Good day, ladies and gentlemen, and welcome to the Sappi Limited Second Quarter 2018 Results Conference Call. Please note that this call is being recorded. I would now like to turn the conference over to Steve Beney. Please go ahead, sir.
Thank you. Good day, everybody. Thank you for joining me on the call. I'm joined by a number of my colleagues and I'll be going through the presentation deck, the investor presentation deck, and I'll refer to page numbers as I move through. Starting on page 4, highlights for the quarter, EBITDA excluding special items of $211,000,000, that's up from $208,000,000 in the prior year.
And then bottom line profit $102,000,000 compared to $88,000,000 last year. Earnings per share, excluding special items, 17 U. S. Dollars same as last year. And then net debt, was 1632,000,000 up from $1329,000,000.
The main reasons for the jump obviously are the acquisition of Calm, which occurred during the year. Or a quarter, $132,000,000. And then the stronger versus the dollar as we convert that, that had a significant impact. And obviously, the higher CapEx that's come through During the quarter, we completed the acquisition of Calm Specialty Paper business and that's integrating nicely into CEPI. Moving to Slide 5, the EBITDA and operating profits, you can see the impact over the last couple of years and the growth that's come through.
Some of the key metrics, net debt on the back of a the number that I just explained to you is slightly higher at 2.2 leverage. We continue to target lower than two times, and that remains in place, and we will maintain that discipline. EBITDA margin percentage at 14.1 still healthy. And then return on capital employed 16.8 percent. Moving to the earnings bridge on Page 6, pleasing to see sales volumes growing across the board in all regions and in all the segments, whether it's dissolving pulp, packaging, graphic paper all up.
So that was encouraging. Then we were able to realize higher selling prices, in again, in all our businesses. And clearly, that had to be done in graphic paper to offset the impact from higher raw material costs, primarily pop, which you see in the in the red block under variable costs. The exchange rates had a significant impact. The fact that we've got a stronger rand now against the U.
S. Dollar, the net impact of all of that was $10,000,000 down on last year, giving us the $2.11 that you you see as you saw us achieving. Across to Slide 7, the product contribution split dissolving pulp, was 45 percent of EBITDA, a little bit lower than previous quarters or recent quarters, but that's because of the stronger run that I referred to. Printing at 39% and packaging at 16% and that is rising. And we'll continue to rise as we integrate Carmen complete the conversion projects.
Moving to Slide 8. The debt maturity profile And, this paints a good picture. There's no short term material debt. The next larger item would be the securitization in 2020. And we would expect to roll that over.
We don't anticipate any challenges. And then our bonds, our Eurobonds are 222023. So we have quite a bit of runway there. On Slide 9, the CapEx development, a little bit later in the presentation, I'll be talking about all the projects that are underway. But obviously, we've got the conversions from graphic paper to packaging that we have undertaken in the U.
S. And in Europe and the expansion and debottlenecking projects for dissolving pulp. And again, I'll go into more detail. That's why the number has risen in 2018 and in 2019 relative to where we've come from in recent years. Turning to the divisions.
And on Slide 11, we talk about printing and writing graphic paper, It's encouraging that operating rates have been healthy. All our machines are full. In both the respective regions, we've clearly benefited from the fact that there were capacity closures and conversions in those regions And it's allowed us to or it's ensured that the supply demand balance is more in line, which has enabled us to put through a series of price increases, which we had to do because of rising paper pulp prices. We began I think we began raising prices April last year, April 17, and we've seen a series of these since then each quarter. And there's been a further one announced for the next quarter as well.
There's always a lag effect, but you can see in our performance and our profitability, we have been able to implement these selling price increases to offset much of the impact from pulp. The conversions reduce our exposure once they're completed to this market. We continue to make investments and focus on efficiencies, the investments that we make will be to lower costs. And a good example of that is the GRACON PM9 investment that we announced, I think, last quarter for $30,000,000 ongoing focus on costs and efficiencies. Then moving to packaging and specialities on page 12, the there's obviously a global push now towards paper based packaging to replace plastics, and that's creating further opportunities for us.
We're very excited about the prospects, the most of the markets that we're in, are growing between 1% 5%. And in fact, we've been beyond this. We would expect more conversions across the board in a highly fragmented market. We've put we've recently announced price increases to offset the higher pulp costs. Calm was completed at the end of February, and I have a slide on that later.
I'll go into more detail. The conversions that we've announced will boost our capacity and, because we're limited by the capacity we have available currently. But obviously with Maastricht having recently been completed in the board space and Somerset in the process of being finalized, that will give us opportunity to grow our packaging. And then the The calm and the Rockwell Technologies will give us further scope for growth. Then on dissolving pulp, and I move to Slide 13, the demand continues to be strong, We've seen a lot of new viscose capacity coming on board, which is depressed viscose prices a little bit.
But dissolving pulp because there has been strong demand continues to be stable and we would expect that to continue for the foreseeable future. As we look across the board, there's a little bit of new capacity coming on board in 2019, but relative to the market demand growth, we think the balance in the market is very favorable. The fact that paper pulp prices have been rising has helped support the DWP. Pricing as well. The prices have been steady over the course of the last couple of months, and we would expect that to continue.
We continue to look for opportunities to grow our capacity. And obviously, we've got the debottlenecking projects underway at the moment. Moving to Slide 14, Sappi Europe, and they've done a great job at putting through price increases to offset the higher raw material costs. We got an example of the one product on the top right. And you can see that it's been continuously rising over the last year.
The markets have been relatively better. And as I said earlier, our machines are all full. At the same time, specialities and packaging is going extremely well. Volumes up 12%. That excludes the calm.
And, that will expand further as we move more of our Maastricht capacity into folding boxboard. The costs were up mainly as a result of pulp, but, latex has also been an issue as well. Then on to Cepi North America, the Similarly, we've put through a series of price increases. The market dynamics in that market with some recent closures has been more favorable. And again, our machines are full, which has helped us to put through these price increases, at the same time dissolving pulp, demand has grew has grown and we, we saw we saw a little bit more capacity to dissolve in pulp at cloquet during the quarter relative to last year.
In addition to pulp costs, energy and chemicals have also risen. But you'll see from the performance that we were able to offset those. Then on to South Africa, obviously we're up against the stronger rand compared to a year ago, 12, approximately 12 ran to the dollar a year ago with 13. So that has a a significant impact. So obviously profits would be lower than last year.
However, in spite of that, the performance has been good. DWP volumes have been strong. At the same time, packaging has had a excellent start to this financial year. And we've seen volume growth there, which has more than offset the or demand growth, which more than offset any impact from the drought conditions in the Western Cape. Then we turn to the 4 pillars of our strategy.
And the first one is the costs advantages and focus on costs. On page 18. We continue to do a lot of good work on our procurement side. We've talked about this last quarter, the $60,000,000, and we are still on track to achieve that in this financial year. Focus on the, continuous improvement across all the mills has offset some of the impact from raw material costs.
In Europe, we continue to look for opportunities to debottleneck pulp capacity to because Europe is only is about 55% top integrated and clearly within a cycle like this where raw material or pulp prices have been rising that has put pressure on us. The cycle expansion, which will go into a little bit more detail later will help lower variable costs. And then we've got the Grakom PM9 paper upgrade, which will deliver nice payback and lower costs. Then rationalizing declining businesses, the 2 big conversion projects underway, in Europe, Firstly, at Lanaken, we'll progressively move out of lightweight coated as we, complete at Lanaken, reduced exposure at Maastricht, and Somerset, as we finish that conversion On page 20, the maintaining of a healthy balance sheet, as I said earlier, We are still committed to the 2 times net debt to EBITDA ratio. And we'll use that as we as we move through this period of conversions and growth projects.
The cat finance costs are approximately 60 to 7 $60,000,000 to $70,000,000 per annum. And we renewed our RCF during the quarter. That's been unutilized. But it's always nice to see that we can achieve that. And we did that at a lower spread 165 bps versus a previous rate of 1.19.
So that's encouraging. Then on Slide 21, in terms of our growth into the higher margin areas. We have debottlenecking at our various DWP mills, the investments that we've made in terms of the Rockwell Technology and the CALM acquisition, We think we can grow further, at our South African packaging mills in Botswana and together. And we continue to look for opportunities for additional hardwood timber supply in, in South Africa. And then last quarter, we talked about it, but we applied for the environmental approvals for the expansion of Saiccor by a further 110 we're hopeful that we'll get that soon, that environmental approval, and then we could commence the whole construction, which would be complete early in 2020.
On Slide 22, the Calm acquisition has gone very well. Integration is proceeding according to plan. There's been no surprises for us, or no material supply prices. They We're very happy with the assets that we've acquired, the people, are fitting in very well into Sappi. And we continue to believe that there will be synergies of $10,000,000 to be realized within the next 2 years, which would give that business, a $30,000,000 EBITDA, which is what we said at the time of the acquisition And just to remind you, it's the 2 mills, which you see pictures of in Northern Italy.
Further opportunities as we accelerate growth, we were finally able to sign the in Goodwana Energy Biomass project with the Department of Energy. Construction begins in March 2018. This SAPI has an equity share of 30%. So we equity account it. We don't consolidate this onto our our balance sheet, and it will deliver good returns and good, black economic empowerment benefits as well.
Moving to Slide 24, the specialty packaging expansion And this is just a reminder of all the component parts of the conversions that are underway, but the primary ones being the Maastricht conversion to folding boxboard, they'll continue to make some coating wood free on the machine, but that will ramp up as we move ahead towards more and more folding box port. And then the other big one is Atlantic and I talked about that already, but enabling us to make the coated wood free on PM8 there. The Somerset construction is in the process or has just been completed literally in the last couple of days. We're now in the process of testing all the products. And there will be a ramp up over the next, the next couple of years.
And we've targeted additional 350,000 tons of packaging and specialities on that machine. In terms of DWP, just to remind you, once again, we have the smaller project at Saiccor, gives us 10,000 in the short term. Then with Wanna, the additional 50,000 will be completed in September. Of this year and then cloquet an additional 30,000, tons by next financial year. In top of all of that, this is Saiccor expansion that I referred to.
120,000 sorry, 110,000. And then we continue to scan the external market for opportunities to boost our dissolving pulp capabilities further. And that brings us to the outlook. And on page 27, just to summarize and recap, dissolving pulp demand remains good. Prices are stable and We have a favorable outlook over the next couple of years.
Q3 will be impacted. We have a shut. In fact, we have shuts at all all three dissolving pulp mills during this quarter. In Europe, operating rates are strong. Paper prices have been rising and as you saw, we had a further price increase announced.
Some are set conversion as we talk is in the process of being completed. And we've again, we've been able to put through selling price increases. Packaging continues to grow as customers switch to paper based solutions. So taking all of that into account, obviously, we're still up against stronger rent. But markets across all our segments are in a pretty good state.
So taking that all into account with the shuts, we say that the Q3 performance will be broadly in line with last year in terms of profitability. So operator, that's me gone through the deck. If you I'll hand it back to you for questions.
You. Our first question is from James Tyman of Precien Securities.
Yes, thank you. I've got two questions. The first one is, in the last call, you mentioned that there was capacity switching from dissolving pulp to paper pulp. And I'm just wondering whether you've seen any more of that happening given that we're seeing paper pulp prices continuing to outpace dissolving wood pulp? And then secondly, in the U S, I know that you're looking at a price increase for June or July.
For fine paper. Just wanted to know whether that feels like a realistic option for you. Okay.
In terms of the switching of capacity between dissolving and paper pulp, I don't think there's been anything materially changed since our last earnings call. A lot of it has already shifted across the paper pulp. Mohammed, is there any other major changes you've seen in the last few weeks.
Steve, no, only just to add that, the switch from dissolving pulp to paper pulp is not only going from dissolving to, bleached paper pulp, but also, from dissolving to unbleached crop up in China.
Yes. Okay. Thanks. And then, Mark, how confident are you on your price increase for July?
Well, we just announced the price increase on the web grades on Friday. We expect that to go through. We generally see about 25% to 30% of your price coming through and as we announced. And then by the end of 90 days, about 80% of that would be too.
Did you get that, James?
Not really. It's promising, it sounds like, is it?
Yeah. And we're confident that we can get it through. In the short term, 25 to 30. And by the time we we get a couple of months out, we'll we're confident that we'll get 80% of what was announced.
This is the July increase we're talking about, is it or to be successful? Yes.
Our next question is from Brian Morgan of RMB Morgan Stanley.
Hi guys, thanks very much. Congrats to the numbers. So if if I can just ask, you make a you make a note in the in the presentation pack about, increase in increase in supply in specialty packaging. Could you just expand on that a little bit?
Are you talking It's on slide
12. So on slide 12, you say more conversion expected into various grads of a highly fragmented market?
Look, there has been announcements by other competitors out there, not specifically in the same grades as us. But clearly with the global push towards paper to replace plastics. Everybody's looking for opportunities. And with potential new legislation and in the UK and in Europe. It's really a bit of a risk.
We're getting a lot of contacts from FMCG Companies, wanting to focus on paper based solutions and for their packaging. And it's really a very exciting time. And obviously, the fact that we've we've been making investments in this area. We've acquired Calm. The conversions that are underway, we think the opportunities of ours.
Barry, I don't know if you want to expand any further. No, I think that answers it.
Steve, just the concern, obviously, is this is obviously a cyclical industry, and we obviously just worry that with you know, attractive looking markets tend to tend to attract a lot of a lot of supply. And, and just interested to hear your thoughts in that regard. I'm I'm just worried I'm just worried that that that we're chasing chasing a chasing a side here that, that that could end in sales.
Yes. Look, in the sectors that we're in, the competition that we're up against there tend to be smaller niche players, the we're not talking the mass packaging categories. They are many of them are highly technical and the machines that compete in that space are not the larger machines. They tend to be smaller machines. And based on that, we're reasonably confident that there won't be a mass shift from the large producers into those categories.
Okay. And then if you could remind us, the payback periods on these conversions, 3 to 4 years, if memory serves, is that still intact? Nothing changes there. Okay.
And then if we can, just
in terms of that CapEx outlook for 2019 that you've provided a small increase for 2018, What what roughly, what portion of that would be would be maintenance CapEx?
It's between $150,000,000 $200,000,000
$200,000,000. And then in terms of in terms of turn criteria for the expansion components of that CapEx, could you give us a rough number? Anything about 20%, fifteen percent? What sort of number should we be thinking about?
We all the big projects that we've looked at are, between 1520 IRRs.
Between 152020?
Correct.
Okay, that's excellent. Thank you very much. I appreciate it.
Our next question is from Ross Kriffer of JP Morgan.
Good afternoon, everyone. Thanks for the call. And just with regards to the Somerset conversion and perhaps SBS market in North America, What if you could maybe just give an idea of how many what sort of sales volumes you would expect from that Somerset SBS? And then in terms of pricing, if you could give us some insight into that market, would you expect to have to take a discount on those volumes, perhaps how will What do you expect the margins to be versus current specialty margins?
All right. Mark, I'm going to hand over to you talk about the ramp up. Obviously, we've got certain commitments at the moment. But there will be a time period for ramping up. So you want to elaborate further?
Mark?
Yes. Yes. Can you hear me okay?
Yes. I can hear you now.
Alrighty. We're in the process of starting starting the machine up now and we'll be, ramping that up over the course of this month into next. We do see the SBS market as being a fairly large part of them that we are putting in the machine, but just remind all on the call that the machine also will be making, C1S technical papers and also graphic papers. So it's not It's not, we're not planning on ensuring to be 100% dedicated at this point in time to any one market segment. The total volumes, as you mentioned earlier, Steve, out and as we ramp up over the next year or so, could go as high as 350,000 tons of packaging grades large part of that would be in the board grades.
Yes.
Yes. And then And Mark, just there was a second question just on the pricing.
Well, we're, we're, we're all, we're looking at, you know, the market pricing and we feel comfortable with that market pricing up product, we are quite confident. We'll be, we'll be a very good product in the market and we wouldn't be surprised when we have to expect the product will drive a lot of demand just because of the design of the product and the quality, we expect to have this rebuild machine. So, I think the question was do we see discounting in the market? We don't, that's not part of our strategy.
Okay. Thanks very much guys.
Our next question is from David Drew of BINL.
Good day guys. Thanks for the time. Just a few questions from my side. We just within our coverage, I think some of the factors that we have struggled with is certainly the less transparent cost in the seas such as wood as well as wages. Perhaps you can just comment on the direction of wood and wage costs across your businesses in the U.
S. And Europe. So that's my first question. And then my second question is, what do you I mean, what will the delta be in, the scheduled annual maintenance impact versus last year because I'm still struggling to reconcile to get your guidance. And my feeling is that we could see a high impact from annual maintenance shuts.
And then just my last question, quite a high level one, but can you perhaps comment on the risks from potential land expropriation in South Africa? Thanks.
Okay. We'll take each of the questions in turn. Firstly, on wages, in Europe and U. S, we would expect those to be in line with inflation, around 2% or 3% Yeah. And the second part of the question was on wood.
The near term outlook is lower prices on the wood front, particularly in the U. S. The annual maintenance shut. Obviously, the first one we've obviously got is the fact that we've got Somerset, which, has an extended shot for the conversion. And then also we have the Cycor shut as well, which is about, looking at I'm looking at it relative to last year.
It's probably an incremental $5,000,000 relative to last year's impact. In Goodwana was, in Q3 last year, Q3 this year. So there's not a material difference. So the 2 bigger ones relative to last year are the combination of Somerset and, Saiccor. Combined, if I add the increase at Saiccor of about, as I say, $5,000,000 and then the remaining time period for some would say you're looking at $5,000,000 or $6,000,000.
So that's about $10,000,000 relative to last year additional costs of shuts. Does that answer your question, David, on that one specifically?
Yes, Steve, that does. Thanks very much. Yes, then just the last one on land expropriation.
Yes. I mean, clearly, it's a very sensitive issue and we've been engaging and we've made submissions. We are using business leadership as our communication vehicle. We've had comprehensive discussions with them and we've we've had assurances indirectly through business leadership that the threat of, of land expropriation will not impact on on productivity. It won't impact on jobs, economic growth for the country.
So it's not something
Hi. Year over year. And it's mainly due to this, one of you had in South Africa about transfer pricing. I'm asking if that difference of SEK 80,000,000, it was 100% coming from this issue or was there something else in it?
No. The $18,000,000 is just 100% from that issue.
Okay. And then in terms of camp paper, you talk about synergies. Did you quantify how much you expect and over what kind of time frame?
$10,000,000. And by the end of 2 years, we'll have be running at that level.
Okay, great. And then, during your previous call, you had mentioned when it came to your capital structure that your priority at the moment was your CapEx expansion plans. And you were monitoring the markets as your 2020 bonds are kind of callable. But it wasn't high on your list of things to do. Is that kind of how you're still looking at it?
Yes, for the time being, it's not something we're planning on doing. Clearly, the market continues to look favorable. And as that window opens, we'll we'll monitor it, but it's not something that we are it's not a major priority for us. No.
Okay. And the fact that your other bonds, 20 23 has become callable April next year. Is that a factor in terms of timing like to do something together in April next year when both of the loans are callable or not really that you could do something? No, it's
not really, as I say, it's not really it's not really an immediate factor for us. As they move into the callable window, we'll monitor it. But Our focus at the moment obviously is on these, conversion and debottlenecking points.
Okay, fair enough. And then in terms of in your presentation slides, you mentioned dissolving will pop capacity coming on stream in 2019. I mean, given where things are currently, when projects are expected finish what sort of capacity we are talking about in terms of percentage of the market?
Look, as we look forward, let's talk the demand side first. We continue to believe that the market will grow somewhere around 5% or 6%. And if you convert that into absolute actual tons, you're talking 400,000 or 500,000 tons per annum. And as we look at the new capacity that's coming on board, it's not in excess of that. So we think the market balance will continue to look favorable over the next few years.
So you expect the additional capacity to be absorbed by the increase in demand?
Yes. So I'm talking about 5%. Approximately.
Okay. Okay. And lastly, on the coated woodfree, competitor of yours mentioned during the call that the deliveries in Europe for the whole market was up 1% last year in 2017 fiscal year and, which is 2% to 3% structural decline that we normally see in this market in Europe specifically? Having finished such a good year, do you think in terms of volumes this year in Europe in coated woodfree? We would see some sort of accelerated decline when it comes to volumes having done a good year already.
I don't know what inventory levels are like. And I think they mentioned, they were already seeing some softness. Is that something you already also see or not really?
Yes, I don't think really. And clearly over a longer period, we have seen a gradual slowing on the pace of decline. You're right. 2017 was a better year. The European economy was stronger and and the demand for graphic paper benefited on the back of that.
2018, the start, the early months of 2018 have not been as positive as 2017, but that doesn't change our longer term outlook. And we've said it many times that we continue to think in in the near term future will be down about 2% or 3%. And that's And despite what happened last year and we'll take it when it comes, we continue to believe it will be down 2% or 3%. And that's what we build into our models and And that's why we wanted to take capacity out of coated woodfree and allocate it to other segments. And primarily focusing on the packaging side.
We will pause a moment to see if we have any further questions.
Okay. Operator, if there's no further questions, I'd like to thank everybody for joining us on the call today, and we look forward to discussing our results at the end of next quarter.
Ladies and gentlemen, that concludes today's conference. Thank you for joining us. You may now disconnect your lines.