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Sappi Limited (NYSEMKT:SPP)

Q3 2012 Earnings Call

August 03, 2012 9:00 am ET

Executives

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

Mark Richard Thompson - Chief Financial Officer, Executive Director and Member of Group Executive Committee

Mark Gardner - Chief Executive Officer, President and Director

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

Analysts

Caroline Learmonth - Barclays Capital, Research Division

Campbell Parry - Investec Securities Ltd., Research Division

Lars F. Kjellberg - Crédit Suisse AG, Research Division

Nishal Ramloutan - UBS Investment Bank, Research Division

Operator

Good day, and welcome to the Sappi Third Quarter 2012 Results Conference Call. [Operator Instructions] Please also note that this conference is being recorded. I would now like to turn the conference over to Roeloff Boettgerr. Please go ahead, sir.

Roeloff Jacobus Boëttgerr

Thank you very much. Very good morning, good afternoon to you ladies and gentlemen. Thank you for joining us for our quarter 3 results presentation. I'd like to draw your attention to Slide #2, the forward-looking statements and Regulation G requirements.

Moving then on to the summary of the results, operating profit excluding special items at $60 million, which is in line with the guidance we've given and also exactly the same as the operating profit for the corresponding quarter a year ago. Market conditions deteriorated during the quarter particularly in the European area. Importantly, we've extended the maturities and lowered our finance cost from the refinancing of the 2014 bonds. That came with the once-off charge of $89 million, the main reason for the negative EPS during the quarter. We did have the impact of the planned annual maintenance shuts at our major paper mills, which is a seasonal factor as communicated to you prior to the quarter. Both our chemical cellulose expansions remain on track in terms of both budget and timing.

Moving on to Slide #5, the financial summary. I think what's important to our like year is the fact that volumes were down slightly on a year-to-year basis but not quarter-on-quarter. In Europe, YoY volumes were down year-on-year about 7%, volumes for our pulp businesses were very good, particularly for Saiccor. But on the sales line, you see quite a significant drop quarter on quarter, as well as year-on-year, that was mainly driven by the exchange rate effect converting euro and rand sales into dollars. But those also affected by lower pulp prices and also paper prices for certain grades of paper in addition to the volume, I think.

EBITDA down also quarter-on-quarter, mainly as a result of the special market conditions and with also the effect of the flat [indiscernible] negatively impacting the EBITDA. I did discuss the earnings per share, $0.20 mainly affected by the once-off finance costing, effect that $0.20 you see there although ratios following the same things as well are meant to be.

Moving on to Slide #6, operating profit excluding special items, the paint [ph] in line with the previous year of actually $60 million and moving on to the EBITDA rate, slightly lower than the previous year mainly as a result of these better market conditions and the effect of the flood at Cloquet.

Looking at earnings, Slide 8. As I mentioned before, the $0.20 loss largely as a result of the $0.17 related to refinancing, but then also the price fair value adjustment of our operations [ph] amounting at $0.03, bringing it back to a $0.01 positive if you exclude those one-off charges.

Looking at our divisional overviews, I think the divisional margins, all of them coming down as expected, the result mainly of the shuts but also being a weaker quarter. All our businesses we expect those margins to move back to more tentative [ph] levels even in the quarter to come.

Quick overview of our European business on Slide 11. Our volumes were down sequentially due to seasonal factors and the planned maintenance shuts and our sales volumes down 7% year-on-year but all our profitability matrices has improved during the quarter. Average sales prices were higher than the last quarter. It was helped by the weaker exchange rate in terms of our export sales and that also relieves a little bit of pressure in the domestic European markets. Variable and fixed cost reductions achieved in the last year is critical in us achieving the results we did and we're on track to deliver on that $100 million saving year-on-year in our European business.

Moving on to the North American business, Slide 12. Industry conditions certainly were tougher but our coated paper sales held up very nicely in that market despite fierce competition. The pulp markets unfortunately quite weak mainly in terms of pricing, which did affect our North American business and the Specialty business also experiencing quite tough trading conditions, particularly at China with the mods not having been that we were used to over the last year or so.

We had a severe flood at the Cloquet mill which took the mill out 7 days. Some of you visited that mill in fact 10 days before that flood occurred. I'm happy to report that the mill is back at full operation with no serious damage to the mill whatsoever.

On the South African side, again 2 stories: Excellent chemical cellulose production at our site global. The average NBSK prices were slightly higher than the previous quarter, but most definitely quite a lot lower than the previous year. That was accounted to a large extent by the weaker rand in the last quarter. So we made an excellent EBITDA margin of 30% translating into nearly ZAR 500 million of EBITDA during the quarter. As a result of pulp prices edging downwards at the very good operating rates, we did postpone the shut of the one line at cycle to the quarter, in which we are now. That shut is done very well and we end up starting up a bit off that line, at Saiccor.

The Paper Packaging business is still underperformed. Better than the last year I might add, we are getting the benefits of the restructuring cost reduction exercises but market conditions may end up with demand being quite a lot lower, particularly in the packaging area, and also fierce competition from -- in imports. Also important to notify you that in terms of our annual wage negotiations in South Africa, which last year led to a stop and last for 3 weeks have been finalized and we've settled with labor earlier this week, so thereby eliminating the risk of a strike during this year.

Looking at our strategic focus areas, Slide 15. Very important for us to maintain the excellent production rates, customer service. Cycle events indeed happen during the last quarter. We remain sold-out and looking forward to continue to good operating rates at volumes. We're making very good progress in finalizing contractual commitments for the capacity we're bringing on at both the Adamas and [indiscernible] mills and that puts us in a good position particularly given all the capacity coming to market. Talking about those 2 projects, they're both on schedule in terms of -- and our target in terms of both timing and budget. There's some CapEx and we hope still confident that both those mills will start to use chemical sealers [ph] in the third quarter financial books of next year.

Moving on to Europe. We are confident that we will see further improvements in our cost base in our European business to improve our competitiveness in Europe and the weaker euro is also assisting that business in making it more competitive in terms of exports.

In North America, working very hard to restore our margins to more like 10% levels with pulp prices still remaining low that continues to put pressure on us, but our paper businesses doing very well, all those running very efficiently following the shuts. We continued to squeeze out the benefits of the restructuring in our South African paper operations and that is accelerating now, which is seeing more of that coming through in the first quarter, but market conditions remained weak at this point in time as far as the market's concerned.

In our debt situation, we remain fairly committed to reduce our debt even further. We've made very good progress for the sale of nonessential assets that boosts our cash generation and therefore reducing debt and I'll talk about that just now. If you look at the net debt development on Slide 17, a good time was for the finishing [ph] debt increasing ever so slightly and mainly as a result of the volumes of cash cost related to the refinancing and a weaker operating quarter. We are confident that when we look at this slide at the end of this quarter that debt bar for the quarter would get to the $2 billion, if not slightly below the $2 billion mark for the first time in many years.

The debt refinancing Slide 18, I think most of you are aware of the successful refinancing of the 2014 bonds, which came in at a of cost of $89 million, $44 million of that was non-cash, $45 million of it cash but fortunately, most of the cash cost that we incurred there would be recouped through the unwinding of swaps now in this fourth quarter of around $36 million, which has worked out very well for us indeed. The new bonds will lead to interest charge reduction of $45 million per annum and a cash saving of $30 million per annum, a very important progress made there.

Importantly as well, if you look at Slide #19, we substantially improved our maturity profile. Going forth with this nearly $800 million maturities during this 2014 half having been taken care of and the maturity profile being as close to ideal as one could get at this point in time, I think, given where we're coming from with no large maturities due out for 2017 and even then, very manageable going forward.

Moving on to the outlook. Market conditions as you all know, are tough, and there's little visibility. And we expect them to be tailing weak and weaker than a year ago with lower volumes from most of our products and some pricing under pressure. In Europe, however, we expect to maintain the pricing momentum that we've had in the third quarter to [indiscernible] into the fourth quarter, current mechanical [ph] under pressure. Stock prices remain fairly under pressure, trending downwards this point in time and [indiscernible] with the repression of our pulp businesses.

The current U.S. dollar, the state of the euro and the rand, overall, is favorable to our business, putting a bit of pressure on our North American business but that the low-cost tightly managed business, which can deal with it. Our Saiccor productions remains sold out and both conversion projects are safely on track with very good progress towards securing long-term supply gains for those businesses.

The benefits of the refinancing will start flowing through in the fourth quarter. And we're also moving into a quarter that is seasonally stronger than the third quarter. Given that, we believe our fourth quarter operating profit to be higher than the equivalent quarter last year, which was $80 million but for the full year to be slightly weaker than last year. That guided to actually raise our debt [ph], which you can calculate. We also expect positive earnings per share for the full year.

Cash generation is expected to be strong in this final quarter of the year, both from operating point of view, but also starting to get the benefits of our strategic actions to sell non-core, nonessential assets. As far as that's concerned, there's a $63 million in the bank for the sale of the Biberist property as well as the Adamas property in New York and potentially more during this fourth quarter that will hopefully get over.

In summary and conclusion, we remain confident that the actions that we've been taking in our business in terms of cost strategically positioning the company and making us a lower-cost producer, as more nimble will result in this business much greater position for growth. Our margins are improving and we'll continue to improve, and we feel confident as well that despite the fact that we now are accelerating with spending on these 2 expansion projects into the next financial year that we'll be able to reduce our debt while completing these projects on time and on budget.

Thank you and we, together with Martin, we'd be happy to answer try our best to answer any questions 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

First of all, just in terms of costs and underlying profitability in both Europe and South Africa, can you confirm in terms of disappointing performance in the third quarter, in Europe it was really a volume issue and in South Africa, presumably challenges on the paper and packaging side, which presumably a loss-making at the moment. And the second question is, can you just confirm you're still tracking your previous guidance, you're tracking in line with your previous guidance for European and South African cost savings? And then finally, what will be the impact in terms of volumes and potential profit. In terms of the closure, the plant closure of Saiccor in the fourth quarter?

Roeloff Jacobus Boëttgerr

Caroline, yes. The performance in both the South African and European business were not at the levels that we would like to see them. We expect that weaker performances [indiscernible] the shuts but at both these operations, we had volumes that were lower than what we expected. In Europe, year-on-year 7% down. From a cost perspective and I'm talking Europe first, we absolutely went on target with $100 million. It was slightly than that, tracking that for this year. If it wasn't for that, it would have been a different story in the European business. From a pricing point of view in Europe, current wood free prices improved but current mechanical prices were weak. So it was -- and apart from the shuts and the fact that seasonably a weak quarter, the weakness in addition to that, was certainly a volume issue in terms of the mod [ph]. In South Africa, exactly the same things there. We were at pressure of volume loss. The bulk was lower than what we expected, particularly for our packaging papers in South Africa. Pricing is more or less what we expected it to be but very strong competition from April and in the lower demand in the domestic markets particularly in the agricultural side. As far as cost savings are concerned, the cost savings as a result of the restructuring in South Africa was slower to materialize than what we initially expected but we did communicate that. It was the result of an agreement reached between us and labor, which postponed it by a month or 2. But we are on track to achieve that in this financial year store. Markets, however, remain fairly weak. The cost of the shepherd [ph] was postponed at cycle. I need to point out that it's the shut of only one line. That is not very significant and that the effective in the fourth quarter is now lower than what it would have been in the third quarter as a result of pulp prices coming down. And we've been operating the part of the mill that can be shut and the rest of the mill very efficiently. So it won't be a significant effect that we see in the fourth quarter as a result. Depending on what you see significantly but certainly, not tens of millions of dollars.

Operator

Our next question comes from Campbell Parry of Investec Securities.

Campbell Parry - Investec Securities Ltd., Research Division

Starting off first thing in Europe. Just looking at sort coated wood free and coated mechanical operating rates industry-wide, it seems to have been sort of 2 different things, with wood free operating rates on average rising to about the sort of 92% level, with mechanical operating rates in the industry dropping to about mid sort of 80%. Where would you say you guys are in relation to that especially in the coated mechanical case? And then in North America, you mentioned when you were out there that you're expecting a modest increase in prices for the second half, and given that your prices Q3 over Q2 looked pretty much unchanged. Do you can get -- do you think you're confident of an increase in Q4?

Roeloff Jacobus Boëttgerr

Well as to relevancy, I used to talk about it. [indiscernible] get the effect of pulp prices however. I'll give you Mark to comment on those operating rates and get involved on the pricing in North America.

Mark Richard Thompson

Yes, in terms of operating rates, Sappi for the wood free coated side is broadly in line with the industry, perhaps slightly above because we did some more closures. So this sort of 90% -- 92% is about correct. Our information for quarter 3 of the industry operating rates for mechanical coated is nearer 90% than your mid-80s and we were slightly higher than that.

Mark Gardner

In North America, we announced back in the end of Q2 coming into Q3, a price increase in our wet grades and as many in the industry did. Also, pricing is lowest factor supply and demand. And demand has not been strong enough at this point for us to implement that price increase.

Operator

Your next question comes from Lars Kjellberg of Crédit Suisse.

Lars F. Kjellberg - Crédit Suisse AG, Research Division

Couple of questions, I should say. Starting with the new contracted business. Can you sort of elaborate where you stand today in terms of share or volume that you have contracted. And just, if you can, share this sort of -- obviously looking at an NBSK link or a new formula for that. Why don't we start with that question first?

Roeloff Jacobus Boëttgerr

Definitely. Yes, I had to give you some more information. Obviously, we gave fully what we can disclose also from the customer point of view. As far Ngodwana is concerned, which is the one we started with first, we are where we want to be in terms of long-term contracts, which means [indiscernible]. We deal with, finalized and we're really looking forward to produce and deliver. The vast majority of those contracts are on the same basis as what we started, begun at Saiccor. In other words, NBSK-linked. There are other smaller contacts, which we do on purpose in a different fashion. As far as Cloquet is concerned, we are much further down the line in terms of finalizing context for that capacity than we actually anticipated at this point in time. And the majority of that is also NBSK-linked. But we have added new customers to our customer base through this increased capacity which is quite exciting to us and allowed us to look at how we deal differently. But in short, [indiscernible] a large proportion of that has already been taken care of and we are presently surprised with how far we are at this point in time.

Lars F. Kjellberg - Crédit Suisse AG, Research Division

What are you seeing from your competition? You're obviously talking about the excess capacity building. Are you seeing any sort of change in behavior from your competition as you seemingly are gaining market share quite meaningfully from -- with your new volumes? And another unrelated question, given that we're now seeing market pressures coming through and in particularly in Europe, are you starting to engage in any new material cost savings program to mitigate the top line pressures?

Roeloff Jacobus Boëttgerr

The issue of competitive behavior, we have a very focused approach to the market with our capacity. We're working extremely closely with our customers. I think having had this very long relationships, working closely with them on a technical basis and a quality basis, it does give us an advantage. But perhaps the most important factor here is that we are a low-cost producer and all 3 regionals would be at the lower end of the cost curve. I certainly believe that with where pulp prices are at the moment, as pulp as well as NBSK no matter how you look at them, is putting tremendous pressure on a number of these operations. And I think we have enough income now. We have seen some cancellations off capacity coming to market and you need to be competitive if you want to gain share and gain customers in the market like this. So I can't speak for the competition, but we're fortunately, in this business, in a position where we can set it around [ph]. And as far as further cost reductions, we would view that market conditions will remain challenging and not only in Europe but each one of our businesses. We are launching additional programs to further reduce cost that you might want to talk about that should service centers in Europe, which we believe promising. In North America, there's continuous improvement in all areas of cost reduction and in South Africa but it's not only related to people. A lot of it is related to process, score to logistics and [indiscernible]. Barry, I don't know if you would like to elaborate [indiscernible] particularly with the process in Europe.

Barry John Wiersum

Yes. very briefly, we are starting a new shared service center in Kraków, Poland. That will open in the autumn. It has been planned and it's now being announced internally. We shall be moving certain parts of our overhead activities over there. From then on, that will take place over period of perhaps a year. And that we expect that to be something that's -- develops over successive years. Secondly, we have a new program on continuous improvement and Six Sigma, which we are launching throughout the company, continuous improvements in there. For a long time, we're extending that. And now thirdly, in terms of variable cost, this goes in waves. We had a major wave, which has been completed at the middle of the year. And a new wave is starting now. So the answer to your question is, yes, most assuredly there will be significant further cost savings.

Lars F. Kjellberg - Crédit Suisse AG, Research Division

Can we put any numbers to that at all? What should we expect within, say, 12 months, 18 months?

Mark Richard Thompson

It's on a bit early for that.

Operator

[Operator Instructions] Our next question comes from Nishal Ramloutan of UBS.

Nishal Ramloutan - UBS Investment Bank, Research Division

Just in terms of Europe, do you see any further closures that are actually necessary to turn to the market and do you intend to also contribute to any of these closures?

Roeloff Jacobus Boëttgerr

We've contributed handsomely to the industry [indiscernible] in all areas, I have to add, in the last 3 years. But in South Africa and in Europe and just a year or 2 ago in North America, we made a dig here and will still believe that we will continue to do what is right for Sappi. And if the right thing for Sappi shows further capacity in order to improve our business, we will do so. The issue with South Africa is always that it turns in at the wrong time. You do it in favor or the beneficiaries are your competition, more so than yourself. If you do it at the right time, where you can retain your customers and reduce your cost, then it makes absolute sense. We have a plan in place that should the market move in certain directions, we would certainly move and implement further closures. Whatever it takes for us to get to the margins and efficiencies, the profitability of our businesses, we will do. So we're ready to do what we need to do. And as far as industry action and consolidation is concerned, we now record for a long time now that we open to participate on the basis again that there would be a benefit for Sappi more so than those who don't participate.

Nishal Ramloutan - UBS Investment Bank, Research Division

And just going to South Africa, I mean would you venture a number in terms of how much of the cost savings you've realized already, and maybe just an update in how much more you expect to achieve? And just if the tough conditions continue in South Africa and obviously, outside of chemical cellulose, do you foresee that you'd need to do any additional actions besides those already identified in this cost savings review?

Roeloff Jacobus Boëttgerr

We did communicate that we were talking about $30 million, $35 million per annum savings. We did also say that they're coming in slightly slower than expected. By the end of this financial year, we will get that run rate, no doubt about that. Is that enough? That's a good question. It depends on what happens in the market and the market is not good at the moment in terms of volumes. It's weaker than what we thought. We do have an alternative plans and if it continues to be weak, we certainly will do more to further lower our cost base in addition to the continuous actions on our business. We don't have any specific plan at this point in time. But if market conditions continue like this, we will have to -- we have no choice but to do so. That's applicable for all others.

Nishal Ramloutan - UBS Investment Bank, Research Division

And just in terms of wood costs, what are you seeing across the regions?

Roeloff Jacobus Boëttgerr

Wood costs in South Africa, it's basically flat. It varies. I think with -- and it's still for all our businesses, to be really honest. We see input costs in general. The market continuous to be fairly weaker that it is now, we see a threatening in all of our input cost. Energy is not an amazing [ph] per year at the moment other than in South Africa. Chemical costs have flattened. Pulp prices are all coming down. And there's a one at least, these are good news in a better market, is that generally, we'll make an obviously conservative [indiscernible] input prices. Also like, we're more efficient than we used to be.

Operator

Our next question comes from Shane Ashikara [ph] of Schroders.

Unknown Analyst

My line is really, really bad. So did you say you expect your net debt to come down to $2 billion at the end of your Q4?

Roeloff Jacobus Boëttgerr

We indeed did. Yes.

Unknown Analyst

Right. So I'm you guessing working capital reversal will be part of this improvement?

Roeloff Jacobus Boëttgerr

Yes. Working capital certainly will be also an improved operating profit and thirdly, the benefit of the assets found, which are already advanced $63 million but perhaps more. And we've referred to interest rate swaps, which we're underlining, which could bring in $40 million.

Unknown Analyst

Right, okay. On working capital, assuming the prices stay where they are for pulp and for your products, do you have some sort of rough estimate how much reversal you expect in Q4?

Roeloff Jacobus Boëttgerr

Well, it's not 100, we'll be very disappointed.

Unknown Analyst

And going back to that $2 billion figure of net debt number, if I remember right, that was kind of your target to be below $2 billion. Now that you reach that, are you comfortable with these levels or [indiscernible] still remains as a focus area for you guys?

Roeloff Jacobus Boëttgerr

Absolutely, it will remain a focused area. We set ourselves a target to achieve that by the latest end of 2013. We think we'll get there before that, but it will go up slightly during next year as we speak on these 2 projects. And well, we think we made around $2 billion for the next year, just hopefully below that depending on exchange rate and so forth. But that's certainly off the level which we're targeting in the longer term. We would like to bring that further down. We've said that all along. We would feel comfortable, on these comps feeling good and comfortable about it given where we are at the moment at below the $1.8 billion or even a bit lower than that. So we'll remain a very, very serious progress here. We look at it really in the longer term as debt to EBITDA and we'd like to choose that below too.

Unknown Analyst

And further disposals will be part of this plan or you think you're down with disposals so far?

Roeloff Jacobus Boëttgerr

No. We hope to have more disposals. None of them are massive but we -- the effective 50 million -- 50 million today, that will add up, will continue to look at that as well. Working capital will remain a very important area as most important of all. Cash generation to operate with cash flows.

Operator

Gentlemen, we have no further question. Do you have any closing comments?

Roeloff Jacobus Boëttgerr

No, just other than thank you very much for taking the time and your interest in our company. We appreciate it. Thank you.

Operator

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

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