Smurfit WestRock PLC (SW) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Smurfit Kappa Group 2012 first quarter results afternoon call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. Please note that this conference is being recorded.

I would now like to turn the call over to Mr. Gary McGann, please go ahead.

Thank you very much, operator. Good afternoon, ladies and gentlemen, and welcome to the 2012 first quarter earnings call. I'm joined on the call today by Ian Curley, our Group CFO.

Before reviewing earnings, we'd like to preface the call with safe harbor disclosure.

Now although the Group doesn't provide financial projections or specific earnings guidance, our discussions may include predictions, estimates or other information that may be considered forward looking. While these statements represent our best current judgment on what the future holds, they are subject to the risk of uncertainty, which could cause actual results to differ materially. Throughout the call, we will attempt to discuss important factors relating to our business which may affect our predictions.

Let me first of all go through a brief overview of the quarter 1 results and we would then be happy to take your questions.

We're pleased to report a strong EBITDA of EUR246 million for the first quarter, significantly ahead of market expectations. In a tough operating environment, this performance reflects the increased efficiency and the ongoing strength of our integrated system in Europe, combined with the continued solid performance from our Latin American operation.

In the first quarter, our box demand in Europe was 0.5% higher than year ago levels. Somewhat lower volumes in France, Spain and Germany were offset by a 3% growth in the UK and Italy. Our Eastern European operations also experienced good volume growth, in particular, in Russia, where the recent acquisition of our second operation in St Petersburg is exceeding expectation.

Unlike boxes, which represent approximately 87% of our total packaging volume and where our leadership, innovation and design allows us to differentiate and add value for our customers, corrugated sheet feeding is a commodity product, where pricing is the main decision factor.

Reflecting our strong stance on pricing and returns, our sheet feeding volumes reduced by 8%, year on year, in the first quarter; by lowering prices, this business is easily recoverable. Overall, our total corrugated volumes are 1% lower, year on year.

As a result of the lower paper pricing environment that prevailed in the second half of 2011, and in line with the usual three to six months' lag, corrugated prices came under pressure at the beginning of 2012.

The reversal of the paper price decline during the first quarter, combined with our strong market offering contributed to better than expected corrugated pricing retention in the period. From January to March, our prices reduced by 3% and are currently expected to remain stable through the second quarter.

As expected, input costs were significantly higher in the first quarter. From December to March, OCC prices increased by over EUR30 per tonne, while on average, our energy and distribution costs increased by 3% and 6% respectively compared to the fourth quarter.

Against that backdrop, and despite lower end-product prices, our EBITDA margin remained broadly stable at 13.5% in the period, primarily as a result of the improved efficiency of our containerboard mills system and a further EUR30 million of cost take-out delivered in the period.

Today, we have announced an up-scaling of regional two year cost take-out target from EUR150 million to over EUR200 million to be delivered by the end of 2012. And this implies over EUR100 million of costs saving benefits for the full year 2012.

Our solid first quarter performance also highlights a higher contribution from our former specialties operations. Last year, we integrated these operations into our existing European packaging segment, with a view to improving the overall cost efficiency of our solid, graphic and carton board businesses, while at the same time further expanding our one-stop shop platform for paper-based packaging solutions.

This initiative is beginning to deliver results. Although our efficient integrated system delivered a relatively strong EBITDA margin performance in the first quarter, the announced closure of three less efficient recycle mills in Europe since the beginning of 2012 highlights the need for the industry to secure incremental pricing, in order to compensate for a generally higher input cost environment.

In that context, in April, the spread between OCC and testliner remained approximately EUR60 a tonne lower than at its 2007 peak.

Another permanent mill shutdown was announced yesterday in Germany, bringing the total announced recycled capacity closure so far this year to 215,000 tonnes, representing approximately 1% of the relevant industry capacity.

Entering the second quarter, Chinese demand for OCC reduced somewhat, which led OCC export prices to decline by approximately EUR15 a tonne in Europe. As a result, we currently anticipate some downward pressure on domestic OCC European prices in May but expect a reversal of this trend in the near term, as the Chinese have to return to the market to support their relatively strong local demand growth.

While OCC prices are expected to remain volatile, we believe that the medium-term pricing trend for that commodity is upwards. The view is underpinned by expectations of continued Chinese demand growth for the material, combined with supply constraints in the US and Europe, where collection rates are already at or close to the economical limit of 75% to 80%.

The limited availability and higher cost of fiber is, clearly, increasing barriers to entry for new capacity in our industry. This reduces the risk of supply overhang from excess capacity additions in the future, thereby providing SKG with a platform to further reduce earnings cyclicality and continue to enhance returns.

Only one new machine is currently expected to be built in Europe over the next two years, representing an incremental 1.7% of capacity.

The start-up of a competitive machine in the UK in January 2012 was more than offset by continued downtime and an increase in European containerboard exports in the first quarter. Stable demand combined with necessary broad based supply discipline led to a progressive reduction in industry inventories during the quarter. Lower inventories, combined with a higher input -- but with higher input costs allowed SKG to implement approximately EUR80 a tonne of a price increase for recycled containerboard between February and April.

On the kraftliner side, the supply outlook is expected to remain tight in the near to medium term, supported by a reduction in US imports into Europe, since the fourth quarter of 2011 and the recent closure of the 290,000 tonne mill in Norway. This permanent closure represents approximately 7% of the European kraftliner capacity of 4.1 million tonnes.

As the clear kraftliner market leader in Europe and a net seller of approximately 500,000 tonnes per annum, the Group should strongly benefit from the resulting more consolidated market for that grade. Between March and April, we implemented a EUR30 per tonne price increase for Kraftliner. And currently expect to secure a further EUR300 a tonne increase during the second quarter.

Our Latin American business continues to perform in the first quarter, delivering 11% growth in EBITDA year on year. Latin America currently contributes to 23% of the Group's overall EBITDA and provides us with a superior margin and geographic diversification.

Latin America is one the Group's target regions, due to its higher growth rate and our established operating presence in the region.

At EUR1.8 billion, our sales revenue in quarter 1 was 1% higher than in the first quarter of 2011, and slightly lower volumes were largely offset by a 2% increase in average European box prices, year on year. Compared to the fourth quarter, our sales revenue is broadly unchanged, as a 3% sequential volume growth was more than offset by a 2% average decline in corrugated prices in Europe.

While our EBITDA of EUR246 million was broadly stable compared to the fourth quarter of 2011, our EPS reduced sequentially, largely as a result of a swing in our tax line, due to a tax credit in quarter 4.

Turning to cash flow and net debt, as typical in the early part of the year, the Group reported a net cash outflow of EUR16 million in the first quarter, primarily resulting from an expected increase in working capital. On an absolute basis, our working capital increased by EUR88 million in the quarter, which was broadly similar to the first quarter of 2011. Our working capital to sales ratio, however, reduced to 8.7% at March.

Now, let me hand over to Ian.

Our working capital sales ratio, however, reduced to 8.7% at March 2012, compared to 9.2% at March 2011, highlighting our ongoing focus on cash management.

Capital expenditure of EUR63 million during the quarter was EUR9 million higher, year on year, and equated to 74% of depreciation. For the full year 2012, we expect to maintain our capital expenditure at its normalized level of 90% to 100% of depreciation.

Our net debt of EUR2.78 billion at March 2012 was marginally higher than the year end 2011 level, but EUR286 million lower than the March 2011 level. Our net debt to EBITDA ratio of 2.7 times was unchanged compared to the year-end 2011, however, and remains well within our stated objective of 3 times through the cycle. The Group's ongoing cash flow generation is expected to generate further deleveraging in 2012.

During the first quarter, we successfully completed amendments to our senior credit facility. Following the EUR330 million debt prepayment from cash on balance sheet that would be finalized during the second quarter, we will have effectively removed all of the Group's senior credit facility debt maturities in '12, '13 and '14, providing us with an extended average debt profile of 5.4 years.

The amendment also provides us with the increased flexibility to raise longer-dated capital at a time of our choosing, to refinance our senior credit facility and our senior sub notes due in 2015. It is worth noting that having significantly extended our debt profile and increased our financial flexibility, we expect our interest costs in 2012 to be slightly lower than that in 2011, as the debt prepayment will more than offset the increased margin on the remaining senior credit facility.

Turning to the outlook, the recently implement price increases for testliner and kraftliner should underpin some box price recovery during the second half of the year, which combined with our leadership position in packaging innovation and sustainability. And our efficient operating system will support the delivery of performance ahead of current market expectations for the full year.

In that context, and subject to macroeconomic volatility and normal business risk, we'd expect to deliver a 2012 EBITDA performance similar to that achieved in 2011. This will, in turn, support good cash flow generation and further deleveraging, thereby allowing us to expand our available range of strategic and financial options.

Thanks, Ian. We're now very happy to take questions, and we'll turn it over to the operator.

Thank you. (Operator Instructions). Mark Wilde, Deutsche Bank.

Just a near-term question, first. Ian, can you help us quantify the impact of that Venezuelan downtime in the second quarter?

About $4 million.

About $4 million there, Mark.

Okay. All right. The next question, just I'm curious about energy costs, and whether you think that the relatively high European energy costs represent any kind of a long-term concern about competitiveness? Over here in the US right now, we're looking at $2.30 natural gas.

Ian, do you want to --?

Yes. If you look at, for the first quarter, and the prior year, just out of interest, energy costs in quarter 1 this year were EUR127 million, playing EUR116 million last quarter. That was up about 10%. But if you look at quarter 4 -- quarter 1 playing quarter 4, quarter 1 was EUR127 million playing about EUR124 million in quarter 4, so roughly [lying ball].

And if we look forward for the remainder of the year, we would see energy costs going up by, we suspect, in the order of about 5% or 6%. So, no big increases there, Mark, you know?

Mark, the issue of European energy is kind of an involving one. Obviously, in the US, you've got a particularly good situation right now. Our energy is -- the two predominant sources are gas and electricity, and we've -- the major of those two is gas. And we have -- gas has moved to decouple from oil prices, and we have materially improved our cost base as a consequence of forcing that decoupling from our suppliers.

And that, together with the fact that we take a continuous hedging approach over a 12 to 18-month period, if you like, allows us to take the severe swings out of it, whilst at the same time managing the underlying activity downwards. And so, in terms of our fixing policy, we have about 58% to 60% of our energy fixed for 2012. So we have a fairly strong confidence level in the numbers that Ian would have given you.

Okay, all right; a couple of other questions. I was pleased to see that this cost take-out program got bumped up by EUR50 million. I wondered if it's possible to just get a sense of what are the big buckets here that you're finding to take costs out of, or is it just a matter of a lot of singles.

There are three or four big headings areas, Mark. The first one, interestingly and ironically, is energy, and we have a continuous investment program behind alternative energy sources, as you would be aware, particularly in our kraft systems, whether it's containerboard, sack, or MG paper. And we're reaping the benefits of substantial investment over the last number of years as this begins to feed through, and we sell to the grid.

And the second one is, and it's the second largest cost in our overall cost base, is labor, where we are continuing to drive comparative operating efficiencies, basically, with an internal benchmarking system across 300 plants, we have an ability to match the good, the bad, and the ugly, so to speak. And we're also taking headcount out on a continuous basis, because it's obviously inflating at 2% to 3% per annum no matter what the environment is.

The other one is optimization of recipes, raw materials, grades, the standardization of grades and deckles, and if you like, matching our capacity to the market demand in the most optimal way possible. And that's a continuing, evolving program. And then there's a bucket of the rest, so to speak.

Okay, all right. And then you mentioned kraft paper, Gary. I know there have been a number of Kraft paper initiatives in the market. You guys didn't really say anything about that this morning. Could you give us just some update on what you're seeing over in Europe?

I think what we're seeing, Mark, is -- we had a slow enough beginning, but we've a reasonably tight kraftliner market now, and it's driven predominantly from supply side, where we've had a bankruptcy in Norway, which has taken 7% capacity out of the market.

And then on the demand side, obviously, one of the issues that you'd be familiar with in the US as well is that the recovered paper, waste paper, is being -- is probably being over-recycled, and there are some moves to switch, or to pull more kraft into the fiber basket. And the combination of the two of those is giving us quite a reasonable outlook in 2012, for sure, and maybe beyond. And obviously, with Smurfit Kappa Group with 34% of the production capacity in Europe, we stand to benefit more than most from that.

Okay, then, a last question I had. Just a -- long-term contracts that you mentioned in the release this morning, 90% of all the pan-European customers contracted for one to six years. What percentage of the total business does that represent? And have you done anything in any of those contracts to maybe change the way that pricing works on some of these longer-term contracts?

Well, first of all, in the contractual aspect of our business, which we call pan-European, is about 20% of our overall business. We have other parts of our business that effectively mimic the contractual behavior. In other words, mimic the contracts in terms of use of the indices to drive up or down pricing. So that gets us up to about a third of our business, or 30%.

In terms, Mark, of the contractual negotiations and relationships, there's a very wide variety of them, from good margin business where our customer wants fixing for a year at a time; and that's a challenge always in a volatile industry, but we'll do it for the right customers. Others who want basically to have the price testing done every three months, very few, mainly six months, nine months.

And in terms of how we convert -- into these contracts, how we convert pricing -- we'd like to, because there are drivers other than material that are impactful on our business and our margins, and there's no mechanism to get pricing for them, so we have to use the material moves as the platform on which to get recovery of all input cost moves against our margins.

But there's no real ability, I suppose partly because Europe is a very fragmented industry for us, still, because the top five are still less than 50%. There's not a mechanism where the industry can impose a different approach to pricing on the big international corporates.

Okay, fair enough. I'll pass it along. Thanks, Gary.

Thanks, Mark.

(Operator Instructions). James Armstrong, Vertical Research Partners.

My first question is on the cost take-out program, to follow-up on Mark's question. How do you see the cost take-out flowing through the year? Will it be more a flat line, or will it be back-end loaded?

Well, we've upgraded, James, as you know, the two-year program from EUR150 million to EUR200 million, approximately. We have achieved in 2011 of that EUR200 million approximately EUR100 million, and we have reported in quarter one about EUR30 million. So, effectively, we've EUR70-odd-million to do in the balance of the year. So there's not a lot of room for spikiness in that. It's probably reasonably evenly across the year.

Perfect. Then switching gears a bit, you have quite a bit of cash on the balance sheet. As you go forward, would you expect to use the majority of this to pay down debt? Or will you keep a significant portion on the balance sheet as we go forward?

When you look at it, James, we will finish the mend and extend during the course of quarter 2. So we will use about EUR300 million of that cash. So at this moment of time, on a like-for-like basis, we would have about EUR500 million of cash on the balance sheet. And then overall you'll see that our actual interest bill will be marginally down year-on-year.

As we progress from that, and as Gary said, with the EBITDA guidance, you would see further debt pay down. And as we go along, we'll just see what will we do with that cash. What is the benefit of debt pay down versus acquisitions, for example? We always have a look, proactively, at our capital structure, the bond market, our bonds, our 2015s [I'll call them]. So there's a variety of things there that we would look at with regard to the cash. But you always need a certain amount of cash on deposit within your system to keep it going.

Okay, that's fair. How much cash are you comfortable with on a normalized basis? What levels should we be expecting as we go forward?

Yes, I think expecting, going forward, if you look at the past three years, most companies would keep a lot of liquidity on the balance sheet. I think it's a very good message, particularly now we've moved into the corporate world, the fact that we've a lot of unused lines or whatever. But it's been very important to actually keep cash in the balance sheet. So a lot depends on the macroeconomic factors too. As I said, it shows a sign of confidence.

But the underlying amount of cash, typically, that you would use in your system could be up to EUR200 million, or whatever. It depends on seasonality and stuff like that. But you would always expect to see a minimum of maybe EUR200 million, depending.

Perfect. That's what I needed. And lastly, with OCC coming off a touch, I know you guided to higher containerboard prices in the second quarter. Is there any push back with OCC off a little bit near term that may be pushing that price increase out a little bit?

Bear in mind, if we take the two grades of testliner first of all, we have effectively got EUR80 a tonne through April in the Testliner grades. Out of the EUR100 that we announced, it is unlikely we'll get the final EUR20 while we have some short-term weakening in OCC. Sense we have is that should be fairly short lived, because the general demand trend is upwards and the supply side, in terms of collection levels, is up at economic levels.

On the kraftliner side, we've got EUR30 a tonne in April of the EUR60 we announced, and we expect to get the second EUR30 a tonne in the circumstances I outlined in my response to Mark Wilde. We should be able to get the second EUR30 through in quarter 2.

That's as much as we see right now, and obviously the most important challenge from Smurfit Kappa Group's point of view always is, given that we're a market facing packaging business, is to get that through to the corrugated prices in appropriate order.

Thank you very much.

Thanks, James.

(Operator instructions). Gail Glazerman, UBS.

Hi. I guess you've talked about European exports rising and helping tightening the market. Did you see any sense of those exports being repatriated as the domestic board prices improve? And I'm just wondering if you can talk about what markets you think those tonnes went to.

They're generally, first of all, when we talk about European export markets, they tend to be near European markets such as North Africa and Middle East-type markets specifically.

In terms of repatriating them, to be honest with you, the demand environment in Europe is fairly flat and there's no expectation that it's going to materially change as the sovereign economic issues continue to prevail here.

And so, therefore, the key driver of the pricing activity, the cost push and a reasonable degree of discipline on the supply side, which is a combination of downtime, not too much of that, and the tonnage into the export markets rather than dumping excess tonnes into a flat market.

Can you talk in just a little bit of detail about the Latin American price environment? Are you seeing board prices rise? I know, obviously, a lot of the US producers have put our April price increases.

Yes, if you take them country by country, effectively in Mexico is quite dependent on US export prices, because effectively it trades against the landed US prices plus some for convenience. And, therefore, the paper pricing in Mexico is a function of US export pricing. Hasn't had too much momentum so far, but the expectation is there will be some. And, obviously, we pass that through our own system into our box system.

In Colombia, we are getting some pricing. Again, the big challenge in Colombia is not domestic, but rather the exporting and importing activity of Colombia, given the very strong country performance and consequentially the strong currency performance. And so pricing, again, has to have regard to international price levels, and with particular reference to the appreciating peso.

Venezuela is a high inflation country and so, therefore, we do get pricing there and they are seen as pricing there. And we're also seeing some pricing in Argentina. They're somewhat offset by softer volumes in the latter two.

Okay. And can you just talk about some of your non-containerboard markets, things like craft paper, machine glazed paper, what you're seeing in terms of just demand, and price trends there.

In general, the sack Kraft is progressing well. It had been soft enough but we're beginning to see some resurgence, both in terms of activity level and pricing and similarly for MG paper, so not a bad picture, quite frankly, right now.

Okay, thank you.

Thanks, Gail.

(Operator instructions). Mark Wilde, Deutsche Bank.

Just a couple of follow-ups. Ian, is it possible to get a little color on where the major CapEx projects are going to be this year?

I suppose we could, Mark, we could probably take that offline, And I think Bertrand will come back to you on that, on the detail -- that extensive detail.

There's no massive new [projects], but we can give you detail offline.

Okay, that's fine. And then the other one is, two of the big competitors down in Mexico have recently combined. That would be IP and Inland. And I just wondered whether at this point you're seeing any change in behavior from the combined entity down there.

Not materially so, Mark. Quite honestly, I think our general perspective would be that a bigger leader in the market place, owning a bigger chunk of the business in Mexico is good in the sense that IP's objectives are to make a return on the investment that they've made in the acquisition. And that's always positive, where people are actually running for profits rather than for activity levels. So our expectation would be marginally positive, but we're not seeing anything material yet.

Okay, right. And one last thing, actually; you mentioned that small bag and box acquisition you made in Argentina.

Yes.

And you also mentioned that you'd had labor issue down there in the first quarter. I wondered, Gary, if you can just briefly summarize the puts and takes from your perspective of doing business in Argentina, because it's a place that makes a lot of corporates very nervous.

To back up a small bit and contextualize it for you; we're first of all in Latin America 28 years now. And in that 28 years, we've had excitement in one country or another at some point in time through it. And in all occasions our local management has tended to manage our way through it.

One of the outstanding countries in terms of overall performance, etc., is Colombia. 10 years ago when we were talking, we were asking questions like this about Colombia; FARC, guerillas, disaster in the economy, nobody investing in it, etc. So it's an exciting place to be and it has its challenges.

In Argentina, the pros and cons of being in Argentina, well, the first key pro is we are there. And so there it's important that we make the best of it. We have a good position there. We have some short-term aberrations with the strike; that's hopefully going to be fixed very shortly. But the business in general is in reasonably rude health.

And as you say, we've invested in Argentina in the bag and box business, which is part of our program to internationalize to a greater extent, what is, an attractive sector for us and where we make higher returns than some of our other businesses.

In Argentina as well, we have a widely geographically diversified business that allows us to cover a lot of different sectors from agriculture to industrial, and particularly strong exporting. And so while we've got some noise down there, to put it mildly, it clearly is still a huge exporting country and, obviously, a lot of our packaging is in those exports.

And Mark, the convertibility happened in 2001/2002. And during that previous period of turmoil, in actual fact, it was still a reasonably good period for us. And from 2002 up to the present time, the business climate in Argentina has been very good. So we've enjoyed over a decade of good times there. So it's a country we still have a lot of regard for.

The old principle, Mark, and you'll remember it from of old, is we've four cornerstone businesses in Latin America. And we generally have two up, two down, and the year we have three up is a home run. And we're in two up, two down as usual. But the two up, bear in mind, are the two biggest ones, which is Mexico and Colombia.

Okay, very helpful. Listen, good luck in the second quarter.

Thank you very much, Mark.

If there are no other questions, can I thank you all for your interest in today's call and for your continued support. We're very pleased to report, essentially, stable revenue and a relatively strong EBITDA outcome of EUR246 million for the quarter.

The operating and financial disciplines, for which we are well known and which sustained us, will remain a key focus of the Group. And supported by over EUR800 million of debt pay down since 2007 and continued investment in our business, we're better placed today than at any other point in our recent history to both withstand any threats and to capitalize on any opportunities presented by current market conditions.

Continuing cost inflation and a more positive supply environment support continued price recovery. And for 2012, and subject to macroeconomic volatility and normal business risk, we expect to deliver an EBITDA outcome similar to that of 2011. The expected outcome is ahead of current market expectations.

Again, thank you for taking the time to be on the call. And have a good day.

That will conclude today's conference call. Thank you for your participation, ladies and gentlemen.

Thanks, Operator.