Good afternoon, ladies and gentlemen, and welcome to Sappi Limited's third quarter of 2019 results conference call. All participants will be in listen-only mode. There will be an opportunity to ask questions at the end of today's presentation. If you should need assistance during the conference, please signal an operator by pressing star and then zero. Please note that this conference 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, and thanks for joining us on the call today, where we're going to be talking about our third quarter 2019 results. As always, I'll call out the slides as I move through the presentation. I'm going to start on page three, which has some of the highlights for the quarter. It was a challenging quarter for us across many of our major product categories, but the primary reasons that we encountered difficulty was firstly, on graphic paper. We saw weak markets in Europe and the U.S., both down double digit, which has meant that we had to take production downtime of about 89,000 tons. The impact of that was about $19 million on EBITDA.
At the same time, we saw lower dissolving pulp prices, that's on the back of excess VSF capacity, which pushed down VSF pricing and ultimately led to dissolving pulp prices following them downwards. In terms of some of the ratios, perhaps the one I'll call out to you is that the leverage ratio net debt to EBITDA did rise to 2.4x , that obviously was off the back of the lower profitability. This morning, we also announced the acquisition of the Matane mill in Canada, I do have a couple of slides on that later. I'll talk to that then. Moving to slide four, our earnings bridge relative to last year, the same quarter last year. I'm just calling out some of the major variances.
On volume down on a year-ago for the reasons that are highlighted on the first slide, the production downtime that we did take. On pricing and mix, we saw higher selling prices, which helped offset some of the pressure that we faced. Obviously, as some of our higher-priced products continued to grow, we improved the product mix. Variable costs were up on a year-ago, and perhaps just to call out the main reasons, it was primarily linked to higher wood costs in the U.S. and in South Africa. Also we saw higher energy prices down in South Africa. Pulp costs, and I'm guessing some of the people may have questions about that. Pulp costs relative to last year were about flat on a year-on-year. As we go forward, we would expect pulp costs to come down further.
The other thing that is in the variable cost here would be the fact that the euro and the rand are weaker than a year ago. You had the increased costs of raw materials, and pulp being one of them, being impacted by that. On exchange rates, that's a translation impact, and that was favorable during the quarter by $8 million. Moving to slide five, the contribution split across our segments. Dissolving Pulp continuing to be the largest segment at 44% of EBITDA and Packaging and Specialities 17%. As I've said to you in recent quarters, we will expect that to rise further as we move forward. Slide six has our debt maturity profile, and you'll recall from the last quarter we announced the refinancing of our 2022 bonds, now pushed out to 2026 bonds. We have a fairly clear runway over the next few years.
The next refinancing that we'll have to face, a big one, will be the 2023 bonds, but we've got some time to look at that as they get closer to maturity. Slide seven has our CapEx, and the number estimated for this financial year is just over $500 million. It's primarily linked to the Saiccor expansion of dissolving pulp and the conversion that we've done at Lanaken. In 2020, I would expect the number to come down to about $470 million. We have primarily the end of the Saiccor project.
If we look beyond this, and it's not on the slide, but if we look into 2021, we would expect CapEx to come down further, and certainly be below $400 million. It's important to call out that all the major CapEx projects that we have talked to you about over the last one or two years are now either completed or, in the case of Saiccor, close to completion. We don't anticipate, and we haven't committed any other major CapEx projects. That is something, obviously, that we've planned. The Matane acquisition, which I'll talk to you about a little bit later, we did envisage at some stage spending money on improving our pulp capacity, but that is no longer required because we've been able to get the additional pulp capacity. As I say, I'll talk about that a little bit more later.
Moving to our segments, firstly, on page nine, the graphic paper markets. As I said earlier, markets have been weak and they continue to be weak. We anticipate that there will be significant capacity reductions coming out from competitors over the next 18 months, and many of those have already been announced. That will clearly benefit the balance in this market. Paper prices have come off. They've held up reasonably okay, but they have started to come off a little bit, particularly in the U.S., with a little bit in Europe, but holding up reasonably well. Pulp prices have fallen significantly from a cost perspective, and we're starting to see the benefit of that, but we will see significant benefits as we move forward over the next few quarters.
As always, our focus has to be on the cost side and ongoing improvements in productivity, all of those things. The operating rates will be crucial. We clearly took production downtime over the course of the last couple of quarters. We expect capacity to come out from competitors. In Europe, we need to evaluate our own capacity, and I'll talk a little bit more about that on a further slide. Pulp integration, as I've told you before, is critical because it does lower the cost base, and that's why we acquired Matane. Turning to Packaging and Speciality Papers. Broadly from the market perspective, we've seen additional containerboard conversions. However, on the speciality packaging front, where a lot of our capacity's focused, we have seen some producers exiting because of cost pressures over the course of the last 12 months or so.
Demand continues to grow, and we continue to believe that the long-term prospects are encouraging. As we know, there's a big shift for paper-based packaging solutions to replace paper, to replace plastics, and that's creating significant opportunities. Strategically, we continue to believe that that is an exciting opportunity. In terms of selling prices, they did rise. We include here a few of the categories where it did rise. Flex-Pac labels on the silicone-based papers. The pulp prices falling will have a benefit on this segment as well. In terms of the strategy going forward, we have to ramp up. Following those conversions, we have to ramp up as fast as possible. It is going according to plan, and we expect it to grow further as we move forward. Pulp integration being critical as well. Turning to the regions.
On Europe, it was because of the weak domestic graphic paper market, we took 30,000 tons, which equated to $8 million. Selling prices are still higher than they were a year ago across both graphics and Specialities. Variable costs higher, although, as I've pointed out to you, we would expect those to come down further as we move ahead. Pleased to say we completed the Lanaken conversion during the quarter on time, on budget. We'll obviously move forward with the carouseling following the completion of that project. In North America, which is on slide 12, we took 59,000 tons of downtime, which is $11 million EBITDA impact. Completed the Cloquet DWP debottlenecking project, which adds 30,000 tons of capacity. Going forward, the packaging volumes we would expect to continue to grow. Again, the variable costs were still higher.
Wood cost higher, as I mentioned earlier, but with the lower pulp prices coming through and obviously in time, the benefits of Matane, that will reduce costs. We announced a couple of weeks back that Mark Gardner, the CEO of Sappi North America, is retiring. Mike Haws, who works within the Sappi North American team on the production side, he led the production team. He is taking over from him with effect from 1 October. There's a transition process underway. That's going smoothly. Turning to slide 13, the dissolving pulp markets. The viscose has been under pressure. We saw significant amounts of capacity coming on board. That squeezed pricing. I think it's fair to say that the trade wars between the U.S. and China have impacted on textile exports out of China into the U.S. That has impacted on volumes.
What we've seen is that you saw a significant inventory build during 2018 and then a softness coming through in 2019, which has further exacerbated the challenges we face. However, overall demand for dissolving pulp continues to be strong, and we continue to believe that it will grow at 6% per annum. Selling prices have come down, and I've talked about it. However, based on the additional supply that we expect to see coming through and the fact that at these prices, there will be higher-cost producers under significant pressure and coming out of the market, we do think that the balance will improve and that, in time, will improve pricing. We've obviously got the project at Saiccor to increase our capacity by 110,000. That's, as I said earlier, the last of the major internal projects, and there are no further growth projects at this time planned.
We evaluate externally, but we're not looking to add any additional capacity at this point in time. On slide 14, which is South Africa, the lower dissolving pulp US dollar pricing did have an impact. The dissolving pulp volumes were lower than Q2 because of the annual maintenance shuts at Ngodwana and Saiccor, but higher than a year ago, obviously because we added the additional capacity last year. The containerboard volumes, a little bit of seasonality there. A delayed start to the citrus season, but we do expect that to pick up nicely in Q4. Variable costs, 14% higher, wood and energy, but also the weaker rand having an impact on costs as well. Turning to the strategy and the various pillars. Firstly, on costs, as you know, it's an ongoing focus and particularly on the procurement side and continuous improvement.
Firstly, on procurement, we've targeted another 60 million this year, and we're on track to achieve that. The pulp integration has been something that we've been working on for some time. I will talk to Matane just now. The Saiccor expansion that I referred to will lower variable costs a ton at the Saiccor mill. As I said, we are evaluating the capacity in Europe for graphic paper. We know that other capacity's coming out, but based on our projections, and if demand were to remain at these levels, we're probably one mid-size graphic machine too much. That's something we're evaluating at the moment and something that I will give feedback at the next quarterly results. We are looking at our capacity. On slide 17, the Matane mill acquisition. It's a high-yield pulp mill, 270,000 tons, hardwood, aspen, and maple, located in Matane, Quebec.
You can see where it is on the map. It's southern Quebec. It's near our Somerset mill. Importantly, it's on a port. From a logistics perspective, if volumes were to be exported, the costs are relatively low. I would stress to you that it's already a major supplier for our mills, both in Somerset and in Europe. Moving to slide 18. The acquisition supports our strategy with a strong focus on costs. As I said, it is already a major supplier. There are other customers there, and clearly, we'll meet those commitments. Importantly, it's going to support the growth in the higher-margin packaging business. Primarily, that pulp is used in that segment. It increases our pulp integration, and as I say, it's going to supply both Somerset and our European operations. Importantly, it does secure a supply of raw materials.
As you know, many of you know, these pulp mills have been in demand from various players across the world, it was important that we had to secure our raw material supply. At the same time, it does reduce our costs. As we all know, pulp does go through volatile times, it will reduce the volatility of our earnings by securing the raw material source. We did contemplate building our own pulp line at Somerset, and we estimated that to add about 200,000 tons of capacity, it would have cost us $210 million. That's over $1,000 a ton. You do the math on this, you see it's about $600 a ton. It's substantially lower cost for Sappi, and strategically makes lots of sense. As I said, supports our growth business on the packaging side.
The purchase price, if we look at the 2018 earnings, yes, they were higher because pulp prices were higher. It was about 3.3x the earnings of 2018. We know pulp prices are down, and we estimate on a sustainable basis through the cycle, it's about close to 7x the estimated EBITDA of $25 million. Turning to slide 20, which is maintaining a healthy balance sheet. We are committed to bringing our net debt to EBITDA to 2x. Obviously, with the softer earnings and the acquisition that we've made, we do temporarily go above those levels. I've already talked through the fact that the CapEx levels will come down. We are a strong cash generator, and by the time we get to the end of 2021, we are very close back to those levels.
The CapEx program that we have talked about over the last couple of years is substantially complete. We have no major CapEx plans other than what we've already talked about. We don't anticipate any change to our dividend policy. We have sufficient cash resources to maintain that dividend policy. Turning to slide 21, the accelerating and the higher growth segments. The dissolving pulp, we have made these investments. We've got the 110 coming from Saiccor. I don't expect anything more in the near future. On the packaging front, however, obviously we will continue to ramp up at Somerset and Maastricht. That's a planned process. It does take time because you have to go through an accreditation process with customers, but it is progressing and the volumes each month continue to rise. Turning to slide 22, which is our outlook. As I've said, much of this I've covered already.
Just to reemphasize, the dissolving pulp pricing is under pressure. However, volumes are good and we're confident about utilizing the expanded capacity that I've referred to earlier. Packaging and Specialities, the end markets are variable. In Germany and in Europe, we obviously have seen a little bit of economic weakness. However, over time we expect that to improve and volumes are growing and the ramp-up and the trials are continuing and progressing as planned. The further weakness in graphic grades could result in additional downtime. We estimate a similar amount of downtime in Q4 to what you saw in Q3. However, as I said, we expect significant industry capacity to come out over the course of the next 18 months, which will improve the balance. As I said, we are looking at our capacity ourselves in Europe. The CapEx for Q4 should be about $200 million.
There's a little bit of the Lanaken cost still to come through, but the majority of that would be at Saiccor and into 2020 similarly. Based on the weak graphic paper markets and the dissolving pulp softness on pricing, we expect the results for Q4 will likely be below that of the same quarter last year. Operator, that's me gone through the slides. I'm going to put it back 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 one on your touch-tone phone or the keypad on your screen. At which time you'll hear a confirmation tone. Following this process will place you in the question queue. If at any time you decide to withdraw the question, you're welcome to press star then two on your touch-tone phone to remove yourself from the question queue. Just a reminder, should you wish to ask a question, you're welcome to press star and then one to place yourself in the question queue. The first question comes from Ross Criha of JP Morgan.
Hi, everyone. Thanks very much. Just on dissolving pulp EBITDA. If you look at the margin there, it's significantly lower year-over-year, despite a higher rand dissolving pulp price. Just wondering, you called out wood and energy costs in South Africa, is that the main driver? How do you see the outlook there? What exactly is driving higher wood costs in SA? Just a second question on pulp and cost savings. What index should we be looking at for pulp prices? If you look at Chinese net pulp prices, you would have kind of expected some savings in Q3. Just wondering what we should be looking at to get an idea of how to measure that benefit.
Yeah. On the EBITDA for dissolving pulp, just remember there's also a U.S. mill in that segment. The lower pricing would've had an impact on the profitability in the U.S., because although the ZAR prices are up, the USD prices were down. Then to the other point that we talked about earlier, the higher wood costs in both regions also impacted on profitability. On the pulp, yeah, the Chinese prices came down substantially more. Look, the place where we buy most of our pulp is in Europe. We buy about 1 million tons there. It's better to look at European pulp prices, both primarily hardwood but also softwood in Europe as well. You should look at them in EUR because obviously USD prices may be coming down, but the USD has strengthened against the EUR.
Okay. Thanks, Steve.
That's not come down as Sorry, just to give you an example, on a euro basis, both hardwood and softwood this quarter compared to a quarter a year ago, it was actually only 4% down.
Okay. Makes sense. On the wood cost.
It will come down.
I mean-
I should stress to you, it is gonna come down further.
Yeah
as we go forward in the next couple of quarters.
Okay, perfect. Just on the wood costs in South Africa, what's behind that increase? Is that not normally related to energy prices?
Yeah. It's to do with the purchase, the extra parity price for the wood, but I'll let Alex, are you there to talk a little bit further about that one?
Yes. Steve, thank you. Basically, we're not fully self-sufficient in terms of our wood supply. We're only about two-thirds self-sufficient, so we need to buy wood in the market, and we compete with wood chip exports, which effectively goes into China, into pulp producers, but it also goes into biomass requirements in the East. Being exposed to that does affect the wood chip price. Secondly, just in terms of the margin as well, because we'd taken the shut in the third quarter, that obviously had a effect on cost as well.
Okay, brilliant. Thanks a lot.
Okay, thanks.
The next question comes from Brian Morgan of RMB Morgan Stanley.
Hi, guys. Thanks very much. Can you give us an idea of the maintenance shuts in South Africa during the quarter? Were they quite expensive? Certainly looks as though, and I can see the numbers.
Yes. In fact, all four of the mills took a shut this quarter. In terms of its impact, I'm just pulling out a slide, if you just give me a second. As I say, it's all four mills. In terms of its loss contribution in dollars, you had the big shut in Ngodwana. We had the Project Vulindlela shut at Saiccor, and even at Tugela we took a shut. The estimated loss contributions in dollars was about $14 million.
Fourteen.
Yeah.
It's less than the same time last year, right? Do you have that number?
Yes, you're right. It was there last year. In fact, it was higher last year.
Was higher last year. Okay.
Yeah.
In terms of the specialties, it looks to me as though customer approvals Certainly feels like they're taking longer to come through than I originally thought. Is that the case? If so, why would it be?
Okay, I'll let Mark chat to that.
Sure. Hi, Brian, this is Mark.
Hi, Mark.
In the case in North America, we are out with a lot of different customers who are going through their qualification process, and it is taking a little bit longer than what we originally had thought. I would say so far we're being successful and quite pleased with the results. It's just that the process of going through two to four different downstream runs of their customers just takes longer than what we had originally anticipated. We're behind on the ramp-up due to that, although it's still moving up pretty quickly, and so far we're winning a lot of accounts from the product attributes and the product quality that we're producing.
Yeah. Thanks, Mark. Berry, on your side?
Yes, on the European side, the paper pulp business is now growing nicely. It did take us quite a long time to get the product right. We did install a completely new technology, and it did take us quite a while to get that right. Now we have got them right, and the orders are beginning to come in nicely.
When should we be at full ramp-up in the two locations?
Well, firstly, in fact, in both locations, as we originally talked about, we would expect within two years. If we look at the evolution on the Somerset PM1, as I say, it gets bigger every quarter, and I would expect that next year on PM1 Mark to be over 200,000.
Yes.
Tonnes.
Yep. Three years from the startup date, we anticipated the machine to be full.
Which is up to close to the 400 level.
Yes.
That's at the full price point.
In a similar time horizon as we ramp up at Maastricht as well.
Okay. That's at full price points. That's running specialties, no commodity grade.
Yes. There's multiple benefits. Obviously, benefit on the selling price side and optimizing the volumes, but also on the cost side and the efficiency of the machine. Yes, up to the margins that we originally anticipated.
You're comfortable that the market can fully absorb all of this new capacity?
Brian, this is Mark again. Yes. In North America, when we did the study and kicked off this project, we looked at that market and we needed somewhere between 6% and 7% of market share, anticipated with the machine at full capacity. Just rather recently, we've had the announcement that came out where another producer in North America is going to take out 360,000 tonnes of SBS. That wasn't in our calculation. That would much net out what our increase would be into the market.
Okay. Cool.
Just to remind you, our strategy is built around targeting independent converters. There is an appetite there to take up volumes from someone like Sappi, and it is progressing as we expected.
Okay. Cool. Thanks, guys.
Thank you. The next question comes from Wade Napier of Avior Capital Markets.
Hi, guys. Thanks for the time. Just a quick one. With the balance sheet deteriorating, are you still going to pay a dividend at the end of the year? Second question, I don't know if I heard you correct, but you mentioned that you don't currently envisage adding any more DWP capacity beyond your current projects. Does that mean that you're no longer looking at the phase 2 of Saiccor's brownfield expansion? The third question is, with today's announcement that you're acquiring the Matane mill in Canada, plus your sort of indication that you made sort of take out a European paper mill over the coming months, are you sort of now no longer considering further European pulp debottlenecking projects, which you previously sort of described as extremely attractive investments? Thank you.
Thanks for the questions. Firstly, on dividend, yes, we are committed to maintaining our dividend payments and cover. We don't anticipate any changes there. With the cash that we're generating and now that we're at the end of this CapEx cycle, CapEx levels will come down. We are very comfortable with that. The DWP expansion, phase two of Saiccor, that could come in time. I don't envisage it coming in the next two or three years. As we've talked about, the market is a little bit softer at the moment. Hey, we've got to complete phase one of that project. We've got to beat it down and ramp up the volumes and all of those things. I would say that's some years out now. On the Matane, just remember one thing that some of the volumes coming out of Matane are going to Europe.
It does help with their pulp integration. Those pulp opportunities, there are other ones, and some of them are smaller and some don't involve lots of CapEx, so we will continue to boost pulp integration even though we've acquired Matane. I just want to point out one thing. It wouldn't be a whole mill that we would close. It could be a machine, but not a whole mill. How much that would cost, it would depend on the machine, and perhaps that's what you were alluding to with your question. It could be around EUR 30 million related to that closure.
Thanks very much. Maybe just to follow up with today's acquisition. Just reading through the presentation material, you sort of discussed the BCTMP market as being 5 million tons, and about 40% of that market supplies printing and writing paper and 60% paper board and specialties. You've got sort of operating rates for that grade increasing towards 96%, but if I just do the simple math here, 40% of a 5 million ton market is 2 million tons, and demand is declining in printing and writing paper at 5%-10% a year. You're losing sort of 100,000-200,000 tons of demand for this grade a year, and then the specialty demand growth, which is the remaining 3 million tons, is increasing at 3% a year, so that's 90,000 tons.
Demand is actually declining in a totality for this grade of pulp, yet you've gone and bought a pulp mill. I don't understand this.
Wade, we're going to be using it substantially for our own needs. It's to lower our own costs. It's not that we Yes, there are external volumes, but it's primarily for our own purposes. It's not that we are exposed to that variability. Mark, do you want to add to that?
Yeah. I understand that, Steve, you're essentially talking about a sustainable EBITDA of $25 million on a 270,000 ton per annum pulp mill. You're talking less than $100 per ton on EBITDA profitability, whereas investments in dissolving wood pulp, you'll know this better than I do. Your cash costs on dissolving wood pulp are sort of $450-$500 a ton, and your selling prices are $750-$900 a ton. The profitability just looks so much better. Just help me out here.
Yeah. Hi, Wade. Maybe I can help a little bit here and hopefully not add too much confusion. The 5 million tons of high yield capacity in the printing and writing segment, a lot of that is integrated. It's not market. As printing and writing comes down, so doesn't the integrated pulp that goes with it come down. You have to look at the printing and writing segment as kind of not being in the market to buy the pulp. Most of those printing and writing mills have a BCTMP plant right there, very close or integrated with them.
Yeah, that helps. Thanks, Mark.
Thank you. Ladies and gentlemen, just a reminder, should you wish to ask a question, you are welcome to press star and then 1. Your question then placed in the question queue. The next question comes from Maria Pienaar of Comalote Kashiri .
Hi. Thank you for taking my call. It is just to ask regarding the acquisition. You said that you will be using internal resources to finance the acquisition. Could you give rough estimates as to what will be used? Will it be cash? Will it be the debt facility that you have?
Hi, it's Glen here. We'll be using our available debt facilities, plain and clean. We do have sufficient cash should the purchase or the completion of the purchase happen soon. We have available cash after debt facilities that we will utilize as far as that is concerned.
You will use 100% from the debt facilities in terms of cash? Just to understand you correctly.
That's right.
How much will that increase your leverage in terms of net debt to EBITDA, please?
It will be about 0.4x .
Okay. Thank you very much.
Thank you. The next question comes from Petr Osovich of Iron Shield Capital.
Peter, are you there?
Unfortunately, his line seems to have dropped. He's going to have to reconnect into the queue. Ladies and gentlemen, just a final reminder. Should you wish to ask the question, you're welcome to press star and then one. Thank you, Peter. He's back in the queue, and you can raise your question now.
Hello, can you hear me now?
Yes.
Yes.
Oh, okay. Thank you. Thank you very much for taking my question. Just if you could give us a bit more color on how you think about adding capacity in specialties, and specifically, what kind of specialties you think are most beneficial for you to add, and how do you see the market for those developing?
Yeah. Thanks, Peter. I don't think we're going to be looking to add any capacity in the near future. We've done the conversions at Somerset and Maastricht, and obviously, last year we acquired the Carmignano mills in Italy. It's not going to be additional capacity over and above that. We need to ramp up further and grow our volumes based on the additional capacity that we've already added.
Okay. In this case Sorry, go on.
Sorry, someone was just reminding me. In South Africa, we do think there are packaging opportunities on linerboards, containerboard down in South Africa.
Okay.
That was primarily into exports, fruit exports out of South Africa.
Understood. Can you please remind us what kind of specialties you are now focusing on ramping up, and how is it going?
There are a number of categories, it includes silicone paper, FlexPack, various labels, obviously, we've now invested in box boards, the SBS. Berry, do you want to expand further?
Perhaps the most significant one that's growing fastest is barrier technology papers to replace the plastic packaging. That is just getting going now, and there's big opportunities there. Secondly, the digital imaging paper, which is sublimation paper, that also is growing very quickly. Those are perhaps the really exciting ones. The other ones, as Steve mentioned, are ones that grow constantly.
Right. To what extent did you manage to fill up the new capacity? I mean, like 25, 50, 75%?
In terms of Europe, the capacity for the lightweight, so Alfeld, Carmignano, and Condino, they're pretty well full. For the paper board, we've still got a long way to go in Maastricht, as we discussed before. It'll take another year or two before we've got those filled.
I think in the U.S. it was 88% up on a year ago.
Yes.
You mean for the specialties?
Yeah.
Okay. Thank you.
Gentlemen, that was the final question. Do you have any closing comments?
No. If there's no more questions, I just want to thank everybody for joining us on the call, and I look forward to spending time with you in three months time at the end of the financial year. Thank you.
Thank you. Ladies and gentlemen, on behalf of Sappi, that concludes today's conference. Thank you for joining us. You may now disconnect your lines.