Roeloff Boëttgerr - Chief Executive Officer and Executive Director
Mark Thompson - Chief Financial Officer and Executive Director
Jennifer Miller -
Robert Hope - Group Head of Strategic Development
Berend Wiersum - Chief Executive Officer of Sappi Fine Paper Europe
Lars Kjellberg - Crédit Suisse AG
Robert Faulkner -
Unknown Analyst -
Sappi Limited (SPP) Q3 2011 Earnings Call August 4, 2011 9:00 AM ET
Thank you very much. A very good afternoon and a good morning to you, and thank you for calling into our quarter 3 2011 results presentation. I'd like to draw your attention to Slide #2, forward-looking statements and Regulation G disclosure requirements.
Moving on to Slide #4, and before I talk to the departments, I'll start to give an introduction and put our results and our year-to-date performance in context. The financial year 2011 for Sappi is a very important year, and that is the year where we are affecting a very significant intervention in a large part of our business, with a view and an objective to make Sappi a much more competitive and lean organization to deal with market conditions which we expect to continue to be quite challenging for years to come with a slow recovery. And should it be better, obviously, we'll be in a better position in any event.
And throughout the year, we've dealt with our business, particularly in Europe and in South Africa, to take out major amounts of cost and to make the business leaner, more cost-effective. And unfortunately, that results has resulted in certain once-off costs, many of that being noncash, but also certain cash costs. And that will continue to be the case also in our fourth quarter so that we can enter the 2012 year on a much better footing.
With that being said, if we could move to quarter -- Slide #4, our operating profit, excluding special items, amounted to $60 million for the quarter compared to $75 million for the equivalent quarter one year ago. That turned out to be slightly lower than what we expected as a result of general economic uncertainty in most of our markets, particularly so in Europe. And we have also pointed out that we had a number of large planned annual mill shuts, and 1 or 2 of them, particularly in South Africa, did overrun slightly, the one at Saiccor, in particular, as a result of a power failure outside of our own control. North American and chemical cellulose market, however, continued to perform strongly during the quarter.
High input costs in all areas of our business were only partially offset by higher selling prices for our products. Our loss per share, excluding special items and once-off debt restructuring costs, was $0.04 a share compared to $0.02 during the previous quarter. And I'll talk a little bit later about the once-off costs that affected our bottom line.
Moving onto Slide #5. In terms of quarter 3, you'll see most of those areas being red in terms of sales volumes. However, in dollar terms, up ever so slightly. And all the ratios, also not great, being a challenging quarter as expected. On a year-to-date basis, however, we are performing well compared to the previous year, and operating profit, excluding special items, for the year-to-date, a 34% improvement on the equivalent period one year ago, with all the indicators moving in the right direction on a year-to-date basis.
Moving onto Slide #6, operating profit excluding special items. A weak quarter as expected and breaking the trend of continuous improvement in operating performance for the third quarter.
On Slide #7, the EBITDA trend showing [indiscernible] the same situation. In terms of the earnings in the prior quarter, you will see that we've had an adjusted EPS in quarter 2 of $0.09, which were affected by restructuring provisions and assets impairments. As I mentioned to you, the cost of the intervention, some of them being cash and others noncash. And quarter 3, a loss of $0.04, and the main once-off item there, the cost of restructuring our debt. And I'll talk about that a little bit later. But that was a once-off cost of $43 million in restructuring during the quarter.
Moving on to our divisional overviews. You'll see that the margins on all our operating divisions declining, mainly as a result of the shuts. We've had shuts in all 3 regional businesses. At North American the margin at 8.6% is actually very healthy, taking into account that we did have a shut, and if you compare that to the equivalent quarter a year ago, you can see that it's been a good quarter for that business.
And Southern Africa margins declining quite sharply as a result of not only the shuts and, as I said, slight overrun, but also the paper and packaging business experiencing very strong competition from imported products on the back of a strong rand and a delay rather than weak demand for Kraft products as a result of the food season being later than usual.
Europe, very low margins as a result of the shuts, very high input costs and slower demand than expected.
On Slide #11, as I pointed out to you, Sappi Fine Paper Europe, tough market conditions. However, we did have higher prices realized year-on-year. Price increases was announced for coated wood free paper, and we're expecting also further price increases, which we've already announced for coated wood free paper. Input costs were high, but market pulp prices have started to drop. And we've also seen a deceleration in the increases and input costs in general. As I pointed out, Biberist Mill ceased production of coated fine paper and also now will be ceasing production for the uncoated fine paper. That will bring about an ongoing cost reduction of $50 million per annum, and the first of that benefit should start coming through towards the end of this quarter.
In addition to that, the other measures that we implemented and will be implementing in our European business will bring about a further or additional $50 million in cost savings. So Sappi Fine Paper Europe will enter the new financial year with a cost base at least $100 million below that of the current financial year. We do expect economic uncertainty to persist for some time to come, not only in Europe but elsewhere as well, and therefore, very important for us to control those areas which we can.
Sappi Fine Paper North America volumes were up on Slide 12, so are prices, and costs also increased in effect despite the fact that we had a strong quarter, with volumes being up 3%. The cost inputs and raw material prices started increasing quite sharply during the quarter. We did see a little bit of a lull in market demand in the first half of the quarter, but it rebounded quite strongly towards the end of the quarter, and that's continuing as we speak.
Sappi Southern Africa, the 2 main parts of the business, chemical cellulose, both performing strongly, good demand, good prices, slight decline in pulp prices. We view that as being actually positive for us because on the back of the very high stock prices, there was quite a number of additional mills and conversions with increased capacity announced. Many of those have now gone quiet and we believe will never come to market because of the overheating of the market cooling down quite significantly at this point in time.
For the Paper and Paper Packaging business, a tough environment, as I said, the strong competition from imported products, and then our cost base also not as low as it should be, therefore, our intervention. And as you know, we've as recently as yesterday announced the closure of our Adamas Mill which will take 40,000 tons capacity out of the South African market and significantly improve our cost base. I'll talk about some of the other actions we've taken in this business as well.
Moving onto Slide 15, just giving you an update on the 4 main components of our strategy, which we're now actually picking up good momentum and implementing. In terms of the maintain and optimization -- or maintenance and optimization of those businesses, they are performing well. And in North America, we continue to focus on our cost reduction and also actively managing our customer and product mix with a view to maintain or even improve our operating margins, and we're doing well. As far as that's concerned, our North American team is doing a very good job and feeling positive about the future for that business as well.
In terms of chemical cellulose, I've mentioned to you that demand is remaining strong. The benchmark prices are declining towards longer-term trends. We view that as being positive. The rand remains very strong against the dollar, putting pressure on our margins, but despite that, we had very good operating margins. And the mill has settled down at Saiccor very nicely now, producing consistently at or above desired levels.
Unfortunately, our South African business has been impacted by nearly 3-week long labor strike in July, which came at considerable cost, but that has now been resolved. And production is ramping up in all our facilities to maximum rates again.
The second very important part of our strategy is to improve, or just to put it bluntly, fix those businesses that have not been performing. Europe, being the most important one, being a large business [indiscernible] and has not performed well for quite some time now. The Biberist closure will bring about a very significant capacity reduction of 500,000 tons, the benefits of which start flowing through towards the end of this quarter, not only in terms of the $50 million in cost savings but also the effect of supply and demand and particularly, our own operating rates as we are confident that we will retain all our customers as we transfer production from Biberist to lower-cost mills. There's also the other measures we're taking, and the $50 million additional cost savings on top of Biberist, we are very confident that that will be achieved. We're also far advanced in the implementation of our new service model, and it is already bearing fruit.
In terms of Paper and Paper Packaging in South Africa, we are in the process of matching our assets, on Slide 16, to our resources and the markets. The first step in terms of that was the closure of the Adamas Mill. That will significantly reduce our fixed and variable costs. The payback in terms of cost to benefit will be less than a year, in fact, closer to half a year. But we are in the process of doing further restructurings within the South African business, in fact, quite significant intervention in that business. There will be further costs in our fourth quarter in doing so, and it will affect every single mill and every single department from fixed costs, overheads, sales and marketing and administration. We will see a significant cost reduction with us achieving, hopefully, the run rate by the middle of next year already as a result of all these interventions.
In terms of our growth strategy, very important, not only if you look at the cost side of our business but also the growth and revenue side. We're very excited about, first of all, on Slide #17, chemical cellulose expansion at our Ngodwana Mill. We're now disclosing to you that we intend to spend around about $340 million at that mill. And not only will that expand our chemical cellulose capacity on a very competitive basis in terms of cost, as a result of our wood, energy and distribution cost and the fact that Ngodwana in itself is a large mill with scale benefits. But in addition to that, it will allow us, at the same time, to improve the balance of the mill as well and simplify the process very significant and therefore, also gaining other benefits in the rest of that mill.
This expansion is to respond to customer needs. We've got very realistic pricing expectations, and most of the additional capacity is the subject of long-term supply agreements with long-standing good-quality customers.
We're also expanding our specialties business in North America, particularly on the release paper side. And we're working with very exciting projects which will increase capacity and product range of a very successful high-margin business.
Our European Packaging business, although small, is performing exceptionally well, growing fast. And we have plans also to expand on that.
Forestry resources. Unfortunately, the closure of the Adamas Mill is affecting our Eastern Cape profits in South Africa quite badly. But we've announced plans to increase and expand our forestry operations in that area by a full 50,000 hectares.
Energy projects in South America also is important to us, and there are some very exciting projects where we cannot only reduce our reliance on third-party supply of electricity, but we can also reduce the costs and, indeed, in some areas also generate income through that. In Europe, we also have some projects where we have plans to reduce the cost of energy.
Moving onto our balance sheet and the net debt position. Most important action that we've taken during this year was the refinancing during our third quarter, where we refi-ed nearly $900 million of debt through the issue of a EUR 250 million bond, and a $350 million bond, which extended those maturities of the euro portion by 7.5 years and the dollar portion by 10 years at very competitive rates. And I think this time around, we've got our timing spot-on because just after that markets deteriorated quite sharply. It did come at an additional cost of $43 million.
In addition to that, on the next page, Page 19, you will see that the whole debt maturity profile has improved quite significantly. We've increased our RCF, revolving credit facility, from EUR 209 million to EUR 350 million and extended it to 2016. We also issued a South African bond of ZAR 500 million.
And all in all, Sappi is in a much better position, both from a cost of debt point of view as well as a maturity point of view.
The next opportunity for us in terms of our debt is to take care of the very expensive $800 million 2014 bonds. And where we are sitting today, depending on market conditions during next year, we believe the second or third quarter of next year will allow us to start refinancing debt at much improved rates. We also remain totally committed to our debt reduction. And although this quarter showed an increase in debt, it was largely as a result of accounting cutoff dates and once-off charges with regard to the debt restructuring as well as currency. As long as the dollar remains weak against the rand and the euro, the translation from those into dollars has a negative impact.
Moving forward, Slide 21, we expect market conditions to remain challenging, and we've got very little visibility in terms of what's going to happen in the European and world market. But we are entering our busiest period in terms of demand for graphic paper in Europe and North America. We expect to start realizing the benefits of our cost and capacity management plans towards the end of the fourth quarter.
Input costs remain high, but they've certainly been leveling off in costs and with market pulp prices softening. And that is very, very good for our European business. And if we can get a price increase and contain input costs, our margins will certainly start to widen in that business.
We've got very strong order book for chemical cellulose, and the mill is ramping up to full production. We're confident that we'll come in with a good performance today.
Our South African Paper and Paper Packaging business will be unfavorably impacted in Saiccor to a certain extent as well by the strikes that's now ended and the stronger local currency. But those are conditions and issues that we need to manage as well as we can.
We expect a considerable sequential improvement in operating profit, excluding special items, but our fourth quarter will fall well short of the equivalent quarter a year ago as a result of market conditions but also the strikes that we faced.
For the year, however, we still expect a much improved operating profit excluding special items for the full year compared to the previous year, and we expect particularly strong cash generation during our fourth quarter.
I think it's important for me to note that at this point in time, a year that will be significantly based on operating profit level than a year ago, cash generation improving very strongly towards the end of the year, the net result not being great as a result of the once-off costs related to debt and business restructuring. But Sappi is going into the future now as a much improved, leaner, well-focused company with not only a much lower cost base but an exciting growth strategy on which we've started accelerating our plans. And the investments and work has started on that.
Thank you very much for listening in, and I'm ready, together with my colleagues in Europe and North America, to take any questions that you have. Thank you.[audio gap]
[Operator Instructions] Our first question comes from Caroline Learmonth of Absa Capital.
A couple of questions. Can you give an indication of the rough size of the impact of these major maintenance shuts onto your operating profit this year and if possible, the delay was it roughly equally spread? Or was it more of a major impact, for example, in South Africa? And then the second question in terms of the restructuring that you're currently finalizing and working on regarding in the South African business, is it still your intention to get operating margins for Southern Africa up into the high teens operating margins? And then thirdly, if you could give an indication of the run rate you think you're at in terms of cost inflation in each of the geographies? And tied in with that, what sort of price increases and when will you be trying for in coated wood-free in Europe? And finally, are there any more capacity closures needed in Europe in your view?
That was quite a question. I'll try to answer with a collection of each short question. First of all, let me look at the shuts. If you compare it year-on-year, then yes, they were one shut more plus they were more cost features this year than they were in the previous year. Without going into any detail, our shuts this year cost us between $10 million and $20 million more than the equivalent period a year ago. The shuts were in all our regional areas. But the business that's been worse or mostly affected by them was South Africa. The reason is because it's Adamas, which is our high margin mill and it is in Ngodwana, which is a large mill. So I'm not going to give you more detailed information about the cost of the shuts. But South Africa is more affected. And yes, the cost of the shuts are more positive than the equivalent period a year ago. In terms of the restructurings in South Africa, more work to be done. And we are certainly committed to get our margins up to close to the 30% where we belong. Will we be doing it next year? I think that's not during the year. But certainly, we expect it to improve quite substantially. But in terms of paper and paper packaging, the benefits of our restructuring will come through the year and towards the end of the year so we should be getting this. But all in all, we expect a much improved performance of a lower cost in South African in paper and paper packaging business. At Saiccor we're also continuously improving and fine-tuning that mill. And now that it's running at full capacity on a consistent basis, clearly it gives us the opportunities to further improve on that business. In terms of paper price increases, we have announced it so that most of our competitors further price increases in Europe for coated wood-free paper for September. I think that's essential for us to get because cost prices are still high. Obviously demand plays an important role here as well. But, yes, the Biberist closure we believe will add a significant impact on the supply and demand. Clearly you can just -- as I quickly alluded to what you seek in terms of capacity and further closures that is required in that market, which is -- demand is today, we could do with further capacity reductions. In terms of cost increases how about in the Slide 3 given the -- at the back. But certainly for most of our businesses, we are now in a position, where costs are starting to be flat. Berend?
Yes. In terms of costs in quarter 4, the European business, of course, will have a cost deflation because of the closure of Biberist and because of the cost measures that we're taking. In terms of overcapacity, the wood-free coated market in Europe was down substantially in quarter 2 and it is down about 5% for the year so far. It is down significantly more than other fine paper. So it is where LWC is still relatively positive. It seems to have hit more wood-free coated. There is some stock -- destocking going on in past. My own view is that there is still overcapacity. It will depend on how the markets behave towards the September, October period. We have very little certainty of what it's going to do. If it starts to recover to where it was in the previous year, we would say the overcapacity is not very much. And although still some capacity shut is needed, it will not be dramatic. However, if it continues at today's level, then more capacity shuts will be required.
[Operator Instructions] Our next question comes from Lars Kjellberg of Credit Suisse.
Lars Kjellberg - Crédit Suisse AG
I have a couple of questions. First of all, if you wanted to give more to the tune of the spiked costs, what they actually cost you in fiscal Q4? And also the fits in diversity relation to the Brit and European restructuring. How much of this do you believe you're going to bring down to the bottom line higher? And the other way of asking that question I guess is how much of an inflation offset is this? And the final question I guess is relating to your goal relatively levered balance sheet, how much CapEx do you think -- do you feel you can afford going forward to this strategic growth in less than time, this restructuring efforts?
Firstly, restructuring we have not disclosed at this point in time, but it is significant. For 3 weeks, we had virtually all our mills with the exception of Saiccor being out of production. And certainly, the cost of the strike is in more than -- it's multiples of $10 million, not many of those, but that should actually go with the disclosure. And once hedged all, we'll still calculate now with the stock being over how quickly we are ramping up but that's going very well. So it's been significant. You can read it alone. It's a $20 million plus. As far as the CapEx is concerned, we have set ourselves a target to do our restructurings and the expansions, particularly in terms of Chemical Cellulose over the next 2, 3 years. We have additional plans to what we think is encouraging. Obviously in all areas of our business, for further expansions and growth, on the basis that we would not like share debt increasing to beyond $2.5 billion, as an average for the year. It might have a quick spike as you expand on this. So we feel comfortable that all the plans that we've made for expansion, for growth and for improvement of our business can be done without increasing our debt beyond the $2.5 billion level. That is obviously subject to us continuing to performing according to plan. But our plans are realistic. And therefore with great confidence that we can execute our plans without constraints in terms of the balance sheet. We remain absolutely focused to very careful manage our cash resources, liquidity and the state of our balance sheet, no doubt about that. Mark, would you like to add anything in terms of our balance sheet cash generation?
No. I can't -- I don't have anything to add really to what you said there. We are very conscious of it, and we will manage it very prudently and our liquidity as well.
Lars Kjellberg - Crédit Suisse AG
So what that means there's some flexibility in your CapEx program, is there not? Is that the way that...
Absolutely, yes. No doubt about that. We came in any of these programs as we can because it's under our control. You can delay it or you can actually also fast track some of them. In terms of the commitment, for instance, during the Ngodwana project, the last thing we would want to do is to delay because then it becomes very costly, at the end of the day. But in terms of the [indiscernible] projects, yes, we can. And I think we've demonstrated particularly during the 2008-2009 period that if things really goes very badly in the economy, that we can generate a huge amount of cash very quickly by just rapidly reducing stocks and capital expenditure, not only in terms of expansion, but also in terms of even maintenance CapEx. And certainly, we remain committed to do that, if required, we hope it won't be required. And taking out all this costs makes us much more robust. With regard to the cost savings, I can tell you now that we expect to enter the new financial year with the cost ratio in Europe being $100 million lower from the current cost base. And we expect that to flow through to the bottom line, even in market conditions as they are today. So in that regard, not hoping to fail from the market and actually anything you would like to add in terms of your selling [ph] upside [indiscernible]
I think you covered. it. We are just focusing on cost reduction in all aspects of the business and we have plans in place due to these efforts.
I hope that covers your questions.
Lars Kjellberg - Crédit Suisse AG
And just one slight follow-up. How dependent is the system you're going to point [ph] to exceed in terms of your volumes, which you kind of state you are very confident in doing?
Berend, would you like to comment?
Yes. The volume transfer, they are going well, I must say. We have been able to make a similar product of what was being made at Biberist in more than one mill. And we have tested that with the customers who are buying from Biberist and they have approved those products. Transfers are now happening both with the big merchants as well as with the direct customers. And so far, that is proceeding very well, indeed, I must say.
At least, I can tell you that of the $50 million savings much less than offer that's the payment on the current mill [ph] . That's very important for us to mention to you that, that mill, unfortunately as a result of the strong Swiss franc, high input cost, energy cost was a loss-making for us. So by closing it, we're immediately actually improving the situation irrespective of transfer or not.
Our next question comes from Robert Faulkner of Babson Capital.
Robert Faulkner -
I've got 3 questions. Could you just comment on what you're seeing in terms of the coated fine utilization rate in the industry right now? Secondly, with the pulp prices easing, could you kind of quantify how much you've seen pulp come off and what the drivers are? And thirdly, I think the industry is announcing another round of sales price increases for coated fine. Given the kind of softening raw material environment, do you think that this round of price increase is going to be met with a degree of resistance? And how confident are you that you're able to keep hold of the sales process that you have already put through and not give them back?
Okay. Just to give our colleagues in Europe a break our voice. I'm going to ask first Berend and then Jennifer Miller, our Senior VP for Marketing and Sales. And they will talk about the operating rates of current pulp paper and their businesses. Then I'll ask Rob Hope to just talk quickly about the pulp prices and the direction we -- how he sees that and how we see it as a company. And then Berend again on the sales prices and the ability to actually see that through. Jennifer, would you like to talk about the operating rates in the North American coated fine business?
Yes. Thank you, Roeloff. Certainly, we have been coming off from tepid market conditions and weaker operating rates. But we are running forward as Roeloff has referenced earlier in the call. And it looks like the whole industry is enjoying the typically strong season in the fourth fiscal quarter. In terms of sales price increases, you'll see that for the quarter, we continue to post very strong price realization and good achievement of the prior increase announcement. Further price increases in North America, frankly, would depend on very solid strong operating rates. And I guess, I'll hand it back to Berend.
Thank you, Jennifer. Berend?
As far as Europe is concerned. My sense is that the trough, the lowest end of order [ph] capacity probably did happen in June, which was a period of -- a month with extra holidays but also a very much weaker demand overall. July does look a bit better. And what we can see is that whereas orders were being placed a long way out beforehand, they're coming closer to closer deliveries. So all those lead times between ordering and request for delivery are shortening, which means that the stocks are being met and expenses [ph] are coming down. That's generally quite a positive sign. Operating rates for the industry in June were certainly way below 90%. I would say they were extremely unsatisfactory. In July and August, they will be better. But the pricing is or the price announcement is for September. And at this moment in time, it's very hard to say what September will be like. But if September is the same as last year, although we got a couple of incentive last year, then I would say the price increase has got a good chance if only because the cost inflation on all the players has been so enormous that there's really not much choice. They have to raise the pricing.
Thank you Berend. Robert, quick word on pulp?
As far as pulp prices are concerned, there has certainly been some softening into this quarter. Quite a large part of that effect has been partly [ph] from buying from China, which has been quieter. We become wise enough not to predict future prices. But what you're seeing right now is that there is precisely more softness in the hardwood pulp pricing area, softwood prices are softening. And there's no doubt, that buyers in Europe are being pretty hard on prices, and there's likely to be some further softening through this quarter.
Our next question comes from Hamit Marua [ph] of Morgan Stanley.
Unknown Analyst -
I know someone asked about CapEx earlier, and maybe I didn't get it. But is there a specific target for 2011 in terms of plans?
We don't have a specific target. But we do know that we're now accumulating strength on the Ngodwana expansion project. We have our normal maintenance CapEx in terms of small, other projects. We don't expect it to be higher than about $3 million [ph] , $50 million for the year in that region.
Unknown Analyst -
Okay. And again, on EBITDA, do you have any sense of where you might sum in approximately?
We have, but we can't tell you.
Ladies and gentlemen, we have no further questions. Mr. Boettger, would you like to make some closing comments?
Not other than thank you very much to all of you who called in. We appreciate it very much. Thank you.
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