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Sappi Limited (NYSEMKT:SPP)

Q2 2011 Earnings Call

May 09, 2011 9:00 am ET

Executives

Roeloff Boëttgerr - Chief Executive Officer and Executive Director

Berend Wiersum - Chief Executive Officer of Sappi Fine Paper Europe

Analysts

Myles Allsop - UBS Investment Bank

Lars Kjellberg - Crédit Suisse AG

Unknown Analyst -

Caroline Learmonth - Macquarie Research

Question-and-Answer Session

Myles Allsop - UBS Investment Bank

Okay. And then just going back one of the first questions around the dividend. Do you need to see net debt below $2 billion to think about paying a dividend? Or would you launch into starting a dividend if you see confidence in the outlook and so on before you get to $2 billion net debt level?

Roeloff Boëttgerr

Yes, I wouldn’t link it to only the $2 billion debt level. I think that will have to do. I am confident that we are with the cash generation going forward. We are getting more and more confident on the results and the outlook on it. All in all, as I tried to be alluded to was that we're getting closer to putting a figure on the dividend will be at the end of this year. We will have to foresee what the remainder of the financial year looks like.

Myles Allsop - UBS Investment Bank

Okay. Maybe one very last question. On the Asian coated paper expansion because we are obviously seeing a lot of capacity being added so it doesn't really get felt in the market. It's in see what's happening with editions in Asia on the coated paper side.

Roeloff Boëttgerr

Berend, you’re a specialist and look at it everyday. Would you like to look at this one?

Berend Wiersum

Well, obviously, the imports into Europe from China have been curtailed by the passing of the provisional antidumping measures. As you may know, there was a report that we see this morning that the Council of Ministers has approved antidumping and anti-subsidy duties covering sheets and cutter reel for sheets into Europe. We do see that there is a net major new capacity from South Korea in the shape of [indiscernible]. And we expect that to be certainly some of that will be coming into Europe but in recent history, it's been the case that Korean prices also have been reasonable based on the fact that they have to pay for their own assets. So I wouldn't expect there to be a tremendous change. I do notice that there might much more active, all of them, in what we call our export markets. So in terms of South America and some of the peripheral European countries and certainly also in the Far East. Then of course, there's a major expansion by Asian producers in those markets.

Roeloff Boëttgerr

I think it's safe to say that they had a lot of closures beginning there as well happening as well based on environmental conditions. So we hear all about the big new additions but we hear not so much always about the large number of smaller closures.

Berend Wiersum

Yes, and in addition, we hear that the Chinese market has been growing quite substantially. So it's fair to agree that new capacity is being used in China or in Asia.

Myles Allsop - UBS Investment Bank

Okay. So you're not so worried at the moment about it. It feels okay.

Berend Wiersum

That feels okay, yes.

Operator

[Operator Instructions]

Roeloff Boëttgerr

Well, thank you, and I think people have always the opportunity to contact Berend or myself or anybody else to ask the questions once you’ve had time to look at the results in more detail.

Operator

Thank you, sir. We have no further questions from the audience.

Roeloff Boëttgerr

Thank you very much from all of us at Sappi. I appreciate it.

Operator

Ladies and gentlemen, [indiscernible]. Thank you for dialing in. You may now disconnect your lines.

Operator

Ladies and gentlemen, good afternoon, and welcome to the Sappi Limited Second Quarter Results for the Year 2011 Conference Call. [Operator Instructions] Please note that this conference call is being recorded as well. At this point in time, I'd now like to hand the call over to Sappi's CEO, Roeloff Boëttgerr. Thank you, and over to you, sir.

Roeloff Boëttgerr

Thank you very much. A very good morning, and good afternoon to you ladies and gentlemen, and thank you for dialing in to our results presentation call. If I may draw your attention to the forward-looking statements and the Regulation G requirements on Slide #2.

We can then move on to the summary on Slide #4 with some of the highlights. Earnings per share, excluding special items of $0.09 for the quarter, up from a loss of $0.03 the previous quarter. And the operating profit, excluding special items, up $227 million, up from $54 million. However, our results were impacted by $128 million charge, which includes the envisaged -- or cost of the envisaged closure of our Biberist mill. And half of those costs will be noncash, and the other half will be cash items.

We have seen good demand for the majority of our products throughout the quarter. Our input costs continue to increase. Cash generation was strong, with a $222 million operating cash generation and a net cash generation of $100 million during the quarter.

On Slide #5, important that all the arrows point to the right direction there. Turnover quarter-over-quarter and half-year on half-year on an annual basis, up 16%. EBITDA, also up very strongly both on half yearly and quarterly basis. And the adjusted earnings per share, $0.19 for the half year and $0.09 for the quarter. All the ratios also going in the right direction.

On Slide #6, we're dealing with the operating profit excluding special items, and I think 2 issues that I would like to point out here, and that first is that we're continuing this positive trend of improved results. And if one looks at quarter 2 and quarter one, it's important to point out that quarter one had additional week. And if you equalize the number of weeks and the 2 quarters' results were actually on top.

Moving on to Slide #7. The EBITDA trend, same issue, yet a very positive trend of EBITDA development also during the quarter.

On Slide 8. We're dealing with the earnings versus the prior quarter, but more importantly, also with the special items. Although we ended up with an adjusted earnings per share of $0.10 positively impacted by special items from the previous quarter, in this particular quarter, the adjusted EPS is $0.09 but the unadjusted at $0.14 loss, mainly as a result of the restructuring provisions. The asset impairment of $0.12 noncash and the restructuring $0.12 will be cash, mostly related to the envisaged Biberist mill closure, which I'll come to later on again.

For our divisional overviews. Moving now on to Slide #10. You see that our European margins during the quarter remained below for a number of reasons, mainly because of increased input costs and at the same time increase in selling prices. Our North American business, returning to the healthy margins. In fact, previous quarter's lower margin was as a result of the shut of the Somerset Mill for the recovery boiler upgrade, and we expect to normal now.

Our Southern African business, margin is down to large extent for technical reasons ensured the quarter, and also have to do with some shipments from Saiccor Royal and additional shipment in the previous quarter and one less the current the quarter and led by low return and less turnover of the fixed cost. But margin is still on a reasonable basis there. We hope to improve that shortly.

Moving on to Slide 11. Looking at Europe in particular. Healthy increase in volumes. Sales up 19% quarter-on-quarter, both as a result of volumes as well as price increases. And we've had a weaker price realization for coated wood-free paper, mainly as a result of the dollar-based exports, and they're sitting with a very strong Europe. But we did have to -- we had to deal with cost inflation for wood, pulp, energy and chemicals, which are quite significant during the quarter. We've embarked on achieving more than $100 million per annum cost savings in our European business. Half of that will come from the envisaged closure of the Biberist mill and the other half from a range of measures dealing with very fixed and variable cost that emerged to it coming from variable cost. And the benefit of that, we expect to start seeing coming through from our fourth quarter onwards. We are actually confident that we will achieve that.

Moving on to Slide #12. Our North American business. Again, volumes and price, up quarter-on-quarter to recovering quarter the previous year, but costs up also quite significantly. Our volumes and prices led to a 9% increase in surface, with raised coated paper prices during the quarter. But we did have some seasonal weakness in demand. In spite that, however, our operating rate is very high during the quarter, reaching a healthy demand for our pulp and specialty papers and sales pricing indeed. And as we export some of these, and most of it in effect with a weaker dollar that's being to our advantage.

The Somerset recovery boiler upgrade for which we took a shut during the first quarter turned out to be a great success in terms of its reliability costs, as well as output increases.

Moving onto Sappi Southern Africa. The 2 main businesses here are Paper and Paper Packaging business, tough, recently tough period for us and that the strong brand negatively affects pricing and also improve volumes, affects negatively our volumes as a result of imports competing. So challenging market from that business. Higher volume for chemical cellulose business, a very strong demand for mill, and cycle operated and performed extremely well, very lively. Price is also up. Costs were starting to rise, and our margins could have been better and slightly strong against the dollar. But despite that, that business is now performing really well, and we hope to also do good for the business.

We'll then move on to an update on our strategy, where we are with and what we're planning to do. As we said before, there are a number of pillars related to our third-year leg. Our third point is to maintain and optimize the performance of our good performing businesses. Starting with North American in this regard, we need to continue to focus on cost reduction, and we will continue to actively manage our customer and product mix of all 3 businesses, pulp, paper and the specialties.

Chemical cellulose. Demand remains very strong for this business. Benchmark prices continue to raise. As I mentioned before, production were also good and that we need to keep them at that high level and also reduce our costs. And we've mentioned that we're accelerating our expansion plans in terms of chemical cellulose.

The second leg of our third year relates to the improvement of those businesses that are not yet performing at the level where we are satisfied with it. And our most important business in this category is Sappi Fine Paper Europe, a large business there. We are making progress. We're confident that we're now getting through issues or very close to a stage where this business will turn around and really strong performance. We need to manage capacity efficiently, and we've always said that. And we've now proven with this envisaged closure that we're compelled to act further and that will take out a big capacity in upon the envisaged closure. We need to get through the price increases on this business, with those input costs are continuing to rise, and that goes to coated mechanical as well coated fine paper. And we're confident we will beat those price increases.

As I mentioned, $100 million of annual cost savings, $30 million or more from that envisaged closure and $50 million and more from a combination of fixed and variable costs. The majority of that will be variable, and it’s in our control. We know what to with the plans we're making, and we will start implementing on that. The same is to Pulp Paper and Paper Packaging business in South Africa where we have to match our assets to our resources and the market and need to take out further costs. As we envisaged -- or not envisaged but decided increase and output of chemical cellulose would also help us to further get effect to those debts.

Moving to the third leg of strategy, which is to invest in growth businesses and higher-margin businesses. The first action here is the chemical cellulose expansion, which has been approved now that will act to a 210,000 tons of chemical cellulose production. It will be low-cost production in the lowest quartile, and this is based mainly on wood to energy and the process that we'll be following to get the production up and running. And once we respond to customer needs in the varying market and we hope to start production in the first quarter of 2013.

Other business had been growing, and that's growing well for us. The specialty businesses both in North America and Europe, North America Release business. Plus we are hoping also to bring to market new products in the not-too-distant future, higher margin businesses in first grade markets. Our Packaging business in Europe, performing well with opportunities to further improve and grow those businesses. Forestry will remain a very important part of our South African business. We will continue to seek, and in fact, we are successful in getting opportunities to further expand and to improve our yields very importantly, because that is not capital-intensive.

We're also looking at a number of possible energy projects at generating to lower our cost, to make us more self-sufficient and to improve our environmental footprint. Somerset is a good example of a very good project here, and we will update you as we go along in terms of the expansion.

Moving onto the final leg of the strategy, which is management of our balance sheet, cash generation, and cost of living. On slide 18, here the trend is still over continuing reduction in debt. The debt go up. At the end of our first quarter, we mentioned that, that was mainly as a result of growth in capital and movements, but also weak dollar and strong year end, which on conversion of our end and year-to-date results in a higher dollar number. But we started bringing it down again, it's $2.4 billion, which sets us up below $2 billion of net debt by 2012. We made a good progress in that regard. And depending on currency movement, we might even achieve that by the end of this financial year. But equally important, to actuate debt level and perhaps more important is our ability to serve the debt and the cost of the debt. And we're working hard to bring down the cost of debt. Our ability to service the debt, no problem, as we're strongly generating cash, and we've been able to refinance.

If we move over the Slide 19. Very successfully just like to quarter end where we raised $705 million in euro and in dollar costs at 6.625%. Banks continue our maturity profile. They’ll expect a clearing of all the major maturities up until 2014. And those that we still have almost at year end, related to regional and foresee any problems to refinance and renew those. The next step change that we are looking forward to make in terms of bringing down the cost of finance will be when we take care of the 2014 maturities. And we hope to start dealing with that towards the end of 2012 and beginning in 2013, and that will have a very meaningful impact on the cost of our debt going forward.

Obviously, working capital management and [indiscernible] capital management will form a part of this. I need to mention that if one looks at our extension at a good one, and our plans to grow our businesses despite that, we're still committed to bring down our debt, and we do not foresee any major spike in debt increase about these projects.

Moving then onto Slide #21 in the outlook. We expect business conditions in our major markets to remain favorable, but at the same time, input costs to continue to increase. The benefits of the actions that we’re taking in Europe, we're expecting to achieve it in our results as from the first quarter.

Our third quarter, however, is a result of a combination of it being historically a weaker quarter and affected through our planned outages and 5 of our pulp mills that are included in the product cycle built a stop set and record will have a negative effect in terms of cost and lost production during that period. However, if one looks at the year, we believe that this improving trend of operating profit excluding special items will continue its positive trend for our financial year, and our third quarter results to be around somewhere the results as we had in the previous year during the same quarter date and mark that the outages, the cost of outages, planned outages will be higher during this quarter, which in fact brings me to the end of the presentation. We supplied you with a number of supplementary slides. And I, together with a number of our colleagues in Europe and North America, we're quite happy to take any questions that you might have. Thank you very much.

Operator

[Operator Instructions] Our first question comes from Caroline Learmonth of [indiscernible] Capital.

Caroline Learmonth - Macquarie Research

Two questions. First of all, on cost savings in Europe. And you've identified a number of $50 million plus $50 million. Can you give any more detail or anymore indications of what types of savings are within those total numbers? And then the second question is on the potential for the year-end dividend this year. If we understand it correctly, there are some restrictions on dividend payments in terms of your debt arrangements. But subject to those and subject to strong cash generation versus perhaps some of these cash cost of restructuring, what can you say on the outlook for dividends this year?

Roeloff Boëttgerr

Thank you, Caroline. In terms of the cost savings, the $50 million and $50 million that we set ourselves, those are minimums. And we hope that it will be higher. And $50 million result was the envisaged closure of Biberist. On the balance, it's a mixture of fixed and variable costs, and most of that will be variable. We're not disclosing it for competitive reasons, obviously, what we have in mind here might, I think, suffice to say that on the variable costs and maybe you can add if you want to here. And it would be not only in terms of what we pay for input costs, but certainly also will have to do a lot with the usage of those variable costs. And that, again, can be certain to improve efficiencies. And secondly in different ways of making our product to take costs out of it without affecting the quality and printability and attributes of our products. And Berend, would you like to add to that before I answer the next one?

Berend Wiersum

No, I had nothing to add, Roeloff.

Roeloff Boëttgerr

If we then move on to your question about dividends. At this point in time I do not think that it is totally ruled out, the possibility of a dividend. We made it very clear before that when we start paying dividends, we want to make sure the dividends will be reliable, sustainable and of meaningful number as well. And that if at anything, there will be an increasing trend or the decreasing thing. We're watching this space carefully. And in fact, if one looks at looks at the performance our business, it is continuously improving, so we're getting closer to a time where we can pay dividends. I would not like at this point in time to guide whether there will be a dividend or not at year end.

Operator

[Operator Instructions] Our next question comes from Myles Allsop from UBS.

Myles Allsop - UBS Investment Bank

Just first of all, on the dissolving pulp market. Could you give us a sense of what's happened to prices just recently? I mean, we're seeing cotton prices coming down, is that starting to have an impact on the dissolving pulp market?

Roeloff Boëttgerr

There is not yet perhaps a little bit of profit, but as you know, if you look at our contract pricing that leads to in this kind of premium. And you know that India is close to being really strongly. And even in the spot markets, prices remain high on the back of good demand. Alex, anything you want to add to it?

Alex Thiel

No, I think that's fine. Despite the ends, we can deliver[indiscernible]

Myles Allsop - UBS Investment Bank

Okay. Just on this expansion. How concerned, I mean, when you look at the number of projects out there and dissolving pulp globally. I mean, we're talking about where it's 50% capacity growth over the next 3 years. How concerned are you that this is a temporary kind of spike in demand because of cost rather than kind of structural sort of change in the mix of fiber consumption?

Roeloff Boëttgerr

I think a very good question yet albeit one that we can spend a lot of time on before we decided to invest and come back to this expansion. Demand growth is expected to continue quite strongly on low fundamentals. Our decision and what's happening is not driven by cotton in the short term. We think it's long term certainly. The availability of increased cotton production will be favorable for chemical cellulose. And yes, there's a number of talked-about, announced and rumored capacity expansions. Some of that will happen. Others in our opinion will not happen. What is to us crucial is that we are, if not lowest cost producer, then very close to the lowest cost producer of chemical cellulose in the world. And whatever production we have, have to match that. And as in all commodity businesses, if you’re not the lowest cost producer in the cycle there will be periods where it can be painful. We certainly are confident that what we bring to market will be first quartile or lowest quartile in terms of cost of production. And also very importantly, in terms of cost return capital investment will be very competitive. So we are confident about the market. But yes, we take note of all the other factors as well. We think -- perhaps one last issue to add here, as you know of proportion of our volumes are contracted to very long-standing customers, and that will be the case in our future expansions as well.

Myles Allsop - UBS Investment Bank

And can you give us a sense of CapEx, your guidance of the group in 2012 and '13 and '11?

Roeloff Boëttgerr

Our maintenance CapEx is about $150 million, between that and $200 million as we go and throughout the year. We don't expect that to expand rapidly. It will be in that range of between $150 million and $200 million. It moves from time to time exactly, more or less. And then added to that are the normal de-bottlenecking and improvement CapEx that we spend. And as you know then this recently announced expansion at Ngodwana. So we're not guiding specifically here, but I think perhaps easier to [indiscernible] we're saying hopefully it will be helpful. But we're not expecting albeit to really increase significantly the start of these additional projects. Most of it will be funded through operating cash flows.

Operator

Our next question comes from Phil Woods [ph] from JPMorgan.

Unknown Analyst -

So I just want to dive into the release paper investment a little bit more. Is this on an existing machine or a new machine? How much capacity do you think about adding there?

Roeloff Boëttgerr

At this point in time, I think they're about investing for added capacity. Mark, would you like to add to that? We are growing our business as it is, and we have ample capacity to further expand. This is a highly specialized market and it's not only about volume. Mark?

Mark Gardner

Yes, thank you, Roeloff. Our release business is based out of our Westford, Maine plant. And that plant does have additional capacity, even working for quite a few months to expand into other markets where that technology may have application. And we're pretty optimistic about some of the opportunities we see there. We do already have in place installed capacities take up the more demand that we're seeing. We're seeing strong demand in our traditional release businesses or from around the world. And we're looking forward to potentially some very strong demand in new markets that we're looking at.

Unknown Analyst -

How much capacity do you have there today on release paper?

Mark Gardner

The total capacity is approximately 25,000 to 30,000 tons.

Roeloff Boëttgerr

And that we are expecting that if we go to double shifts and all that -- we have an ability this year to spike nicely without furthering the investment.

Unknown Analyst -

Got you. And how do you think about the growth rate in that business?

Roeloff Boëttgerr

It is high. And it is potentially very high if we are successful with some of the things we're working on. We are, at this point in time, hesitant to give any further info and that we think we are to perhaps something special.

Operator

Our next question comes from Lars Kjellberg from Crédit Suisse.

Lars Kjellberg - Crédit Suisse AG

A couple of questions. You talked about capital efficiency, I think, in Ngodwana. Can you please tell us roughly what you're going to spend? And also exactly what you're doing at the mill. Are you just continuing any other operations there? I just want to talk, ask you about maintenance costs. Clearly, that there's lumpy pattern into this. Is there any particular this year? And if so, what are the maintenance costs do you expect to have this year? And what would you see as the normal maintenance cost? And I have a couple of couple of questions, but if you start there.

Roeloff Boëttgerr

We're not just disclosing CapEx unfortunately that we're spending on. Alex, perhaps you just want to enlighten us on what the move on pulp following this expansion.

Alex Thiel

Yes. Essentially, we will not produce a market pulp, but we will produce chemical cellulose. And that will be the 210,000 as higher than the amount of market pulp that we produce at the moment. We will also expand the production capacity on across liner board. And while top line that we currently producing there will be shifting to some of our other strategies. That really in a nutshell covers it.

Roeloff Boëttgerr

And we'll continue to produce pulp to use in most manufacturing. In terms of maintenance cost, just repeat what exactly you're asking.

Lars Kjellberg - Crédit Suisse AG

You're talking obviously a very big chunk on maintenance costs...

Roeloff Boëttgerr

Yes. What we've guided, yes we have the [indiscernible]. We've had shuts at a quarter year ago as well, but this would be more expensive. And we're talking tens of millions in terms of total costs for the quarter. It's not totally out of the line and it's totally planned for. But unfortunately, it's also falling in a seemingly weaker quarter and therefore our guidance that we expect our quarter results to be roughly in line with our some of the quarter or previous year. But our underlying business would be our offering.

Lars Kjellberg - Crédit Suisse AG

But you wouldn’t consider this aspect particularly large or there’s nothing unusual with particular jobs in the Q2?

Roeloff Boëttgerr

No. Just so happens that all of them are in the same quarter. It so happens that are these, the third quarter is not the greatest quarter. But did make sense for us to do it.

Lars Kjellberg - Crédit Suisse AG

And then finally on Biberist. Can you elaborate about the timing of actual decision-making? And assuming that's decided to shut down, when should you exit the Biberist?

Roeloff Boëttgerr

Very good question. And obviously, with the consultation process, but subject to that, Berend, the timeline.

Berend Wiersum

Assuming the decision is made to close, it would happen at the end of this month. And that May, at the end of May, we would just make final decision. If that decision was to close the mill, then we would stop the production of coated wood-free paper by the end of July.

Operator

We have a follow-up question from Myles Allsop from UBS.

Myles Allsop - UBS Investment Bank

You talked about the need for further codifying price increases. Can you just give us a sense when you think the next sort of opportunity will be? Is it going to be after the summer now? I mean, with the able increase only took 10 years [ph], it seems not a huge amount.

Roeloff Boëttgerr

It is essential for us to get back [indiscernible]. And we're up from July onwards. And Berend, [indiscernible] give a bit of guidance

Berend Wiersum

Well, firstly, to define price increase which is gone through in April was particularly for an in-depth side and that was around 25 years. Stock prices will follow later. As far as the next price increase is concerned, that will happen in July. That will be a general price increase covering all papers including mechanical and coated wood-free in July. And I expect that we will be announcing on the coated wood-free front and price rise within the next 2 weeks.

Myles Allsop - UBS Investment Bank

That's helpful. And can you give us a sense of the cost inflation you’re seeing kind of the group level this year. You say that it's going up materially. Can you just give us a sense of how much that really is?

Roeloff Boëttgerr

Yes, that's quite a complex question. Depends if you're talking dollar, [indiscernible], euro. The pulp prices I think we all know, it’s been quite substantial. Also in Europe increasing quite a lot for wood and the result -- and that’s driven by harvesting cost to a large extent and chemicals also went up by fuel. Harvesting costs obviously driven by fuel. So we've had various degrees of cost increases with the strong brand in euro having some shield or providing some shield to these dollar cost base increases. And what we have just give you in the detail, we will guide you a little bit more to that. But trying to look at that across the group is really nonsensical because it comes from different areas affected by the S&P. Europe is the business that's been affected most by this cost increases as it’s initially integrated.

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