Good day, ladies and gentlemen, and welcome to the Sappi Third Quarter 2016 Results Conference. 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 0. Please also note that this call is being recorded. I would now like to turn the conference over to Mr. Stephen. Please go ahead, sir.
Thank you. Hi, everyone. I'm joined on the call today by a number of my colleagues. I'll call out the page number of our investor presentation as I move through the deck. I'm going to start on slide four, which has some of the key highlights for the quarter. EBITDA, excluding special items, of $160 million. That's compared to $109 million last year, showing nice growth. Bottom line net profit up from $4 million to $32 million. Earnings per share similarly up from $0.02 to $0.11. Pleasantly, our net debt continues to come down with $334 million below last year and reached $1,583 million by the end of the quarter. That's the lowest it's been for many years. Moving to slide five, some of the key ratios for us. Our net debt to EBITDA has shown significant improvement.
We're now at 2.2 compared to 3.1 last year. That's getting very close to our target that we've set ourselves of 2 times. Interest cover continues to improve and EBITDA margins up substantially from 8.6% last year to 13.1% this year. Our return on capital employed, we've communicated our target to you guys, and that's 13%, and I'm pleased to say that we were above that at 14%. In terms of our EBITDA bridge, which is on slide six, you can see the key factors contributing to the growth. Just to highlight a few, firstly, volumes are down relative to last year. It's important to point out that we did sell Enstra and Cape Kraft earlier in the financial year, so we don't have those volumes.
Obviously, graphic paper in North America and Europe have been under a little bit of pressure, and that's resulted in some lower volume, and there were some timing differences on the dissolving pulp volumes. We saw favorable price and mix, higher selling prices for our South African business and our dissolving pulp, and also a mix improvement flowing through from the higher contribution being made by Specialties as that business continues to grow. Throughout the financial year and into this quarter, we've been able to take out variable costs, and you can see we achieved a significant benefit in this quarter contributing to the growth. The other thing at play was the exchange rates, and clearly the weaker ZAR has helped boost our profitability. Moving to slide seven, the contribution split between specialised cellulose and paper.
You can see that from operating profit on the right-hand side, specialised cellulose makes better margins and has a higher contribution of profit. When it comes to EBITDA, it's roughly half/half. Our paper business continues to be important, and it continues to generate cash for us to invest in other areas of the business. Moving to slide eight, the evolution of our net debt to EBITDA, and this is a very nice slide. It tells a good story. You can see that we've been continuously coming down over the last few years, and we would expect that trend to continue gently into the next quarter and beyond. Looked at in a slightly different way on slide nine, you can see the cumulative cash flow.
We've started it at October 2012, and we did that for a reason, because we wanted to show the negative impact of the investments that we made at Ngodwana and Cloquet for dissolving pulp. But you can see that since then, there's been a dramatic cash generation. From the trough up to where we are today, that's nearly $1 billion of cash that we've generated over the last three years and really reinforces our ability to generate cash. Slide 10 has a maturity profile for our debt. Following all the good work that's been done, we've been able to push out a number of our maturities in 2022, 2023, and obviously beyond.
The next thing that we have to tackle is the 2017 bonds that mature, and the anticipation is that we will be able to repay those with the cash generation in the business in 2017. On slide 11, the CapEx. Again, you can see the investments that we made in dissolving pulp 2013. Since then, we've strived to keep our CapEx at $300 million or below. This year is the same. We expect the year to end about $240 million, which means that the last quarter, we've got quite a bit of investment this quarter, but it should be about $100 million, giving us the $240 million for the full year. Turning to the divisions and just to put the global markets in context. Firstly, on global paper, it's fair to say that recent months in the U.S. and in Europe have been tough for graphic paper.
We have seen demand coming under pressure, and we have seen pricing pressure as well. That's something that's probably going to continue as we move forward. Fortunately, we've been able to take out substantial costs out of our business to offset the impact of those market forces. Yes, market conditions have helped us in terms of lower commodity prices, but we have been, through a number of initiatives in the business, being able to benefit the costs and, through good work on the procurement side, reduce our variable costs. If we turn to slide 14, let's set Europe first. I'm pleased to say that the margins continue to improve there. We have seen, despite all the difficult market conditions, we've been able to grow our profitability quite nicely year on year.
The specialty business had a very good quarter, up 15%, and those are in markets that are growing between 1% and 5% in the various categories. That's something that we will continue to do and try and expand as we move forward. As I said earlier, all the good work done on costs has enabled us to offset the negative impact from market selling prices. In North America, similarly, we have seen demand and prices coming under pressure. Again, we've been able to take costs out, and once again, grow the profits relative to last year. Dissolving pulp has been good, and we'll talk about that a little bit more on the next slide. On the Release paper side, it's doing okay, but the Chinese market continues to be tough there. The other positive aspect of our results is, again, on the specialty side.
We started expanding our C1S last year, and we've seen very nice year-over-year growth there. That's an opportunity as we move forward. Moving to slide 16, the Specialised cellulose market. Overall, it's been better than we had expected and certainly better than when we last discussed the market three months ago. Demand has been good, and pricing has benefited, not just for Dissolving pulp, but a high correlation with the improvement that we've seen in Cotton and VSF prices. Clearly, in this period where the dollar has been relatively strong, any of the non-U.S. dollar producers have benefited. Our strategy here continues to be to maintain low-cost position, we do think there are growth opportunities as we move forward. This is a market that is increasing, and we want to preserve our position.
We continue to work with our customers to support common growth strategies. In South Africa on slide 17, in addition to the Dissolving pulp, our packaging business margins continue to get better. Despite the timing of shuts and all that, it was another good quarter for us. We were able to get better selling prices, which offset the impact of the weaker exchange rate on our raw material cost. Overall, we're doing well there once again. Turning to the strategy slide, I'm going to jump to slide 19. We have the five pillars which we've talked about in the past, again, just to focus on the key drivers. Firstly, on cost advantages.
It's something that we have worked on, I think we see evidence of all the good work that we've been doing, we still think there are opportunities as we move forward. Some of the projects are listed. We've got new turbines going in at Saiccor and Tugela, which will improve our cost base. We had the boiler upgrade earlier this year in Ngodwana. Yesterday, we announced an investment in a Somerset woodyard improvement, that will give us nice cost improvements as we move forward. We did talk last quarter about our global procurement initiatives, we said that we wanted to get at least $100 million per annum savings, we're on track to being able to achieve that over the next couple of years. A lot of good work being done there. In terms of rationalizing our declining businesses.
This is really being realistic about our traditional graphic paper business. Strengthening where we have good core assets in graphic paper, where we do have cost advantages, and we'll continue to invest at those mills and strengthen there. At the same time, other assets which are maybe less competitive, we need to look at opportunities to deploy those into other grades on the specialty front, which are growing and can generate higher returns for us as we move forward. In the short term, and I'm on slide 21, in the short term, we continue to focus on cash, but at the same time we have to grow the business, and we've been making moderate investments. We do think there's further opportunities to grow packaging in South Africa, specifically Ngodwana and Tugela, and we do have electricity opportunities down in South Africa.
Pleasingly, on the dissolving pulp side, both at Saiccor and in Ngodwana, we think we can boost our production through some smaller projects. Those combined hopefully will give us another 100,000 tons over the next year and a half. At the same time, globally, we are looking at opportunities to boost our specialty packaging. I mentioned that on the last slide. We have seen that we've been successful there, and we will continue to grow further. On slide 22, focusing on the balance sheet now. We obviously sold Enstra and Cape Kraft earlier this year, it generated cash for us. The next big milestone I talked about earlier is the 2017 bonds, which are $400 million, which we can call in April, and that will be the last of our, what we would regard as our more expensive debt.
It's about 7.75%, and compare that to the recent bond issues that we've done at about 4%. This will be the last of the more expensive ones and certainly will put us in a much stronger position as we move forward once those are gone. On slide 23, we turn to the longer term, and clearly as our balance sheet continues to improve and we strengthen our position, we need to start thinking about the future opportunities. I've talked about some of these, but we do think that the specialty packaging can grow further. It makes margins in the low teens, and they are in growing segments, and we think we have the skill set to be able to take advantage of that.
On the dissolving pulp side, beyond the debottlenecking opportunities in South Africa we have in the short term that I talked about, we need to start thinking about longer term and future growth investments there as that market continues to grow. At the same time, we've established this biomaterials business, and we think there are opportunities in lignins and sugars, and we had some announcements in recent quarters about demo plants that we've established, and we do believe that that will be a revenue source as we move forward. Turning to our outlook, to move to slide 25. Overall, dissolving pulp remains positive. As I said, it's in a better place than when we last spoke, so we're feeling pretty good about that. The drought conditions remain a risk factor for us.
The good news is that we've had excellent rainfall over the last couple of weeks, and the river levels have risen, and they're higher than they were a year ago. It always remains a risk, but hopefully this will see us through until the summer rainfalls come. Things are certainly a lot better than they were a couple of weeks ago. The graphic paper markets, I've talked about a few times, are weaker, but all the good work that we're putting in on the cost side is allowing us to maintain margins. Q4 is a better quarter for us traditionally, and orders so far have been robust and looking good. The implications of Brexit are still being evaluated. There will be lots of long-term effects of what has unfolded.
In the short term, specifically to our U.K. sales, if you convert those GBP sales back into EUR, we estimate the impact is about EUR 25 million per annum. We're looking at ways to compensate for that, and that may entail pushing up our prices. That's something we're working on, and we will be taking actions very soon there. Based on our current market conditions and assuming current exchange rates, we expect that EBITDA for Q4 will be in line of the same quarter last year. I do point out that last year's Q4 was a very good quarter for us. The CapEx, as I said, $100 million. Again, focusing on maintenance and efficiency projects. We expect to reduce debt further.
We'll certainly go below $1.5 billion by the end of the year, and hopefully we'll be very close to that two times target by the end of the year. Yeah. That's the slides in the investor deck. Operator, I'm going to put it back to you then for question.
Thank you very much, sir. Ladies and gentlemen, at this time, if you do wish to ask a question, please press star and then one on your 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. Our first question is from [Nishal Ramdall] of UBS. Please go ahead.
Hi. Yes. Good day, everyone. Just two things from my side. I mean, paper market's clearly weak and probably weaker than you anticipated. Is that accelerating any plans you've got for your own mills, in terms of conversions and closures? Just the second thing is, maybe can you just give us some color on dissolving pulp? I mean, what's keeping the prices so strong, particularly considering the weak paper pulp prices?
Yep. Okay. On the first one, in terms of the paper market. Yes. I mean, as I said earlier, we continue to look at all our mills and all the machines and what's the best use of those assets. There are certainly a number of our machines and mills which are very competitive, and we will continue to invest in those mills. However, there are other machines that maybe are less competitive. What we've been doing both in Europe and in the U.S. is looking at these and seeing whether we can reallocate some of that production towards specialty grades. We've been doing that already. I'll give you some examples. We've been doing it at Ehingen. We've been at Maastricht in Europe. We've been doing it at Somerset in the U.S. We'll continue to look for those opportunities.
It may entail in some time that we may do something similar to what we did at Alfeld PM2 two years ago. There may be investments going forward, and those would be investments that would give us very attractive paybacks and will allow us to strengthen our position in specialties. On the dissolving pulp, I'll let Gary expand further, but look, there's a number of factors at play. The underlying demand for viscose has been good. There has been some inventory build-ups by the viscose producers as well. That's benefited us. Another factor that's contributed to the growth is that the competing products, cotton, polyester, the demand for all of those has been pretty good. Year to date, dissolving pulp demand is up 8% this year, so it's performing better than We've got forecasts of around 4% or 5%, and pleasingly it's up 8% this year.
It's certainly in a good position there. Gary, is there any other items you want to add to that?
No, Steve, I think you've touched on the key issues. As you say, the cotton market, it's about some dynamics in it and it has created quite a good demand on VSF and [F4] market dissolving pulp. Also on cotton linters in the marketplace, the supply of cotton linters is a bit under pressure. As you said, the demand is still there and we're getting full requests from all our customers.
Thanks, Gary. Okay, Nishal.
Yeah, no, thank you for that.
Thank you very much. Our next question is from David Roux of Merrill Lynch. Please go ahead.
Hi. Good afternoon, guys. Just three questions from my side. The first question is just on one of your main customers, Lenzing. They've been quite vocal on announcing some expansion plans for their sort of specialty fibers as well as own pulp. I'd just like to get your sense of whether you see this as a risk or more of an opportunity. The second question is on group CapEx. Just for the fourth quarter, that $100 million in CapEx, if you can just perhaps give us a split of allocation by region. Lastly, if you can just give us an update on your thoughts around a dividend and possibly reinstating it. Thanks.
On the first question about Lenzing, clearly we can't speak specifically about a specific customer. More broadly, what I would say is that our customers are talking about growth potential, clearly we have strong relationships with these guys, and we believe that through those strong relationships that we will be able to boost our capacity as we move forward and to benefit from the growth potential that is there. As I said earlier, we think the market is growing at around 4% and 5%. We think we can, through these debottlenecking opportunities in South Africa specifically, we'll add 100,000 in the next 18 months. Beyond that, there will be a further dissolving pulp investment. We would not commit to such a large investment if we weren't confident that we will be able to sell that product.
We do think overall, it's favorable for us moving forward. The CapEx by region, I don't have that in front of us. I don't think we go into that specific detail. Just to summarize, it's obviously in the short term focused on the efficiency projects and maintenance projects. We did announce yesterday the investment of the Somerset woodyard. That's part of the investment in the last quarter. In South Africa, we're starting work on these de-bottlenecking opportunities at Saiccor and Ngodwana. We've got the turbines at Ngodwana and, sorry, at Tugela and Saiccor as well. It's spread over, David. The dividend, we've been public before. We said we don't want to commit to a dividend until we get below the two times EBITDA, we've got to be confident that we can maintain it at those levels.
Clearly we're getting very close to those levels. We need to take a look at the end of this financial year and make a decision based on that. We wouldn't commit to a dividend until we're confident that we can keep it below two times EBITDA. It is getting very close.
Thank you.
Thank you. Our next question is from Sean Ungerer of Arqaam Capital. Please go ahead.
Good afternoon, Steve. Just two questions. In terms of the bonds in 2017, just to confirm what you were saying earlier. Am I understanding you're going to repay that from operating cash flow, so you're not going to raise any new debt to sort of replace that by any means? Then just secondly, in terms of procurement benefits, obviously we've seen quite a bit come through already. Sorry, the line sort of blanked out earlier, so I couldn't hear if that was related to the $100 million. I just want to get a bit of clarity as to how much more we can sort of see play out. Thanks.
Yes. The answer to the first question is we would use our own cash flows to repay those bonds next year. There is no plans to issue a new bond. Then on the procurement, the savings that we've targeted, that $100 million, those are not in our numbers so far. Those would be additional benefits over 2017 and 2018.
Cool. Thanks.
Thank you. Ladies and gentlemen, a reminder, if you wish to ask a question, please press star and then one. Our next question is from Brian Morgan of RMB Morgan Stanley. Please go ahead.
Hi, guys. Apologies if you've spoken about this already. I missed the first part of the call. In terms of the $100 million that Sean spoke about, have you achieved any of that yet? That's the first question.
No. That's what I was saying. The savings that we've achieved so far are not included in the $100 million target. These are further initiatives where we believe we can achieve them over, some of it will come in 2017 and the balance into 2018, so it will be over the next two years. It will add up to $100 million per annum, at least.
All right. None of it's been achieved yet, huh?
Correct.
Okay. The second question is just on the balance sheet. Cash generated in South Africa can be used to offset European and U.S. debts. Am I right?
We have ZAR 2 billion per annum, isn't it? Yes, that's right.
ZAR 2 billion per annum. Okay.
Yes.
Perfect. I'd just like to understand how clear and present the threat is at [Glart] at Saiccor. Are you just giving us a broad risk here, or is it something that you're particularly concerned about?
Look, when we drafted this thing two weeks ago before the rainfalls, we were concerned about it. It's still a risk. However, the rainfalls we've had over the last two weeks have resulted in the river flows being much higher than they were a year ago. Clearly, those levels could go down, but it probably bought us time, certainly to get us through the next month or two. It still remains a risk factor, and if the dry conditions resume ahead of the summer rains, then that could put at risk. As we stand today, we're fine.
Okay, perfect. That's great. Thank you.
Thank you. Our next question is from James Hutchison of Barcap. Please go ahead.
Hi. Good afternoon, gentlemen. Three questions from my side, please. Firstly, in terms of the contribution of specialty grades to European profitability, I know it's not something you've given historically, but Steve, you have highlighted a number of times in your discussion as being a highlight this quarter in particular, and volumes up 15%. It would just be really helpful for us to get a sense of what the base is and how material that is. The second question is just coming back to dissolving pulp. Do you have a sense of how much dissolving pulp capacity is due to come on in the second half of this year and into next year? The final question is just in terms of the typical working capital movements over the fourth quarter.
Can you just remind us typically what happens in terms of your working capital in or outflows over the fourth quarter in a given year? Thank you.
Yeah. On the specialty side, it's not something we specifically disclose as of yet. Overall, in terms of our EBITDA contribution across the group, it's between 10% and 15%. That should give you a rough size.
Yeah.
That's something that we would want to go as we move forward. DWP expansions, I don't think there's any new specific ones coming on board. There have been ones over the last few quarters. We've had Jari, we've had Sun Paper coming into the market. Gary, do you have any others coming in the second half of the year?
I think 2017, you've covered most of them, Stephen. 2018, there's some additional capacity that has been announced in the public domain, I think you've touched on next year.
If you look over the next 18 months, we are seeing demand growing at a faster place than supply. There are some big projects being looked at for 2018.
Thank you.
Glen, do you want to just chat about working capital in the last quarter?
In terms of working capital, our last quarter is the quarter that we have the lowest working capital over the year. We usually see inflows between about $30 million and $50 million.
Great. Thanks, Glen.
Thank you. Ladies and gentlemen, a final reminder. If you wish to ask a question, please press star and then one. Our next question is from Riccardo Ottaviani of Ares. Please go ahead.
Hi there. I just have a quick question. You mentioned that your exposure to Brexit would result in roughly €25 million per annum impact. Was that on the EBITDA number?
Yes, that's right. That's just a simple currency translation on our-
Yeah
GBP sales.
Sure. I have another question.
No, before we just leave that, but clearly-
Sure
We need to figure out ways to compensate for that, and then that could involve price adjustment.
Understood. Yeah, my other question was, so your stated leverage target is up two times. Do you also have a target in terms of becoming investment grade or that's not one of your targets?
Look, it's not specifically one of our targets to be at investment grade. Clearly, as our financial position continues to improve, our credit ratings should also improve. I think they should be better than where they are now, but that's my view.
All right.
it's not a target in itself, no.
Understood. My final question is, I think I read in your presentation that you had a timing effect in relation to some maintenance shutdown in the U.S. What is the EBITDA impact of this maintenance, like this timing effect?
Yeah, I'll pass you to Mark. We had the Cloquet shut this quarter, including the lime kiln, Mark. Maybe you just want to expand a little bit further there.
Yes, sure, Steve. Thank you. Yes. We do our annual pulp mill maintenance outage in this past quarter at Cloquet every year. That's the same as every year in the past. On top of that, this year, we also had a lime kiln, a major project to rebuild and upgrade the lime kiln at Cloquet. That went on. One other thing that was a little bit different this past quarter than prior years, we took a cold outage at our Westbrook mill. We had really three events, all maintenance related or maintenance/upgrade in terms of the lime kiln.
Understood. Is there an EBITDA number that you think, do you have an estimate of what the impact was on EBITDA for this timing effect?
We typically see about a $7 million-$8 million expense on our annual outage at Cloquet.
Okay. Yeah.
That's pretty typical. The lime kiln and the Westbrook outage would add a little bit more cost to it this year versus prior years.
Understood. Thank you very much.
Thank you. Our next question is from Brian Nunes of Gramercy. Please go ahead.
Hi. Good morning, Steve. Could you just tell us when your next ratings reviews are with S&P and Moody's?
I'll let Glen expand further. We were recently moved to a positive outlook by Moody's, weren't we, Glen? You maybe just want to talk.
Oh, we speak to our rating agencies on a quarterly basis. They indicated that into next year, next calendar year, they'll be reviewing our status.
That's both of them, right?
Yes. Both S&P and Moody's.
Sorry, which time next year? This time next year or?
No, early in first half of next year. Financial year.
Got it. Thank you.
Thank you very much. Ladies and gentlemen, a final reminder, if you wish to ask a question, please press star and then one.
Operator, if that's everything, I'd like to thank everybody for joining us on the call this afternoon, and I look forward to discussing the business with you again at the end of the financial year. Thank you very much.
Thank you very much, sir. Ladies and gentlemen, that concludes this conference. Thank you for joining us. You may now disconnect your lines.