Smurfit WestRock PLC (SW) 2012 Q3 法說會逐字稿

Welcome to the Smurfit Kappa Q3 results conference 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 will now turn the call over your host, Gary McGann. Sir, you may begin.

Thank you very much, Operator. Ladies and gentlemen, good morning or good afternoon, and welcome to today's third quarter results conference call. I'm joined on the call today by Tony Smurfit, who is the President and Group COO; and Ian Curley, who is our Group CFO.

At the outset, I'd like to remind you that our remarks may include forward-looking statements, including statements concerning expectations about our future financial performance, economic conditions, or market conditions. These statements are neither promises nor guarantees, and are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated.

Today, we announced a strong EBITDA outcome of EUR280 million for the third quarter. The Group delivered a good performance across all financial measures, with industry-leading, underlying, EBITDA margins of 14.9% within the period, and return on capital employed at 12.7% on an LTM basis. This performance reflects the strength of our integrated product offering, and the continuing focus on cost and operating efficiency.

Within the period, we completed two successful bond offerings totaling EUR690 million, extending our maturity profile, lowering our debt servicing costs, and diversifying our funding sources.

We also announced our agreement to acquire Orange County Container Group, that's OCCG, for $340 million. And this acquisition, when completed, will deliver immediate earnings growth for the Group, and will significantly strengthen our position in a high-growth region. It's expected to close before the end of the year.

Turning to the third quarter performance, the performance in the quarter reflects generally strong results across our total integrated system. It also reflects the value of, and contribution from, our kraftliner mills, the announcement of a price increase in recycled containerboard, and stable pricing and volumes in corrugated.

In generally difficult market conditions, our results demonstrate our continued support of our customers in selling their products through our proactive innovation, high-end packaging, and our commercial focus, supplemented by cost take-out programs for the customers.

Before turning to our third quarter performance in more detail, let me review the steps we've taken to strengthen our business in 2012. It is important to emphasize that these actions have been supported and facilitated by a strong operating performance throughout our integrated system.

Firstly, we have significantly improved our capital structure and financial flexibility. Our net debt to EBITDA has reduced to 2.58 times, and our average debt maturity is now 5.7 years.

We recently completed two bond issues totaling EUR690 million, which lowers our debt servicing costs, improves our debt maturity profile, and diversifies our funding sources. We've improved credit ratings underscoring our consistent delivery against debt pay-down targets. We also have an improved equity capital structure and our free float has increased to 92%.

Our consistent debt pay-down has broadened our opportunity set. We have outlined on many occasions that growth is back on the SKG agenda, and that our focus for growth will be on higher growth sectors and markets within our existing portfolio of businesses, such as Latin America and Bag-in-Box.

Our acquisition of OCCG in quarter 3 is a clear example of that focus, and the circumstances in which we will make acquisitions. With an appropriate long-term debt profile to the industry, and a clear commitment to our progressive dividend policy, we believe that we are also well positioned to create shareholder value by delivering and driving EBITDA growth. The OCCG transaction is accretive on completion and clearly supports that objective.

Let me say a few words about Orange County Container Group. It's principally a Mexican business with two converting plants, a mill and a substantial recollection system in the US. We're acquiring an integrated producer of paper-based packaging, which serves a market that's both strategically important and attractive to our existing Mexican business. The acquisition increases our exposure to the higher-growth Mexican market, with a pro-forma share of 17%, and strengthens the Group's position within the key Maquiladora region.

The US mill provides security of supply for the acquired corrugated operations. We also see significant opportunity for the US mill through the transfer of production capability from our European recycled system, where we are the clear market leader.

Turning now to our third quarter performance, revenue in the quarter declined 2% year on year. On a like-for-like basis, sales declined by approximately 3% on the prior year. Pre-exceptional EBITDA for the quarter was EUR280 million as already stated, 6% higher than the third quarter of 2011, particularly reflecting earnings growth in Europe.

The underlying third quarter EBITDA margin was 14.9%, and our consistently strong margin, despite continued cost inflation, highlights the emphasis on cost take-out, and operating efficiency within our business. We have an ongoing rigorous cost take-out program which focuses all levels of management on the key cost areas of raw materials, wages and salaries, and energy, amongst others.

We delivered EUR20 million of savings in the third quarter, and a total of EUR164 million in savings over the last 21 months. On completion of the 2011/2012 two-year program, a new cost take-out program will be put in place for 2013.

Free cash flow was EUR118 million in the quarter, in line with the prior year. Finally, EBITDA was EUR16 million higher in 2012 and capital outflows were lower. These were offset by a reduced working capital inflow and higher tax payments.

Following an increase of EUR97 million in the first half, working capital decreased by EUR6 million in the third quarter. Working capital amounted to EUR656 million at the end of September, representing 9% of annualized sales, similar to last year's level.

Our CapEx for the first nine months was EUR180 million, representing 69% of depreciation, compared to EUR196 million and 75% depreciation in the first nine months of 2011. The lower level in 2012 is as a result of timing and the full-year CapEx is expected to amount to approximately 90% of depreciation, slightly ahead of the 2011 level.

In terms of our balance sheet, as already highlighted, we have delivered consistent net debt reduction. Net debt was EUR2.64 billion at the end of September, and our net debt to EBITDA was 2.58 times, comfortably below our stated objective of remaining below 3 times net debt to EBITDA throughout the cycle.

The successful refinancing completed during the quarter will reduce the Group's interest cost by approximately EUR10 million per annum. At the end of the quarter, we have strong liquidity with EUR1.2 billion of cash on the balance sheet, and undrawn committed credit facilities of EUR525 million.

Of the total, approximately EUR600 million is derived from the proceeds of the September refinancing activity, which is being applied during the fourth quarter to fully prepay the 2015 7.75% subordinated notes and part prepay the senior credit facility. Using year one pro forma OCCG EBITDA numbers, SKG's net debt to EBITDA is expected to be below 2.7 times at the year end.

Turning to our performance in Europe, we reported revenue of EUR1.47 billion for the quarter, and EBITDA of EUR226 million, an underlying EBITDA margin of 14.9%.

Total corrugated volumes for Europe declined marginally in the quarter and are down just 1% for the first nine months of the year. The principal cause of the decline continues to be the loss of sheet volumes due to our focus on price over volume. European box volumes have remained broadly flat for the nine months to September.

In kraftliner, we implemented a EUR50 a tonne price increase in the quarter. Resilient demand for the grade, together with the closure of significant capacity in Europe during the second quarter, and the successful price increase of $50 a tonne in the US, should ensure a continued tight supply environment for this grade in Europe in the medium term.

In recycled containerboard, following downward price pressure in the second and early part of the third quarter, we achieved a EUR30 a tonne price increase in September. A material price increase was required as the spread between recovered paper and recycled containerboard prices had become uneconomic.

Further recycled containerboard price increases will be necessary to recover expected increases in the cost of recovered paper prices due to global containerboard capacity growth and recovered fiber supply limitations. There is some evidence of this upward movement being visible in October.

Turning to our performance in Latin America, we reported revenue of EUR356 million for the quarter, and EBITDA of EUR63 million; an EBITDA margin of 17.5%. This margin is within our normal range of 16% to 21% for the region, and an improvement on our performance in the first half, and particularly quarter 2. The margin recovery reflects the absence of one-offs, continued pricing progress and our cost take-out in the period.

Mexican EBITDA increased by 6% year on year in dollar terms in the first nine months, illustrating the benefits of capital investment and the Group's cost take-out efforts. The success of the paper price increase in the US is expected to provide a further boost to pricing initiatives in the domestic Mexican market.

In Argentina, in an increasingly challenging economic environment, quarter on quarter volume performance improved by 4% while our Venezuelan business improved its sequential quarterly volume by 17%.

In Columbia, stable corrugated demand and continued progress on pricing delivered an improved EBITDA outcome, while reduced interest rates in the country maintained stable exchange rates for the period.

The region's return to its historically better margin level underscores our belief that our Latin American business remains integral to the Group's long-term growth and development, providing geographic diversity and access to high growth markets.

For information, I would like to draw your attention to the fact that a number of convertible share options granted to executives and management in 2002 and 2005, and which expire in early December 2012, have been exercised today by Tony Smurfit and Ian Curley and myself. Details have been announced by way of the standard regulatory announcement to the stock exchange on completion of the transactions. Following the exercise, a number of the shares have been retained and the balance has been sold into the market.

Turning to Board matters, in a separate press release yesterday, we announced the appointment of Christel Bories as an independent non-executive director of the Smurfit Kappa Group Board, with immediate effect.

Christel is a French woman and is a very experienced executive, having had a widely based and significant international responsibilities in a number of companies and businesses related to our own. We are confident that she will add significant value to the Smurfit Kappa Group Board.

Before concluding, I'd like to summarize the medium-term value drivers for our business. We have an integrated, efficient packaging system, which delivers sustainable and quality earnings and consistently strong pre-cash flow.

Building on our performance to date, we will continue to have material cost take-out opportunities underpinning our industry-leading margins.

We have Europe's most significant kraftliner system. We have strong businesses in Latin America, which are delivering growth, providing earnings diversity and superior margins, and this will be further enhanced with the OCCG acquisition.

We've attractive investment opportunities in both higher growth markets, such as Latin America and Eastern Europe, and in sectors such as Bag-in-Box. We have a capital structure, which provides increased strategic and financial flexibility. We have a clear and unequivocal commitment to a progressive dividend stream, which provides certainty of value.

(Technical difficulty) acquisition, where it is considered the best use of capital, and in that context, we've a proven track record of identifying, acquiring and integrating undervalued assets.

I want to thank you for your attention and I'm now going to throw it open for questions which Tony, Ian and myself will try to answer. Over to you, Operator.

Thank you. We will now begin the question and answer session. (Operator Instructions). Mark Wilde, Deutsche Bank.

A couple of things. First of all, can you just give us some kind of an outlook for box pricing in both Europe and Latin America over the next three to six months, based on what you're seeing right now?

I think, Mark, as you can appreciate, it's very difficult for us to give outlooks for 2013, given that we haven't really finished 2012. And traditionally, we really don't guide 2013, or the following year, until we're well into it. This year was an exception where we thought the market was running away with their expectations.

I suppose what we can say is that box prices have been stable, and they have been underpinned by paper pricing pressure; which, in turn, has been underpinned by recovered paper price and cost increases, which have been stable for the last few months, but we are beginning to see the pressure upwards again. Not just in recovered paper prices, indeed, but also in terms of energy, starch, etc.

So the general cost environment is underpinning upward pressure on paper pricing; which, in turn, is currently holding box prices. And if it sustains and grows, obviously box prices will have to follow suit. But we certainly aren't at a stage where we could predict.

Okay. All right, that's fair enough. It sounds like, however, in -- at least in Mexico, there's probably some knock-on effect from this board hike in the US.

Yes, I think the board hike in the US is clearly a key driver of Mexican paper prices; which, in turn, as you know, drives box prices. So it is a long time coming but yes, that's a positive.

Okay. And I wondered, on the Latin American business, just a couple of things seem to me to be going on right now. First of all, it's drawing more -- the region's drawing more attention from other global competitors. We had, a couple of weeks ago, one of your biggest global competitors make a move into Brazil.

And at the same time, it sounds to me like we may be starting to see a trend to more consolidation in the Latin American market. You've made one move, but it sounds like there may be some other things going on as well. Can you just talk about both of those issues?

Well, I suppose what we could do is talk about our situation, Mark.

I think, as you know, we are consistently on record as saying that Latin America is a very attractive theatre of operation for us; one that we believe, in a way, is under -- misunderstood or maybe not properly understood by the market, in terms of its capabilities and its performance, consistently over the last couple of decades.

We have a unique management structure of local people with international skills and experience feeding off an international company with high level standards and European standards of innovation in packaging design, etc. And so it's a market that is very much on our agenda, and has been for some time.

We have been focused, clearly, on deleveraging and have got to the point where we believe our leverage structure is very, very acceptable long term. And, therefore, we are back in the market.

And so we certainly, in key markets such as Mexico, and it's well known that, in the right circumstances, Brazil will be on our agenda, etc., we are focused on certainly continuing our activities in that region.

I think the fact that others are interested in it is not surprising. But in terms of consolidation, it's not as fragmented a market as some of the European markets, for example. And it is not certainly as fragmented as the US was before the major consolidation push. But yes, I think there's room for more activity.

Okay. And then, finally, Gary, I wondered if you or Tony could talk a little bit about the impact of the capacity additions that are coming. I think in Europe, it's mainly in Central and Eastern Europe; and then, you've got some capacity coming in both board and sack craft down in Brazil.

I'll get Tony to answer that one, Mark.

Yes. I think, just to take the sack craft, Mark, issue first. We see relatively tight markets globally in sack craft. And you saw there's been an announcement of closure down in South Africa in sack craft. So we don't particularly see any erosion in the sack craft market, as we speak.

On the capacity additions in Europe, I don't know if you picked up, there was an announcement of a closure by an independent company called Frohnleiten -- called Hamburger, of a mill in Austria called Frohnleiten, which is going to take 170,000 tonnes of capacity out in Q1, or early Q2, as we understand it.

And that, obviously, will help the introduction of the Stora Enso tonnes next year, which are coming on. And it won't run at full capacity initially either, if they've taken about 80,000 to 90,000 tonnes themselves.

So I think, as Gary said, there is an absolute need at the moment for recycled paper prices to increase. Because with the current increases in our input costs, whether it's energy, starch, waste paper seems to be trending upwards at the moment, that there will be a need for recovery to some sort of profitability levels out of the recycled paper business. But there really isn't that much there at the moment.

So I think the capacity will be absorbed, and I think that the east of Europe and Russia per se are growing much stronger than the western part of Europe. So I think there should be -- that capacity coming into the market should be absorbed easily.

The total amount of tonnes, Mark -- just for information, the total amount of tonnes both taken out of the market in Europe and announced to be taken out, as Tony said, Stora Enso themselves, now amounts, year to date, about 470,000, 480,000 tonnes.

So it's lost sometimes in the attention span that this is going on behind the scenes. And that doesn't count a machine in Italy owned by [Romanella], which has been idled, but hasn't been declared totally out of the market; another 90,000 tonnes. So there's a two-way flow here.

Okay. All right, it sounds good. Listen, good luck in the fourth quarter, and into 2013. And congratulations on a good third quarter.

Thanks, Mark.

Lars Kjellberg, Credit Suisse.

A couple of questions, starting off with the good luck in Q4. You've implied guidance for Q4 as in the range of, I guess, EUR235 million'ish, if you put an equal sign between what you have generated and meeting 2011. Could you run us through a couple of thoughts on how you go from EUR280 million to EUR235 million? Is it maintenance, seasonal effects, or any degree of market erosion that you want to comment on, if you would?

Obviously, Lars, we leave it up to you guys to figure out which is the right number. I think our guidance is in line with -- and that -- let's work with your number.

There are two key moves. As you know, quarter 4 versus quarter 3, in general terms, has a degree of seasonality attached to it, in the sense that Christmas tends to be a very -- December tends to be a very, very short month in the significant part of our system, based on Christmas. And indeed, in this year, in the December month, or the New Year turn actually loses a further day. So the number of days available are less, and so you get the seasonality factor.

And then, the second thing, and you're right to draw attention to it. You may remember on our previous results call, we mentioned that our Facture mill had a collapsed tank, which took the paper mill out of action for about 75 days, at a time when the kraftliner market was already tight, quite tight, and indeed very tight, following the previous enclosure.

And, therefore, we took a decision, a short-term decision to postpone maintenance downtime for Nettingsdorfer and Pitea our other two big kraftliner mills in Europe, in order to ensure supply for our customers.

That effectively impacted to the benefit of quarter 3 by about EUR10 million, and to the detriment of quarter 4 by about EUR10 million. So the combination of the seasonality, plus that factor, is effectively the critical path between the two quarters.

And in terms of market movement in the quarter, should we expect any significant changes, or is it more the same?

The environment that we've seen in quarter 3 effectively continues into quarter 4. We're obviously confident enough to basically say we've been consistent on guidance for the year, from a very early part of this year really. And we have no reason to change our views at this point in time.

Okay. Just one other question. Obviously, there's a tremendous amount of cost coming out of your system. One thing that I'd also like to have your view on is on the revenue side. You've had a steady and increasing change for value-added products, and considering very strong margins now in -- well, across this year, in a very adverse macroeconomic environment. Is that a trend that will continue? And should we expect that business to generate high margins? And today, how much of the value-added business of your total corrugated proposition?

Well, I'll get Tony to say a few words. Just to deal with the stats first. In round sum numbers, we are still approximately 60% a fast-moving consumer goods, food and beverage, household consumables type of product areas, which are quite resilient, first of all, to slower economic environments, austerity situations, etc.

But secondly, we're obviously targeting end consumers as a key part, in many instances, of our customers' marketing mix, in terms of display packaging, retail-ready packaging, etc. And this is a growth market in Europe; Europe is well ahead of most parts of the world and it's certainly a key focus area for us.

We have, as we've often said in these calls, unique tools in our view, both in terms of innovation, in Pack Expert, Paper To Box, logistic systems, etc., and, indeed, a strong interaction with the retailers in terms of understanding their dynamics and their world and, indeed, working with them to define packaging potential and opportunities for the future.

So against that backdrop, it's not surprising to see that we are winning business in -- with the major international guys that sell into that system. And in that regard, I think we're seeing, A) business retention; and B) the type of pricing levels that are appropriate for that high quality value-added type of product we sell.

But our margins are also significantly helped by the strong work we've been doing on cost take-out consistently over the last three, four and maybe even five years.

So it's a combination of effectively working all sides of the P&L and balance sheet that is getting us to the point where we are beginning to see some real returns for the effort.

I've just realized that I haven't left anything for Tony to say on this, so, Tony, is there anything I've missed?

No, I think just, Lars, just to reinforce Gary's point; the whole organization is always striving to add value, both for our customers and, of course, for ourselves. That means ultimately using the tools that are available to us, which we've developed.

We're very, very sophisticated in how we actually give our customers an offering, whether it's innovation or reducing their costs and that's a thing that the whole organization is gearing to. So that, obviously, will lead us to higher value-added packaging, whether it is in display or shelf-ready or litho-lamination.

The one other point I suppose to make, Lars, is it's always a judgment call as to how defensive you want your profile of your business to be and how available for growth in better times.

We've taken a view, I won't say that we've sat down and mathematically decided 60%'s the right number, but we're quite comfortable with that type of number in that it gives us a very strong backstop against downward pressure by selling into markets that continue to consume, no matter what the economic environment, but leaving a decent percentage of our business available for upside growth potential in slightly better markets.

It has served us well. I think the quality of our earnings consistently through these volatile periods since '08 let's say, '08/'09 has been such that it reflects that type of profile.

Final question then. Can you confirm you're on track for the EUR200 million by year end? And you referred to earlier a -- incremental cost take-out programs for 2013; any thoughts on that today?

No, I think we'll take the first one. We are on track for the EUR200 million by the year end and in terms of 2013, as we've consistently said, effectively each year, if you look at our payroll, which is about EUR1.6 billion across our total system, ranging from low inflation markets like Germany to high inflation markets like Argentina, we factor into our thinking about a 2% to 3% labor inflation, even with all the actions we're taking.

That means, effectively, we need EUR45 million to EUR50 million of cost take-out before we start. So it isn't an option for us; it's a requirement. And then the extra is, if you like, the ability to improve our margin.

So you can take it as a given that we will be very focused and active in this area and we have quite a degree of potential still. We've investments that haven't started to pay back because they're still going through energy-saving activities, labor-saving activities, automations, etc., and we've further areas in terms of our capital investment slate, which should deliver returns.

Remember, our view is 50% to 60% is maintenance CapEx. Therefore, if we're up to 90% or 95% of CapEx depreciation, the other investments should be making returns and that's where we expect to get some of this as well.

Thank you.

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

The first one I have is, is there any specifics when Orange County is expected to close? Are you including any of that additional EBITDA in your guidance?

James, Orange County will close in November/December and we have not included any EBITDA in our guidance.

Okay, that's helpful. And then secondly, the tax rate that you reported was lower; is that just due to geographic mix or is there something else going on there and should we expect that to stay at lower levels going forward?

When you look at the tax in general around the place, what you're seeing is that if you take nine months on nine months, you'll have seen tax, cash tax, up by the order of about EUR35 million. That's broken out, effectively, in Europe and in Latin America.

What you're seeing in Latin America is that you've got a timing difference; you pay tax particularly in this year versus the prior year earnings; whereas the case of Europe, you're seeing higher cash tax in the countries such as France and Germany where they cut back the tax losses that you can use from 100% to 75% to 50%.

So I think going forward and we'll give guidance on this in the New Year, the cash tax rate would be broadly, I think, about EUR110 million cash out, but again, as I said, we'll give guidance on that at the time.

With regard to the P&L tax rate, again, we'll look at that when we have guidance for 2013, but you're looking at, as we said before, somewhat in excess of between 30% and 35%.

Okay. And lastly, as OCC tightens up, a lot of people are talking about lower OCC quality, at least here in the States. Are you seeing any signs that OCC is starting to diminish and are your yields on OCC starting to fall, so you'd have to buy more to produce the same amount of board? And are you seeing any other quality issues related to OCC?

I think the statement is correct. OCC is getting worse in quality. In Europe, what we tend to use is starch to get the strength that the fibers are not giving us as they used to. We're seeing more dirt in our waste, so therefore that's another indication.

So it is, ultimately, going to -- it is going to be an issue or is an issue and it will require more starch to give the strength characteristics that are required in a recycled sheet.

That's something that we live with. Starch, as you know, is going up in price and again, I suppose from our perspective, gives us a chance to highlight the benefits of kraftliner because we don't really use that much starch in kraftliner, obviously. So I think, in a general sense, your statement is correct.

One of things you have to remember obviously, and you know this, is that the US market is very much kraftliner dominated. And so I'm not saying people are talking there but because it's actually true. But one of the real factors that people keep missing about Smurfit Kappa Group is we are uniquely positioned in terms of having either/or options. We have a strong recycled containerboard system but we are short 300,000, 400,000 tonnes in it. And we have a uniquely strong and primary position in Europe in kraftliner where we're 400,000 odd tonnes long.

So in many ways no matter which way this develops, we are well positioned for security and supply on the one hand, and indeed quality of earnings through the integration on the other hand.

Thank you very much.

Barry Dixon, Davy.

A question on pricing, I'm just trying to get a sense I suppose of both kraft and recycled pricing trends. And I suppose coming at it from a demand perspective first of all, given that the spread between kraft and recycled containerboard in Europe, do you think A) that that spread is sustainable given that it sets almost historic highs?

And B) are you seeing any switching out of kraft and into recycled which is helping to shore up demand for recycled?

Second part of that I suppose is, are you seeing any changes or any improvement or what's the export demand like for recycled containerboard currently at the moment?

You talked then about the EUR30 a tonne increase of the EUR100 that you've announced, would you expect to get more through by the end of the year regardless of what happens to OCC or is it dependent on OCC?

And could I ask as an addition to that, is how disciplined have the independent producers been in terms of adhering to that price increase? Or have they tried to break ranks perhaps as the demand environment maybe doesn't look as healthy?

Second question then is really on --

Barry, can I suggest to you for a minute? That's four questions but you may not be counting. Could you hold on those for a minute and we'll try and answer them --

All right, okay, thanks Gary, sorry about that.

No, no, otherwise we'll lose track of what you're --. Let me take the last one, I'll let Tony take the first couple of ones.

In terms of the recycled containerboard pricing, our position is very clear. The announcement of the price increase which we made was necessary to restore economic sense to the recycled containerboard sector. And it is manifestly evident to us, as a very, very big player in this sector, that the economics are currently inappropriate and -- and if they're inappropriate for us, they're wholly unsustainable for many. Take, for example, as we've often mentioned, the 2.3 million tonnes on machines of 100,00 tonnes or less that have no integration and are selling at spot.

So to your point, are the independents breaking ranks? At the end of the day, the small independent guys have to either get price or fill their middle. They can't afford to do neither. And obviously as you come into the softer period of the year for Christmas, as you come into a Stora Enso new machine coming on stream, nervousness creeps in and I suspect there's an element of that in terms of securing their volumes which has certainly not helped to get further price increases.

Whether and when further price increases in recycled containerboard happens is a question. But the whether is in our view much more definite. There is no doubt that the economics absolutely require it and one of two things will happen. Either further casualties will occur or price increases will go through or potentially both. So in our view right now, the fundamentals haven't changed and the need hasn't changed and the question is when.

Tony, do you want to take that?

On the gap question, yes the gap is at a historically high figure right now. But that said, as Gary just mentioned, recycled is just too low. And so therefore we expect at some point that that will increase. The gap, the demand on kraftliner is very strong and there's no reason for us to in any way adjust our pricing at least for the foreseeable future to take that gap down, so therefore, the gap will exist.

But we do expect it to narrow by recycled pricing ultimately moving up. Because as Gary just mentioned, the reality is with waste paper now trending upwards, with starch and all energy costs trending upwards, we do actually see a very significant margin squeeze in recycled papers. But we run our machines fully to our own integration, others do not have that luxury. And I think that they will be suffering at the moment.

Switching, Tony?

Switching, we're not seeing that much. Obviously our problem during the summer with Facture made it necessary for us to go to some of our customers and say we needed to supplant with TL1, which is a hybrid grade where we buy pulp and we put it on top of a recycled sheet.

That's not a long-term solution. It has a small niche place in the market, but it's not a long-term solution to kraft, because it doesn't have the strength characteristics or the wetness characteristics of kraftliner. But in an emergency, that's what we have, we have the use of that.

A lot of the switching, Barry, has already happened. You always get it around the edges but it's not a -- kraft is still a very good product and still needed for many applications.

Okay. And the export demand for recycled holding up reasonably well?

Yes, there's no particular issues that I've heard of in that.

And, Barry, just to square that circle, inventory levels in recycled containerboards are at very acceptable levels.

Okay, perfect, that's great. Thanks for that.

David O'Brien, Goodbody Stockbrokers.

Just a couple from me. Firstly, just on input cost inflation. Would you be able to quantify what you're seeing in Q3 across wood, energy, transport and starch?

And then just secondly, if you look at the pan-European sales, the volumes into that line of customers was up 6% year-on-year for the first half; but just according to the presentation, it looks like they're up 3% for the nine months implying a little bit of weakness in Q3. If you could just give us a little bit of color around that?

Yes, if you take the quarter to date, as in the quarter 3 playing quarter 3, what you're looking at is, across the board you're looking at raw materials, recovered fiber is down about 17% and wood costs are up a bit at 20-odd%. Distribution costs up; energy and water about 1%; repairs and maintenance around 2%.

So broadly, I suppose when you look on a like-for-like basis with OCC it's probably flat to minus 3%. Probably the year to date is a better comparison, which is nine months on nine months, because you're taking the recovered fiber effect there as minus 12%. Wages and salaries, as Gary said, is off distribution costs, up by about 4%. Energy and water by 4%. Admin costs down. So nine months on nine months, you're seeing the total cost effectively flat to minus [1%].

That's great. Thanks very much.

And on the second question, David, let me just ask Tony to say a few words.

I would say there's nothing apparent, I'd say there is a more seasonal issue that's occurred. I haven't heard of any particular losses, in fact quite the contrary. We are continuing to gain business in the pan-European area. So with the exception of one or two customers that I know that they've moved out of the product into a different line or into a different area, we're not seeing anything that gives us any cause for concern.

Okay, that's great. Thanks very much.

Just one question, please. Following up on the question on testliner price increases, could you just talk us through a little bit the mechanics of the price increase. Are you still looking to push through more of the EUR100 price increase that has been announced? Or at this stage, do you think you'll need to let that rest a little bit and come out with a fresh price increase; perhaps a fresh announcement sometime in the New Year? Thanks.

I think Gerard we're probably in the area of semantics here. There's a price increase announcement of EUR100 a tonne out there of which we've got EUR30 a tonne. Clearly, what happens next is going to be a function of market evolution. I wouldn't like to be calling it one way or the other. It actually doesn't quite matter.

At the end of the day, pricing is pricing whether it's the original price increase announcement or a new price increase announcement. In our case, what it's about is actually getting customers to pay the higher price that's clearly needed for this grade. And indeed for the smaller independent guy who's trying to get price levels that will sustain him and not cause him to hit the wall.

Okay, fair enough. Thanks.

Mikael Jafs, Cheuvreux.

I have a question about the Bag-in-Box business and you're discussing about that growth potential. Perhaps you could say a couple of words on that part of your business; market growth, what should we factor in? How should we think about it?

And then also, how big part is your pouch business of that business? Perhaps some more light on that part, given that we've been discussing the other part for the whole call almost.

Obviously we don't break out the detail, Mikael. But let me get Tony to answer your question.

Mikael, I think the Bag-in-Box business is growing very strongly. We'd like to make sure that it gets to the level that you guys in Scandinavia are using Bag-in-Box which is at 50% or so of wine consumption. Whereas in the rest of Europe, it depends on the country frankly.

But it is a strong growth business for us and as we mentioned on the last call that we are investing in our Bag-in-Box business in Spain, we're building a new plant. And we continue to invest in the existing businesses, as well as acquiring businesses where possible. So it's an attractive area because it's got so many applications.

Specifically about the pouch business, that's really a business that we're just launching and we believe it's got a lot of potential to other forms of packaging. But it's clearly early days and doesn't represent a big amount of Bag-in-Box business [at this time].

But the Bag-in-Box business, to your point, Mikael, is a higher growth, higher margin business and one in which we have great expectations. But it's still relatively small within the scheme of things but has the potential to be much, much bigger and you can see we're putting money behind it.

Yes, thank you for your answer. And then perhaps just one follow-up question. I know it might be difficult to answer, but when you're looking on this business, what type of volume growth do you see, is it in the 5%, 10% range? If you can't answer, you can't, but if you can --

If you take it that we're working -- as Tony has mentioned, production operations in Canada, in Russia, in Argentina, in Italy, France and Spain, clearly it gives you a sense that each of those countries have very different, even basic GDP dynamics and growth, part of which we benefit from, particularly in the likes of Russia and the likes of Argentina and so on.

And so we would expect materially higher growth than you would see in the normal market. So if you take GDP and the fact that we are growing our business in those markets, you're probably up towards more like the 10% and the 5%.

Okay. Many thanks.

We have no further questions at this time. I will now turn the call back to your host, Gary McGann.

Thank you very much, Operator. Ladies and gentlemen, let me again thank you for participating in today's call. Let me reiterate our business position and proposition.

Against a range of strategic financial and operating measures, the Group is pleased to deliver strong progress for both the third quarter and the first nine months of 2012. The continued strength of our operating performance has delivered net debt reduction of EUR483 million in the last 24 months. This has broadened the available range of strategic and financial options open to us to deliver value, and positions the Group for continued performance and growth.

Experience and the quality of our people, the differentiated nature of our market offering, and the increasing quality of the assets backing our business give us renewed confidence that we can continue to deliver a quality earnings stream with industry-leading EBITDA margins in a 13% to 16% range, and returns well in excess of our cost of capital.

This progress, together with the strength of our underlying businesses, will sustain a progressive dividend stream in 2013 and beyond, by continuing to target accretive acquisitions to enhance growth.

Again, thank you for your attention and have a good day.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.