Good day, ladies and gentlemen. Welcome to this Sappi third quarter 2017 results conference call. All participants are currently in listen-only mode, and there will be an opportunity for you to ask questions later during the conference. If you should need assistance during the call, please signal an operator by pressing star and then zero. Please also note that this call is being recorded. I would now like to turn the conference over to Mr. Stephen Binnie to head up.
Thank you. Good day, everybody. Welcome to the third quarter results call. I will call out the page numbers as I move through the presentation deck. Firstly, on Slide four, the highlights for the quarter. EBITDA, excluding special items of $155 million, marginally down on last year's $160 million. Profit for the period, bottom line, up from $32 million last year to $58 million in the current year, obviously on the back of significantly lower interest charge. Earnings per share was flat at $0.11. We continued to bring down our net debt. It was down $265 million year-on-year and down to just above the $1.3 billion mark. During the quarter, we repaid $400 million of our bonds from available cash reserves that we had on hand. Turning to Slide five, some of our key financial ratios.
Net debt to EBITDA continues to come down, and you can see it, the Q3 2017, we're now down at 1.7 times. That's below our targeted level of two times. EBITDA margin at 12.3%. The return on capital employed, this is obviously the quarterly number annualized at 12.8%. The third quarter is our lowest quarter because of the shuts that we have. Annually, that number is over 17%. To Slide six, the EBITDA bridge from last year to this year. On sales volume, we've seen positive growth across all our product categories. Dissolving pulp continues to be good. Speciality packaging goes from strength to strength. Also, even in this quarter, we actually saw positive volumes coming through from our graphic paper. Prices were up in dissolving pulp. Remember, the bulk of the contracts are priced off of the previous quarter spot prices.
We did continue to benefit from the higher prices. Also on the mix side, there's a shift away from graphics towards specialities, which sell at a higher price. Costs were under pressure predominantly because of higher pulp prices, but a number of the other chemical market prices were up on a year ago. The big impact negatively was exchange rates. The ZAR has strengthened significantly year-on-year, and that had a negative $14 million relative to the last year. Turning to Page seven, the contribution split across product categories. You can see that EBITDA is split roughly half-half between Specialized cellulose on paper. Within paper, graphic paper, coated paper is 35 of the 50, and our specialities in packaging is 15.
That continues to grow, I think I've said it a few times, but by the time we get to 2020, we're targeting for that to be a 25/25 split. On to Slide 8, the maturity profile for our debt, it tells a very encouraging story. We've now refinanced or repaid all of our shorter term debt, we really have nothing maturing now in the next few years. We've pushed out the securitization now to 2020, and all our bonds are now 2022 and beyond. In a very good position. On to Page 9, the CapEx. For this year, we are looking at about $330 million. That's a bit higher than prior years, but that's because we've commenced these conversion projects from going from graphic paper to specialities and the debottlenecking down in South Africa.
Next year, we're estimating at about the $450 million mark, the continuation of the conversion project. Also we're putting in a new wood yard at our Saiccor mill to give us more space there and get it ready for future growth. Moving forward to Slide 11, the trends in paper markets. As I said earlier, the demand for graphic paper was better this quarter. It's the first time we've seen growth in some time, and it was particularly strong in the export markets. Specialities, the markets continued to look good for us, they're growing at between 1%-5%. Unfortunately, selling prices are down on where they were a year ago. In both Europe and the U.S., we have announced price increases Effective 1 July.
Looking at the performance in July and the order book going forward, we're encouraged by how those price increases have been undertaken. Unfortunately, costs have been an issue, in particular, the paper pulp for our European business, because it's only 55% integrated. Latex is another cost that was up year-on-year. Going forward, we will continue to look for opportunities to convert capacity away from coating towards packaging and ongoing focus on cost. Turning to each of the regions, page 12. Europe, firstly, I've mentioned it a couple of times, but the higher raw material prices did impact on margins. Although graphic paper volumes were up during the quarter, as I say, we put through a price increase, it is encouraging so far. Specialities continues to really do well for us, up 17% year-on-year.
In North America, performance in absolute terms similar to last year, benefited from better dissolving pulp prices and volumes and costs well managed. Unfortunately, the coated paper prices are down 6% on last year. That was obviously before the price increase that we announced in July, which is looking encouraging for us. On the packaging side, albeit from a relatively small base, the volumes there are up 20%, those will accelerate once we complete the Somerset conversion. The dissolving pulp market next, that summary on Slide 14, we continue to see strong demand. In terms of capacity, if we look out towards capacity that's been announced in the marketplace, we expect over the next four or five years for it to grow at about 5%, that is consistent with our expectation on the demand side.
We continue to believe that the market is encouraging and in balance. Shorter term, we did see the prices come down April through June. In July we've seen a recovery, and we're encouraged that prices will continue to rise as we move forward over the next couple of months. Also, with paper pulp prices being so high, there may be some capacity being attracted back away from dissolving pulp towards paper pulp. We continue to work closely with our customers to look for growth opportunities. We have some short-term opportunities in South Africa to give us up to 100,000 tons. Longer term, and I talked about this on previous calls, we are looking to add further capacity. We estimate in the next 5 years we need about 500,000 tons, and we are evaluating opportunities both internally and externally. In South Africa, turning to slide 15.
Unfortunately, the stronger Rand does have an impact on margins. That was the number I shared with you on the earlier slide. During Q3 is when we have a big shut in Ngodwana. You do have higher maintenance costs associated with that. Dissolving pulp prices I've talked about were good relative to year-on-year, and our paper business predominantly in packaging towards the citrus export market is very strong for us and continues to grow, and we think there will be further opportunities in the future. Moving to the strategy side and our 5 pillars of our strategy. Firstly on page 17, our ongoing focus on cost. Firstly, we've listed a few of the projects we're working on. The first one is the Somerset wood yard project, which we're going to be commencing soon.
We estimate the cost of that will be about $50 million, and that's in the CapEx numbers that I highlighted to you. The procurement initiatives are ongoing and successful for us. We promised $100 million, and we're on track for that. By the end of this year, we'll be tracking at $63 million. We also had a project for the Somerset Mill as well, also a wood yard, and that's expected to be completed in the next couple of months, and we'll be ready for production early in the new financial year. Moving to slide 18. Rationalizing our declining businesses. I've said it many times, we continue to anticipate a demand reduction for coated paper, and we look for opportunities to move that capacity elsewhere. We announced earlier this year some projects in Europe.
Firstly, to take Lanaken out of lightweight coated mechanical paper, reducing our coated wood-free exposure at a number of our Maastricht, predominantly in Europe, a little bit at Ehingen, and the Somerset PM1 machine as well. Moving to slide 19. We look for opportunities to expand growth through moderate investment. The projects that we list here, some of them we've talked about previously, just to reemphasize, we've got the debottlenecking at Saiccor and Ngodwana. Obviously, the conversions that I talked about, we made a small acquisition for a business called Rockwell. It was small. We acquired it for its technology. It was £8 million we paid for that up front. That's to help us on the barrier paper side for our speciality packaging. We brought on board their R&D.
We continue to believe that there are opportunities for expansion in packaging in South Africa, at Ngodwana and Tugela. What's important strategically is to continue to secure hardwood timber supply. Moving to slide 20, the balance sheet focus. We have done a lot of good work over the years. We obviously repaid the bonds in this quarter. Going forward, our cash interest cost is now down to between ZAR 60 million and ZAR 70 million. Slide 21. Obviously, as we continue to reposition the business away from coated paper, we look for opportunities in a few areas. Speciality Packaging will continue to accelerate on the biomaterials front. As you know, we put in place a few different pilot plants for different product categories. Those are ongoing and hopefully will generate revenue in the future. Dissolving pulp, excited about the opportunities.
I've already talked about the fact that we want to grow capacity. We are evaluating a number of different opportunities. Turning to our outlook finally, on to page 23. Dissolving pulp prices, as I've mentioned earlier, are predominantly benchmarked off the previous quarter spot price, our contracts. That will mean lower prices in Q4. However, as I said, spot prices have already started bouncing back up. The longer-term market dynamics appear very favorable. We expect demand growth to be 5% or 6%. It's a very good opportunity for us. In Europe, market demand has stabilized. Actually, export markets are pretty good at the moment. U.S. is tough. A lot of that coming through from exports. Obviously, we're focusing on getting price increases across the two businesses. Specialities continues to grow. We have margins in the mid-teens, EBITDA margins.
The conversions that we referred to earlier are on track. We're excited about the growth prospect. CapEx for the quarter, ZAR 170 million, which includes the projects that I've referred to earlier. All in all, based on our current market conditions, we expect full quarter results to be slightly below that of 2016. That's really because of the stronger rand. That's the main reason. Full year will be above last year. Operator, I've gone through the presentation deck. I hand it back to you for questions.
Thank you very much. Ladies and gentlemen, at this time, if you wish to ask a question, please press star and then one on the touchtone phone. If you decide to withdraw your question, please press star and then two to remove yourself from the queue. Again, if you wish to ask a question, please press star and then one now. Our first question is from Wade Napier of Avior Capital Markets. Please go ahead.
Hi, guys. Thanks for the opportunity to ask some questions. Can you just maybe give us some color on what's actually driving the strong sort of growth in export markets? Secondly, I see you want to invest in a woodyard at Saiccor to potentially sort of expand operations. If we read between the lines there, that seems like a big investment to expand for potential debottlenecking. Does that imply we may be looking at a brownfield expansion at Saiccor? Can you just give us a bit of flavor on the North American variable costs? Obviously, Cloquet is producing more DWP, which would imply you're buying more hardwood pulp. How did your sort of variable costs decline there? Thanks very much.
Yep. Okay. Sorry, Wade, I missed the first question again. Do you mind just repeating?
Growth and exports.
Oh, growth and exports. Yes. Look, obviously, the fact that raw material prices have risen significantly has created an opportunity for better margins in export markets. We have been able to push up prices a little bit relative to European markets. David, you want to expand a little bit further on specifically Which countries the growth is coming from?
Yes, Steve. It's a number of countries, including South America, Middle East, Southeast Asia. A part of the reason is that demand in China has been very strong for Chinese home producers, and a lot of old high-polluting capacity in China has been closed down. This has focused Chinese paper producers' minds more on China, and they've been less aggressive on the export market, and that's opened up an opportunity for European suppliers.
Yep. Thanks. On your second question, the woodyard at Saiccor, I will let Alex expand further, but if you've been to the mill, you'll know that we are somewhat restricted for space there for expansion. By us spending on the woodyard, that will create space for us. Longer term, yes, we do see growth opportunities. We don't anticipate adding the big volumes in the next year or two. I'll let Alex expand a little bit further.
Thanks, Steve. The one opportunity we have, we have a logistics flow issue with the restricted space. By investing in the woodyard, we are able to improve quality by being able to sort fiber types. The timber that we actually cook into a further variety of species, so we cook the species specifically. That actually has a reasonably good payback. We're investing in the woodyard, there is a fairly good return in terms of dropping your variable cost, improving the quality of the product, then also setting you up for future expansions.
Yeah. Then North American variable costs, I'll let Mark expand further, we have seen Yes, you're right. They've had to purchase more pulp, timber prices have been coming down in the U.S. Mark, do you want to talk further?
Sure. Thanks, Steve. Yeah. You called it out with our Project Renault work. A lot's been done over the last year on our variable cost, variable usage at all of our sites. We've been able to manage our costs accordingly and not really have had the margin erosion on the variable cost side due to some of the material costs going up because we've been able to offset that with good work on usage, and also material pricing has been good too because of the way we've been able to procure some of our materials.
Thanks, Mark.
Okay. Thanks very much, guys.
Thank you. Our next question is from Sean Ungerer at Marcom Capital. Please go ahead.
Good afternoon, everyone. Thanks for your time. Just quickly, in terms of the $100 million savings, obviously the ramp-up at the moment is pretty decent. Are you sort of leaning towards a bit of upside after that? Secondly, the timing of DWP at the port. Normally it's like 5,000 tons, this time it was like 15, which sounds a bit high. Are you worried this is going to happen again? In terms of Europe, obviously really solid volume growth. On the cost side, is there anything else you guys are trying to do to sort of improve that a little bit? If you look at the U.S., in terms of breaking down the impact of domestic kind of free sheet prices, how much is demand versus the euro/dollar at the moment? Thanks.
Okay. The $100 million upside. Yeah, we're tracking ahead of the $100 million number. We were at $63 million, and we are above those levels. Obviously, the way we measure those is they're independent from market moves. Clearly, some of the rises in the pulp price that we've talked about have offset the benefit when it comes to looking at the bottom line. I'm slightly wary to commit to a specific number above $100 million, but the $63 million that we're referring to is tracking ahead of where we thought we would be at this point in time. I'm confident that we can beat the number. The port delay, I'll let Alex speak to a little bit more. You're right, the number is higher than it normally is. Unfortunately, there was a shipment at the end of June that didn't get off in time, and that volume will flow into this quarter.
We're doing a lot of work internally to make sure that by the time we get to the end of September, there's not spillage into next year. That's looking at accelerating some of the shipments. Alex, I don't know, anything you want to add to that? Alex?
Thanks.
Hello?
Thanks very much.
Sorry, did you catch that? The European costs, clearly, we've been impacted by the pulp. Our pulp integration that I referred to earlier in Europe is 55%. Barry, long term strategically, we obviously want to look for opportunities to improve our pulp integration. Is there anything you want to add to that?
Well, I think in part, thank you, Steve, to the question, have we done anything to offset the rather extreme effect of pulp price rises in Europe? Yes. We did do some hedging during quarter 3, that took some of the edge off it. Rano is playing a big role in terms of finding ways to purchase pulp, which takes some of the edge off it. We have been improving the efficiencies and therefore the conversion efficiency of raw material into finished product rapidly over the past year. Finally, we have been able to put through some price rises, that's also offset those costs.
Yep. Thank you. Finally, Mark, the question was on the price increase for coated free sheets in the U.S. Do you want to just talk about how successful we've been?
Yeah. Thank you, Steve. Yes, the price increase that we announced for July has been going through quite well. Obviously, as we go through this quarter, we'll see more of it start to hit the bottom line. It's being driven by, I think, a couple of things. One is the seasonal uptick in demand, we're starting to see that, and it's encouraging what we're seeing for backlogs grow. The other is the capacity closures that have been announced with the Resolute closure of PM3, also the permanent closures that have been announced on PM3 at Ehingen have tightened up the photomechanical market, that carries all through to the coated woodfree market on the website in particular. It's moving in the right direction from what we've seen and where we're at right as of now.
Yeah. Okay, thanks, Mark.
Thanks, Sean.
Thanks very much, guys.
Thank you. Our next question is from David Rood of Merrill Lynch. Please go ahead.
Hi, guys. Can you hear me?
Yeah.
Okay. Thanks very much. Just a couple of questions. Just expanding on that point on the hedging of pulp in Europe. How far forward have you guys hedged? Can we expect a much larger impact from variable costs in Q4? My next question is how much DWP is Cloquet producing now on an annualized basis? Two last questions for Glen. Just on the ex-dividend date, do you guys intend to follow a similar pattern to last year in which the ex-dividend date was in January, or would you guys likely revert back to the pre-2008 pattern where it was in December? Just last question, in terms of the specialty paper business, when can we expect separate disclosure of this business in the financials?
Yeah. Okay. Thanks, David. Firstly, on the hedging of pulp, it's rather limited, the pulping hedging that we do. Clearly with pulp prices being as high as they are now, it makes less sense. We don't have significant volumes of hedges in place at the moment. Dissolving pulp at Cloquet is currently projected at about 230,000 tons, about two-thirds. Glenn, on the dividend?
All right. On the ex-dividend date, we don't anticipate changing it from what we had this year. The expectation is that we'll stick with mid-January of the coming year. In terms of the specialty paper, we're looking to start not next year, the year after, as far as disclosing it separately.
David, the reason for that is we've got the two conversions underway at the moment. We want those to be completed, and then we'll be able to provide meaningful numbers at the segment level. What we'll try and do is provide the key numbers, but ultimately give the detail after the conversion.
Okay, great. Just to be clear, likely from Q1 2019.
That's correct. Yes, David.
Thanks.
Thanks, David.
Thank you very much. Next question is from Brian Morgan of RMB Morgan Stanley. Please go ahead.
Hi, guys. Thanks very much. Just one question from my side is, you're adding a fair bit of capacity of SBS at Somerset. Just wondering what your thoughts are in terms of placing that paper in the market.
Yeah. Obviously, the conversion is underway at the moment. We've assessed the market. The attractiveness for us in that market is that we are going to be an independent producer of the SBS. We've been in consultations with a number of the independent converters. Mark, do you want to just briefly talk about the progress that we're making there?
Sure, Steve. Thanks. Yeah, the project's moving along very well. We have all of our major equipment and construction and engineering progressing right on timeline. We are now starting to take time at our regular maintenance shut to do some of the pretty major shut rebuild work, which is just to remind folks, we'll be doing the major part of the rebuild will go on during the March, April timeframe of next year. We're very active on the different products. There's a lot more than just SBS on the list of products we'll be making off the machine. We're working very active on that work side, product design, product development, working with customers in advance of the machine starting up. We expect to have a fair amount of the product coming off the machine already pre-sold and placed as we move into the different markets that we'll move into.
Our technology that we're applying there will give us, we believe, a unique and differentiated product in the market. We're pretty excited about it. It's moving along right on plan.
That's brilliant. Thank you.
Thanks, Brian.
Thank you. Next question is from Ross Krischer of JP Morgan. Please go ahead.
Hi, guys. Thanks very much. Just looking at your conversions, I realize, it's still a way out till things actually happen and variables can change. Would you be able to quantify at all your expectations around any contribution in FY 2018? Just on your expectations of adding additional DWP capacity. Has there been any progress on that? Do you have any more thoughts on where and when that could be? Just in terms of your guidance of earnings being slightly down in Q4, this is a bit cheeky, but is it fair to assume that's low single-digit %?
Yeah. Okay. The conversions that we're doing, obviously, there's a sequence of projects in Europe, the big one obviously being converting Maastricht. That's gonna take up most of next year. You're only gonna really see the benefits from the European conversions in the 2019 year. The North American one, as Thomas said, expected to be completed about April. You'll start to see a little bit of a ramp-up as we move into Q4 of our next financial year. You'll get the full impact, obviously, in 2019. Dissolving pulp capacity, yeah, I said on the last call that we're working away looking at opportunities internally and externally. The work is progressing nicely. I did say we would give detailed feedback probably at the February results call for the December results call, which will occur in February. Just some of our thoughts.
There are smaller debottlenecking opportunities, obviously, within our current mills. You've heard briefly about Saiccor. We're doing a lot of work to get Saiccor longer term ready for growth. At the same time, from an external perspective, we're assessing what potential pulp mills are out there that we could look at, and that could potentially be converted to dissolving pulp. We have a number of possibilities which we're evaluating. As I say, as we progress over the next few months, we'll be able to give you detailed feedback. It's progressing nicely, and we do think there are opportunities there. Finally, the earnings. Yeah, I said marginally down in the outlook statement. Yes, it's single digits. Yes.
Okay, thanks. Thanks a lot.
Yep. Thank you.
Thank you. Our next question is from Matthew Ahlers of Coronation Fund Managers. Please go ahead.
Hi, guys. Just a couple of questions. On the divi cover, you've given guidance to the end of the year. Is there any possible guidance you can give whether it's gonna go from five straight down to three, or whether you're probably gonna do five, four, three in terms of the divi cover? What assumptions are you using in your outlook? In terms of the pulp pricing, is it give or three months foresight as to what it will be, or if pulp prices come down, there's a chance that your earnings guidance could be a little bit light? A final question in terms of, you talked about DWP pricing going up. Could you give it a bit more color on that?
Yeah. Okay. The dividend cover will be better this year. Matthew, we haven't made a call yet whether it will be four or three. We'll obviously see how the last quarter unfolds. Certainly, by the time we get to the end of next financial year, it will be three. We'll make a call at the end of this year whether it will be four or three. Let me take the dissolving pulp first. Barry, I'll come back to you on the pulp, our outlook on the pulp prices. Dissolving pulp prices dropped to $830 spot prices a ton. If you look at the market dynamics and where the marginal tons or cost per ton should be, it is around the $830-$850 mark. That is where we would expect the prices to bottom.
Over the last few weeks, it's gone back up to $845, the indications are that it will
Continue to rise in the next few weeks. I don't think there's any surprise, we think it will move upwards. Pulp prices, hopefully getting to closer to the top, but Barry, I'll let you talk to where we assume the last couple of months for it to be.
Yeah, thanks, Steve. It's probably worth dividing up into softwood and hardwood because they're moving at different rates. Hardwood listed that it has achieved the peak now and it isn't rising any further. There's new capacity coming on in a number of places, starting in this quarter and then going on into the final three months of the calendar year. Hardwoods, there is new capacity coming on, but there is sufficient demand to keep volumes pretty tight. Stocks are still pretty low in terms of pulp and of hardwood pulp. There are still strong attempts by pulp producers to get further price rises during this quarter. We suspect that that will be the peak, but we don't expect any benefit from declining pulp prices very much during this quarter up to the end of September.
Sorry, what assumptions in terms of ZAR and pulp prices are you using for your outlook statement? Because ZAR is moving around on so much at the moment. We might be at ZAR 13 or we might be at ZAR 13.50, it does change it quite a bit.
Okay. The ZAR 13.30. The pulp, we're predominantly exposed in Europe. Barry, and do you want to just talk about our assumption on the pulp price? Obviously July has already been completed. We're into August and September. Barry, our assumption on the pulp price for those months.
Well, the pulp price, look at the fixed prices and we expect the hardwood price is going to be at $8.60, might go to $8.80. The softwood price is around $8.90. It's obviously better.
That's consistent with our projections.
Thank you.
Thank you very much. Our last question is from Ricardo Tebiani of Ares. Please go ahead.
Oh, hi there. I just want to get a sense in terms of purchasing power for your coated free segment. Where do you see operating rates in Europe and U.S., and how does that compare in terms of recent years or in historical context? Thank you.
Operating rates in Europe at the moment, as an industry, are just below the 90% mark. Sappi is above those levels, and we've seen demand growth, so slightly below 90%, which means it's close to the market being in balance. Barry, anything you want to add to that?
I think the big help for the Europeans is the strong export market, and that has produced a lot of extra volume, which has filled capacities up. It's also the case that there has not been a summer slowdown in Europe, you're seeing pretty good demand in Europe. Generally in quarter three, the demand was above last year. Right now, capacities are well filled.
Does Ricardo-
Thanks, Ricardo.
Yeah, sure. Would you say the operating rates are higher at the moment versus, I don't know, last year and let's say five years ago?
Yeah.
Given all the capacity cuts that are occurring in the market?
Yes.
This is much acceptable?
Yes. Operating rates are higher. Obviously, there was a lot of capacity came out of the market over the last three or four years. As Barry has alluded to, the demand in Europe has been better in recent months. We've got a strong export market at the moment. It has pushed up operating rates relative to where we've seen them over the last two or three years. Obviously, all of that is causing us to be reasonably confident about the price increases that we announced.
Perfect. Thank you very much.
Thank you very much. Gentlemen, we have no further questions. Would you like to make closing comments?
Just want to thank everybody for joining us on the call, and we look forward to discussing our results at the end of the year. Thank you very much.
Thank you very much, sir. Ladies and gentlemen, that concludes this conference call and you may now disconnect your lines.