Stora Enso's (SEOJF) CEO Karl-Henrik Sundstrom on Q2 2016 Results - Earnings Call Transcript

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Stora Enso Oyj (OTC:SEOJF)

Q2 2016 Earnings Conference Call

July 21, 2016, 8:00 AM ET

Executives

Ulla Paajanen – Investor Relations

Karl-Henrik Sundstrom – Chief Executive Officer

Seppo Parvi – Chief Financial Officer

Analysts

Antti Koskivuori – Danske Bank

Mikael Jafs – Kepler Cheuvreux

Linus Larsson – SEB

Lars Kjellberg – Credit Suisse

Mikko Ervasti – DNB Markets

Harri Taittonen – Nordea

Mikael Doepel – Handelsbanken

Oskar Lindstrom – Danske

Kevin Helgard – Goldman Sachs

Tom Burlton – Bank of America

Presentation

Operator

Good day. And welcome to the Q2 Stora Enso Earnings Conference call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Ulla Paajanen, Head of Investor Relations. Please go ahead, madam.

Ulla Paajanen

Thank you. Good afternoon, everybody. I am Ulla Paajanen, I am the Head of Investor Relations here at Stora Enso. And welcome to our Q2 2016 earnings call.

With me is here today our CEO, Karl-Henrik Sundstrom, and our CFO, Seppo Parvi. And that we would start the conference by presentations from Karl and Seppo. Please, Karl, go ahead.

Karl-Henrik Sundstrom

Ulla, thank you very much. And good afternoon or good morning or good evening depending on where you are in the world. So it’s been a very active quarter here at Stora Enso operations. And it’s actually quite a lot of the part of the jigsaw falling into the right places.

We have started up the consumer board mill in Beihai and we are ramping up ahead of time, we started before. The Varkaus kraftliner mill is ramping up and we solved the issues with the pulp mill that we had in the first quarter.

We have also started up the LVL machine in Varkaus for wooden elements in the month of June. We have now three divestments recorded Suzhou and IL Recycling totaling 289 million euros in cash consideration.

We have set ahead with the feasibility study through cross-laminated timber production of Gruvön, in Sweden and we have had the first commercial contract from the lignin in Sunila Mill. And then we did a Eurobond refinancing of 300 million.

If we look on the group financials, so sales came in 1.4% lower than the same period last year. However, if you look at the business, excluding the structurally declining paper and the divested Barcelona Mill, it’s actually an increase by 3.6%.

Operational EBIT increased by 9.2% and that includes a €6 million bad debt provision in the Paper division. We came in on a record cash flow of 493 and we kept for the fourth consecutive quarter in a row a return on capital employed of over 10% then we came down a little bit of below 13% if you excluded Beihai Mill.

And we have continued to strengthen the balance sheet. So net debt to the EBITDA is 2.3 versus 2.7 a year ago and that is in the same quarter as you have the dividends. So cash flow has been strong.

I think when you almost have a double-digit growth in the EBIT, I think it also understand – it understand what's the happening in the underlying business. And if you look on the business like Biomaterial had basically flat results despite the 6% decline in sales.

We had a very strong performance in wood product and we had in other, we had a decline in result of a 11 million. That is coming from top of that reduce base by lower energy costs and the other parties because we have less profit coming from land sales in Toronto and Belize. But all in all, that’s 19 million or slightly more than 9% increase.

Now if you look on some of the one-time items that we are having in the quarter, so we are having compared to the same period last year, we are having 3 million higher EBIT impact in Beihai Mill, due to the ramp up and the clean out of the issues that we had an impact announced in the first quarter.

That’s another 9 million and then we had a 7 million EBIT impact in the paper division, one coming from the incident that we had during second quarter the Veitsiluoto Mill and then 6 million from the bad debt. If you take that all together, you see the underlying performance of the business and that’s actually an over 18% increase.

As I said before, we have stabilized the business on a totally new level when it comes to return on capital employed, and as I said also early that it’s the fourth consecutive quarter in a row.

In basically one a half year we have managed to accomplish quite a lot, everything from starting the Murow sawmill, the Sunila Biorefinery, the de-bottleneck Imatra. We are building Virdia demo plant. We are investing in two coasting facilities and we recently decided to increase the capacity of fluff.

At the same time, we have divested in total a number of sites and if you only take the paper examples here, which are the Uetersen, the Arapoti, the Kabel Mill and the Suzhou that has been announced. That is actually reduction of one third of all the paper site.

Then coming to the big event of the second quarter, that we started up ahead of time, the Beihai Mill and we are now ramping it up faster then expected. Ramp production is expected in 18 to 24 months. The estimate which is excluding the recently announced PE Coating remains at €800 million. But it do include BCTMP mechanical pulp mill capacity of 220,000. Right now that is a very important investment for the future of Stora Enso.

Coming to Varkaus, the transformation of Varkaus from a 280,000 tonne paper mill to becoming a 390,000 kraftliner mill, plus an LVL, its ongoing with the last part being ready in the month of June when we actually started to deliver from the LVL machine making wooden building element and we are expecting full production in mid-2018.

We have solved the problem as I mentioned earlier of the pulp mill at most part of the region, we had a little bit of a setback in the first quarter and we sorted that out towards the end of the second quarter.

This is a little bit more details of the 289 million in cash considerations on the announced divestures that we have announced during the second quarter and this is an important part of the transformation and also an important cash generator.

Before handing over to Seppo, I would like just to remind you of this slide that I have been using for a number of quarters and that is shown the transformation from 2006 to year-to-date. And as you can see, we are now having two thirds of our sales coming from the growth area, compared to 30% in 2006. And over 80% of the profit coming from the growth area, while it was only 38% in 2006.

With that, I hand over to Seppo.

Seppo Parvi

Thank you, Karl. And I start with some key figures, very good profitability on our balance sheet. First of all sales, walk you through this year we're at €2.526 billion, that is 1.4% down versus a year ago. But excluding the structure decline in paper and divestment actually sales increased 3.6% that is inline and meeting our strategic target to growth asset in the market.

Operational EBITDA margin was 13.2% that is clearly above 0.4% delivered a year ago and operational EBIT increased 9% year-on-year for the fourth quarter in a row. Operational EBIT margin was 8.9%.

EPS excluding items affecting productivity went down €0.06 driven by three main facts, one of them being a higher financing cost due to the bond buybacks. We also had negative FX from revaluation of currency of USD loans in Poland and China and lower results from forest associates that is Bergvik Skog and Tornator.

EPS basic went down €0.01. And operational return on capital employed excluding Beihai project was 12.5% up from 10.9% a year ago and cash flow from operations record high at €493 million.

Net debt to operational EBITDA decreased from 2.7 a year ago to 2.3 and actually was flat against Q1 at 2.3 against dollar despite the dividend, but this again good proof point cash flow generation capabilities of our transfer.

Going forward, at divisions, I start with consumer board, the operational return on capital excluding Beihai was 35% that is clearly above our 20% target for the packaging divisions. Sales grew 4.4%, thanks to higher sales volumes and stable prices.

Operational EBIT decreased by 2 million, but you have to note this is affect of Beihai mills start up was 80 million in the quarter. And we have two important investments going on in the divisions relating to additional growth in capacity, both in Imatra mill in Finland, and Beihai mill China and this is to me the increase in demand for our wood service part mainly globally.

Then moving to packaging solutions, where sales increased 14% year-on-year, mainly due to ramp up of kraftliner business in Varkaus and higher sales in Australia and Poland. Operational EBIT excluding Varkaus and Inpac in China increased by 2 million and we are moving forward with the visibility study as announced earlier in Ostrołęka mill in Poland related to new potential containerboard machine. And we expect to finalize this study by end of the year and come back to this subject in due course.

In biomaterials, operational EBITDA margin was 24.6%. Sales decreased somewhat due to lower sales prices and operating EBIT decreased slightly to €57 million due to lower power prices partly offset by positive FX affects. And further step was taken at Sunila Mill where we signed the first customer agreement for the lignin business.

In Biomaterials we have announced an investment at the Skutskär pulp mill to increase our fluff capacity by 160,000 tonnes and that is on top of our current 250,000 tonnes capacity.

Wood products had a good quarter and excellent retail and operating capital 25.6%. Sales is been down 1.8%, mainly due to strategic reduction experienced on goods trading. Important to note, that operational EBIT improved by €10 million, mainly due to higher deliveries, import product mix, mainly the more value added products were sold inline with our strategy and lower good cost.

Our new products are aligned for LVL at Varkaus mill started in June and full production is expected in mid 2018. We also announced a feasibility study in Sweden to a build the CLT production operation at Gruvön Saw Mill in Sweden.

Then moving to paper, where EBITDA improved 42% year-on-year. We have to note this step even though that the reported sales is been down 8% sales for the business excluding divestment and convergence went up 4%. So based on some underlying growth in the remaining paper business.

Operational EBIT improved by €31 million due to better sales prices and lower costs and please note that this includes in total €7 million for bad debt in Sweden and incident at Veitsiluoto Mill.

Cash flow of the investing activities, the strategic target for our paper business was at 5.8%. I would like to note the target 7% was actually exceeded if we exclude one-time restructuring cash cost coming from Kabel and Suzhou mills during the quarter.

We have started to look at how we manage the paper business, due to continuously increasing competition and cost pressures in this business and we are initiating a broad sector plan for the most efficient play to manage the paper business going forward. We will come back to this subject in due course as the project moves forward.

And a couple of comments on the Eurobond refinancing we have in Q2, we reached to €300 million Eurobond in June for a seven year period and quite happy of the entries. There was a coating door [ph] open on the market that we were able to utilize. We reached the transaction before the Brexit voisi in UK and appetite for the bond transaction [ph] it was more than seven times over subscribed. And the Q bond issue was 2.125% or yield of 2.17%. This is actually lowest keeping at a price in our rating category for seven year bond very successful transaction.

We almost used the proceeds to repurchase bonds mature in 2018 and 2019 in total for €362 million and top of that you know the €50 million of our other bond mature in 2018. So the main purpose of this transaction was not to increase our liquidity, but to restructure broad portfolio and thanks to this we are now expanding our debt maturity profile to 4.4 years.

Time to summarize maybe now with the strategic targets, I commented some of these already during the presentation. But in summary, growth targets 3.6% during the quarter meeting our strategic target to growth asset in the relevant market. Net debt operational EBITDA clearly below the targeted 3.0, the same for debt to equity standing at 58% also clearly down from a year ago 70% and target of 80.

Fixed to cost to sales deal above target at 20% but clearly we are confident that 20% target is reachable going forward. Return on capital employed is going very high was 12.5% only a bit below the 13% targeted level.

Consumer board divisional target 20% return on operating capital, they were 35%, so clearly above the target. Packaging solutions still behind the target at 7.7% but that is of course due to the ramping up of Varkaus operation and tendency in China and Inpac.

Biomaterial at 8.9, which is the same level as a year ago, below the 15% level but we have some maintenance works done at Montestrutto having an affect on the profitability for the quarter also.

And wood products like set excellent quarter, return on capital at 25.6% clearly above the 18% target level. And paper excluding cash restructuring costs at Kabel and Suzhou mills at 7.9% or 5.8% including those, so at that targeted level there also.

With that, I hand over back to you Karl.

Karl-Henrik Sundstrom

Yes. Thank you very much Seppo. And let’s look upon the guidance for the third quarter of 2016. Sales are estimated to be similar or slightly lower than the amount of €2.526 million recorded in the second quarter 2016.

Operational EBIT is expected to be in line with or somewhat lower than the €226 million recorded in the second quarter of 2016. These estimates include the negative impacts of the scheduled annual maintenance shutdowns and Beihai Mill start-up, which I estimated to be approximately 30 million and approximately 16 million higher in the third quarter 2016 than in the second quarter 2016 respectively.

So, before we go into the Q&A session, I think it’s important to remember that Stora Enso offers a interesting successful transformation journey, strong focus on customers and innovation, strong profitable growth, strong cash generation, strengthened balance sheet and sustainability in business focus.

With that, I hand over to Ulla for the Q&A session.

Ulla Paajanen

Yes. Thank you, Karl. Yes, we are ready now for the Q&A session. Could you please give the instructions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And we'll take our first question from Antti Koskivuori of Danske Bank. Please go ahead.

Antti Koskivuori

Yes. Thank you and good afternoon from my side. About the Beihai start up, now you have few weeks, months behind you and then you probably have more insight then you had before.

Could you little bit talk about the outlook and the contribution of that mill, now you – if you get the guidance more or less same for the H2. But how should we view the 2017 and is there going to be gradual ramp up or is there – gradual improvement in the EBIT contribution, is it more going to be like stiff change at some point of the curve or how should we view that? And then also, if you are willing to comment about your thoughts when the mill could reach EBIT breakeven, that would be very helpful?

And second question, the paper division project where you say, you are looking for the most efficient way to manage the business, and what kind of tool box you are talking about here, is it cost cutting or more structural measures or maybe the strategy of the division, or if you could elaborate a bit about that? Thank you.

Karl-Henrik Sundstrom

So Antti, thank you very much. So regarding to date, even you know, we are ahead of the curve right now, where we'll be running it slightly more then a month since we – or two months actually, slightly more then two months, since we running Beihai and right now its going ahead. We are ahead, we are producing more - trying grades than we expected.

However, I don’t – I am not at the position right now to give you any further notice of this, how it’s going to ramp up. We are going to give you a guidance quarter-by-quarter, I think that is better.

And saw it’s slightly different, we change it slightly compared to what we said last time and we came out a little bit shorter on the more positive side 18 versus guided 20 and now we increased it to an addition of 16 for the third part. So let us give us a little bit more. But right now all signals is steady – its going quite well and we are producing more time quality and more confident than expected.

When it comes to paper, it is to make sure that we can have the right circumstances around paper that they can manage in a different way. So it will be cost, it will be different ways, because you know we have five divisions who are growing.

And one it’s declining because the paper structure is declining and that we need to look upon how we work with it and how we set up certain things. Because I think it is important that we need to create structure for paper that is future proof, but this is an internal project to be able to go for this, did that answer your question?

And we will give you more information when we know more. And however because we are a big company and when this is all over the paper division it will be and off the room, and side order wanted to go out public with it that we have started it then also lot of room is coming through yen, throughout this channel, is that an explanation Antti?

Antti Koskivuori

Yes, I think that’s a good explanation. Thank you very much.

Operator

Thank you. We'll take the next question from Mikael Jafs of Kepler Cheuvreux. Please go ahead.

Mikael Jafs

Hello. A good afternoon, everybody. I have three questions. The first one would be around your new project regarding the paper business. Is it possible to give any examples or some color and flavor on regarding what you will look out off out for except for the one that you already stated?

And the second question would be on Varkaus, the level of production in the kraftliner machine versus full production, could you sort of give us some idea on where you are today compared to situation where the machine would run fully?

And then the third one would be around the dividends from Bergvik and Tornator, could you just explain a little bit on how you accounted for those? Thank you.

Karl-Henrik Sundstrom

Mikael, I will answer the first two questions and then on the dividends and how we account for that, I'll give to the expert Seppo. One typical example that we needed to look upon is that, for example when it comes to IT infrastructure, that’s a typical example, should we have different like the IT infrastructure for paper, instead of being part of our system that we are developing for a lot more and for growth example, that’s typical. Should we have the same HR support. All these things are coming in and so for these are the typical examples.

Mikael Jafs

Okay. That’s fair enough.

Karl-Henrik Sundstrom

And is yes, started, and it’s an open, it might come up new things and we will keep you updated about it. And when it comes to Varkaus, if I remember right, I think we produced 67,000 tonnes in Q2 and we produced 60,000 tonnes in Q1.

And full capacity we believe here in the first part of 2017 which is a little bit of a delay because we need to change our some equipment in the first quarter of next year. But one quarter delay versus the official plan.

Mikael Jafs

Okay.

Karl-Henrik Sundstrom

Did I answer your question?

Mikael Jafs

Yes, perfect. Thank you.

Karl-Henrik Sundstrom

Then we take the dividend.

Seppo Parvi

Okay. And relating to dividends from Bergvik Skog and Tornator, first of all during the quarter we received about €45 million dividends from Bergvik Skog and Ternia [ph] from Tornator. But this has no profit and loss affect. Of course it has an affect on our cash flow and net debt.

And the reason why it has no affect on a profit and loss when we get dividends from this books associated [indiscernible] of those the two on one line in our EBIT, operational EBIT line. So it is already now resolved - our share of the company resolved and then we get dividends it’s of course cash flow aspect, no result affecting profit and loss.

Mikael Jafs

Okay. Thank you so much.

Operator

Thank you. We'll take the next question from Linus Larsson of SEB. Please go ahead.

Linus Larsson

Thank you very much. Thank you very much and good afternoon to everyone. May I just come back to the previous discussion about this project that you have initiated in your papers division, you corrected on one of the new slides, saying that, that this is a question of internal measures only. Can you just clarify or confirm that this is not the matter of potential ownership change of your paper division?

Karl-Henrik Sundstrom

That was quoted in that report I think it was from direct, its and internal project we are running.

Linus Larsson

Yes. That’s very clear. That’s very clear, and you gave some examples of what that might entail. Thank you very much for that. On something completely different then FX, could you give us some idea of the sequentially FX development Q3 on Q2 and not least taking into account the recent development of the Brazilian Real.

And any thoughts on that maybe - timing wise maybe not even third quarter, maybe its coming later. But it was a major positive last year and how should we think about that in the next couple of quarters?

Seppo Parvi

Yes. It’s Seppo. Let me take this FX related question. During the quarter the positive FX was about €28 million, €29 million. It is less than last year and full year the estimate some €75 million broadly positive FX this year versus last year from FX. Earlier at the year there have been talk about the 100 million, but it’s a bit less, but there some positive comments from the FX.

In short, we occasionally get great plus on Brexit, how did that affect us, of course we get negative from Pound, Sterling being weak, but at the same time Dollar has been getting stronger, Swedish Krona weaker. So net-net we are marginally better off in short term at least when it comes to core assets. So no major affect from that side.

Karl-Henrik Sundstrom

But longer terms affect the Brexit, it is not because we can compensate, because we are selling goods and products that don’t being produced inside UK. So we can up our prices, the longer its what's happening for the UK, but even more important what happen to the Europe economy was a Brexit.

Seppo Parvi

And your question on Brazilian Real, just to remind that 10% more is about 30 million on our result. So it’s not sourcing difficult if you compare to Dollar or S Swedish Krona for instance.

Linus Larsson

Great. That’s very helpful. Thank you very much. And one last question if I may, impact has been a bit of burden recently, what was the EBIT contribution in Q2 and any guidance as to what you are expecting in the third quarter?

Seppo Parvi

Well, we don’t comment more in detail individual units, its next time in Q1, but that’s been performing as well as expected because of some customer losses mainly and the other came on improving the customer product portfolio there going forward.

Karl-Henrik Sundstrom

But the aim is to improve the performance and impact.

Linus Larsson

So Q2 is better than Q1 and it’s…

Karl-Henrik Sundstrom

Absolutely, Q2 is better than Q1, absolutely.

Linus Larsson

And it wouldn’t be farfetched to think that Q3 would be even slightly better?

Karl-Henrik Sundstrom

Everything we say is included in the guidance that we've given, so we don’t give an individual.

Linus Larsson

That’s, okay. Thank you very much.

Karl-Henrik Sundstrom

Thank you.

Operator

Thank you. We'll take the next question from Lars Kjellberg of Credit Suisse. Please go ahead.

Lars Kjellberg

Thank you and good afternoon. Couple of questions, I have been curious on not so much on the guidance per se, but the maintenance cost you are talking about, the 30 million sequential increase that would imply almost 60 million in maintenance costs in the third quarter.

How should we see that heading into Q4, will that be a material sequential reduction in the maintenance activity?

Seppo Parvi

As you know Lars, we give guidance only for the coming quarter. We at least speak now in for your benefit in the interim report and your maintenance kit source. So compared to that I can not comment much more.

But of course you can look at the total maintenance cost this year versus last year, it is coming down, if you take into account the fact that we have been closing some - divesting some units. So if that essentially if you look at the full figure it’s of course less than last year.

Lars Kjellberg

Looking at your schedule, I was sort of on the impression it would be a similar maintenance cost in the third quarter versus the second which was of course a big step-up from zero in Q1. But just to get the numbers right, so you are basically talking 30 plus to 28 that is…

Seppo Parvi

Let to be straight, the increase between Q1 and Q2 was 28 million, an increase from Q2 to Q3 is about 30 million and we are not giving absolute figures as such out, it’s a difference between the two quarters.

Lars Kjellberg

I understand…

Seppo Parvi

That’s what we are abiding on and telling all the time.

Lars Kjellberg

Okay. You've done your bond refinancing, what sort of impact should we see if any on your net interest costs going forward?

Seppo Parvi

That sort of be of course coming down as we are repaying higher cost bonds, replacing those with lower cost, our interest rate now is about 4% in our loan portfolio.

Lars Kjellberg

And what is the delta there just to be clear?

Seppo Parvi

300 million is only fraction of the total loan portfolio, so we have total about [indiscernible] interest rate.

Lars Kjellberg

Understood. And when you're looking at your CapEx, you obviously provided a guidance for the current year, I think we were quite curious what you are thinking about 2017 and I understand that’s subject to potential decision regarding Ostrołęka?

But can you provide any guidance excluding Ostrołęka and also the impact of the divestures of Kabel and Suzhou how that would potentially impact your CapEx in '17 onwards?

Seppo Parvi

I can only repeat Lars what we have been also telling earlier that now that we are ready big projects we expect our capital expenditure come down towards depreciation levels that we have given also, plus 100 million for the forestry.

Lars Kjellberg

That would apply in the range of 600 million?

Seppo Parvi

600 plus, 630, 650.

Lars Kjellberg

Okay. Just one final question from me, you're looking at the fluff products market and I appreciate that, it is a nice growing market, but at the same time this is a market that you are seeing a tremendous amount in new supply coming into.

How do you think about selling that fluff into the market and is that a meaningful sort of return in that investment versus continuing with paper pulp?

Karl-Henrik Sundstrom

Lars, in terms of – this is Karl, yes, because we have been one of the very few producers of fluff in Europe. Secondly there is a consolidation happening on the Delaware [ph] fluff market which means that it’s actually a rarely well received with the customers.

Lars Kjellberg

So is that what you are saying that, that customers would like to have someone else to do business with, that’s essentially what you said?

Karl-Henrik Sundstrom

Yes, you know…

Lars Kjellberg

Makes sense.

Karl-Henrik Sundstrom

So that was the reason I sit here, first approximately in Europe, Europe uses a lot of important fluff and suddenly we have become one seller and that’s why one of the reason why we increased capacity. And it is you know, this investment for this 160,000 is a marginal increase over an existing mill. So with an infrastructure so it’s a good deal.

Lars Kjellberg

Very good. Makes perfect sense. Thank you.

Operator

Thank you. We'll take the next question from Mikko Ervasti of DNB Markets. Please go ahead.

Mikko Ervasti

Thank you. And good afternoon. Couple of questions from me. Can you please give some comments about the pulp price developments in the hardwood and softwood and their impact on your ASP is now going forward into the second half of the year?

And then another question on the wood products business, so you had a strong result now in the second quarter, and this LVL line started in the end of the quarter. So will there now be like a heavy cost burden without this volumes really going forward into Q3 and what kind of magnitude would there be? Just to help us understand the rest of the year for that journey? Thank you.

Karl-Henrik Sundstrom

So if I look upon the pulp prices so to say going forward, and for the next quarter, I would say that softwood Europe is stable, hardwood Europe is stable, softwood China stable, hardwood China slightly higher.

And then you have to remember that the cost of investments for some wood divisions are not that high in - through produced wood mechanically. If I remember right, investments in Varkaus for the LVL machine is some 40 million and that depreciate - I know we haven’t given, but its…

Seppo Parvi

If you look at the wood products in LVL investments and the scale is totally different compared to forest is very high and [indiscernible] small figure, so what [indiscernible] figures, it is in royalty terms the size of the company are not the figures, not seeing specified.

Mikko Ervasti

Okay. Thank you.

Operator

Thank you. We'll take the next question from Harri Taittonen of Nordea. Please go ahead.

Harri Taittonen

Yes, good afternoon. Harri Taittonen. First question on the linerboard market overall what you are seeing there and there is been sort of price increase announcement by some of the competitor and so potential seen there, how do you see that in terms of kind of acceptance for your products with Varkaus?

Karl-Henrik Sundstrom

Yes, so for Varkaus kraftliner we see to say, we see a slightly high here in the kraftliner in the next quarter.

Harri Taittonen

Right.

Karl-Henrik Sundstrom

That includes the probably slightly lower and then on containerboard based on recycle paper its stable.

Harri Taittonen

Okay, okay. And then sort of just a question, sort of the group level, kind of the wording on the guidance, I have understood, that the crowd more or less that inline is plus minus 10% somewhat below, its anything up to 20% lower, and this was the wording you used last quarter around and the clean EBIT and that being about sort of 9% lower, was that, tell me, three months ago was this sort of outcome pretty much in your mind and on your mind when you sort of gave the guidance as to Q1, what was the Q2, did it sort of give surprises to you compared to what your thoughts of them rolled in April?

Karl-Henrik Sundstrom

So what I would like to say you got it basically – you got to drive when [indiscernible] should be. But we were cautious due to the Beihai and the Varkaus caught up. It was starting up you know, everybody in this industry is being starting up machines on this side, know how challenging it is.

Harri Taittonen

Of course. Yes, and would you say that – is there, essentially repeat the same guidance now, but the reason is slightly different, how you refer to more concrete cost basis and if so…

Karl-Henrik Sundstrom

I think obviously we are more secured about Varkaus because we sold the pulp production program that we have there, but I am probably – not more cautious about Beihai because it is yes, two months of operations. And then we all having higher maintenance sequentially.

Harri Taittonen

Absolutely. Okay, thank you. On sort of the last question on the wood products, I mean, this was an impressive improvement in earnings, and you have done the same in the second quarter a few years ago and it then was fairly short term, I mean, improvement, is there kind of – how sustainable or as it vary, you repay to approach - efficiencies in the lower wood cost which kind of suggesting now the improvement is more…

Karl-Henrik Sundstrom

It is seasonable then partly, but its also lower wood cost, but I would like to repeat, that the - when it comes to return on capital employed for the last eight quarters I think compared to historical as anybody else in this industry in Europe we have out shown and invested on return on capital employed. It is a bit volatile, but it’s volatile on a higher level now.

Seppo Parvi

And I think also it’s fair to say it’s less volatile than in the past, if you look at the history of wood products.

Harri Taittonen

Okay. Excellent. Thanks.

Karl-Henrik Sundstrom

Thank you.

Operator

Thank you. We'll take the next question from Mikael Doepel of Handelsbanken. Please go ahead.

Mikael Doepel

Thank you. Good afternoon. Just quickly coming back to the question about the paper and paper division and the project that you have launched there and I do appreciate that, what you're saying it’s an internal project right now.

But if you think further out, further down the road, would you be willing to discuss also some external options or partnerships regarding this business that might or could lower your exposure to that business?

Karl-Henrik Sundstrom

As I have said always if somebody is coming to me, offer me the value that these goods after divert, and you see now we have improved two quarter in a row, strong cash generation and if you exclude - if you exclude the one time payments for Suzhou and for Kabel its actually yielding very, very well above the target.

So if somebody, I am willing to discuss. I am not willing to be bigger and longer in paper. But if somebody – I go back to my old statement. Is that…

Mikael Doepel

Yes, that’s clear, but what I am thinking here is that you know, given the your CapEx levels are obviously or should at least come down from levels that we have seen at last five years or so, the importance of this cash flow, that you are getting might become a bit smaller than it has been previously and that might – that change your view on things?

Karl-Henrik Sundstrom

That’s not the reason why we are doing this, this is an internal to make sure that can generate fashion and if it would be something like you discussing, the values isn’t higher.

Mikael Doepel

That’s right.

Seppo Parvi

This is the worth how to manage paper business.

Karl-Henrik Sundstrom

Yes.

Mikael Doepel

Okay. That’s good. Thank you very much.

Operator

Thank you. The next question is from Oskar Lindstrom from Danske Bank. Please go ahead.

Oskar Lindstrom

Hi. Good afternoon. I'd like to follow up on Harri's question around the liner market, but focused more on the consumer board market and how you see the outlook there and then specifically about sort of your liquid packaging board business.

And I mean, I realize you have longer contracts there. Are some of these or how many of these contracts are coming for up for renegotiation ahead of next year? That’s my first question.

And then the second question is around the recycle paper market, and if you see – how do you view the risks of new capacity there impacting kraftliner?

Karl-Henrik Sundstrom

So we – you're absolutely right, we have a very good market share, relative market share in consumer board. I think it is – we are 40% bigger competitively in size. With Beihai we will be at 1.7 times bigger down here as competitor, which is giving us a huge strength. And those contract they are no - if I remember right, I think there are renegotiations next year with one of the big client, that’s what I have in my memory. But I am not hundred percent sure. But that’s stable.

When it comes to recycle paper, in the second quarter there was some price pressure in it, but for Ostrołęka mill which we have increased down foothold, we compensated by more volumes and we don’t notice it, but there is always a risk that there are other deeper building and that you have to be careful about.

And that’s also why we announced the feasibility study ahead of time to make sure people understand that we are looking at it. But that’s a very important part of the feasibility study if think somebody is building at the same time.

But also I think you can convert a look of paper machine to recycle board mills, but we need to be aware of that they will not be as sufficient as the machines you having in like Baienfurt and Ostrołęka and they don’t have the same technical feature.

Oskar Lindstrom

If I may, a follow up question on that last, I mean, do you think the – it might be a difficult to answer, but do you feel that maybe there is too much concern among investors who are in the market about the conversion of paper machines into board machines?

Karl-Henrik Sundstrom

I think there is always good to have – so we don’t create what we created in paper too much structured over capacity. And that’s why I think if you go into this you need to exactly know where you've been in this, how well integrated you are with the books plan to corrugators rest, external, because a recycle container board it only travels about thousand kilometers, and a corrugated box travel 20 to 30 kilometers, you need to know exactly where you're building it and how you have the rest of the set up around. So it’s important where you are and you have to be cautious. There is always room - what?

Oskar Lindstrom

You are not overly concern about overcapacity in the sort of medium term a couple of years out?

Karl-Henrik Sundstrom

I am not over concern about the area where we operate which is in Ostrołęka area and Eastern Europe I am not concerned. I might be more concerned when it comes to Central Europe.

Oskar Lindstrom

All right. Thank you.

Operator

Thank you. We'll take the next question from Kevin Helgard of Goldman Sachs. Please go ahead.

Kevin Helgard

Good afternoon. I just wanted to tick up in terms of contracts for both pulp and paper, if you are expect pulp prices to be stable into 3Q, does that mean we have seen the full affect of the lower hardwood prices, or will contract mean that there is still a bit of weakness in terms of pricing coming into 3Q?

And then in terms of paper contracts, how are recent contract negotiations looking, is there a pressure on prices or do you expect them to stay stable as well?

Seppo Parvi

The pulp market [indiscernible] basis, so I think its fair to say the affect is smaller in the figures already.

Karl-Henrik Sundstrom

And when it comes to paper, it is at right now impossible to say where they are going because we are in negotiation. So I rather not answer that because I might be wrong or I might be right. But we are right now negotiating the half year contract in publication paper.

Kevin Helgard

Okay. Thank you.

Operator

Thank you. And we'll take the next question from Tom Burlton of Bank of America. Please go ahead.

Tom Burlton

Hi, guys. Thanks, just had one question, last time I missed the one, its already been asked, is on the other segment, in your numbers still I think that that was where a lot of the variance versus actually facing seem to come. I wonder whether you could help in terms of guidance and how we should we think about that going into Q3 and for the rest of the year?

Karl-Henrik Sundstrom

Maybe I'll take this one. We know that the China team for you this segment offer, because there are many different items driving it. If you look at the result of our flexibility to Q2 it was I would say two main drivers, one is being low NAC prices, and second one piece that we saw from the forest associates Tornator and Bergvik Skog where we have less choice, really state gains land sales related things.

Difficult to give you sort of clear guidance where you should be growing with that, but I think it’s far away, farfetched if you talk sort of an average from what you have seen with the past three or four quarters.

Tom Burlton

Okay, fine. Okay. Thanks.

Operator

Thank you. We'll now move to Mikko Ervasti of DNB Markets. Please go ahead.

Mikko Ervasti

Thank you very much. A follow up question. Regarding this operational EBIT, and the one-time items you have now specified, I just quickly pass through the other presentations from the past and this time around you really seem to like to highlight this one time items.

Can you now confirm that these are truly of one-time and one-off nature and not repetitive in essence like bad debts can probably happen every now and then and this impact issues are sort of internal efficiency you have, but you want to quantify this. So you can please elaborate on that, that will be very helpful? Thank you.

Karl-Henrik Sundstrom

First of all I think whenever we had the bad debt of size we have always to feel fit, and this was a fairly big one. And that I cannot guarantee not happening again, even thought we are working extremely hard for it not to happen.

The other part in that schedule it mainly related to Varkaus and that’s part of the ramp up, [indiscernible] when you ramp up you get the full depreciation and you gradually increase your capacity and your margin while you steam in the machine.

And that will continue for both Varkaus and Beihai. We are saying we would be EBITDA breakeven in the third quarter and EBIT breakeven through the end of 2016. And so these would be the – that might show the underlying business for you and Beihai

really are ramping up during the next 18 to 24 months.

Mikko Ervasti

Okay. So this…

Karl-Henrik Sundstrom

That’s probably…

Mikko Ervasti

Due to the ramp up…

Karl-Henrik Sundstrom

Yes, yes. And that’s why we will guide now going forward the impact of Beihai continuously, that’s why we also give you guidance on when we will be EBITDA or EBIT breakeven for Varkaus, that’s when you get to your modern track.

Mikko Ervasti

All right. Thank you.

Operator

Thank you. That will conclude the Q&A session. I will now turn back to the speakers for any additional or concluding remarks.

Karl-Henrik Sundstrom

Yes, thank you very much for spending a full hour with us. We are not in the midst of vacation time, especially in the Nordic. I think it’s important to remember that we are in a transformation and we are moving ahead quite fast.

We happen to look in the second quarter, what I am especially proud of is that the underlying business is very strong improvement and we are ramping up two mills at the same time and we continuously generate a lot of cash and we are strengthening the balance sheet. Thank you very much. Have a nice summer.

Seppo Parvi

Thank you.

Ulla Paajanen

Thank you.