Ladies and gentlemen, good day and welcome to the Sappi Limited fourth quarter 2016 results conference. All participants will be in a listen-only mode. There will be an opportunity for you to ask questions later during the conference. If you need assistance during the conference, please signal an operator by pressing star then zero. Please note that this call is being recorded. At this time, I'd like to turn the conference over to the Chief Executive Officer, Mr. Steve Binnie. Please go ahead.
Thank you. I will go through the investor presentation. What I'll do is call out the page numbers as I go through so that you can refer to it. Firstly, on Slide 4, highlights for the year. EBITDA was $739 million, up from $625 million last year. Bottom line profit almost doubled from $165 million to $319 million. Pleased to say that the net debt came down further. We reached $1,408 million. That's down $363 million from last year and further reinforces our ability to generate cash. Very pleased to say that we declared our first dividend since 2008. The amount of the dividend was $0.11. It will be paid in January. For the quarter, EBITDA was $209 million, up from $201 million. That was a strong number last year and again this year.
Bottom line profit up from $83 million to $112 million. Moving to Slide 5, just graphically you can see our evolution of the EBITDA and profits. Just some of the key ratios. Pleased to say that the net debt to EBITDA has now come down to 1.9 times. Over some period of time, we've been talking about our target being below two. Very pleased that we got below that in this quarter. Clearly, that was one of the triggers for us declaring the dividend that we talked about. EBITDA percentage continues to improve. Was up at 15.6%. Again, nice improvement there. On Slide 6, the EBITDA bridge from last Q4 last year to this year. Just highlighting some of the key items. Firstly, volumes were down.
We did talk about it in earlier quarters. Graphic paper, our traditional coated graphic paper continues to be under pressure. We have seen volumes come off there. However, we were able to offset the impact of that through good cost management. You can see positive bars there coming through on variable and delivery costs. Exchange rate, we did also benefit from that, the weaker Rand during the course of the year. On Slide 7, the contribution split between paper and specialized cellulose. Perhaps start on the right-hand side, the operating profit, 61% coming from specialized cellulose. 39% from paper. When you look at EBITDA, which is obviously a proxy for cash generation, you can see it's roughly 50/50. Paper continues to play a role.
Within the paper of 54%, clearly there's our traditional coated graphic paper, but we've also got the specialities, which continues to grow nicely. Moving to Slide eight, the net debt to EBITDA. You can see there's been a tremendous improvement over the course of the last two years. You can see it coming down from 4.6 times to 1.9. On Slide nine, you can see what that means on our cash flow basis. From the bottom of our cash generation at the end of July 2013, that was just after we invested in the conversions at Cloquet and Ngodwana. You can see that over the course of the last three years, we've generated over $1 billion of cash. Moving to Slide 10, our maturity profile of our debt. All the bonds that we refinanced in the last year or two are out in 2022 and 2023.
In the near term, we have a $400 million bond, which is maturing in 2017. That's the biggest part of the $513 million that you see on the left-hand side. We anticipate using our cash reserves to pay off those bonds, and the cash is the gray bar on the left. We've been able to generate cash to be able to do that. Moving to Slide 11, our CapEx. 2016 has been pretty consistent with recent years. You can see our maintenance CapEx has been around $150 million. As we look forward into 2017, we expect a similar number. Our overall CapEx, we expect to be higher this year at $350 million, and the reason for that is we are investing in South Africa in our debottlenecking opportunities for dissolving pulp, and we've set aside some capital for specialities growth as well. Turning to the divisions then.
Firstly, on paper, on Slide 13. In terms of supply and demand, it's fair to say that the coated graphic paper markets have been tough during 2016. Probably a little bit softer than we even had forecasted this time last year. As a consequence of that, operating rates have declined. We continue to see closures to offset some of that, but the market has been under pressure. On the specialities side, on the other hand, we see those markets continuing to grow in the sectors we're in between 1% and 5%. As a result of the softer demand, selling prices have been declining, but we've been able to offset the impact of those lower selling prices by a focus on costs, and clearly, the market for pulp and energy has been lower. That assisted us further.
Our strategy will be to continue to anticipate demand as we move forward and take out capacity if it doesn't make sense, and we look for opportunities to convert capacity towards specialities, which is growing, and with a strong focus on costs. Within the geographies, firstly on Europe, very good results for the year. We've seen nice growth despite the fact that demand has been soft. All in all, we've seen flat pricing for the year. If you recall, in the early part of the year, prices rose and then they came back in the second half of the year. Specialities volumes were up for Sappi, up 15%, and our margins continued to improve there. As I said earlier, we were able to take costs out of it and ensure that profit growth came through for us. On Slide 15, North America.
Similar, the market's challenging. We have seen prices down 5% from a year ago. Offsetting that, dissolving pulp at the Cloquet mill, obviously, it was a strong market there, and we were able to boost profitability. Similar to Europe, we were able to do a lot of good work on costs, and that ensured that the profits for North America were up significantly on the prior year. Slide 16, turning to dissolving pulp. It's been a very good year for dissolving pulp. The demand has been strong, prices have been rising, and we've been able to sell all our capacity. One of the reasons for the good growth is that the cotton linter pulp supply has been constrained, and that tightened the market further. Selling prices have been rising alongside cotton and VSF.
Obviously, with our South African business, the weaker ZAR has boosted our profitability from a cost base. Our strategy will be to maintain that low-cost position. We're optimistic about the growth in this market. We've talked about it many times, 4% or 5% per annum, and we believe that there will be growth opportunities for us as we move forward. In the short term, we're looking to add another 100,000 tons in South Africa over the next year or two. Beyond that, we're looking at opportunities to grow further, whether it be in South Africa or outside. On slide 17, in South Africa, in addition to the dissolving pulp that we talked about, the containerboard has been strong. Albeit that it was impacted by the drought situation, but underlying demand has been good and volumes were up on a year ago.
We saw higher selling prices across the board, which boosted profitability. As I said already, dissolving pulp prices have been very good and the weaker exchange rate did put some pressure on input costs. We have to import some of those raw materials. Turning then to our strategic focus, our five pillars of our strategy, and I'll talk about each one of those in turn. On slide 19, on the cost side, we recognize that we are in commodity businesses. We continue to focus on cost efficiencies. A number of smaller projects in South Africa, we've invested in some new turbines at a couple of the mills. In Europe, we think there are efficiency opportunities at some of our mills like Lanaken and Kirkniemi. Importantly on this side, we've got our group procurement initiatives underway.
We've talked about this already, but we want to realize at least $100 million. Of that $100 million, $13 million was realized in the current year. That takes us to slide 20, which just reinforces the point that I just made. In addition to the $13 million of the $100 million that we've realized, we do have ongoing continuous improvement initiatives. If you look at all the good work that we've done over the course of the last few years, you'll see that we continually improve our efficiencies and our cost base. Of the $100 million, we think we can get another $50 million in 2017, and that will offset the lower graphic paper prices that we talked about earlier. Our focus areas, look, it's across the board. It's all our raw materials and on the freight side as well. On slide 21, rationalizing our declining businesses.
I've said it many times, we are pragmatic about where our coated graphic paper is going, and we try to anticipate demand. We continue to look for opportunities to convert some of our capacity towards specialty grades, like what we did at the Alfeld mill a couple of years ago. That's ongoing work as we move through the year. On slide 22, moderate investments. We think that there's opportunities in South Africa to boost our packaging businesses further. In Ngodwana and Tugela, there's some electricity opportunities, and I've already talked about the debottlenecking. We continue to look for opportunities to expand on the specialty front. Obviously, we're mindful of the two times net debt target that we've set ourself. We'll always use that as a guiding principle, and we will not overstretch this balance sheet. Moving to slide 23, the balance sheet.
We've done tremendous work at improving the balance sheet. Debt will come down further in the course of the new year. As I said earlier, we've got the 2017 bonds that are maturing, and we'll repay that with cash. Accelerating adjacent businesses from a strong base on slide 24. In addition to the specialties that I talked about, we do think there are opportunities with lignins and sugars, the nanocellulose pilot plant that we've got. We've got a sugars pilot plant at Ngodwana. We've set a little bit of capital aside to look at these opportunities. Turning to our outlook, which is on slide 26. Dissolving pulp markets continue to be strong, albeit that they have come off a little bit in the last couple of weeks. They are significantly higher than they were a few months ago.
Demand for graphic paper has been weak. However, we've been able to offset that through good work done on costs, and that's allowing us to maintain margins. Taking all of that into account, and exchange rates, clearly the rand is stronger now than it was a year ago at this time. That does put a little negative pressure on our numbers. At these levels, we expect the 2017 EBITDA to be in line with the good performance that we achieved in 2016. CapEx is $ 350 million that I talked about. I've already mentioned the bonds. Operator, I'm going to turn it back to you then for questions.
Thank you, Mr. Binnie. At this time, if you would like to ask a question, please press star then one. If you decide to withdraw your question, you can press star then two to remove yourself from the list. To ask a question, please press star then one. Our first question is from Roger Spitz of Bank of America Merrill Lynch. Please go ahead.
Hi. Thank you. Good afternoon. Should we interpret the EBITDA guidance for 2017 as an improvement in dissolving wood pulp EBITDA being generally equally offset in a rough manner with the decline in the graphic paper EBITDA?
Yes. Marginally so. With the costs that we're taking out of the business on the graphic paper side, we are able to offset the lower selling prices. There's a marginal shift. We've been pretty realistic about our expectations for the year. From a capacity point of view, there's no additional capacity coming on board. Overall, it's only a marginal shift.
What you're saying is that actually the guidance for both DWP and graphic paper will each be like they were respectively in 2016. It's not that there's a shift between them. They're both going to be roughly in line with 2016, is what you're saying, I think.
Yeah. Look, if you look at where markets are currently, dissolving pulp prices are higher, that's being offset by a weaker rand. Sorry, a stronger rand.
Okay.
With the rand that, I think at the moment, what's it? About ZAR 13.50, ZAR 13.60. We had a weaker rand during the course of 2016.
Got it. Do you see within graphic paper any shift between the U.S. and Europe in terms of EBITDA there from 2017 to 2016?
Not a significant shift. Clearly imports do come in from Europe into the U.S. market, we're not anticipating a dramatic shift in terms of our contributions, no.
Got it. You've been talking in the past about making a greater shift towards some of the specialized cellulose grades. I know you're already in there to some extent, at least that's my understanding, it sounded like you were going to do a bigger push. Would that come post this currently debottlenecking, or would it come when you were talking about adding more significant capacity in the future? What might be the timing of that shift?
Yeah. What we're doing at the moment is we're evaluating all the machines in the group that currently make coated paper. We're evaluating whether it would make sense for them to perhaps switch their capacity towards specialties. It's work in progress at the moment, and we'll be able to give further updates as we move during the course of the year. In terms of timing, if it is something that we choose to pursue, it would occur late 2017 and into 2018.
Thank you very much.
Thank you. Our next question is from Brian Morgan of RMB Morgan Stanley. Please go ahead.
Hi, guys. Thanks very much. Just you make the comment about capacity that needs to come out, particularly coated mechanical capacity that needs to come out in Europe. When do you think it'll become critical that type of capacity is removed? Are we six months away from a point where the industry is forced to take capacity out?
Look, based on our numbers, we look at ourselves, and based on where we're at at the moment, the mills are still cash positive, so it doesn't make sense for us to take capacity out. As I said in my answer to the last question, we're evaluating the machines and seeing whether there's an opportunity to convert one of them to specialties. That's likely to be the immediate answer. We're not looking to close a mill or a machine at this stage.
Yeah. During the course of 2017, you'd look to do a conversion?
We would look to commence one perhaps.
Yeah. Okay, perfect.
Yeah.
In terms of your net debt, are you expecting to remain below two times for every quarter, every reporting quarter?
That would be our target at this stage, yes.
Okay.
Clearly, Brian, just to be clear, going forward, that is our guiding principle. Obviously, three or four years down the track, if we were to make a larger investment in dissolving pulp, you may temporarily go above that, but it wouldn't be by much. That would be our guiding principle as we allocate our capital and control our CapEx.
Okay, perfect. Thank you very much.
Thank you. Our next question is from James Hutchison of Barclays. Please go ahead.
Hi, good afternoon, gents, congrats on another solid quarter, I think more importantly, for getting yourselves in a position to be able to reinstate the dividend today. A couple of questions from my side, please. Just firstly, on the dividend, how should we think about that going forward? Have you decided on a policy in terms of payout ratio or cover corridor? I got a couple of other questions, so maybe just take them one at a time.
Yeah. Our policy will be to go to three times. The dividend we declared today was five times covered. It will be three times. Obviously, at the end of this financial year, we'll make a call whether when is the right time to get it to three, Our longer-term goal is to get it to three.
Great. Thanks. Just secondly on, I'd like to get your views on dissolving pulp prices beyond the first quarter guidance you've given. Clearly, part of the current strength is down to stable supply and demand dynamics, Some of the other supportive pillars, as you mentioned, constrained cotton linter pulp supply, associated cost care supports with that, high viscose staple fiber prices seem fairly short-term or at least sort of short duration. How do you see dissolving pulp prices developing into the second quarter and then into the back end of 2017?
Yeah. Look, as you know, the bulk of our business is on contractual basis, and the prices are set with reference to the previous quarter's average prices for CCF. We're halfway through this quarter, which will be the reference point for our pricing for Q2. We're fairly confident of obviously Q1 and Q2 prices. As we get to the back half of the year, look, prices have spiked considerably in the last couple of months. Sure they've come back in the last two or three weeks, but they're still significantly higher than they were a few months ago. We're reasonably confident that prices in the second half of the year can be relatively strong compared to what we've seen in 2016 and 2015.
Okay, thanks. Just the last question is just around your dissolving wood pulp production at Cloquet. Just given that you're less concerned around the drought situation in KwaZulu, have you started scaling back production in dissolving wood pulp production in North America?
Roughly we're two-thirds, one-third at Cloquet, two-thirds being dissolving pulp. Clearly, when we had the drought situation at Saiccor, we made a little bit more at Cloquet. Based on the current economics, it is favorable to make dissolving pulp at Cloquet, so we are maintaining those volumes. However, we have to evaluate the situation as we move through the rest of the financial year. We're still making kraft paper, but dissolving pulp volumes are a little higher.
Okay, great. Thank you very much.
Thank you. Our next question is from Lars Kjellberg of Credit Suisse. Please go ahead.
Yeah, thank you. I just want to come back to Europe a bit. If you look on the specialty paper offering, that seems to be doing very well. Can you give us any sense of how big a share of volume that is in Europe? More specifically, what sort of activities you are engaged in, i.e., in which niches, if you like?
Yeah. Okay. I'll start with the answer, then I'm going to hand over to you, Berry. In terms of volumes, it's around about overall about 300,000 tons that we are in specialties. That's something that clearly we want to grow as we move forward. As I said in the presentation, it was up 15% for the year. It's primarily at the Alfeld mill, but at some of the other mills, we're making a little bit of specialties. To my point earlier, we are looking at all our machines as we move forward. Berry, do you want to expand a little bit further on the different grades?
Sure, Steve. There are three big businesses really that we are involved with. One of them is flex pack. This is lightweight, coated but one side packaging going into such areas as soup pouches and banderoles and yogurt lidding, and these sorts of things. Then there is the release liner, which goes into such things as if you've got decorations on police cars and things like that or on planes, then it tends to get applied through release paper technology. The third big area is the board, so the SPB SBS board, which goes into cosmetics, very, very high-quality packaging.
In that particular market, there seems to be a bit of a squeeze coming in, not so much maybe on SBS side, but generally on high-quality paperboard. Are you seeing any of that, and how competitive would you be in that business?
In the quality area that we operate with, there are very, very few players, and that market is growing. We find we're growing with it. We do not find that there is a particularly hostile competition at this time. You never know what the future brings, but it is quite different from the sort of the rather larger Folding Box Board area, which I agree with you, is getting a bit crowded.
Very good. Just finally, how much money or interest cost savings would you save if you cash in the $400 million bond, just to clarify?
The $400 million bonds come at a coupon rate of 7.725%. Yeah, we'll be cashing that in. You can work it out from there.
Very good. Thank you.
Thank you. Our next question is from Slakanipo Mwabe of Bank of America Merrill Lynch. Please go ahead.
Hi, guys. Can you hear me?
Yes.
Hi, this is actually David, his colleague, but anyway. Steve, perhaps you can just talk about your current supply agreements in DWP, in particular, one of your larger customers in Austria. It seems that there's an increasing focus there on backward integration, which would make sense given where market prices are. I mean, it doesn't necessarily sound like this would be limited to new capacity. My question to you is, do you see any risks to your current contracts there? Say there was some risk there, would you be comfortable that you could place these volumes elsewhere in the global market?
Yeah. Look, the contracts we've signed are long-term contracts that will see us through the next four or five years. We've already locked that up. In terms of the customer that you're specifically referring to, yes, they do talk about backward integration, but they do have very aggressive growth plans. If you do the math, the possibility of backward integration really applies to the incremental volumes. Having said that, it's not that they're necessarily looking to build their own pulp plants. What they mean is that they're referring to strategic alliances as well. That's a possibility. It's ongoing discussions that we have with them. In terms of the risk, all I can say is that we're fully sold out, and we continue to be fully sold out. In fact, we can't make enough of the products.
We have other customers out there that are looking for additional volumes from Sappi, and clearly, we've locked up a significant proportion of our volumes on long-term contracts. We do think there are opportunities to place additional volumes with other customers.
Okay, great.
Okay. Yeah.
Great. No, that answers my question. Just lastly, what is the actual CapEx number allocated to the debottlenecking in DWP in the forthcoming year? Lastly, can you perhaps tell us how much of EBITDA comes from specialty paper?
On the second one, it's not something we disclose yet, but it could be something that we'll disclose further in the future as we expand the business. In terms of the CapEx for the debottlenecking, it's about $100 million.
Thanks.
Thank you. Our next question is from Ian Gazard of Blue Mountain. Please go ahead.
Yeah. Thanks for taking my question. I just had a question on the rand. We're seeing a little bit more optimism in commodity markets. The rand has come up a little bit. How are you positioned if the rand strengthens a lot, and have you considered hedging?
Look, the Rand is volatile, as you indicated. Long term, to try and hedge the Rand is extremely difficult. What we've got to focus on is the things that we can control, and it's to make sure that we are among the lowest cost producers. Typically, our big competitors are also in emerging market economies, and their currencies go with the Rand. We can only focus on what we can control, and that's to make sure that our costs are low and that we're efficient in the manufacturing of dissolving pulp.
Okay, thank you. That makes sense. Just to follow up is on input costs, are you seeing any trends there? Some of the players here in North America are talking about higher input costs. What are you guys seeing?
I'll let Mark expand further, clearly, the pulp prices have been low over the course of the last few months, and they're still relatively low. There's been a little bit of an upward tick, which pushes costs up. They are lower than they were this time last year. On the wood side, Mark, I'll let you expand further, wood prices have been coming down further.
Yes, Steve. Thanks. Yeah. In North America, our wood baskets, where we're located in Minnesota and Maine, we have seen over the last year with the work that we've been doing and just the demand on those baskets and the good weather that's finally been in place for extended periods, the wood costs have come down fairly significant from where they were a year ago. Looking forward, the work we're doing, we think the wood costs will stay fairly flat or possibly could even go down further.
Okay, great. Thank you very much.
Thank you. Ladies and gentlemen, a reminder to ask a question, please press star then one. Our next question is from Joan Sehim of Spread Research. Please go ahead.
Hi. Thanks for taking my question. You say that specialty paper volumes were up 50%, whereas market average is 1%-5%. How do you explain this outperformance? Also, would you be interested in M&A to penetrate the specialty market?
I didn't hear you entirely, but I think what you were asking was that, considering that volumes in the markets have been up 1%-5%, would we consider M&A? I think what's important is that we've reached our debt targets, and yes, that does provide us with more flexibility as we move forward. I would refer you to the point that I raised earlier, and that's that we would always use that net debt to EBITDA of two times as a guiding principle. We would never overstretch this balance sheet. Yeah, there might be smaller opportunities out there, but as I say, we wouldn't overstretch the balance sheet.
Okay. Thank you.
Thank you. Our next question is from Lars Kjellberg of Credit Suisse. Please go ahead.
Yeah, just a quick follow-up. Steve, you mentioned that the dissolving wood pulp prices had eased off a bit. Could you give us an sense by how much?
It's not by much, Lars. It's about $20 in the last couple of weeks, but I think they were as high as Gary, correct me. I think they went as high as $980, $990. Gary?
Steve, that's correct, about $980, as you say, dropped off about $15-$20 in the last couple of weeks.
You can see, Lars, it's significantly higher than what we saw during the course of 2016 financial year.
For sure. Absolutely. Can you share what you've sort of put into your forecast in terms of trajectory in pulp prices, in those prices going forward?
We had assumed it was relatively flat during the course of the year relative to where we had come from. It was about $850-$860.
Okay. For your assumption, your guidance, you're assuming a relatively flat average price for dissolving wood pulp through 2017.
Yeah. Look, Lars, just to be more specific, clearly we know what our Q1 prices are.
Yep
We've got a feel already for what Q2 may be. Then, as I say, for the rest of the year, we had assumed it at $850 beyond that.
Understood. Very clear. Thank you.
Thank you. Mr. Binnie, there are no further questions. Would you like to make some closing comments?
Thanks, operator. I just wanna thank everybody for joining us on the call, and we look forward to updating you on our results at the end of Q1. Thank you very much.
Thank you. On behalf of Sappi Limited, that concludes today's call. Thank you for joining us. You may now disconnect your lines.