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Executives

Roeloff Jacobus Boëttgerr - Chief Executive Officer, Executive Director and Member of Group Executive Committee

Alexander van Coller Thiel - Member of Group Executive Committee and Chief Executive Officer of Sappi Southern Africa

Barry John Wiersum - Chief Executive Officer of Sappi Fine Paper Europe

Mark Gardner - Chief Executive Officer, President and Director

Analysts

Caroline Learmonth - Barclays Capital, Research Division

Lars Kjellberg - Crédit Suisse AG, Research Division

Nishal Ramloutan - UBS Investment Bank, Research Division

Sean Ungerer - Avior Research (Pty) Ltd.

Ross Gilardi - BofA Merrill Lynch, Research Division

CJ Baldoni

Kevin J. Cohen - Imperial Capital, LLC, Research Division

Nitin Dias - JP Morgan Chase & Co, Research Division

Sappi Limited (SPP) Q2 2012 Earnings Call May 10, 2012 9:00 AM ET

Operator

Good day, and welcome to the Sappi Limited Second Quarter Results. [Operator Instructions] Please also note that this conference is being recorded. I would now like to hand the conference over to Roeloff Boëttgerr. Please go ahead, sir.

Roeloff Jacobus Boëttgerr

Thank you very much. Good morning, and good afternoon to you ladies and gentlemen, and thank you very much for dialing in to our second quarter results presentation. If I could, as usual, draw your attention to the second slide forward-looking statements and Regulation G disclosure requirements.

Moving on to Slide 4, the quarter results. Profit for the quarter, $58 million, a big improvement on the equivalent quarter year ago. Consequently, also, earnings per share at $0.11, and taking it on a year-to-date to $0.20 a share. Cash generation for the quarter strongly in line with the equivalent quarter a year ago at $91 million. And our net debt, despite quite a lower CapEx in terms of our projects, at $2.1 billion.

What's intriguing to us is that our performance, particularly for Europe, has been much improved based not really on market conditions, but mostly the cost savings that we've implemented in that business. The chemical cellulose business continued to perform very strongly during the quarter.

Moving on to Slide 5, the financial summary. I think here, with our guidance through the slide in detail, we all have a -- it's a story of the top line, generally under pressure in terms of both volume and price. But the bottom line, when one looks at margins and the profitability, fairly good. And that on the back of, I think, an improved business in terms of competitiveness and cost base. That, to us, is pleasing, and we think sustainable going forward.

On Slide #6, the operating profit development. The good thing was the fourth consecutive improvement in operating profits. Not at the level where we want it to be, but it's a different business to the one that we completed before, and in our opinion, a higher-quality business with bigger prospects.

EBITDA, on Slide 7. Very much a similar thing, with good prospects to improve on that going forward. Earnings versus the prior quarter slide that most of you probably are familiar with. Not much to say about this. Adjusted EPS pricing and basic EPS $0.11 for the quarter versus the $0.09 and $0.07 the previous quarter with a few adjustments during the quarter, as we actually planned to have.

We look at our divisional businesses. So geographical businesses start at 10%. For us, the most pleasing fact of the year is the European business now achieving our targeted margins of above 5%, on the back of our aggressive intervention in that business. Because, as you all know, we weren't much helped by either volume or price in that business; it's more cost strength. North American business margins, improving. Not yet at a level where we want it to be, but certainly much improved on the previous quarter, and that's the average for the quarter. The -- it continuously improved during the quarter. At the end of the quarter, it was close to the double-digit numbers that we got used from that business. South African margins decreasing on the back of a stronger rand and pricing pressure, demand pressure particularly on the Paper business in South Africa. Chemical cellulose continued to perform very well.

Moving over to Europe, on Slide 11. Operating profit is up quarter-on-quarter, as well as year-on-year. Much improved cost base for this business, and the overall quality of the business has certainly improved. Market conditions remained challenging. Prices were generally lower, but despite that, margins were up. The business also continued to perform very strongly in terms of cash generation, and generated more than half of the total group cash generation for the quarter, which is in line, in fact, with historical performance from a cash perspective. But it's now falling to at least the operating and net profit.

In North American business on Slide 12. Much improved operating performance, but not yet at last year's levels or the levels that we're targeting. Margins have improved, but as I said, some way to go to get to the 10% plus. Production efficiencies and liabilities improved significantly throughout the quarter, and indeed we were still experiencing a little bit of startup issues during the beginning of the early weeks of the second quarter. Pulp prices has the biggest effect on this business, and although it has improved slightly, if I compare this quarter to the equivalent quarter a year ago, pulp prices are a lot lower. And that has put pressure on our margins. The casting and release business enjoyed improved prices and volumes during the quarter, particularly in the Chinese markets. Paper prices and volumes under pressure, but we have seen that price is now moving up. Here at Sappi, we've announced further price increases, but not only us, but most of the players in the North American markets. And indeed, that's the pace for Europe where paper price increases have been announced and by just about every player in that market.

Our South African business on Slide 13. Chemical cellulose, very strong performance. EBITDA margins, 30% for the quarter, which is really in line with what it's been historically as well. Good volumes. Prices were down as this -- NBSK, as you all know, has not been great on a year-on-year basis, and we link to that. And the rand has strengthened during the quarter. We had very good production efficiencies, and in fact, I can confirm to you that Saiccor's running extremely well.

Paper and paper packaging business is still underperforming, and that really is our focus area group-wide, an area that needs most of the improvement. It's a very competitive environment in terms of price, cost and volumes. Lots of imports into South African markets. However, we are making very good progress with our restructuring process right through our back business in South Africa. Benefits rolled out, coming through in quarter 3 and accelerating into quarter 4.

Moving on to the focus areas for the medium and short term for our business, Slide 15. Very important for us to maintain the excellent cycle production rates and the customer service that we are having at this point in time. I can confirm to you that both our chemical cellulose projects in Cloquet and Ngodwana -- it's progressing very well. Both of them are on time and on budget at this point in time. And we have very good customer support and commitments for volumes when those projects start up in the first half of 2013.

As far as our European business is concerned, we're consistently and continuously working on further improving on our cost base of that business to further improve our competitiveness, and there's more to be done. We are not finished yet with regard to that. In terms of capacity, we are running very high operating rates in that business. And we'll continue to ensure that, that is the case and do what is necessary to deal with market conditions.

As far as North America is concerned, we need to restore those margins, and we aim to be back at the 10% levels very soon. I said, as far as the South African paper and paper packaging business is concerned, we need to squeeze out the benefits of the restructuring that we're going through to ensure that we are a more competitive business, that we indeed compete on a international basis.

Debt remains a very important issue for us at Sappi, not only the quantum of the debt but also the cost of that debt. Debt is coming down. We have plans to accelerate debt reduction. We actually committed to that. And not only is the quantum of the debt important, but, obviously, the cost of that debt. And we have exciting possibilities in terms of reducing the cost of our debt going forward. And we're certainly considering a possible refinancing of the 2014 bonds, when market conditions are favorable for us to do so.

Moving on to Slide 17, and the net debt [inaudible] obtained here and our aim now, to reduce the debt to below $2 billion in the very near future. That's very much doable, despite even the CapEx projects at Cloquet and Ngodwana.

Our maturity profile on Slide 18. And you're familiar with this slide as well. Apart from the 2014 bonds -- actually, a very good picture. And as I've said, hopefully, in the not too distant future, we'll deal with that, which would not only improve the maturity profile tremendously but will hopefully also bring down the cost of our debt very significantly. And good thing about that is fall through -- it falls through to the bottom line on a continuous basis. We're happy to also -- about the fact that we refinanced recently in South Africa $500 million of bonds through the issue of a 750 million rand bond at a fixed swap rate of 7.8%, redeeming a fee that was starting at 12.13%.

In terms of our outlook, on Slide 20. Demand is expected to remain challenging, but included cost developments are fairly positive. Our European business will continue to benefit from the cost reductions and efforts we're putting in there. And as I said, we will start getting the benefits of these strategic interventions in our South African business. We expect our chemical cellulose business to continue to perform strongly. We are, however, entering our weakest quarter seasonally and historically, and we do have major shuts in our third quarter. Our guidance that our third quarter results will be in line with that of the previous year is on the conservative side, the soft side. We're working very hard to ensure that we do everything to actually have a better result than that.

For the full year, we're expecting operating profit, however, to be in line with that of previous years in minimum, and that we will have positive earnings. Now for that to happen, it means that fourth quarter will be significantly better than the third quarter but also better than the fourth quarter the previous financial year. And we're working hard to ensure that, that is indeed the case. We -- as to positive net cash generation for the year total, it was a reduction of debt. And as I've said before, we will consider refinancing our higher cost debt, including the 2014 bonds, when we deem market conditions to be favorable to do so.

In summary, I think I'd like to point out that we believe that Sappi is now becoming a much more competitive business. We're addressing our cost basis in all the areas. We've continued to do so specifically in Europe and in our South African paper businesses. We're really getting traction and seeing the results now through the income statement. We're consistently improving the quality of this business, and we'll continue to do so, with a very, very strong focus on improved margins, net earnings and the direction of shareholder wealth.

Thank you very much. That brings me to the end of the presentation. And me, together with my colleagues, from all our regions, will be quite happy to take any questions which you might have. Thank you.

Question-and-Answer Session

Operator

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

Caroline Learmonth - Barclays Capital, Research Division

Could you please comment on the maintenance shuts in more detail, that you're expecting in the third quarter? Which of the facilities are undergoing the maintenance shuts and in which geographies? And how big an impact are the maintenance shuts on your operating profit level versus other factors such as weak demand? And then, just finally, on the fourth quarter, you say you're hopeful of an improvement. It seems like from the guidance, that level of improvement may end up in fourth quarter profit, roughly at these second quarter levels. What factors are most concerning to you in terms of that fourth quarter performance? Again, is it demand? And again, in which geographies?

Roeloff Jacobus Boëttgerr

Caroline, yes. Thank you for the question. The shuts that we have are at basically at all the major pulp mills, including Cloquet. And Ngodwana specifically is a very large shut. At both of these mills, they are not only normal shuts, but they're also -- during these shuts, preparing for the tie-in of the 2 chemical cellulose projects, which will happen early in next year, which does have an effect on those mills. In addition to that, we have smaller shuts at a number of the European mills as well, but not as significant. But we cannot claim that these shuts have a much more significant impact on our results than what they've had last year. It is roughly similar to what has happened last year, with the exception of the impact of the preparation for the tie in of the chemical cellulose plant. Seasonally, it has been a weaker quarter for us. And I think it's on that basis that we are giving guidance. And far as demand and pricing is concerned, for chemical cellulose, demand is strong. And pricing is weaker than last year, no doubt about it, because NBSK prices are lower, and then the rand is also sort of at similar levels. But moving then on to paper demand. In the U.S., it is weaker than last year, there's no doubt about it, but that was expected, and prices are also weaker. However, there's just been price announcements in North America. Pulp prices in North America are moving up, and that will certainly help. In Europe, the overall demand picture is what we expected. It's not worse than what it was in quarter 2. Seasonally, it's not a great quarter, however. And pricing is fairly stable, if not tending to move upwards slightly under cost pressure at this point in time. Our South African paper business is perhaps the business under most pressure at this point in time, both in terms of demand, but also pricing. There's still various imports still into the market. The market itself is not great. So when we look at our business for quarter 3, we are not actually overly concerned about it. It is very much as what we expected, I think there is upside to it. It is unfortunate that when we have all this traction and we feel good, in fact, about the underlying quality of our business and the competitiveness that we have a blip like this. But we think it is a blip, an upside down blip, I suppose. But I hope that answers your questions.

Caroline Learmonth - Barclays Capital, Research Division

Yes. But just on Q4, is the main factor that you're worried about there, given that your maintenance shuts won't be impacting, is it really demand again in potentially U.S. and Europe and South Africa on the paper side? Is that what's keeping your expectations cautious?

Roeloff Jacobus Boëttgerr

Without that caution in quarter 4, we think it will be a reasonable quarter. And that demand will remain sort of where it was, not great demand. But actually we're expecting -- we're actually expecting a very reasonable result for all our businesses in quarter 4, with the paper business to start helpfully -- starting to improve as a result of all these actions as well. And indeed, for us to have positive earnings and an operating result that is going to be in line with the last year's, if not greater, then quarter 4 has to be a good quarter. It's difficult in very uncertain markets to be more bold than this. One just looks at the European environment, and who knows what will happen here? But we have a much more competitive business. We feel actually quite good about it. I can't give more guidance than that.

Operator

Our next question comes from Lars Kjellberg of Credit Suisse.

Lars Kjellberg - Crédit Suisse AG, Research Division

I was also somewhat confused about Q4, because that typically is your seasonally stronger quarter, but let's just leave it at that. When you're talking about good prospects to improve earnings going forward, what are you looking at, then? What factors? I mean, we -- your guidance for Q4, for whatever it's worth, is not necessarily seeing any sequential improvement versus the fiscal second quarter. You have this tremendous good cost improvement in the European business. How much more can we capture in that business? And also, if you want to remind us about your cost takeout that you have ongoing in South Africa; what sort of impact you expect that to have annualized in fiscal Q4?

Roeloff Jacobus Boëttgerr

In another word, we are confusing people unnecessarily at this point in time, just on the quarter 3, quarter 4. Quarter 3, we're guiding some of that to the last year, so a weak quarter on a conservative basis for a number of reasons, which I've explained. Quarter 4, we actually expect it to be a good quarter, better than last year's quarter 4, which was not great. And it has to be significantly better in order for us to reach the full year guidance. So we feel that quarter 4 will be a good quarter. And as I said, I can't give you more than that. So why do we feel positive about improving our business consistently going forward from here? What gives us that confidence is, first of all, that in Europe, we really have very good traction in terms of our cost reductions. There has been significant cost reduction, but we're not done yet. We have a number of projects to further take out both fixed and variable cost in our European business. We actually have good plans to deal with capacity, even if demand would go down further in European business, which we don't expect to be significant demand changes at this point in time. And we have further -- also, projects which we're working on, which will improve our service offering and product offering. So we're working on both -- on top and bottom line in our European business, but mostly, on the cost side of the business. In North America, it looks that the base where we're now coming from, certainly, we think we can get back to the 10% plus margin thing, where it belongs. Pulp prices are improving. We've had some technical issues, which are behind us in the North American market. We've announced price increases, as I said, as all the other places in North America. And demand is not great, but certainly not bad. It's in regions we've been looking at. So both European and North American business have an outlook, in our opinion, and possibilities that are actually quite -- they're positive. In tough markets -- we're not, for one minute, saying to you that we think that markets are all of a sudden going to be great. In fact, there is risk on the European side, in particular, through their economy. Chemical cellulose, looking forward, we are very positive about that. Our Saiccor mill is running very well. Our costs are coming down. Our quality is excellent. And the mark of our product is good. Where pulp prices will be going, nobody knows, but it seems to be edging up. Same with chemical cellulose, we're very excited about the 2 projects, which once they will come online, will add a whole new gross path and energy to our business. And we've got very good demand and commitment for those products. And you've seen that we've got 30% EBITDA for our Saiccor business. If we can have anything between 20% and 30% EBITDA for these increased volumes, it's very good and it will significantly add to gross for certain. Our paper business in Africa has been bad, and we envision that it will take time to really get to where we want to be with that business, but we're making progress. And every cent we squeeze out there is additional profitability and additional margin enlargement. That's on the operating side of our business. As I said, one looks at our finance cost, huge opportunity for us to reduce that going forward. And that -- now, once you've done it, it's there, and it remains there. And we're very keen to deal with our debt deals and cost of finance, and in fact, improving our whole maturity profile as far as the 2014 in particular is concerned. I think there's a number of areas that we feel we can squeeze out more out of our business. And none of that is pie in the sky, and most of it is, actually, to a certain extent, under our control. We need markets to be reasonable. I hope that helps.

Lars Kjellberg - Crédit Suisse AG, Research Division

It does. I just wanted to follow-up on the European side. Obviously, you took almost $100 million in cost takeout [indiscernible] Q2. Is there time for actually upping that $100 million target, or is that a target that's set for now? A second one, I just wanted to come back to the chemical cellulose. Obviously, there's a lot of talks about all the incremental capacity from all sorts of newcomers into the business. What are you seeing from them in your markets?

Roeloff Jacobus Boëttgerr

[indiscernible] You -- there was an interruption when you asked the question about the $100 million. If you're asking, is there a further portion we can take up? Yes, certainly there is. Will it be a chunk like another $100 million? No, certainly not. Are we taking the $100 million? Absolutely. Just to listen, perhaps, to somebody else's voice and view on this, I'm going to ask Alex to talk to you about the chemical cellulose, the -- how do we feel about it? Are we concerned about the new capacity and our cost versus what we see they're doing. Alex?

Alexander van Coller Thiel

Thanks, Roeloff. Yes, in terms of incremental capacity, our impression is that a lot less capacity than was announced 1 year, 18 months ago is actually becoming reality. Certainly, from our customers' perspective, we have completely full order books; as much as we can produce, we do so. And we don't see their demand actually weakening in the few -- in the medium term. And certainly, in terms of costs, we have now, after the expansion at Saiccor, we think we find out all the production issues and we're certainly seeing, coupled with very good production, significant reduction in variable costs, just because of production efficiency.

Roeloff Jacobus Boëttgerr

We still remain very confident that the 2 lines that we're bringing into production next year will match Saiccor in terms of its competitiveness.

Operator

We have a question from Nishal Ramloutan of UBS.

Nishal Ramloutan - UBS Investment Bank, Research Division

Can you just run us through any price trends in different grades? So is there any action to increase prices? And I think you did allude to that in the result presentation. And by how much and when and how likely do you think -- or how confident are you that they will go through?

Roeloff Jacobus Boëttgerr

I think -- yes, let me get -- Barry, maybe you say to us what you believe is happening in Europe in terms of pricing and timing of that. And then Mark, in the North American market.

Barry John Wiersum

Yes, it's the case that there have been a number of announcements in the media recently over price increases of woodfree products. We have talked of -- and we also announced a price adjustment, because we believe the prices went down too far. And in the light of increased costs, they need to be adjusted. Both pulp and latex and transport costs particularly, have been going up and prices outside the European arena have also been going up, and prices in Europe therefore are generally low. The general expectation is they'll move somewhere in the region of 6% to 8%. If you read other announcements, we have said that in our case, it could be up to around about 7%. It will depend -- it's very country and customer specific, so it's going to be a range. But we do expect prices to move substantially by the summer.

Roeloff Jacobus Boëttgerr

Mark? Barry, but perhaps you just want to comment on what you think for coated mechanical, the after fees. And then Mark can take the call.

Barry John Wiersum

On coated mechanical, I think the flat prices haven't moved since the beginning of the year. The cost pressures on coated mechanical are the same, but I think that's because prices in coated mechanical did not go down as in the same way as coated woodfree went down. I do not expect the same move on coated mechanical, although I do expect them to edge up slightly.

Roeloff Jacobus Boëttgerr

Thank you, Barry. Mark?

Mark Gardner

In regards to the paper side of the business, we have announced a $30 a ton price increase for the June 1 date, and we are busily accepting orders and working on that price implementation. We were also one of just about every player in the North American market to announce a price increase on flat. Our sheet side of our business, those prices are holding. They're bouncing around and potentially flat for the last couple or 3 quarters. And we don't expect that to change much going forward until we get into later in the year when demand may allow some changes in product. On the pulp side of the business, we have announced some price increases in March and April for pulp. That typically ran around $30 a ton, and we're in the process of implementing those on orders coming. And we're pretty optimistic -- hopeful on what we'll go through on that. We have been ordered and we have been part of announcing price increases in North American market on hardwood, as well as other players have announced in that -- in the same period of time. So we're encouraged that going forward, that prices should either stabilize -- continue to be stabilized, or start to go up slightly as the demand drives it.

Roeloff Jacobus Boëttgerr

Thanks, Mark. Alex, would like to comment on what you see in the South African market?

Alexander van Coller Thiel

Thanks, Roeloff. Yes. In the South Africa market, we are -- there might be opportunities in the white paper business, where -- office paper, where we do, and we are intending to take advantage of the increased demand. On the containable -- the packaging market, quite difficult environment. We do see increase in imports, and that does put pressure on our prices. To see what we can do to actually counter that, in terms of duties, that kind of thing, but it does stage that as a very competitive and difficult environment.

Roeloff Jacobus Boëttgerr

Thanks. And just overall, on pulp. Pulp prices seems to be edging up, that will be good for Saiccor. And currently pressure [indiscernible] on all our businesses and recent developments in terms of the rand weakening sightly is good news for us. But one can't speculate on that.

Operator

Our next question comes from Sean Ungerer of Avior Research.

Sean Ungerer - Avior Research (Pty) Ltd.

Just in terms of the net debt levels coming down to the $2 billion mark. When you said in the near future, would that be in the next year, or would that be more closer, the next 18 months? That would be my question [ph].

Roeloff Jacobus Boëttgerr

I would be very disappointed if it's not in the next year. We're working very hard to bring it down, and that's despite these 2 projects. I think we're now getting traction, in terms of a number of issues, which not only in terms of special projects to make us more profitable and generate more cash, our working capital management has not been bad. It's -- we're very tight on that. There's more for us to squeeze out there. There's no doubt about that. And there's a number of other levers that we're pulling in terms of this. And I think -- I am fairly confident that by next year -- before the end of next year, yes, you'll see us reaching those levels we communicated to you.

Operator

Our next question comes from Ross Gilardi of Bank of America Merrill Lynch.

Ross Gilardi - BofA Merrill Lynch, Research Division

I had a few questions. First, Roeloff, when you all finally get your net debt down to $2 billion and can reconsider the dividend, what kind of -- how would you think about it? What kind of dividend would you look to reinstate? Would you potentially just do a very small one just to essentially get back on the board? Or would you look to pay a -- have a dividend yield that is competitive with industry peers? And yields in the sector seem to be around 4% these days. So how will you think about that?

Roeloff Jacobus Boëttgerr

That's a very good question. And first of all, the debt level of $2 billion, we need to get our debt to below that level. $2 billion and lower is not where want to be. We're looking at the gearing ratio of our company, EBITDA to net debt. And we want to go further than the $2 billion, given where our EBITDA is right now. So we will continue chipping away at that debt. And we think in the not-too-distant future we will get to EBITDA-to-debt levels which we feel comfortable with, which from the 1.5 to 2x is really where we want to get to. And we're working and we will get there soon. In terms of dividend, I'm not going to, at this point in time, say to you when we're planning to buy dividends again. But, again, it's soon, in the near future. We're not going to stick our necks out and pay a mess of dividends and to get ourselves into a situation here with debt again. We want to be reliable and predictable in terms of payments -- of dividend payments. So it will probably start off being pretty conservative. And we would like to see our dividends grow and our profits grow, in terms of that. I can't give you more at this point in time. We hope to be able to communicate more clearly in the not-too-distant future, in terms of what we're planning, with regard to that.

Ross Gilardi - BofA Merrill Lynch, Research Division

Okay. That's helpful, Roeloff. And in terms of divestitures, do you have anything on a larger side? And when I say large, I'm talking $50 million-plus to get you to that $2 billion -- or below that $2 billion number, faster than you might otherwise.

Roeloff Jacobus Boëttgerr

Yes, there are potential. There are potential in terms of that, of assets. And luckily, I can also say to you that when we talk about that, it is not the kind of thing which would significantly change the face of Sappi. They include properties, they include issues like that. And -- one can't put a timing on these things. Buying is easy, selling is always more difficult. But I am convinced that we will be successful in sufficient amount of those actions that below $2 billion is very much in our sights and doable, and even below that, given a bit more time after that, to get to very respectable gearing levels. Respectable.

Ross Gilardi - BofA Merrill Lynch, Research Division

Okay. In your guidance, particularly the guidance for the September quarter, not to get too hung up on it. But is it -- to deliver profits -- operating profits roughly in line with 2011, does that assume that you get the paper price increases? Do you have to get the paper price increases to deliver that result? Or would that be upside?

Roeloff Jacobus Boëttgerr

I think that's upside.

Ross Gilardi - BofA Merrill Lynch, Research Division

Okay. Can you give us a little more clarity on what percentage of your new chemical cellulose capacity is contractually committed at this point?

Roeloff Jacobus Boëttgerr

I'm going to be very cautious here, because we are commercially in a stage where it's sensitive for us. We're talking to a number of customers, markets. We feel very confident about our Ngodwana site. We've said that for a long time. And we're making very good progress on all the others. If you ask me, am I concerned that we are going to produce a lot of pulp which we don't have very good customer base for at reasonable prices, not at all at this point in time. Now nobody can see -- and I don't want to sound overconfident and arrogant here, but we're not losing any sleep on this at this point in time. We feel very confident that we're going to have a very good demand and pricing for our products, margins I should say.

Ross Gilardi - BofA Merrill Lynch, Research Division

Can you give us any sense as to what type of operating rate you would be -- where would you be disappointed in terms of utilization within 12 months on your new capacity?

Roeloff Jacobus Boëttgerr

I would be very disappointed if it's below 75%, 80%.

Operator

Our next question comes from CJ Baldoni of Principal Global Investors.

CJ Baldoni

Could you update us on the evolution of your capital expenditures, please?

Roeloff Jacobus Boëttgerr

I can -- and pretty exactly what we're seeing going forward is high capital expenditure during this year and next year, in the order next year of $550 million. Then going down quite significantly over the next 2, 3 years. And we're looking at ongoing CapEx from then on between $300 million, $350 million, both -- and that includes all CapEx going forward.

CJ Baldoni

I'm sorry what was that?

Roeloff Jacobus Boëttgerr

With that -- after next year, around about $300 million. I would say between $275 million and $350 million going forward after next year. Next year will still be high as a result of these 2 projects. So next year, we're looking at about $500 million, $550 million, not being significantly -- to between $275 million, despite that, we believe we can reduce our debt significantly.

CJ Baldoni

So does that mean that this year, you won't hit, like the $425 million that, I guess, you previously talked to?

Roeloff Jacobus Boëttgerr

No, we will. We think in the region of $450 million for this year, $550 million for next year, and then dropping down significantly.

Operator

Our next question comes from Kevin Cohen of Imperial.

Kevin J. Cohen - Imperial Capital, LLC, Research Division

I'm wondering if you could talk a little bit about mergers and acquisitions activity. And is that, at all, a priority for Sappi, if there were some opportunities that come up in North America in the coated market or also as well in Europe?

Roeloff Jacobus Boëttgerr

We have consistently said that we are open minded, that we -- certainly, if there's a possibility of doing a deal that will add real value to Sappi, we would certainly consider that. And particularly the paper markets, more needs to be done, and more is going to be needed going forward to ensure that we produce reasonable profits going forward out of our business. What we feel very strongly about is we're not going to increase our gearing or put pressure on our balance sheet by doing deals in the paper side of our business, or in fact, any part of our business, but particularly in the lower-margin businesses. But we're open minded. We're not hung up in terms of who we deal with or how we do that. But we've got real traction, in our opinion, to have a business of a better quality. If a deal could add further to that, we're open to it. Our paper businesses are really producing good cash now. We think we have attractive businesses -- more attractive, I should say. In the U.S., certainly attractive. In Europe, much more attractive than it's been. Are there any pending deals or things that we can think about -- or that we're busy thinking about at the moment? No, but we're open-minded. And I think in time to come, deals will happen.

Kevin J. Cohen - Imperial Capital, LLC, Research Division

That's definitely very helpful. And then, I guess, you might've touched on this a little bit earlier, but when you look at the commodity end of the dissolving pulp arena, do you have a sense as to perhaps what percentage of the original capacity that was expected to come on between 2012, 2014 -- do you have a sense as to perhaps what percentage has been delayed or outright canceled at this point?

Roeloff Jacobus Boëttgerr

Difficult to say, because you don't really know what other people are doing. But certainly, if we look at people who are actually breaking ground and really constructing and going ahead, it is a lot less than what has been talked about before. Pulp prices have come down very nicely, which is good for us, because -- and I think, people and companies looking at bringing capacity to market on prices of VSF, and the $2,500, $3,000 a ton was just simply unrealistic. We're happy with the prices where they are; we are making very good margins. And many of the announced additional capacities simply cannot make money at that -- at the level where we are happy with now. To put a percentage to it would be very difficult, but certainly, I think, a fair amount of projects are no longer being talked about; it's just gone quiet. I cannot -- and don't want to branch into saying to you what capacity or percentage it would be.

Kevin J. Cohen - Imperial Capital, LLC, Research Division

And what have you seen in terms of spot prices for commodity dissolving pulp? We've heard some anecdotes around USD $1,100 a ton, plus or minus, kind of stable. What are you guys seeing out there, broadly speaking?

Roeloff Jacobus Boëttgerr

That's not unusual to see that kind of pricing now in the spot markets, a bit higher sometimes, and even lower. It's volatile, and it's very small volumes. So I don't know what -- how much one can deduct from that, other than prices are down significantly from where they were. We've been less affected by that. As you know, we work on NBSK link [ph] pulps for a large proportion of our production, and we're happy with the prices where they are. Well, happy -- a high price is always better, but we're very comfortable, and we're very comfortable with our margins at these sites. And I think, perhaps, in the next year or 2, we won't see in our opinion, these massively overpriced spot peaks, and we're comfortable with that.

Kevin J. Cohen - Imperial Capital, LLC, Research Division

That's helpful. And then one last question. When you look at China, what's your sense in terms of the net excess capacity in coated papers there? I mean, at some point, it has to find a home, whether it's in Europe or North America or domestically. But what's your sense in terms of the net excess capacity in coated papers there?

Roeloff Jacobus Boëttgerr

Kind of difficult one. What we do know, it's reducing -- Barry, you're studying that and looking at it very often. What's your sense on this?

Barry John Wiersum

My sense is that the Chinese have announced further completions of old capacity. The market is still growing, although it's growing slower. There is much less new capacity coming on now in China. So the capacity will start to find a home closer to China -- or in China or close to it. Also, they have cost inflation too. It's not quite so -- the difference is not quite so big as they were in the past. So in my sense, I see the Chinese over-capacity still going on for another 2 years. But in another 2 to 3 year's time, I would expect that to be balanced out.

Operator

Our next question comes from Nitin Dias of JPMorgan.

Nitin Dias - JP Morgan Chase & Co, Research Division

My question with regard to Europe -- so can you just remind us how much of the $100 million of cost savings did feed through in the second quarter and how much came in Q1? And what is the exit run rate of those cost savings at the end of Q2?

Roeloff Jacobus Boëttgerr

We are at the run rate of $100 million per annum, if not slightly bigger.

Nitin Dias - JP Morgan Chase & Co, Research Division

And how much was it -- did you get about $25 million in the second quarter in your results, in the European results, or was it less than that?

Roeloff Jacobus Boëttgerr

We said the same thing at the end of quarter 1; we said we're hitting the run rate, and we're saying that now. So yes, it's roughly, roughly -- we're achieving that. And it's not exactly $25 million per quarter. The quarters are longer or shorter. But we have that run rate.

Operator

Our final question comes from Nishal Ramloutan of UBS.

Nishal Ramloutan - UBS Investment Bank, Research Division

I'd just like some more things from the outside. Just in terms of return on capital, I see you obviously went above the 13% in Q2. What are you targeting on a long-term basis, especially post the chemical cellulose investment? So that's the one. And just from North America, you talked about getting margins back to 10%. Can you shed a bit more light in terms of how you're going to do that? And does that include the chemical cellulose investments? So is it post chemical cellulose investments that you're talking about there?

Roeloff Jacobus Boëttgerr

We have said that our target -- the last -- officially committed that the targets for return on capital were put at 12%. We think that's actually too low. We're not officially setting any new targets, but certainly, probably still low. And we'll be looking at setting ourselves new goals and communicating that too. But certainly, you can take it that it will be, clearly, higher than 12%. The North American markets -- margins of double digits, 10% and higher, is not based on the chemical cellulose. It's just restoring margins to where they were for a long time. And the big driver there will be pulp. Pulp price has been very low. And we've had some reduction issues also in the pulp side. So the North America margins could very quickly come back to the 10% plus level. When I said very quickly, certainly by the end of the financial year, hopefully earlier than that. Once we're up and running and the chemical cellulose plants are running full and settled down and all that, here we're talking about 20% plus margins for those businesses. And that will certainly have a good effect on North American, and in fact, South African margin.

Operator

We have no further questions. Gentlemen, would you like to make some closing comments?

Roeloff Jacobus Boëttgerr

Nothing, other than thank you very much to everybody for your interest in our results and for calling in. On behalf of the Sappi team, thank you.

Operator

On behalf of Sappi Limited, that concludes this conference. Thank you for joining us. You may now disconnect your lines.

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