Sappi Limited (SAP) Earnings Call Transcript

[Operator Instructions] Please be advised today's conference has been recorded. I would now like to hand the conference over to your speaker today, Steve Binnie, CEO. Please go ahead.

Thank you, operator. Good day to everybody. Thanks for joining us. As always, I'll go through the investor presentation, calling out the page numbers as we move through, and firstly, just on page 2, just drawing your attention to our statement on forward-looking statements or guidance on forward-looking statements. Page 3 is the key numbers for the year. These are annual numbers. And a lot of this we've talked about in previous earnings calls. It was clearly a challenging year where we had significant headwinds, markets being under pressure, and a lot of impact coming through from cost inflation. A lot of that was linked to the war in the Middle East. At the same time, we had adverse movements in exchange rates, which had a major impact on the South African profitability. Having said that, there were positives and they did gain momentum as we moved through the year. DWP prices, which initially came off, and we'll see it on a later slide, initially came off but then subsequently strengthened in the latter part of the year. Very pleased with the progress of the ramp-up of the volumes coming out of our Somerset PM2 mill, which was a big investment for us. Initially, obviously, as you know, started a little bit slow, but picked up momentum. And by the time we got to the end of the year, the machine, at the speed it was operating, was full. We didn't have to take any downtime. So as we move into the new year, we will be speeding up the machine further to give us additional volumes. So packaging volumes increased, I'm very pleased with that. One other thing to call out, the negative movement in the HGV, the stronger rand did have an impact on our forestry fair valuation, which obviously has to go through the P&L as well. Moving to slide 4 is our earnings bridge, comparing the year to last year. We've done it in a different format to previously because we thought this was a better way to explain the key drivers behind our performance. And we focus on the key drivers or influences to our results. You can see, I'm not going to go through every bar, but you can see that the pulp price had a major impact year on year, albeit did recover in the second half of the year. If you look at the year as a whole, a major negative impact. And similarly, even in the paper segments, both on packaging and graphics, a negative impact. You do get the benefits from the higher packaging volumes coming through, but other negatives, graphic papers would be no surprise to you. It does decline the volumes each year. But the currency shifts predominantly, obviously, the stronger dollar, which had a major impact on our rand costs, but also on the euro as well. It had some impact there. And then the delivery costs, which is the shipping costs, the higher oil prices coming through, and then similarly, non-variable costs, the higher chemicals, the higher the impact, once again, linked to higher oil prices as well. But not just chemicals. In Europe, we've seen higher wood prices come through and energy prices overall globally under pressure. We did a lot of great work on saving costs, but clearly not enough to mitigate all the impact that are here, and that's what gives rise to the lower EBITDA that you see, the 294 million. Turning to page 5, the quarter itself, I'm pleased to say that the quarter was better. Still many pressures, but the pressures have shifted. Our market conditions, we are starting to see improvement coming through. Dissolving pulp is better, the packaging markets are better. In the U.S., in SBS specifically, market has tightened, less supply, demand going up. We have seen selling prices increase significantly, and further increases have been announced. So the market conditions for the packaging in the U.S., specifically SBS, are better and we are more optimistic in the year ahead. And that will obviously be supported by higher volumes. But it's not just there. Globally, packaging markets are starting to rise. You've seen containerboard prices in Europe follow the U.S. upward. And we think that can have a positive impact here in South Africa as we move through the new financial year. I'm optimistic that there can be benefits there coming through. So all in all, packaging is better than when we spoke 3 months ago. And graphics, no surprise, you do have your annual decline in volumes, but a strong focus on cost discipline to ensure that the margins remain reasonable and obviously proactive management of capacity helps us there as well. And then slide 6 has the same earnings bridge, but on the quarter, and you can see there that the main drivers that I talked about, you're seeing pricing benefits come through on the pulp starting to come through. Then similarly, a little bit on packaging, but clearly more to follow. The volumes coming through, but offset by the currency and the higher fuel and chemical prices, good savings on fixed costs, ultimately giving us the 99 million. So to summarize, still headwinds out there. It's predominantly linked now to the higher costs associated with the war in the Middle East. Market conditions are better than when we previously talked. And just to show you evidence of that, slide 7, the first is dissolving pulp. You can see since the beginning of calendar '26, we've seen a progressive improvement. Just to remind you, there is a lag impact on that, but market conditions have improved. There is a healthy underlying demand for fibers, viscose, downstream inventories are relatively low. Ironically, the exchange rate movements do support pricing as well, and we've seen DWP prices continue to rise. At the moment, today it's $924 a ton. And you can see on the right-hand side fiber prices going up as well. Then turning to slide 8, which is another big earnings driver for the year ahead, the Somerset ramp-up, really pleased with how things have gone. We've been able to secure more volume, gain market share, like we promised, and as I said, we ended the quarter with our machines full, record volumes, you would expect record volumes as you ramp up, but very proud of what we achieved. And in the year ahead, as I said, the machine is now full. It's about increasing the speed and getting all the efficiencies associated with all of that. And then on the pricing side, the first price increase has been realized at the end of the quarter, and you'll see the benefits in the quarter ahead. We've now announced two further increases, not just us, the whole market. And like you've seen with the first increase, it does take a little bit of time to be realized into our numbers, but we are optimistic about achieving those price increases. So all in all, and by the way, the other thing I should say is that there has been significant capacity coming out of this market. So we're feeling a lot better in the year ahead and you'll get the progressive improvement, higher volumes, higher pricing. Slide 9 has the graphics markets. U.S. underlying demand does continue to decline just like Europe, but because capacity has come out, the market balance is better. You see relatively stable prices coming through. In Europe, a little bit tougher because of the excess capacity. We did get a little bit of an increase earlier in the year. And we have announced price increases in recent weeks, but it's more difficult. Nevertheless, we are focused on recovering the higher costs. Slide 10 just shows our main categories of costs. We have seen the headwinds of the higher chemicals coming through, delivery costs, and in Europe, yes, higher wood costs coming through in the energy as well. Look, most of that is in the base, the one headache, the immediate headache at the moment, as I've talked about, is in the higher elevated oil prices, and that's what is it we've put into our outlook statement that we will talk about a little bit later. To slide 11, two specific costs, and it's mainly impacts on South Africa, has been the sulfur prices, which have risen dramatically. It's a slide you've seen previously. And the impact of the delivery costs. Just South Africa, you can see roughly about ZAR 400 million each on the year's earnings. So a significant headwind. Next slide, 12, which is our net debt leverage ratio, obviously with the lower earnings, our leverage levels do go up. I'm pleased with all the initiatives that we put in place that we've managed to keep our debt relatively constant year on year and you look across the last 6 quarters, there's a little bit of an exchange rate impact on there that does have a negative impact. So broadly, we've been able, despite having a very low level of profitability, we've been able to keep the debt relatively constant. As we move forward into the new financial year, and as we drop those lower quarters from last year, that will mean that our earnings goes up and it will mean that the leverage ratios will start to come down as we progressively move through the quarters, in addition to the debt reduction, the absolute debt reduction. Slide 13 talks to our liquidity and our debt maturity. We still have substantial flexibility, cash on hand with our undrawn facilities, CF facilities. The major refinancing that we have coming up in the next 18 months time is our 2028 bond and that's something that we've already begun to think about and, you know, we'll pinpoint the right time to refinance that in the months ahead. Moving to slide 14 is the cash flow. The lower profitability having an impact on the cash flow. CapEx, we did commit to you all that we would, we haven't cut back on maintenance. This is the bare minimum that we need to ensure that our mills continue to operate optimally. And we ended the year, I think the number was 210 million, and we're estimating 240 million for next year. Turning to the segments and a lot of these themes I've touched on so I'm going to go fairly quickly. Firstly on slide 16, the pulp segment, you know, progressive improvements, we did see the Durban port giving us significant challenges during the quarter. There were productivity issues there and there was a backlog created. And it meant that there was a 38,000-tonne spillover into the new financial year. It causes disruption clearly, but we do anticipate that we will be able to catch that up hopefully in Q1, that backlog. But overall, markets better, but the strong rand and the elevated costs linked to the war in Middle East did impact on margins. Slide 17 is the packaging segment. Tough year. Clearly, we had the commencement of the ramp-up in the Somerset Mill. And that does impact profitability and overall selling prices across all the regions were lower. So that had an impact. And that's why we are driving now to get higher selling prices to recover those lost selling prices, particularly in the North American SBS market. And you saw that on an earlier slide. And then in graphics, the volumes, down 11% year on year, mainly linked to the structural decline and the fact that we obviously converted at the end of the year at Somerset, so we took graphic capacity out. The margins were reasonable for the year and a strong focus on disciplined cost management, but obviously in Europe we do have, there is excess capacity in that market. And you see that all summarized regionally in slide 19. I don't intend going through that. Just to call out is the South African volumes and a big chunk of that is linked to the port issues at Durban, that 21% decline that you see in the top right box. Slide 20 has our PRIDE strategy, our core fundamentals. I've shown you this before. It continues to drive and guide us. I don't intend going through this, but with our renewed focus on back to basics, this guides us. Slide 21 about controlling what we can control. And firstly, on the portfolio side, we've got the ramp-up of Somerset PM2, which I talked about going very well. The UPM potential joint venture, the key decision now lies with the European Competition Commission. We did put out an announcement yesterday that we hopefully will get, or we will know one way or another in the next few weeks. And then a big focus on pricing, as I've indicated many times throughout this presentation, our costs are rising and we need to mitigate that impact and we've been driving these selling price increases to mitigate against that. With a strong disciplined capital allocation, we've talked about CapEx, working capital, a strong focus. There was an outflow in Q4, but that was linked predominantly to the delays at the shipping at the Durban port and a buildup. The back to basics focus and we've set ourselves in each of the regions cost saving targets across variables and fixed targets. Our key priority, as I said earlier, is to reduce debt and reduce the leverage ratio. The next 3 slides are just what are our key focus areas in the respective regions: completing the joint venture proposal with a strong focus on cost savings targets and those we will continue to work on regardless of the process with the potential joint venture. And then in North America, the story there is to execute on the selling price increases that have been announced and ramp up the volumes further, improve the product mix to boost profitability. And then in South Africa, we continue to have the strong rand. It's important that we focus on what we can control. So a strong focus on operational efficiencies, where we can take out costs out of the business, and maintain operational efficiencies. All of those contributing to improve profitability in the year ahead. Slide 25 has the joint venture, nothing new to report there other than, as you know, we're waiting on the decision from the European competition authorities. Slide 26 has all our ESG awards and many of these we're very proud of. Perhaps the most recent one once again in the Forbes top global best employers, Sappi once again was ranked as one of the best employers, one of the few South African companies and one of the few in our industry that has continuously been ranked there and equally or even more proud that we are ranked as one of the world's top companies for women. So turning to the outlook statement and slide 28, to summarize everything that I've been saying so far, there are green shoots. Market conditions have improved in our pulp segment, market conditions have improved in our packaging segment, the graphics side of things are no surprises. The structural decline continues and a strong focus on cost. Focus on getting price recovery that I've mentioned through, we do have the higher costs. So getting that recovery through, but we do have elevated oil prices. And I know we all watch the Brent crude prices, they are very volatile, but that has a significant impact on the profitability in the quarter and that's taken into account in our earnings guidance. We do have shuts in the quarter of 41 million. That's mainly the Cloquet shut. But there is a smaller shut at Somerset as well in the quarter. Taking that all into account, strong focus on costs, strong focus on productivity, taking into account the current market conditions, which I said are improving a little bit, the scheduled shuts, the elevated oil price, when we take that all into account, that's why we give the guidance that the earnings would be down compared to Q4 in the Q1 period. So operator, that's me going through the presentation. I'm going to now hand it back to you for questions.

[Operator Instructions] We will now take our first question. From the line of Brian Morgan from RMB Morgan Stanley, please go ahead.

Can I start with this one, please? Can you give us a steer on the energy refunds that you're expecting for the December quarter?

Yes, thanks, Brian. Yes, the energy rebate is slightly lower than the prior year, not by much, but slightly lower, which is linked to lower usage. Marco, if you can hear me, maybe if you want to elaborate a little bit further.

Yes, Brian, it will indeed for Europe be slightly less. It depends on the usage, depends on the pricing mechanism that is being applied by the local authorities.

And in some cases, Brian, it's also the structure of the package that slightly changes year on year and that has led us to believe that for the coming quarter it will be slightly less than last year.

Okay, that's very good. Thank you. Steve, can you dive into the port operations a little bit? We've had 38,000 tons of DWP locked up. Could you give us an idea of your confidence around whether that will be cleared through this quarter?

What I'll do, Brian, I'll let Graeme go into more detail. He's had some meetings with the port authorities in the last few days. Yes, a major headache for us, and not only the fact that the sales slipped into the new quarter, but you can imagine you have to find storage space for this inventory and so on. And just to make it clear that it was initially maybe triggered by a software update that was done by the port authorities, but it's not only that. And Graeme will go into maybe a little bit more detail. But we are confident that we can catch up in the quarter. Graeme, over to you.

Thanks, Steve. Yes, Brian, obviously the initial event was the software update, which was done in the peak of the citrus season when ports was already under quite a lot of pressure. That obviously very rapidly caused a backup in obviously not only ours, but everybody's containers, which then flowed into pressure on warehousing space around the area. But the ongoing challenges largely relate around equipment availability and reliability, particularly the gantry cranes. We have been working with the port authorities and shipping lines to get additional containers onto ships when the ships can get in, but short sailing has often caused a problem for us and many others. Most recent interactions though with the port authorities and particularly ICTSI on the DCT terminal, which is where all the containers go out, I think are very encouraging. There's a lot of new equipment arriving from end of December onwards. There's a big program to refurbish the existing gantry cranes that are in the port, because obviously, ICTSI have only recently just got operational control over there. And then I think that, plus the work that we've been doing, both with them but separately, in terms of looking for alternative ways to get the volumes out of the country gives us, I think, good confidence around our ability to catch up all of those volumes within this quarter.

Back to you, Brian.

Thanks, Graeme. That's great. Thank you, guys. And the last question is just on these Eurobonds. Just maybe if you can chat to us a little bit about the interactions that you've had on that so far and then also, I don't know if you have any potential to do a secured lending deal here?

Look, as you would imagine, you have ongoing dialogue with your banks and your advisors, as we do with any bond refinancing, and you try to pinpoint the right time. As part of that conversation, you consider all options. Clearly, the bond market generally has weakened. It's not just Sappi. All the bond markets have weakened. As you evaluate the flexibility and the costs, you will consider all options. But, you know, as we get closer to the date we'll be able to give a more specific update, but, you know, we are confident that one way or another we'll be able to refinance.

Just to follow up there, Steve, would you be able to use South African assets against that?

We are looking at all options, Brian. Clearly we have assets in the U.S., we have assets in Australia, in South Africa. So we're not at that stage yet, Brian, and our prize 1 would be to refinance in the bond market.

Okay, cool. Thank you.

Thank you. We will now take the next question. From the line of James Twyman from Prescient, please go ahead.

Yes, hello. First question from me is just back to this DWP issue, inventory in Durban, which was 38,000 tons at the end of the quarter. Could you say roughly where it is now, whether there has been any reduction so far in the—

Mohamed, do you want to talk to that specifically?

The 38,000 tons we have at the, if I look at what we've actually invoiced in October, we have made up about 10,000 tons out of that 38,000 that we've invoiced. And the plan, as Graeme mentioned, is to try and get through the remaining 28,000 by the end of the quarter.

Okay, that's great. And then you mentioned on the call that the EU is going to make a final decision on the joint venture in the next few weeks. So is this the final, final decision? Is it? And if so, does that mean you put all your final solutions to their concerns in and it's now just a waiting game?

Yes, as you saw from our announcement yesterday, we've proposed certain remedies and now the next step is that the Commission has to evaluate that and then they would have to test that. They typically go through a testing process with market participants and ultimately that influences their final decision.

Okay, and then a couple more if I may. In terms of the Somerset Mill, given the ramp-up in packaging paper production, what is your estimate of what sort of tonnage increase we could see next year compared with this year?

By the time we got to the end of the quarter, as I said, now we were relatively full. We've got the progressive ramp-up on the speed. I'll pass you to Mike and he can talk broadly just about the volumes for the year.

So, James, we're, I'd say, ahead of what we had for a startup curve as far as equipment overall efficiency. And the machine is running very well, and the product's very well received out in the field, and we're essentially sold out. At this stage, we do have a speed ramp-up that was planned, but the exact volume, we have about, I guess I'm struggling to give you an exact, exact number. But...

Yes, maybe I can just comment there. I think what we said is that we would reach an operating rate. James, as you know, we talked to the PM1 and PM2 together as a unit because we optimized production across those two. And we reached an operating rate across the two machines by the end of Q4, about 85% operating rate. And we anticipate, as we indicated, we'll ramp up to full capacity run rate by the end of the year. So yes, you can phase up that run rate and work out the additional tonnages for the year.

Yes. But it's, you know, it's at least, you know, you can hear we're pausing giving the exact number because we don't want to do that. But it's at least 100,000 extra for the year.

Okay, thank you very much. But just back to the timing on the EU decision, I think you said in the next few weeks, whereas I think previously we were expecting it to be end of the year, early next year. Just good to understand where you see there the timing from them and how factual the timing is. Like do they give you an exact date when it is, or are they, you know, pretty general in terms of when they speak to you?

No, it's a specific date. That date, I think it's the 7th of January, right?

8th of January, yes. That is a specific date. Yes, thank you. And then in terms of pricing, containerboard prices move annually in South Africa, and prices for containerboard have moved up pretty dramatically over the last 6 months or so. And how pleased have you been with the price increases that you've managed to achieve? Because I'm sure it's all in the bag now for the year.

Look, one thing I would say to you, James, is that we did change the format of the South African contracts a couple of years ago, and it's 50% fixed and 50% variable. So we know, we clearly know the fixed component, and as global prices for containerboard rise that will support further increases in the quarter ahead. Graeme, I don't know if there's anything you want to add to that.

Just to reiterate that the format has changed. So we have annual volume contracts, then the pricing components are split roughly 50-50 with quarterly adjustments as we go. The price increases that we've seen, particularly in Europe, in kraft linerboard, we would expect for that to be followed through in roughly 50% of our volume as we move through the year.

Okay, thank you very much. And then just a final 1 if I may, what was the FX impact on your net debt for the year?

For the year. Brian, I'll get back to you. I have James. I'll get back to you. I don't know if we... Can I just give me a 1?

Or the quarter then, the quarter.

You got me there. It wasn't much because your euro quarter on quarter didn't move much. So I can, yes, your euro moved from 1.14 to 1.13. So it would have been small.

No, that's great. That's cool. Yes. Thank you very much. Thank you.

About 12 to 15 million for the quarter.

Thank you so much. Thank you so much.

Thank you. We will now take the next question. From the line of Detlef Winkelmann from JP Morgan, please go ahead.

Maybe my first 1 is on this JV. Obviously you already have secured financing for the JV as things stand today. I'm just curious, you know, can that be revisited with the fact that graphic paper profitability is worse than it was, let's say, this time about a year ago, and potentially remedies going through the system, or is it fixed in nature? Just curious on that and what that means for, you know, you call it $100 million worth of cash inflow on conclusion of the JV upfront. Thanks so much.

Yes, look, the decline in graphics was forecasted and was built into the estimates that we provided to the banks. So there were no surprises there. And the underlying profitability was broadly in line with what we discussed with the banks. So that bridge, that guarantee bridge is in play and will not be influenced by the change in circumstances, nor the slight extension on the deadline from the European authorities. So we still have that flexibility, and that's not a concern for us.

Okay, thanks. And maybe just on the second part of that question, just on the remedies as well. I mean, you know, we obviously, and I presume you don't want to tell us what the remedies are or what you guys have proposed. But if the remedies, you know, were to exclude, I don't know, certain mills or they were to delay any closures, et cetera, once closed, conclusion of the JV, would that kickstart any renegotiation on the funding side?

No. I mean, clearly we can't go into specifics and it's a very sensitive stage, but if we look at the impact of all the remedies that have been proposed, no, that would not have an impact on the funding that we have in place and the proceeds that we would get from the deal.