Sappi's (SPPJY) CEO Stephen Binnie on Q3 2016 Results - Earnings Call Transcript

| About: Sappi Ltd. (SPPJY)

Sappi Limited (OTCPK:SPPJY) Q3 2016 Earnings Conference Call August 4, 2016 8:00 AM ET

Executives

Stephen Binnie - Chief Executive Officer

Glen Thomas Pearce - Chief Financial Officer

Gary Bowles - Executive Vice President Sappi Specialized Cellulose

Mark Gardner - President & CEO, Sappi North America

Analysts

Nishal Ramloutan - UBS

David Roux - BofA Merrill Lynch

Sean Ungerer - Arqaam Capital

Brian Morgan - RMB Morgan Stanley

James Hutchison - Barclays

Riccardo Ottaviani - Ares

Stephen Binnie

Thank you. Hi everyone, I'm joined on the call today with a number of my colleagues. I'll call out the page number of our investor presentation as I read through the deck.

And I'm going to start on Slide 4, which has some of the key highlights for the quarter. EBITDA excluding special items of 160 million, that's compared to 109 million last year, showing nice growth. And bottom line net profit up from 4 million to 32 million. Earnings per share similarly up, from US$0.02 cents to US$0.11 cents. And, pleasingly, our net debt continues to come down near 334 million below last year and reached 1,583 million by the end of the quarter and that's the lowest it's been for many-many years.

Moving to Slide 5 some of the key ratios for us. Our net debt to EBITDA has shown significant improvement. We're now at 2.2 compared to 3.1 last year and that's getting close to our target that we've set ourselves of two times. Interest cover continues to improve and EBITDA margin's up substantially, from 8.6% last year to 13.1% this year. And our return on capital employed we've communicated our target to you guys, and that's 13%, and I'm pleased to say that we were above that, at 14%.

Then in terms of our EBITDA bridge which is on Slide 6, you can see the key factors contributing to the growth. Just to highlight a few, firstly, volumes are down relative to last year. It's important to point out that we did sell Enstra and Cape Kraft earlier in the financial year, so we don't have those volumes. And obviously, graphic paper in North America and Europe had been under a little bit of pressure and that's resulted in some lower volume and there were some timing differences on the dissolving pulp volumes. We saw favorable price and mix, higher selling prices for our South African business and our dissolving pulp, and also a mix improvement flowing through from the higher contribution being made by specialties as that business continues to grow. Throughout the financial year and into this quarter we've been able to take out variable costs and you can see we achieved a significant benefit in this quarter contributing to the growth. And then the other thing at play was the exchange rates and, clearly, the weaker rand has helped boost our profitability.

Moving to Slide 7, the contribution split between specialized cellulose and paper, you can see that from operating profit, on the right hand side, specialized cellulose is -- makes better margins and has a higher contribution of profit, but when it comes to EBITDA it's roughly half-half. So our paper business continues to be important and it continues to generate cash for us to invest in other areas of the business.

Moving to Slide 8, the evolution of our net debt to EBITDA, and this is a very nice slide, it tells a good story. You can see that we've been continuously coming down over the last few years and we would expect that trend to continue, certainly into the next quarter and beyond.

And then if we look in a slightly different way on Slide nine, you can see the cumulative cash flow impact. We've started it at October 2012, and we did that for a reason, because we wanted to show the negative impact of the investments that we made at Ngodwana and Cloquet for dissolving pulp. But you can see that since then there's been a dramatic cash generation and from the trough where -- up to where we are today that's nearly $1 billion of cash that we've generated over the last three years and really re-enforces our ability to generate cash.

The Slide ten has our new maturity profile for our debt and following all the good work that's been done we've been able to push out a number of our maturities from '22, '23 and obviously beyond. The next thing that we have to tackle is the 2017 bonds that mature and the anticipation is that we will be able to repay those with the cash generation in the business in 2017.

On Slide eleven the CapEx, and again you can see the investments that we made in dissolving pulp 2013. Since then we've strived to keep our CapEx at $300 million or below. This year it's the same. We expect the year to end about 240, which means that the last quarter -- we've got quite a bit of investment this quarter, but so it should be about $100 million, giving us the 240 for the full year.

Then turning to the divisions, and just to put the global markets in context firstly, on global paper. It's fair to say that recent months in the U.S. and in Europe have been tough for graphic paper. We have seen demand coming under pressure and we have seen pricing pressure as well and that's something that's probably going to continue as we move forward. But fortunately we've been able to take out substantial cost out of our business to offset the impact of those market forces. Yes, market conditions have helped us in terms of lower commodity prices, but we have been through a number of initiatives in the business been able to benefit the costs and through good work on the procurement side reduce our variable cost.

Then if we turn to Slide fourteen, Sappi Europe first, and I'm pleased to say that the margins continue to improve there. And we have seen -- despite all the difficult market conditions we've been able to grow our profitability quite nicely year-on-year. The specialty business had a very good quarter, up 15%, and those are in markets that are growing between 1% and 5% in the various categories, so that's something we will continue to do and try and expand as we move forward. As I said earlier, all the good work done on costs is able to -- has enabled us to offset the negative impact from the market selling prices. In North America, similarly, we have seen demand and prices coming under pressure, but again, we've been able to take costs out and again -- once again grow the profits relative to last year. Dissolving pulp has been good and we'll talk about that a little bit more on the next slide. On the release paper side, it's doing okay but the Chinese market continues to be tough there. And then the other positive aspect of our result is again on the specialty side. We started expanding our C1S last year and we've seen very nice year-on-year growth there, so that's an opportunity as we move forward.

Then moving to Slide 16, the specialized cellulose market, overall it's been better than we had expected and, certainly, better than when we last discussed the market three months ago. Demand has been good and pricing has benefited, not just for dissolving pulp, but a high correlation with the improvement that we've seen in cotton and VSF prices. And clearly in this period where the dollar has been relatively strong any of the non-U.S. dollar producers has benefited. Our strategy here continues to be to maintain low-cost position and then we do think there are growth opportunities as we move forward. This is a market that is increasing and we want to preserve our position, so we continue to work with our customers to support common growth strategies.

Then in South Africa, on Slide 17, in addition to the dissolving pulp are our packaging business, margins continue to get better and despite the timing of shuts and all that it was another good quarter for us. We were able to get better selling prices, which offset the impact of the weaker exchange rate on our raw material costs. So overall we're doing well there once again.

Turning to the strategy slide and I'm going to jump to Slide 19. We have the five pillars, which we've talked about in the past and, again, just to focus on the key drivers, firstly, on cost advantages, it's something that we have worked on. I think we see evidence of all the good work that we've been doing and we still think there are opportunities as we move forward. Some of the projects are listed. We got new turbines going in at Saiccor and Tugela, which will improve our cost base. We had the boiler upgrade earlier this year at Ngodwana. Yesterday we announced an investment in a Somerset wood yard improvement and that will give us nice cost improvements as we move forward. We did talk last quarter about our global procurement initiatives and we said that we wanted to get at least $100 million per annum savings and we're on track to being able to achieve that over the next couple of years. So a lot of good work being done there.

And then in terms of rationalizing our declining businesses, this is really being realistic about our traditional graphic paper business, strengthening where we have good core assets in graphic paper where we do have cost advantages and we'll continue to invest at those mills and strengthen there. But at the same time other assets which are maybe less competitive we need to look at opportunities to deploy those into other grades on the specialty front which are growing and can generate higher returns for us as we move forward.

I'm on Slide twenty-one. In the short term we continue to focus on cash, but at the same time we have to grow the business and we've been making moderate investments. We do think there's further opportunities to grow packaging in South Africa, specifically, in Ngodwana and Tugela. And we do have electricity opportunities down in South Africa. Pleasingly, on the dissolving pulp side both at Saiccor and at Ngodwana we think we can boost our production through some smaller projects. Those combined, hopefully will give us another 100,000 tones over the next year and a half. And then at the same time globally we are looking at opportunities to boost our specialty packaging. I mentioned that on the last slide. And we have seen that we've been successful there and we will continue to grow further.

Then on Slide 22, focusing on the balance sheet now, we obviously sold Enstra and Cape Kraft earlier this year. It generated cash for us. The next big milestone I talked about earlier is the 2017 bonds, $400 million, which we can call in April and that will be the last of our -- what we would regard as our more expensive debt. It's about 7.75%, and compare that to the recent bond issue that we've done at about 4%. So this will be the last of the more expensive ones and, certainly, will put us in a much stronger position as we move forward once those are gone.

Then on Slide twenty-three we turn to the longer term. Clearly as our balance sheet continues to improve and we strengthen our position, we need to start thinking about the future opportunities and I've talked about some of these. But we do think that specialty packaging can grow further. It makes margins in the low teens and they are in growing segments and we think we have the skill set to be able to take advantage of that. And then on the dissolving pulp side beyond the de-bottlenecking opportunities in South Africa that we have in the short term that I talked about, we need to start thinking about longer term and future growth in basements there as that market continues to grow. And then at the same time we've established this biomaterials business and we think there are opportunities in lignins and sugars. We have had some announcements in recent quarters about demo plants that we've established and we do believe that that will be a revenue source as we move forward.

So turning to our outlook, and to move to Slide twenty-five, overall dissolving pulp remains positive. As I said, it's in a better place than when we last spoke, so we're feeling pretty good about that. The drought conditions remain a risk factor for us. The good news is that we've had excellent rainfall over the last couple of weeks and the river levels have risen and they're higher than they were a year ago. It always remains a risk, but hopefully this will see us through to the -- until the summer rainfalls come and things are certainly a lot better than they were a couple of weeks ago. The graphic paper markets, I've talked about a few times, are weaker, but all the good that we're putting in on the costs side is allowing us to maintain margins. Q4 is a better quarter for us traditionally and orders so far have been robust and looking good.

The implications of Brexit are still being evaluated. Clearly, there will be lots of long term effects of what has unfolded. In the short term, specifically to our UK sales, if you convert those pound sales back into euros we estimate the impact's about €25 million per annum. Clearly, we're looking at ways to compensate for that and that may entail pushing up our prices, but that's something we're working on and we will be taking actions very soon there. So based on our -- overall, so based on our current market conditions and assuming current exchange rates, we expect that EBITDA for Q4 will be in line of the same quarter last year. I do point out that last year's Q4 was a very quarter for us. The CapEx as I said, $100 million, and again focusing on maintenance and efficiency projects. We expect to reduce debt further. We'll certainly go below 1.5 billion by the end of the year and, hopefully, we'll be very close to that two times target by the end of the year.

So, yes, that's the slides in the investor deck. So operator, I'm going to put it back to you, then, for questions.

Question-and-Answer Session

Operator

Thank you very much, sir. [Operator Instructions] Our first question is from Nishal Ramloutan of UBS. Please go ahead.

Nishal Ramloutan

Just two things from my side. The paper market's clearly weakened and probably weaker than you anticipated. Is that accelerating any plans you've got for your own nodes in terms of conversions and closures? And just the second thing is maybe can you just give us some color on dissolving pulp. What's keeping the prices so strong considering the weak paper pulp prices?

Stephen Binnie

On the first one in terms of the paper market, yes, as I said earlier, we continue to look at all our nodes and all the machines and what's the best use of those assets. There are certainly a number of our machines and nodes which are very competitive and we will continue to invest in those nodes. However, there are other machines that maybe are less competitive and what we've been doing both in Europe and in the U.S. is looking at these and seeing whether we can reallocate some of that production towards specialty grades. We've been doing that already and I'll give you some examples. We've been doing it at Ehingen and Maastricht in Europe. We've been doing at Somerset in the U.S. So we'll continue to look for those opportunities, but it may entail in some time that we may do something similar to what we did at Alfeld PM 2 two years ago. So there may be investments going forward. Those would be investments that would give us very attractive paybacks and will allow us to strengthen our position in specialties.

On the dissolving pulp, I will let Gary expand further, but look, there's a number of factors at play. The underlying demand for viscous has been good. There has been some inventory buildups by the viscous producers as well, so that's benefited us. Another factor that's contributed to the growth is that the competing products, cotton, polyester, the demand for all of those has been pretty good. Year-to-date dissolving pulp demand is up 8% this year, so it's performing better than -- we've got forecasts of around 4% or 5%, and pleasingly, it's up 8% this year. It's certainly in a good position there. Gary is there any other items you want to that?

Gary Bowles

No, Steve. I think you touched on the key issues. As you say, the cotton market has some dynamics in it and it has created quite a good demand on VSF, and actually for the market on dissolving pulp. And also, on cotton lichters in the marketplace, there's a flour of continuity that's a bit under pressure. But as you said, the demand is still there and we're getting full requests from all our customers.

Stephen Binnie

Thanks, Gary. Okay, Nishal?

Nishal Ramloutan

No, thank you for that.

Operator

Thank you very much. Our next question is from David Roux of Merrill Lynch. Please go ahead.

David Roux

Hi. Good afternoon, guys. Just three questions from my side. The first question is just on one of your main customers, Lenzing. They've been quite vocal in announcing some expansion plans for their specialty fiber as well as own pulp. I'd just like to get your sense as whether you see this as a risk or more of an opportunity. Then the second question is on Group CapEx. Just for the fourth quarter, that $100 million in CapEx, if you can just perhaps give us a split of allocation by region. Then lastly, if you can just give us an update on your thoughts around a dividend and possibly reinstating it, thanks.

Stephen Binnie

Okay, on the first question about Lenzing, clearly, we can't speak specifically about a specific customer. More broadly, what I would say is that our customers are talking about growth potential and clearly we have strong relationships with these guys. And we believe that through those strong relationships, that we will be able to boost our capacity as we move forward and take -- to benefit from the growth potential that is there. As I said earlier, we think the market's growing at around 4% and 5%. We think we can through these de-bottlenecking opportunities in South Africa specifically, we'll add 100,000 in the next 18 months, and then beyond that there will be a further dissolving pulp investment. And we would not commit to such a large investment if we weren't confident that we would be able to sell that product. So we do think overall it's favorable for us moving forward. The CapEx by region, I don't have that in front of us. I don't think we go into that specific detail. Just to summarize, it's obviously in the short term focused on the efficiency projects and maintenance projects.

We did announce yesterday the investment of the Somerset Woodyard. That's part of the investment in the last quarter, and in South Africa, we're starting work on the de-bottlenecking opportunities at Saiccor and Ngodwana. And we got the turbines at Ngodwana -- sorry, together and at Saiccor as well. So it's spread over, David. Then the dividend, we've been public before. We said we don't want to commit to a dividend until we get below the two times EBITDA, and we've got to be confident that we can maintain it at those levels. So clearly we're getting very close to those levels. We need to take a look at it at the end of this financial year and make a decision based on that, but we wouldn't commit to a dividend until we're confident we can keep it below two times EBITDA, but it is getting very close.

Operator

Thank you. Our next question is from Sean Ungerer of Arqaam Capital. Please go ahead.

Sean Ungerer

Just two questions. In terms of the bonds of 2017, just to confirm what you were saying earlier, from my understanding you're going to repay it from operating cash flow, so you're not going to raise any new debt to replace that by any means. And then just secondly, in terms of the procurement benefits, obviously we've seen quite a bit come through already, and the line blanked out earlier, so I couldn't hear if that was related to the $100 million, so I wanted to get a bit of clarity as to how much more we can see play out.

Stephen Binnie

Yes. The answer to the first question is we would use our own cash flows to repay those bonds next year. There is no plans to issue a new bond. And then on the procurement, the savings that we've targeted, that $100 million, those are not in our numbers so far. Those would be additional benefits over '17 and '18.

Operator

Thank you. [Operator Instructions] Our next question is from Brian Morgan of RMB Morgan Stanley. Please go ahead.

Brian Morgan

Apologies if you've spoken about this already. I missed the first part of the call, but in terms of the $100 million that Sean spoke about, have you achieved any of that yet? That's the first question.

Stephen Binnie

No, that's what I was saying. The savings that we've achieved so far are not included in the 100 million target. These are further initiatives where we believe we can achieve them over -- some of it will come in '17 and the balance into '18, so it will be over the next two years. And it will add up to 100 million per annum at least.

Brian Morgan

But none of it's been achieved yet?

Stephen Binnie

Correct.

Brian Morgan

And then the second question is just on the balance sheet. Cash generated in South Africa can be used to offset European and U.S. debt. Am I right?

Stephen Binnie

We have ZAR2 billion per annum, isn't it?

Glen Thomas Pearce

Yes, that's right.

Brian Morgan

2 billion per annum, okay. And then I'd just like to understand how clear and present the threat is at drought at Saiccor. Are you just giving us a broad risk here, or is it something that you're particularly concerned about?

Stephen Binnie

Look, when we drafted this thing two weeks ago, before the rainfalls, we were concerned about it. It's still a risk. However, the rainfalls we've had over the last two weeks have resulted in the river flows being much higher than they were a year ago. Clearly, those levels could go down, but it's probably bought us time certainly to get us through the next month or two. So it still remains a risk factor, and if the dry conditions resume ahead of the summer rains, then that could put it at risk, but as we stand today, we're fine.

Operator

Thank you. Our next question is from James Hutchison of Barclays. Please go ahead.

James Hutchison

Hi. Good afternoon, gentlemen. Three questions from my side, please. Firstly, in terms of the contribution of specialty grades to European profitability, I know it's not something you've given historically, but you have highlighted number of times in your discussion as being a highlight first quarter in particular and volumes up 15%. It would just because really helpful for us to get a sense of what the base is and how material that is. The second question is just coming back to dissolving pulp. You've spoken to the demand side of the equation, but do you have a sense of how much dissolving capacity is due to come on in the second half of this year and into next year? And then the final question is just in terms of the typical working capital movements over the fourth quarter. Can you just remind us typically what happens in terms of your working capital in or outflows over the fourth quarter in a given year? Thank you.

Stephen Binnie

Yes. On the specialty side, yes, it's not something we specifically disclose as of yet. Overall in terms of our EBITDA contribution across the Group, it's between 10% and 15%. So that should give you a rough size, and that's something that we would want to grow as we move forward. DWP expansion, I don't think there's any new specific ones coming onboard there. There have been ones over the last few quarters. We've had Jari, we've had Sun Paper coming into the market. Gary, do you know of any others that are coming in the second half of the year?

Gary Bowles

No, I think 2017, you've covered most of them, Steve. Just 2018 has some additional capacity that has been announced in the public domain, but I think you've touched on next year.

Stephen Binnie

Yes. If you look over the next 18 months, we are seeing demand growing at a faster pace than supply, but there are some big projects being [indiscernible] for 2018.

James Hutchison

Okay, thank you.

Stephen Binnie

And then, Glen, do you want to just chat about working capital in the last quarter?

Glen Thomas Pearce

In terms of working capital, our last quarter is the quarter that we have the lowest working capital over the year, and we see inflows between about $30 million and $50 million.

James Hutchison

Great. Thanks Glen.

Operator

Thank you. [Operator Instructions] Our next question is from Riccardo Ottaviani of Ares. Please go ahead.

Riccardo Ottaviani

I just had a quick question. You mentioned that your exposure to Brexit would result in roughly €25 million per annum impact. Was that on the EBITDA number?

Stephen Binnie

Yes, that's right. And that's just a simple currency translation on our past bill and sales.

Riccardo Ottaviani

Sure, and I have another question…

Stephen Binnie

But before we just leave that, clearly, we need to figure out ways to compensate for that, and then that could involve price adjustments.

Riccardo Ottaviani

My other question was so your stated leverage target is of two times. Do you also have a target in terms of becoming investment grade, or that's not one of your targets?

Stephen Binnie

Look it's not specifically one of our targets to be at investment grade. Clearly, as our financial position continues to improve, our credit ratings should also improve. I think they should be better than where they are now, but that's our view. It's not a target in itself, no.

Riccardo Ottaviani

So my final question is, I think I read in your presentation that you had a timing effect in relation to some maintenance shutdown in the U.S. And what is the EBITDA impact of this maintenance shutdown -- this timing effect?

Stephen Binnie

Yes, we had the -- I'll pass you to Mark, but we had the Cloquet shut this quarter, and including the line kiln, Mark, so maybe you just want to expand a little bit further there.

Mark Gardner

Yes, sure, Steve. Thank you. Yes, we do our annual pulp mill maintenance outage in this past quarter at Cloquet every year, so that's the same as every year in the past. And then on top of that, this year, we also had one kiln, a major product to rebuild and upgrade the line kiln at Cloquet. That went on, and then one other thing that was a little bit different this past quarter than in prior years, we took a cold outage at our Westbrook Mill. So we had really three events, all maintenance related, or maintenance/upgrade in terms of the line kiln.

Riccardo Ottaviani

Is there an EBITDA number that you think -- do you have an estimate of what the impact was on EBITDA for this timing effect?

Mark Gardner

We typically see about a $7 million to $8 million expense on our annual outage at Cloquet. That's pretty typical. Then the line kiln and the Westbrook outage would add a little bit more cost to it this year versus prior year.

Operator

Thank you. Our next question is from [Bryan Nenez of Commercial]. Please go ahead.

Unidentified Analyst

Could you just tell us when your next ratings reviews are with S&P and Moody's?

Stephen Binnie

I'll let Glen explain further. We were recently moved to a positive outlook by Moody's, weren't we Glen? You maybe just want to talk.

Glen Thomas Pearce

Well, we speak to our rating agencies on a quarterly basis, and they indicated that into next year, next calendar year, they'll be reviewing our status.

Stephen Binnie

And that's both [indiscernible]

Glen Thomas Pearce

Yes. Both Standard and Moody's.

Unidentified Analyst

Sorry, which time next year? This time next year?

Glen Thomas Pearce

No, in the first half of next year. Financial year.

Unidentified Analyst

Got it. Thank you.

Operator

Thank you very much. [Operator Instructions]

Stephen Binnie

Operator, if that's everything, I'd like to thank everybody for joining us on the call this afternoon, and I'll look forward to discussing the business with you again at the end of the financial year. Thank you very much.

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