deliveries subsequent in the last couple of weeks.
That has been successful for us. It has not had an impact on the demand for our paper, but it has offset the impact of those higher costs that I've just referred to. Therefore, we do not believe that in our Q1 earnings, that we will have a margin squeeze because of the higher energy costs. We've been able to offset that, and we are encouraged by the way that it has unfolded and the way we've been able to implement the higher surcharge. Obviously, at the same time, we continued to announce selling price increases as well. Moving to slide 15, that is on our product segments. Firstly, dissolving pulp. Prices still strong during the quarter, remained above $1,000.
Come back a little bit in recent weeks, linked to the energy constraint placed in China and the fact that Viscose producers had to reduce their operations, so there was less demand for dissolving pulp. Generally the market is good. Obviously our segment is impacted by the backlog that I referred to. Viscose prices dropped during the quarter, but what we've seen since that energy surcharge or that energy constraint has been put in place is that Viscose prices actually have increased quite significantly. We're also going to have the additional volumes coming through from our expansion project. We have all but complete that project. Most of the equipment has been handed over now to the mill. The last step is the boiler itself.
The team are doing their final tests, and that will be completed in the next week or two, and then we'll be ready to operate and ramp up from that point. It's good to get that behind us and obviously we're gonna see the benefit of the volumes coming through as we move through the year. In terms of longer term, we are encouraged by the dissolving pulp markets. There is additional capacity coming on board, but we believe that the demand is more than enough to offset that. Strategically, as we look forward, we anticipate that our level of contracting will come down a little bit down to 72%.
We're confident of being able to place that into the Chinese and other spot markets. Slide 16 has the dissolving pulp indicators, strong recovery in retail textile demand. You can see that flowing through. The graph on the right just shows you what I was talking about earlier, DP coming down but now a big surge in Viscose prices. That we believe will be positive for DP prices moving forward. The packaging segment on slide 17, great year, record profitability, margins good, very strong demand in North America and South Africa. Europe, a little bit more mixed. As the European economy has recovered, we're starting to see a more broad-based recovery.
Obviously, profitability, as I indicated, impacted in the quarter by the higher costs. That surcharge that I referred to earlier was across all our paper grades, so it was equally applicable to our packaging business and Packaging & Specialties in Europe. Slide 18 has the North American SBS market, and we thought that would be useful. You could see the impact through COVID. You did see a lowering of production, subsequent recovery. Shipments continued to be pretty strong, and we've seen significantly rising selling prices, obviously to offset the higher costs that are coming through there. Markets are good, markets are tight. Slide 19 is Graphics. I think it's fair to say that the recovery in Graphics has exceeded our expectations.
If you look at the market overall, 88% of pre-COVID levels, and if you think about that's over a two-year period. I don't think any of us could have anticipated that, it could have got back to 88 [uncertain]. But within Sappi, our coated wood-free is even better than that, and we've been able to gain market share. Overall, volumes in the segment reached 86% in Q4. And as I say, profitability impacted by costs, but we have been implementing selling price increases to offset that impact. Slide 20 just shows you the respective markets in U.S. and Europe and the recovery in volumes. We're feeling encouraged because both markets now are tight and in balance.
That will enable us to implement the selling price increases that we've announced to offset higher costs. Turning to the regions, Europe, and much of this I've said, so I'm not gonna repeat, but early part of the year impacted by volumes subsequently recovering. Coated wood-free for us is 99% of 2019. So you can see that demonstrates the tightness of the market that I referred to and why we are more encouraged as we move forward. Costs rising, but we have been implementing selling price increases. North America, fantastic year. Across the board, highest quarterly earnings in more than 20 years. All the segments full. Our machines are full. Margins good, improving. We're feeling very good about our North American business.
Yes, we've got higher costs, but we've been able to implement higher selling prices to offset that. In South Africa, we're also very encouraged. Yes, we have challenges, but DP markets still remain strong. Our paper business is good. Containerboard, specifically, strong demand. We are encouraged that we can. The situation with the backlog. I'm gonna remind you again, that margin is not lost, it's just delayed from the fact that they overspill. On slide 24, our cash management. Tremendous work done across the year. Refinancing our bonds, improving the liquidity situation, and that will continue to come down in the year ahead as our profits grow. The leverage ratio will continue to decline. CapEx, I've spent time on already.
On the procurement side, some nice savings there, and we will continue to look for opportunities. Slide 25, I don't intend spending a lot of time on because we've talked about it previously, but the four pillars of our strategy, we will continue to look for opportunities to grow in the higher margin segments. We are gonna reduce our exposure to Graphics as we move forward, but we are gonna redirect that towards packaging grades. There are opportunities to do that in Europe, and in the U.S. The financial health, I've spent time on. It's improved significantly. Our job continues to be to drive operational excellence, and we'll look for opportunities to save on the procurement side. Those cost optimization numbers that are referred to earlier on CapEx, that's what it's all about.
It's about driving operational excellence, lowering us down the cost curve, and generating further savings as we move forward. Enhancing trust. You know, we're very excited about the work that we're doing to reduce our environmental footprint. We've committed to science-based targets, and I'll talk a little bit more about that in a slide ahead, as we move forward. Slide 26 just summarizes what I'm saying. The financial year 2022, further reduction in debt, get that profitability back up again, continue to look for opportunities. We're not gonna commit to any big projects to improve, to increase our exposure yet, but we continue to evaluate opportunities. We think there's lots of exciting opportunities in the packaging space.
Slide 27. With our Thrive25 strategy , we rolled out a new sustainability strategy, and that's across the group, is being embedded in everything that we're doing. What we've done in the next couple of slides is just, it's a scorecard that we keep internally. We've set ourselves targets, which I'm not gonna talk through all of them, but just to highlight a couple briefly, and I'm on slide 28. Firstly, safety, which obviously comes first for Sappi. We missed our targets for the year, but underneath that, some great work being done. South Africa, where traditionally we've had our most biggest challenges, we recorded further improvement, and in fact, we got a record best ever performance.
The U.S. in the final quarter had zero injuries, so very pleased with that. The reason we missed our targets is in Europe. A couple of mills did not achieve their targets, and that's something that we're focusing on, and we'll continue to spend a lot of time so that we can continue to improve. Another highlight for us is our achievement as a Level 1 contributor in terms of Broad-based Black Economic Empowermen t. A lot of great work being done there across the board. You know, whether it's from procurement or it's from an employee perspective, lots of good work that went behind that to achieve the Level 1 level. Obviously, we missed our return on capital employed targets that we've set ourselves.
That's on the back of the lower profitability from COVID, but as we move forward, we believe we'll continue to make improvement. On slide 29, a number of targets there to improve our environmental footprint. The one we did miss out on slightly was our water usage, but that was impacted by the civil unrest and the cold commissioning that we have to do ahead of going live with the Saiccor expansion. But we did achieve our targets across emissions and landfill and biodiversity. Very pleased with the progress there. Turning to the outlook then. Page 31, DP strong, albeit that there is some short-term pressure in the Chinese market linked to the energy constraints.
You know, hopefully that will start to be over, and then we'll benefit from the higher Viscose prices that are coming through. Packaging, good. Strong demand. Graphics now has recovered strongly. The markets are back in balance. We've been able to put through selling price increases. The energy surcharge that I talked about, logistics problems, hopefully over the worst. We do have the Somerset Mill outage during the quarter. That's been done now, it's behind us, but it does have a $22 million impact. It's a cold shut, so it's more than prior years. It's good now that that's behind us and the mill is operating back up to full capacity there. All in all, we're feeling good about the quarter ahead.
We anticipate further improvement in EBITDA relative to the numbers that we just reported to you. Operator, that's me, completed. I'm gonna hand it back to you for questions. Apologies if there was breaking up as I was talking, but hopefully most of that came across, and I hand it to you for questions.
Thank you very much, sir. Ladies and gentlemen, at this time, if you'd like to ask a question, you're welcome to press star and then one on your touchtone phone or the keypad on your screen. If you decided to withdraw your question, you're welcome to press star then two to exit the question queue. Just a reminder, if you'd like to ask a question, you're welcome to press star and then one. The first question comes from Brian Morgan of Morgan Stanley.
Hi, guys. Thanks very much for taking the time. If I may ask three questions, just on the 100,000 tons of DWP that's sitting in inventory at the moment. I get that it's all contractual sales and that's fine. I understand what that means. Just in terms of what you think your customers have done to mitigate not having the volumes, Do you think they've drawn down on their inventories? Have they hit the spot market to get those tons, or they're just taking reduced operating rates? When that tonnage does eventually come to the market, first of all, when do you think it could come? Is it a December quarter issue?
Is it a March quarter issue? What impact do you think that might have on the market at that point, given that it is quite a big chunk of global supply if it does come on all in one go?
Okay. Do you want to give me the other two questions, or do you want me to-
If you could deal with that one, then go from there.
Yeah. All right. I'll let Mohamed elaborate a little bit further, but it's actually a combination of all those things. Their inventory levels have dropped significantly. They did slow operating rates down a little bit, and they did have to go into markets to get some of the additional volumes. In terms of when will it come back, I don't think there's gonna be any meaningful improvement in the current quarter in terms of catching up with the backlog. We do feel that we can sell the current production volumes, but in terms of reducing the backlog, we don't anticipate any meaningful improvement. There could be some, but not anything materially. We would expect that to be spread over the next couple of quarters.
You know, this logistical problem is a worldwide phenomenon, so it's not gonna be solved overnight. It's gonna progressively improve. I remind you once again that we do get the, it is contracted, and we do get the lag pricing. So it is, that's not lost contribution. In terms of that suddenly coming onto the market, it is contractual. So it's not gonna suddenly flood the market. The markets are very tight. Customers are pushing hard for volumes. Maybe not the Chinese customers. You've gotta separate the Chinese market from the rest of the market. Outside of China, markets are extremely tight, and everybody wants more volume.
The DP price that you see quoted is obviously the Chinese price, and that's linked to this energy issue at the moment in China. Ultimately, when we do catch up with those volumes, they will be sold to our contractual customers along with our current year's production.
Okay. Cool. Can I ask then on the energy surcharge, et cetera, we saw about a EUR 50 per ton price increase from recent now for November. I assume that the price index that we look at doesn't have the surcharge baked into it. Is that right?
I think so, but Marco just confirm that.
Yeah. There's a separation between market prices and this exceptional and temporary energy surcharge. Market prices would not include that surcharge.
In our modeling, we should just build an extra EUR 100 a ton into our prices. Are you achieving that across your full graphic paper slate or only a portion of it?
Yeah. No. Sorry, Steve. Go ahead.
Go ahead, Marco. Go ahead.
No. That's across the entirety of our portfolio, and also the entirety of the geographical destinations.
You spoke about demand elasticity, or you referred to demand elasticity, and we did see back in 2018 these epic falls in volumes as a result of price increases. You're not concerned about that this time, are you?
Marco, let me just start with that, and then I'll feed to you. Just one clarification, Brian, on the first one. Remember, the surcharge was only implemented towards the end of October. It's not the full volume quarters. It's not the full -quarterly volumes, okay?
Okay. Yeah. Got it.
We do anticipate it will offset that absolute increase in energy costs that I referred to. I think that's important to point out. Marco can elaborate further, but just from my perspective, we've seen no impact on demand for our product in the short term. It's very difficult to project what it might mean in the longer term, and I guess there is a risk that significant rises in selling prices could soften demand for product in the long term. At the moment, demand is strong and markets are tight. Marco, I don't know if you want to add to that.
Yeah. Maybe very shortly, Steve. There is indeed a tightness in the market right now, which is partly, probably speculative or at least driven by very long lead times and the disturbance on supply chains. Underlying, we feel that the advertising market after, at the end of the lockdowns in Europe has come back stronger than what we anticipated. There's certainly a healthy underlying demand, but there is an additional speculative element. To your question on what it will longer term do to the demand for print media, difficult to say right now. We're early days.
We're calculating in our models with the natural substitution rate as we've seen it before, where there is a leakage towards online and digital media that will most likely continue. There is certainly a residual market that currently seems to be very resilient.
I'm sorry, can I ask just a follow-up question on that, if I may. To what extent do you think we might be seeing over-ordering by customers? Is that a risk or not?
Brian, we're not seeing that. There's been a resurgence and clearly there was a bit of backlog because of the COVID and the dampened demand at that point in time. As Marco has indicated, advertising has bounced back very strongly along with the rest of the economy. As things currently stand, our orders are very strong. Yeah, there's a little bit of, maybe a bit of excess demand, but we are encouraged as we look out on our order book over the next few months.
Okay, cool. Thanks, guys.
Thank you. The next question comes from Sean Ungerer of Chronux Research.
Good afternoon, guys. Thanks. Just a follow-up question in terms of the comments around the markets being tight. I mean, can you just sort of unpack that, tying it into the sort of commercial downtime taken in the quarter, as well as I think there was an impairment on one of the coated mechanical machines in Europe?
I think that would be part of it. Obviously, capacity's come out. There was curtailment that took place during the difficult period. That would have an impact. Once again, just to repeat what I said just now, if we look forward and the underlying demand at the moment, it is strong. A lot of capacity came out of the marketplace. With volumes or market demand recovering, you can see the numbers, close to 90% of 2019 levels. That is a very healthy recovery when you take into account all the capacity that's coming out, that's come out of the marketplace.
Okay, great. Just going back to DWP, specifically on how we should think about volumes and how you're gonna run the machines this year. I mean, if you look at whatever the final number for FY 2021 was in terms of pure DWP, do you mind building a sort of bridge for us, how we should think about 2022? Because obviously, 2021 you had oxygen impacting Ngodwana. You've obviously had 40,000 tons impact from the Saiccor expansion. I think obviously the 100K now, and I think there's probably about another 20,000 tons in Q3 that was split between U.S. and SA I mean, if you look at the, obviously the expansion is up and running now? That will obviously add positively to volumes.
I don't know what sort of impact there will be from the sort of calcium, magnesium line conversion? Maybe if you just build a simplistic bridge for me to understand please.
Sure. I mean, obviously, there's a lot of noise on doing a bridge because obviously you had the oxygen outage in the early part of the year, then you had the riots and all that stuff. If I could approach it from the other side, from a capacity perspective, and if you look at the mills, obviously you have Ngodwana, which is a 250K mill. Saiccor, pre the expansion, 780,000 tons. Then you have Cloquet, which is swing, but is quite a high proportion of the mill.
You'll appreciate I can't give you the exact number because, you know, we have to buy pulp and so on and so forth for our paper business, but a high proportion of our Cloquet Mill will be focused on DP. I think it's more than 75% on DP. On top of that, you have the expansion. Obviously it starts now or in the next week or so, the next couple of weeks. It doesn't all come on board immediately. There's a progressive ramp up, so you have to. It is 110,000 tons in total, but, you're gonna have to progressively increase that.
It's difficult for me to give you an exact number, but Alex, you know, perhaps about half of that over the course of the year, conservatively.
Steve, mind if you take all the issues we had, plus the additional capacity. We're probably in the region of 100,000 tons more.
Yeah. That includes other challenges that we
Well, obviously.
Yeah. I'm coming at it from the other side. Obviously you've got the 100,000 tons of backlog. As I've indicated to you, that will catch up progressively as we move through the course of the year. It's hard to say no. All of it will be eliminated by September next year, but I do think we can make a substantial dent by the end of the year.
Okay, great. Thanks. Just to confirm, I mean, is there any expected impact from the calcium and magnesium line conversion?
No.
volume?
No, we don't anticipate any significant impact, no.
Okay. Okay, great. Just sort of, just think about the year ahead now. Maybe you could just remind us in terms of planned maintenance throughout the quarters across the lines, if you don't mind.
Can we drive what?
Do you mind just running through the planned maintenance for DWP lines this year, just so we get a clear line of sight on that?
Yeah. The DWP annual shuts?
Yes.
Just give us a sec, because we want to pull up the schedule. Just give me one second.
No worries.
Alex will jump in as well. Yeah, this is just the first quarter. Alex, I don't have the full year in front of me, but Saiccor's planned for when, Alex?
It'll be April. April-May.
April-May.
Yeah.
Ngodwana is third quarter.
Yeah.
So-
That will be.
Ngodwana third quarter, Saiccor second quarter, and Cloquet, Mike?
Cloquet is in April.
April. Yeah.
Okay. Great. Thanks. That's really useful to us. Just going back to graphic paper and I think-
Sorry, Sean, before we leave that.
Yeah.
Obviously the numbers I've given you in terms of capacity takes into account those shuts.
Yes, of course. Yeah.
Yeah.
Okay, great. Sorry, going back to graphic paper. I mean, maybe you just sort of update on your sort of, I guess, medium-term, long-term assumptions on demand or if that's changed at all, specifically in Europe. Because I think we're pretty comfortable with North America at this stage.
Sorry, you just broke up at the start of your question. In which segment was that?
In terms of your underlying demand assumptions in Europe.
Yes.
In terms of the structural decline, how has that changed at all, or what is that sort of number sitting at?
No, no. Based on our initial thoughts on this was that COVID would cause a haircut of about 20%, and then we were gonna subsequently resume a 5%, roughly, decline. Things have subsequently transpired to be better than that and you heard the numbers are-
Yeah, sure.
Market numbers are actually 90. A little bit of that, yes, maybe a catch up in terms of demand. In terms of the way we're looking forward, we're presuming that the 5%-6% decline will resume as we go through 2022 and beyond. What I will say is that if you look at operating rates, certainly in the U.S., they're at theoretically 100%. Now, with even in Europe with the capacity that's come out, those are now healthy and in the 90s as well.
Perfect, thanks. Steve, just two more quick ones. Just in terms of the opportunities around sales specialty packaging in Europe. I mean, looks like pretty decent volume growth suggested in one of the slides. You obviously alluded to the U.S. now as well. Maybe just expand a little bit more on that, 'cause it looks like it's a bit of paperboard in the U.S. and perhaps a bit more containerboard. I don't know whether that's coming out of Europe or SA.
I mean, let's take each of the regions. At first in the U.S., obviously we're substantially full on our Somerset machine that we converted. We look for optimization opportunities and hopefully being able to improve margins further. Essentially, that machine is pulled. There's a little bit of opportunity on the other machine at Somerset and our Cloquet Mill, but it's not big capacities. In Europe, obviously, we've got some opportunities, and I'll let Marco talk further. We do have opportunities, obviously, at Maastricht, first and foremost, because we've talked about that.
What Marco and the team are doing is looking for opportunities to redirect some of the capacity on our graphics machines to certain packaging grades , and specialty grades that would not involve a lot of CapEx. Marco, very briefly, maybe you just wanna give examples. Obviously, Ehingen is one of them, but you maybe just want to briefly talk about that.
Yeah, thanks, Steve. Apart from the full specialty mills, it is indeed so that we're looking at ways to create hybrid mills. That is Maastricht that Steve already spoke about. It's Ehingen for the containerboard grades that we have there, which is taking more and more capacity out of the Ehingen graphic portfolio. Recently we have announced to the market as well our commercial plans for further label paper production in Gratkorn, which looks very promising indeed.
Okay, great. Thanks very much, guys. Glen, just in terms of, I think sort of working capital in Q1, I think historically it's been about a $80-$100 million outflow. How we should sort of be thinking about that? I guess just a follow-on to that, and final question, I mean, when should we sort of see CapEx dropping off in the years to come? Becaause I think, at least from my perspective, I was sort of hoping to see it coming a bit lower this year. That's it. Great. Thanks.
Yeah. Just in terms of quarter one, you're right, that is a cash outflow. It will be a bit more than that, just because of the timing of our year-end, quarter- end rather, which is gonna be the second of January. We'll have some more creditors payments in there. You're in the ballpark there. Overall, you're talking about the CapEx, so we've given the guidance as far as this year is concerned. We'll provide guidance later in terms of after that. The focus, and I come back to what Steve said earlier, is initially to get the balance sheet stronger and get the gearing lower.
Maybe just to add to the CapEx. Obviously we've got our maintenance CapEx, and then clearly over the next few years, there are gonna be sustainability investments that we have to make, both from a legislative point of view and to achieve our environmental targets that we've set ourselves. You can see that number in the current year is $80. The other initiatives, you know, if you're talking maintenance just under $200, you add in the environmental stuff, you're getting to about $280. The rest to get you up to the $360 that I referred to is discretionary. Some of it's linked to those smaller cost initiatives that I've referred to. Some of it's linked.
Marco talked about doing stuff at Gratkorn and Ehingen and various other mills. These are not big projects. They're small projects, but they're discretionary. If we look beyond 2022, we haven't committed to any big projects. We monitor the situation, and then we make a decision whether it makes sense to invest. Based on how events are unfolding and based on our positive outlook for 2022, we felt that we could spend a little bit on these cost initiatives. That's why we added it to the CapEx. We'll monitor beyond 2022, but at the moment we haven't committed to anything beyond that.
Okay, thanks very much, Steve. I'm glad to hear you are pretty successful. Yeah. Thanks.
Thank you. The next question comes from Wade Napier of Avior Capital Markets.
Hi, guys. Thanks for the call this afternoon. Just a couple questions from my side. Maybe the first one for Glen on the balance sheet. I appreciate the sort of leverage ratio is coming down as you're starting to sort of move past the worst of the impacts of COVID and some of those very low EBITDA numbers. I mean, how do you think about the balance sheet in terms of absolute net debt levels, and when you would potentially start thinking about more discretionary capital or the dividend resumption, et cetera, so on? I mean, do you sort of have a number in mind, or are we sort of thinking below net debt to EBITDA, still of below 2x, something along those lines?
Second question from me is really in South Africa and load shedding. Has that sort of impacted you? Can you just remind us what your sort of relationship with Eskom is like and whether you have seen an impact there? Then maybe a final question from me on the North American business. I think congratulations is in order there. I think it was a fantastic result. I mean, what are the downside risks to North America? Because it sounds largely positive for the time being, and I mean, you and I both know that North America is not a 20% margin business. I mean, how do you sort of think about this North American performance over the next 12 months or so? Thank you.
Okay, thanks for the questions. Glen will talk about the absolute debt level targets and our leverage levels. I'm gonna hand to Alex, who can share our strategy around load shedding across our mills. Then I'll briefly talk about North America, but I'm gonna hand over to Mike, just to talk about some of those downside risks.
Thanks. Thanks, Wade, for that. Our focus is more on the leverage ratio as opposed to the absolute number. That long-term target of getting towards the two times net debt to EBITDA over the cycle because of the fact that we're in a cyclical business. It will go above, slightly below, and move around that, but our focus is to have it over the cycle get closer to the two times net debt to EBITDA. It's less of a focus on the absolute number and more of a focus on the leverage target.
Thanks, Glen. Alex, load shedding.
Thanks, Steve. As you're aware, we've got generation capacity at our three largest mills in South Africa. We are able to manage this with Eskom. We haven't had a significant impact, but when it comes to the crunch, what we do is we prioritize and we do the load shedding at the mills where we have the lowest margin, in this case Stanger and Lomati.
That enables us, you know, Alex will tell you that Ngodwana is long, so we're okay. Saiccor is a bit short, but we prioritize Saiccor to the detriment of our less profitable mills.
We would sell less into the grid from Ngodwana.
Correct. On North America, business is in a good place, and operating rates are very healthy. You heard close to 100%. That should even with a decline in graphic paper, which we've already talked about, 5%-6% over the next couple of years. Even at those levels, operating rates should continue to be healthy. I'll hand it over to Mike just to talk about some of the what he sees as downside risks and how we're offsetting those.
Sure, Steve. Thanks. I guess from my perspective, you're asking for you know, a bit of an opinion here. You know, obviously things have been strong. The machines are full at this point. The risk, as I see them, are really focused around the logistics, particularly how it impacts our Graphics business with imports. You know, if the international logistics issues were quickly resolved, that could potentially weigh on Graphics with imports. Other concerns would be around variable cost inflation continuing at extreme rates and potentially impacting materials or additional logistics costs. I think those are the concerns as I see them right now in North America.
Wade, does that help?
Okay. Yeah, that's great. Thanks, guys.
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. The next question comes from James Twyman of Prescient Securities.
Thank you very much. You've talked about Europe quite a bit. Overall, taking everything that you've said in terms of price increases and the surcharge, it sort of implies you're saying that you should be breaking even or starting to make some money this quarter. Just wanted to check whether if these surcharge increases have come through, whether that is the case. Second, I just wanted to ask in terms of the Saiccor impact of the expansion, whether there's a positive impact.
Sorry, James.
Yes.
Sorry, James. I'm not sure if your sound is coming through clear to the speakers.
Yes, it's fine. It's fine. James, carry on.
Steve, go ahead. Apologies for the interruption.
Good? Okay. No. Cool. Okay, thanks. No. So with Saiccor, what sort of impact do you think there'll be? Because obviously, when you ramp it up, there is an impact on the rest of the plant. When should we start expecting a bit of a profitable impact? My third question was, Lenzing's bringing its capacity on in sort of Q2. That capacity will either offset some of your production or it'll be sold into the spot market, hopefully by you maybe. Could you just talk around what the impact you see of that capacity when it comes on? 'Cause it'll come on in lumps. It may not be all right away, but it'll come on in some fairly chunky lumps. That was it for me. Thanks.
Yes. Just coming back to Europe. To your first question. The surcharge, bear in mind the surcharge is to offset the energy costs. You've heard from us that we're confident that it will do that. Obviously, other prices have been rising over the course of the year, and our team have been announcing and implementing selling price increases that will offset that impact. What I will say to you is the market is tight at the moment, and that's why we're more confident about being able to execute on selling our price increases. If we get them through, then the margin deterioration that you have experienced over the last year can begin to recover.
When exactly that will be, that's difficult to pinpoint, but we are more optimistic about the outlook. The Saiccor expansion, I think you asked me when does the profits from the Saiccor expansion start to flow? Is that right, James?
Yes, because you've obviously got disruptions that come along as well.
Oh, sure.
You know, these things don't always start perfectly.
No, sure. There's the ramp-up, and that's why we were conservative about the ramp-up. Clearly once we get the quality and we're confident that we will get the quality pulp through, there is a process of ramping up, and ultimately as that volume flows, it will contribute to the bottom line.
Yeah.
Steve, if I may add, essentially we'll ramp up from now, the end of this month to February in terms of the additional volume. We have the calcium to magnesium conversion, which will just then help us on our cost position.
Yes. Yeah, we got a question earlier that would it affect volumes? It won't affect volumes, but it will improve our cost position, and that's very important. It improves our environmental footprint. That's obviously why we're, you know, that was part of the business case. In terms of Lenzing, you saw a slide earlier where we talked about where we expect our contractual volumes to go, and we've indicated 72% overall contractual volumes. We're not concerned about that volume coming onto the market, and we're confident that we will be able to place that tons elsewhere.
In conclusion on Europe, it sounds as though you probably won't be back to break even this quarter, but hopefully next quarter. In terms of the Saiccor expansion, hopefully profits Q3.
James, when you say break even, what line are you looking at?
Very much EBIT level.
Yeah, look, we obviously we're focusing on EBITDA. I, you know, I can't get too specific, you'll appreciate, right? What we're saying is that the energy surcharge will offset the higher energy costs. We're saying that. Secondly, we're saying that the markets are tighter, and therefore we are growing in confidence in our ability to execute on the selling price increases that we've already announced, which will help offset the margin erosion we've experienced in the last year.
Great. Thank you very much. Thank you. Just in terms of the Lenzing thing, so you will be selling less to Lenzing, but you'll be selling more on the spot market. Did you anticipate helping Lenzing sell its volumes to...?
James, I can't get too specific. This is our customer. All I'm gonna say to you is that we're gonna reduce our contractual volumes to 72. We're happy with that, and we're confident about being able to place the rest of the volumes into spot markets.
Yep. That's clear. Thank you very much. Thank you.
Thank you. The next question comes from Michael Dube of UBS.
Thank you. Good afternoon, everybody. I'd like to start off by asking a question around the DWP markets. If you could just talk a bit about the current dynamics you see there, overall in that market right now. Now, I mean, how are the VSF prices trending, as we sit here today? What are the inventory levels there? You know, where are the DWP prices as of today? And so on and so forth. That would be great.
Okay. I'm gonna let Mohamed elaborate a little bit further. Broadly speaking, global markets are great. China, a little bit tougher, obviously impacted by this energy constraint, and it's meant that Viscose producers are not able to operate at full capacity, and that has lowered their demand. I'll let Mohamed go into more detail.
Okay. Thank you, Steve. Just specifically in terms of China, as a result of the energy constraints, what we have seen is the operating rates for VSF in China has came down to around 50%. That in turn resulted in lower VSF inventories and lifted the VSF prices. Over the last week or two, there has been some easing of the energy constraint, and what we have seen as a result of that, the operating rates have now lifted a little bit more, going from about 50%-60%, and the inventory levels are still staying down at around 20-22 days versus the sort of 30-day level that it was at before the energy constraints were imposed.
I think with the VSF industry at the moment, you also have a market inside of China and outside of China. Outside of China, and as you know, we have a big position with buyers of dissolving pulp outside of China. Their markets are very tough, very strong. You're seeing very high operating rates, you're seeing very strong demand. A big part of that is being driven by the fact that a lot of the retailers are also shifting now their demand from China to places like India, to Indonesia, Thailand. Then there's a big demand coming through from Turkey, which is placing a high demand for fiber from the European producers of Viscose. Outside of China, very strong.
Inside of China right now, somewhat restricted by the energy constraint as well as the logistics issues.
Thanks, Mohamed. Michael, over to you.
Thank you. Just to follow up on that, I guess, on the DWP pricing. You mentioned the $940, I think, in the release, in October. Just to remind us, I mean, what was the average price in October and in September and where is the current spot price?
Through the quarter, the results we announced, it was above $1,000 a ton throughout the quarter. So a healthy price. It came down for the reasons that Mohamed described. I think today's CIF is $938.
That's correct.
Still at the $900, basically the $940 mark. $938 is today's price. You know-
No, okay.
Yeah. Viscose prices are obviously high, and if those operating rates in China can continue to pick up, then that could be good for DWP prices.
Right. The VSF prices haven't yet started to increase again, I guess.
No, they have significantly. Go ahead, Mohamed.
Yeah. The prices did go up by over, I think, 20% and you know, from the time the energy constraints were imposed. It went up to about, in terms of Renminbi levels, to about CNY 14,400. It has started to come off a little bit in the last couple of days as the operating rates have picked up. At the same time, I would add, you know, you've got cotton prices still moving upwards. You've got oil prices driving the polyester prices upwards, and you haven't, I think, seen the impact of those higher prices flowing into the VSF prices. It's a lot higher than what it was in September and early October.
Right. Okay. That's fair. I was just looking for that most recent price movement. Good. Just switching gears a bit to the European coated fine paper market in particular now. We have seen quite significant price increases across, you could say, publication paper grades in Europe, both in October and November, if you look at the spot prices provided by, for example, RISI. When we look at the coated fine in particular, though, I think the improvement had been much more slower there on that side. I was wondering what's the reason for that and what are your expectations for the price gains towards the end of this year and into early 2022? I appreciate your surcharges, but that's, I guess, a separate topic.
Yeah. I will let Mohamed and Marco talk in more detail. Obviously we've been going through announcing a series of price increases. I think when you were comparing, were you comparing it to coated mechanical paper when you were talking coated wood-free there? Because you said it was less than-
Yeah. Well, I said publication purpose, basically comparing to magazine papers and newsprint, which are up double digits. Yeah.
Yeah. I'll let Marco talk further, but what we did see is even more capacity coming out of the publication paper space, and those prices did pick up faster. We have been implementing further price increases on the coated wood-free front. Marco, you wanna just talk about that?
Yeah. Just one addition to that, Steve, is that we started earlier on the wood-free coated side. If you take the longer period, call it the last six to nine months, you will end up relatively similar levels. The first mechanical coated price increase was a half- year. As Steve rightly said, the market has become very tight after the capacity closure announcements. There has been a substantial additional increase has followed. Over the longer term, Michael, the increases are pretty similar. We just started earlier with wood-free coated or later, if you want, with mechanical.
No, that's a fair point. Going forward, I mean, have you announced further price increases toward the end of the year or early 2022 for any of your grades?
Yeah. There has been further announcements during this quarter. Also as Steve already alluded, with the markets where they are and the need for margin improvement or the stop for further deterioration, there will be further increases, yes.
Okay, great. That's very helpful. Thank you very much.
Thank you. We have a follow-up question from Brian Morgan of RBM Morgan Stanley.
Thanks, guys. Just sorry, two more things, if I may. Do you have updated guidance on the calcium conversion in terms of what that does to unit costs? That's the one question, and the other question is, give us an update on your discussions around the dam at Somerset that we spoke about a couple of months ago.
Specifically on the calcium conversion and the lowering of the cost, we haven't made those numbers public yet. You know, when we complete the project, we'll give an indication.
Maybe just to remind you what it means is we can recover both the chemicals and the energy on those volumes, rather than having to put that out to waste.
On the second one, Mike, do you wanna just talk about that issue of the dam at Somerset?
Sure, Steve. As far as the dam is owned by another entity and they're in the process of re-permitting that. They have restarted that process. We have received written commitments by the local authorities and the governor supporting the operation and the continued support to have that dam in place. That process of the permitting could be up to another year. We don't see that as an issue, and it's something we're monitoring at this point.
Okay. Cool. Thank you.
Thank you. Ladies and gentlemen, just a final reminder. If you want to ask a question, press star and then one. The next follow-up comes from James Twyman of Prescient Securities.
Yes, thank you. I know, I know we'll be running short of time, but just two quick ones from me. Firstly, the 20% growth in packaging volumes this year is obviously very high. Could you sort of give some idea of the split between the divisions, whether it's higher in South Africa and the U.S. and less in Europe? And secondly, the U.S. prices, they're obviously high now. I don't know whether imports are starting to pick up now, but is there a potential for a further rise in prices, or do you think that's pretty much done now? That was it for me. Thanks.
On the packaging growth, it was mainly in the U.S., as you would expect. That was where most of the volumes came through. Obviously, you know, in South Africa, we've got our capacity and we're limited by our capacity that we have in that space, so it was mainly in the U.S. James, on the second one, I lost you again on which one was, the selling price increases?
Yeah, just in the U.S., obviously you've achieved a lot, whether there's the potential for more increases or whether you think you've pretty much done there now?
Look, I think that's gonna be guided by our costs. Our costs, obviously, you heard from Mike earlier that that's one of the things that we have to offset that impact, and we will continue to do that. If costs continue to rise, we need to address that. We are encouraged, obviously, because the markets are tight. We'll monitor the situation as we move forward.
Thank you very much.
Okay, operator. I think that's time up. I just wanna take the opportunity to thank everybody for joining us on the call today and look forward to discussing our results at the end of Q1 in three months time. Thank you.
Thank you very much, sir. Ladies and gentlemen, that concludes today's event. Thank you for joining us. You may now disconnect your line.