Domtar Corporation (NYSE:UFS)
2013 Goldman Sachs Paper, Forest Products and Packaging Conference
March 14, 2013 8:45 am ET
Daniel Buron - Chief Financial Officer, Principal Accounting Officer and Senior Vice President
Carly Mattson - Goldman Sachs Group Inc., Research Division
Carly Mattson - Goldman Sachs Group Inc., Research Division
All right. For those of you who don't know me, I'm the investment-grade paper and packaging analyst here at Goldman. I'm Carly Mattson. And next up, we have Domtar and Daniel Buron, the CFO. So we'll turn the time over to him.
So good morning. Welcome to Montréal. Hope you're enjoying the city. I know the weather is not great, but I hope you're enjoying the city. It's always a pleasure to present at probably the only conference we're making in Montréal, and since our head office is actually a few streets from here, it's very convenient for us.
I won't spend a lot of time on that first slide. I think you've seen it often enough, but I'm going to likely make some forward-looking statements. And obviously, forward-looking statements are subject to risks that, if you want to have a description of those, you can consult our filing with the SEC.
Who are we? Domtar is a leading innovative fiber-based technology company that design, manufacture and market a wide variety of fiber-based products. Actually, the foundation of our business is a very strong, world-class wood-converting asset for which -- from which we do a combination of steam power and pulp. And the pulp is, in large part, consumed internally in our paper manufacturing process and also, to a lesser extent but growing, in our AI or Personal Care business.
We're the largest manufacturer of uncoated freesheet in North America and one of the largest globally, too. And we have, as I just mentioned, a small but exciting and growing Personal Care business.
At a glance, Domtar is a $5.5 billion company. Paper represents around 80% of that. We have a small distribution business. It's actually still a traditional paper merchant, growing a little bit in the packaging side of the business and the digital and wide-format side of the business, but mainly traditional, so it's actually selling mostly uncoated and coated paper. And we have our Personal Care segment that started in -- 18 months ago in September 2011 with the acquisition of Attends in the U.S.
The Personal Care segment represents more or less 7% of our sales in 2012. Actually, if you look at the fourth quarter run rate, it's more 8% of our business. We've delivered $800 million of EBITDA last year and a free cash flow of $315 million.
Our business is divided into 3 segments: the Papers segment, the Distribution segment and the Personal Care segment. Paper is in turn divided into 2 businesses. One is Pulp, the foundation of the business. And the other business is actually the biggest segment we have, the Paper business.
I have still a few words on each. At Pulp, we produce more or less 4.3 million tons of pulp per year, a combination of hardwood, softwood and fluff. We consume most of it internally, most of it in our Paper business; a portion of it, fluff, in our Personal Care business; and the rest, our long position is actually sold in the market.
We have, more or less, depending on market conditions and trade we're doing for logistic reasons and species reasons, we have more or less the ability to sell 1.6 million tons of pulp per year. And the lion's share of that is softwood. The second specie is fluff. Fluff is a subcategory of softwood. And we have a very small position in hardwood. Most of our pulp is sold offshore, a bit here in Canada and another significant portion in the U.S.
On the Paper side, as I've mentioned, 3.4 million ton capacity, largest marketer and manufacturer of uncoated freesheet in North America. We have 2 uncoated freesheet mills, and this is supported by converting facilities inside and outside our location. Most of our paper is sold in North America, U.S. being the primary market, a little bit in Canada, and we also export a portion of our production.
Paper is actually divided into 2 groups: Communication paper and Specialty and packaging paper. So Communication paper is the one that were -- and we all know is declining average about 3%, 4% per year, if you look at the last 10 years. And that's I think a good forecast for the next few years. And Packaging is actually growing at more or less GDP. We grew last year more than that, in part because of our deal with Appleton. So thank you for that. So that's more or less at a glance our Paper segment, so Pulp and Paper.
Our Distribution, as I mentioned, traditional merchant business, 23 (sic)  locations. Its very original distribution business. We're Eastern Canada and Midwest Eastern in the U.S. It's actually a good route for our own paper. They sell -- and their volume, more or less 30% of what they sell in the market is actually Domtar paper and the rest, 70%, is coming from many, many different suppliers. Obviously, we're their prime supplier of uncoated freesheet, and they buy a little bit outside of Domtar, and they buy coated, obviously, because we're not producing that.
Personal Care segment, 3 locations. The first acquisition was a mill in Greenville, North Carolina. 9 lines of production. That was in September 2011. Early in 2012, we've added the sister company, actually Attends Europe. That is producing with 8 lines of production. And we've also made a smaller acquisition, it's more an R&D arm. Actually, it's very interesting because it's R&D arm with a P&L that's actually funding itself, its R&D. But it's an airlaid business and has a very interesting technology in the business.
So we're mostly branded, mostly institutional sales, with a small presence in the retail business. And given the value of the brand and the quality of Attends' name, I think we have opportunity to grow not only in the traditional market they're servicing but also in the retail side of the business.
Few words on the Paper side of our business. Actually, the Paper business, not the segment. Uncoated freesheet, it's important to note, is used in many, many applications and many, many different end users. So over the years, I had to answer very often the question, "Why should we see you differently than the newsprint?" I think just the statement I made in terms of multiple applications, multiple end users is the answer to that. Yes, there's a portion of the applications that are declining. There's some that are growing. And for those that are declining, some are declining at a rate that you can compare to newsprint, but most of them are declining at a lower pace than that. And on average, if you do a weighted average of that, this is more or less a 3% to 4% decline that we've seen over the last decade and that we expect to see in the coming few years ahead of us.
Interesting point, the pink portion of the graph at the top of the chart represents the recession that we had to go through in 2008 and 2009. So even in that very, very tough market environment, uncoated freesheet ended up, I believe, to be the most stable commodity on Earth. So that's, I think, a sign that there's stability in this market, and we believe that stability is there to stay. It's not stable to a point there is no increase, no decrease, no -- the price is moving up or down, but in steps that are significantly lower than the past, reducing the volatility of our earnings.
And if you look at our performance versus our peers on the graph at the bottom of the page, we've consistently outperformed our peers. And I think you -- to add a little bit to that, I mean, we have, compared to some of our peers, we do have specialty mills that are yes, high cost but also selling at a high price. So if you look at the pure margin as a percentage, it's a little bit lower. So our average is penalized a little bit by that mix. But even with that small penalty that actually we like that business, we're still overall a good leader in terms of margin in our business.
A few words on Pulp. Pulp is a global market. It's totally different than the uncoated freesheet. We're a relatively small player. We're probably #10 in NBSK. We're probably #3 or #4, #3 in fluff, but we're far, far in the hardwood side of the business. So it's a real global market. This is not a place where we can dictate anything or we can have a real influence on production capacity or pricing.
So we have decided, in 2010, that we're going to focus our business -- or we're going to work on the 2 things that actually matters, that we actually control in that business. The first one is let's stick to species we like, so the type of wood that we like, that we believe have the best run rate for the future. So we've picked softwood. Obviously, if you look at what happened and what's going to happen in hardwood, not that price is not good, but in terms of cost structure, the South American with the eucalyptus tree's unbeatable in terms of costs. So competing on the market, I mean, it's not the same thing to have an integrated mill where you consume your own hardwood, but if you're actually trying to sell that pulp in the market, difficult to be competitive in North America.
So we've made the decision to focus our portfolio to softwood, so we sold our only hardwood pulp mill or full-market pulp mill, Woodland, in 2010. And we've also converted a former hardwood mill that was producing uncoated freesheet, Plymouth, to fluff. Actually, another sign of leadership: we've done that and, unfortunately, been followed by 2 other major producers in terms of conversion. But that showed we were ahead of the curve there.
The other thing that you can actually control is your customer mix in that market. So you're trying -- price is price, so you will not influence price, but you can actually make sure that you won't have -- you won't lose volume, or volume won't disappear and reappear and disappear again, so that you'll have to [indiscernible] the market and try to find volume in the black market. So let's make sure that you associate yourself with customers that have a very consistent demand. So we've spent a lot of time working to improve our customer mix, so we're now a lot more around the tissue business and the specialty side of the business with more stable customers. So align yourself with winning customers was our strategy, and I think we've seen the benefit over the last few years.
A few words on market. Pulp prices are increasing as we speak, a price increase announced that should start April 1. The big question I'm always having with investors is, "What's the catalyst in that business? What's going to happen to pulp?" Because even if we're a paper business, the volatile part of our business is actually pulp. So it's difficult to see pulp price to go up fast, but our indication is we're heading in the right direction, and we should have the benefit of the April price increase and many more after.
A few words on our Personal Care business. That is a big part of our next chapter as a business. This is the extension that we're -- or this is the mean we're using to change the business profile of Domtar from pulp and paper, pulp volatile, paper declining, to a business that will be more stable in terms of earnings and also growing overall.
So currently, the 3 businesses -- 2 businesses that we bought, the 2 Attends businesses, are pure play in AI. But who knows where we're going to land in terms of other parts, especially doing baby diapers or fem pro business. But right now, we're in AI, and you have on that slide a little bit of the reason why we've invested in that business.
It's a market that is growing at 6% to 7% per year globally, growing in the countries or the regions that we've invested at 4% or 5%, growing very fast from a very low level in Asia. We're not in Asia yet, but that's something that we'll assess in due course.
We're currently investing in that business. We bought those businesses late 2011, early 2012. We have a plan to double the EBITDA of those businesses, and a portion of that doubling will come with a little bit of CapEx.
Try to illustrate how we're going to look like in 2, 3 years for the earning profile of that business. So Distribution, more or less stable. The Personal Care business, we believe, will grow significantly. A portion of that is already in the works. That's the acquisition we've made that we're going to double. So we've committed to the market that within 5 years, we want to have $500 million of EBITDA that will come from new businesses and new businesses that are in growing markets.
So right now, we have done those 3 acquisitions, so more or less $75 million of EBITDA run rate that will double over the next 4, 5 years. That's $150 million. The rest of that will need to come from further acquisitions.
So that's the Personal Care segment, that's going to grow. And our commitment is also to work very hard in our Pulp and Paper business to reduce volatility and to do -- to create a more stable earning pattern and to use our assets the best we can. And that means repurposing assets if we have to.
And we've done 2 so far -- in fact, more than 2, 3. I'm going to just by memory list those. The first one was the conversion of Dryden into pulp -- into softwood pulp mill, probably 4, 5 years ago. The second one was the conversion of Plymouth to a fluff pulp mill, and the third one is actually the conversion of our Marlboro Mill to a specialty and packaging mill. That's actually happening as we speak. It's a transition that started last year, but a big portion of the investment in terms of CapEx was made in January in 2013.
It's always interesting to step back and look at where we're from and where we're heading. So it's always impressive, I think, when we look at what we've done over the last 4, 5 years. I mean, the first thing that comes to mind is we all went through that recession in 2008, 2009 and happy we're here and still alive. Not all companies in our sector can claim the same.
We've sold our hardwood pulp mill, as I mentioned earlier. We sold our wood business. We've converted Plymouth. We've sold a lot of other non-core assets, raising $250-some million. We've converted Marlboro. We've made the acquisition of Attends U.S. We've made the acquisition of Attends in Europe. We've made the acquisition of EAM Corporation. We had that deal, win-win deal with Appleton. And we've also invested in 3 early ventures that hopefully will bring a new revenue stream for us in the future. That's CelluForce, that's the LignoBoost in Plymouth and also another technology with Battelle in our Dryden facility. So if you look at Domtar, the traditional uncoated freesheet business 4, 5 years ago, and Domtar today, I think we're already very different than we were then.
But what do we need to do in the coming few years? We need to grow our Personal Care business. We need to deliver on our commitment to double the EBITDA of that business. But that's not enough. I mean, we'll need to grow further than that. And again, as I mentioned earlier, you can expect M&A. Obviously, it's always subject to availability and price, but given the ownership structure in that market, it's very unlikely that we won't be able to find something that will make sense for us at a price that will make sense for us and will -- that we won't be able to deliver our commitment to bring $500 million of EBITDA from growing businesses in that time frame.
The other thing we need to do is we need to continue to run very, very hard our uncoated freesheet and pulp assets. They are, as we speak, the cash flow machine in the business, and we need to make sure that we're keeping that as long as we can.
And at the same time, we need to look at -- demand is actually declining. We've mentioned that. We all know that. As demand is declining, we need to find creative ideas to use our assets. The Appleton deal that we just referred to, and I'm sure you've heard about earlier, is one example of that. The conversion of Plymouth to fluff is another one, but we'll need to find more of that, because we do have great assets that are converting our fiber into pulp. And the more we can use that pulp to do a second transformation and create value for our shareholders with that basal assets that is great, I think the more cash and the more value we can create. So that's the challenge in our pulp and paper business.
And as we grow our distribution business, we need to continue to grow that business outside of its traditional uncoated freesheet, coated freesheet market. We need to grow packaging. We need to grow digital. We need to grow wide format. I mean, the issue with that business is that market shrank. There's a kind of fixed cost -- a minimum fixed cost in that business, so if you're not selling something else using your infrastructure, obviously, it's a difficult business. So we're investing time and effort, not money, to grow in other adjacent businesses.
A little bit on our financials. We've been -- we will be a strong free cash flow business, and we have, as we speak, a very efficient -- or a very low leverage as a business. Our goal is to bring back the balance sheet through acquisition and deployment of that capital in our growing business, to bring that balance sheet closer to a normal leverage within the next 24 to 36 months. So we've done a couple of small acquisitions. We will do more. We'll use that capital, and we'll make sure that it's actually working to create value to our shareholders.
What's our capital allocation? Again there, I think it's interesting to come back to where we're from and where we're heading. You may recall that we did the merger -- or we bought the Weyerhaeuser fine paper business in 2007. We ended up in that transaction with a highly-leveraged business. 2008 recession showed us that it was not a good position to be in, so we decided -- actually in 2007, but the recession was just a sign that, that was the right decision -- we decided to reduce that as the only use of cash for a period of time.
Arriving at the end of 2010, a little bit helped by the fuel tax credit in the U.S., we felt that we had the balance sheet we needed to be able to grow the business and deploy our strategic plan. And we then started a small dividend and also a buyback program. At the end of 2010, we've mentioned, we've committed to the market that we'll return to our shareholders the majority of our free cash flow, and this is what we've done since then.
So we bought, since the inception of the buyback, close to $700 million of shares. That's 8.7% of our -- 8.7 million shares. That's 14%, 15% of our outstanding stock. Last year, we've returned, in the form of dividends, stock buyback, around 68% of our free cash flow, so we're very happy of what we've done in terms of value and returning the cash that actually belongs to our shareholders to our shareholders.
In summary, I think good pulp assets, a very interesting Paper business that is delivering a lot of cash, a growing Personal Care business, acquisition in the horizon. So execution will be key, and we've proven in the past that we can make those decisions, we can deliver, we can be quick and sensible, so we'll continue to do that.
That's the end of my presentation. I'm willing to entertain any questions you may have.
[indiscernible] import pressure and [indiscernible]...
Uncoated freesheet, we see -- well, if you look at -- there's the short-term answer and there's the long-term answer. Let me try to give you a little bit of both. Historically, imports have been rather limited in the uncoated freesheet. We've seen a little bit more action over the last 12 months. Actually, we've seen more import, but we've seen more export. If you look at the stats last year, overall, it's a better position for the North American producer because there was a little bit more import but more export, and we're kind of more than offsetting the imports. But yes, price, if you look at global price, uncoated freesheet in North America is probably a good place for some producer. But don't forget that the supply chain to sell uncoated freesheet is complex. The buyers are very sophisticated, so if you commit to a country, if you don't want to be in and out, you have to be there for the good price, the good currency environment and the bad also one. As we're doing in our export strategy, we're exporting 4% of our production, mostly in Europe, a little bit in Asia, and we've been there in good and very bad currency environments and in good and very bad pricing environments. So we're-- if you look at the detail of the statistics in terms of imports in the U.S., you see a lot of hope. There's a month of increases in the country, and then they disappear the month after. So for me, this is noise that's going to, over time, disappear. If you see -- actually, the only exception to that general comment is Portugal, where part of their strategy, Portucel, when they've invested in 2 new machines was to ship a portion, a fixed portion of their capacity to the U.S. And they've been here in good and very bad pricing and currency environments. Actually, I had the opportunity, I think it was in 2004, to look at that business when the Portuguese government was trying to sell its share of Portucel. And I can tell you that at that time, and I'm suspecting this is probably not very different today, they were not making money doing that, but they were protecting their local market. So Portucel is the exception. I think they are here to stay and they have kind of a very loyal and fixed amount of funds that are lending in the U.S. and will lend for the year to come. The rest, I think it's more opportunistic that's going to disappear as soon as the wind is turning. For this reason, I think our -- I won't say low, but I think they are in very good shape. I mean, I can't speak for our inventory, actually. As we speak right now, if you recall in our earnings call in Q4, we've mentioned that we've increased a little bit inventory as we actually normally do in December or November, December timeframe. Since then, our inventory are lower than they were. So we're a little bit tight in inventory. So I cannot comment for others, but I have difficulty to believe that Domtar would be tight and others would have a different or a radically different situation. Yes?
[indiscernible] wood dynamics [indiscernible]...
Okay. The question is on pulp and the market. My first answer is it's a very difficult market to predict short term. So I know I'll be wrong if I'm trying to predict what can happen until the end of the year. If you look at long term, the first comment I would make is there's a risk of -- or at the margin, there's a little bit of substitution between hardwood and softwood in the market depending on pricing. At a certain price gap, some producers will try to add a little bit more hardwood in their mix. But they're going to suffer very quickly from quality. And we've seen that when dissolving pulp was very high. Dissolving producers were actually using a little bit of softwood, and they suffered, and they're going to be hesitant to do it next time. So substitution is, I think, relatively limited between hardwood and softwood. So if you look at -- demand is growing. It's growing 2%, 3% per year. Obviously, in the current kind of a tasteless economic environment, we just don't know where it's going to go. And a lot of people are on the sideline waiting to see a direction. That growth might not be a trend as we speak right now. So demand long term, I think 2% to 3%. Supply side, there's 2 pieces of news that are adding capacity. One is Russia, 500,000 tons, and the other one is Terrace Bay that is having a little bit of capacity. It's a temporary addition, because their goal is to go to dissolving. That's owned by an Indian corporation. On the flip side, there are some softwood conversions to dissolving that are actually happening. I think it's going to be absorbed -- that additional capacity will be absorbed in the market. I think it's going to be this year, and then after that will be back to more or less a balanced supply and demand situation. The unknown is what can happen with producers that -- like us, to be honest, I mean, we're doing that. We've converted hardwood assets into softwood assets over the last few years. So what's going to happen on this side of the equation, that is almost impossible to know. But if you look at where that can happen, it's Northern U.S., Canada and Northern Europe. And it's rather limited opportunity. So there's always that risk of maybe someone will stop producing whatever they produce and they're going to just dry that pulp and will have to cope with a little bit more capacity. But you need to have the drying capacity. You need to have the cost structure to be able to do that. So I think the risk is relatively limited. Our long-term view, and I'm not talking in years ago, I think within -- before the end of the year, I think we'll see some traction in the softwood market, and depending on economic conditions, it's going to be either fast or a slower recovery.
Price increases. It's always easier to talk about price increase after the fact. That price increase is before April 1. My personal bet is you're going to see it in the bottom line of the business. A lot of companies are linked to pulp prices still -- or pulp deals are often linked to RISI pricing, so it's probably going to be half in April, half in May. But I think it's very likely you're going to see that price increase in the businesses. But again, I'll prefer to give you more color at our earnings call because it's going to be behind us and easy to comment. Yes?
That's a very good -- I mean, very interesting. We can have a -- we could have a very long debate on that. We've said that we want that the business in just one big acquisition. So the comment we've made, and we're going to stick to that, is $1 billion to $1.5 billion is kind of the max. There's 2 schools of thought on that. You can do a big transaction that is actually bringing you where you'd like to be. But if you look at what's available, if you look at what other businesses that try to transform themselves over time, the road to success there is to make the right acquisition with the right partner at the right time and build a very strong corporation versus doing a big acquisition. And then you end up with a lot of pluses but also a lot of minuses. Our goal is to do -- to partner with leaders in the Personal Care business. And if you exclude the big guys, those that are branded, the K-C, the SCA, there's no big deal. There's no big corporation. So I think it's going to be -- we're going to reduce the risk of our M&A strategy by doing kind of midsized type of transaction. The one we've done so far I would characterize as probably a little bit small. So you might see bigger than that, but you won't be -- you won't see a huge transaction.
Okay. Let's -- the goal of the business is -- we have this foundation of assets that is the pulp that I referred to, and we need to use the advantage that we have that to convert that pulp into something else. It has to grow also. So if you look at what's growing and what's also consuming pulp, you have packaging, you have tissue, and you have Personal Care. So we're in Personal Care, and we don't want to be the jack-of-all-trades in our line. So our focus will be just definitely the Personal Care segment of the business. But if something happens that makes a lot of sense for us in the packaging or the tissue side of the business, we won't disregard that just because we're aiming to a Personal Care position globally. So it may, at some point, make sense to do something on the tissue side or the packaging side of the business. We've been quite vocal that we felt, rightly or wrongly, that the tissue side of the business -- there's a lot of capacity addition right now in the U.S. We'll need to see some closure. Otherwise, margin pressure will be there. So we felt that it was not maybe the right thing for us to spend a lot of time looking at that. Packaging 2 years ago was more or less in the same situation, or 3 years ago. Tough, tough market. Packaging right now, after the few acquisitions or the few consolidations that happened over the last few years, is definitely a better market than it used to be, so that's something that, who knows? But our clear focus is the Personal Care side of the business.
[indiscernible] investment grade [indiscernible]
I always felt that committing to a credit rating is not adding a lot of value for our business. I think what we need to commit to is we'll be wise and we'll be financially responsible. What it means for me is you have to have credit statistics that will be close to investment-grade land. So you can translate that in whatever you want. But access to capital is key, and you need to be either very close or you need to be investment-grade to have access to capital at almost all times. So our view is, let's be financially responsible. If you need to leverage for a period of time, you need to deleverage quickly thereafter, and you want to be in investment-grade land. In terms of credit, that's taking whatever the decision of the credit agency will be.
I wonder if you can just comment on the [indiscernible] soft year-over-year and [indiscernible]
I think I like your question because you're saying it's just one month. It's very difficult to comment on specific one month. If you look at the last few months, it's been a little bit tougher than it was over the last 2 years. If you look at actually over the last 2 years, demand was more or less flat. And in our case, 2011, I think we actually grew a little bit in terms of volume. 2012, we've declined a little bit. I think we're going to revert back to our long-term assessment of the market that a decline of 3% to 4% is probably what you should bet in the market for the foreseeable future. And we had 2 good years, so maybe we're going to have a bad year this year. My sense is I don't know -- I mean, you're all business persons, so you have your own views. But my sense when I'm meeting with customers or suppliers is a lot of people are on the sideline. They just don't know which direction the economy will take. And until we can resolve that, you're going to have a market that is doing a little bit more -- a market that is standing still versus a market that is actually moving and investing. And I mean -- so it's all linked together. So for me, it can change very quickly. I think it's not positive statistics that we've seen, but nothing to be alarmed. I think we need a little bit more of energy in the economy, and we're going to come back to more normal demand trends. Other questions? Thank you very much.
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