Smurfit WestRock PLC (SW) 2015 Q3 法說會逐字稿

Hello, and welcome to the Smurfit Kappa third-quarter results call. (Operator Instructions). Just to remind you, this session is being recorded. I'll now hand you over to Tony Smurfit, Group CEO. Please begin.

Thank you. Good morning and afternoon, and thank you for taking the time to join our 2015 third-quarter results call. I'm joined on the call by our Group CFO, Ian Curley.

Before commencing, I would refer you to the note on forward-looking statements set out in our press release, which applies to our discussion today.

We're pleased today to report a strong third-quarter earnings and free cash flow outcome. EBITDA of EUR305m and an EBITDA margin of 15% reflect a decent operational performance and good volume growth across the business. We're also reporting EBITDA of EUR855m for the first nine months.

Our strong year-to-date performance reflects the resilience of our integrated, geographically diversified business model and our capacity to drive earnings growth and returns. This is in spite of input cost pressures which we have faced throughout the year and the negative impact of our adoption of the Simadi rate for Venezuela. Excluding the Venezuelan impact, our EBITDA year to date increased by 5% on last year, a result that more accurately reflects the directional performance of the underlying business.

Based on current operating conditions, we expect to deliver a full-year EBITDA result in line with market expectations.

Looking at our returns, return on capital employed remains a key metric for assessing both current performance and future investment. Our return to 15% ROCE reflects the positive impact on our business of effective investment in our asset base, the ongoing integration of acquisitions and our consistent delivery against cost efficiency objectives. We remain committed to our target of 15%.

Turning to our operating performance, Group corrugated packaging volumes grew by over 5% in the quarter and over 6% in the year to date, reflecting acquisitions in both Europe and the Americas, combined with good organic growth across our operations.

Against the strong performance last year, demand levels have remained good in October and the positive fundamentals prevailing in the European containerboard market are helping to drive corrugated price recovery. We are making good progress with the development and integration of our differentiation initiative and we are already seeing the positive impact of this initiative with our customers.

The launch of our Shelf Smart sales process, ongoing development of our network of customer experience centers across Europe and our enhanced commercial offering are better positioning us to address customers' increasingly complex needs through their supply chain and in the marketplace.

Our free cash flows remain strong, at EUR162m in the third quarter, following higher capital outflows relating to our program of high return efficiency investments and a number of one-off items primarily related to restructuring within our European business. As a consequence, net debt to EBITDA at September of 2.6 times is comfortably within our target range of 2 to 3 times.

Supported by a proven track record of free cash flow generation, we believe our capital structure is within an optimal range for our business, providing us with greater strategic flexibility to drive growth and returns.

Looking to Europe, we're pleased to report a solid performance for the quarter. This is in spite of higher input costs of OCC and purchased paper and a somewhat more uncertain macroeconomic backdrop. Most markets reported good levels of growth year on year, and our continued focus on cost efficiency has supported a recovery in EBITDA margin to 15.1% in the quarter.

Our Eastern European business delivered double-digit growth, while our larger Western European markets also continued to grow steadily. Our average corrugated pricing in Europe in the quarter was maintained at a steady level, both sequentially and year on year.

Demand for corrugated packaging has been good in the year to date, with 4% growth year on year. The slight reduction in year-on-year growth to 3% in the third quarter can be partly attributed to the strong level of volume growth in the second half of 2014.

A more important driver was the reduction in the Group sales of corrugated sheet, the more commodity end of our business, which decreased by 8% in the quarter. Demand for the Group's higher value corrugated boxes remained robust throughout the quarter, up 4% year on year and in line with the second quarter.

The average price of OCC rose by EUR25 a tonne from February to a peak in August, but has since moderated slightly. We expect continued high levels of demand for OCC to support prices at their current level and in turn both Testliner and corrugated prices.

Our recycled containerboard operations performed well, and we continue to optimize our European system. In February, we shut an 80,000 tonne mill in Viersen, Germany, and we are in the final stages of ramping up our refurbished 240,000 tonne mill in Kent in the UK. Both have been a drag on earnings in 2015, but will result in a more efficient responsive system when completed and will be earnings enhancing into 2016.

The European Kraftliner market has been well balanced throughout 2015 and our internal consumption has increased 6% in the year to date. While the introduction of capacity into the marketplace in 2016 is expected, the industry successfully implemented a EUR20 a tonne price increase in June, and demand growth is expected to at least match growth in supply.

We will remove ourselves 65,000 tonnes of virgin containerboard from the market in the first quarter of 2016, as we convert our containerboard machine in Navarra in Spain to machine glazed paper, the grade in which the mill is already competing successfully on on a global basis.

In our Americas business, we continue to deliver strong volume growth of 18%. This is largely as a result of a series of successful acquisitions in the last 12 months and broad-based organic growth across the region.

EBITDA in the segment was 2% lower year on year in the year to date, driven by the impact of the adoption of the Simadi rate for our Venezuelan operations. Adjusting for Venezuela and acquisitions, the segment's EBITDA increased by 13%, which emphasizes the strong underlying growth in the business in the region.

Recently acquired businesses in the US, Central America and the Dominican Republic are performing well, and we will meet all of our stated synergy targets. In October, we also announced we had agreed to acquire Sound Packaging, a corrugated sheet and box plant located in Phoenix, Arizona. This transaction will be completed in the fourth quarter and will strengthen our footprint across the southern United States.

In Colombia and Mexico, we delivered solid corrugated volume growth in the third quarter, and we remain focused on implementing price increases to offset the impact of currency headwinds.

In the United States, our Californian business is showing early indications of an improved level of demand with a good performance in September, while the ongoing integration of Bates and Brian Thomas corrugated businesses in Texas is continuing as expected.

Turning to capital deployment, we're now more than halfway through our three-year program of investment in high return projects. The program features over 100 unique projects, with a total expenditure of around EUR150m from 2014 to 2016.

While individually the majority of projects are reasonably small, together they're expected to generate an incremental EBITDA of EUR75m in 2017 and onwards, as they come online. By the end of 2015, the program is expected to deliver incremental EBITDA of EUR18m.

We're also delivering on our cost take-out target of EUR75m for 2015. In the first nine months we have generated cost savings of EUR55m, with significant savings achieved in key cost areas such as raw material usage, energy efficiency and labor costs.

Supported by our strong capital structure, we've been investing steadily in the business in recent years to enhance our asset base and optimize our capabilities. Our total capital expenditure in 2015 will be approximately EUR430m, having been at a similar level in 2014, with a particular focus on continually developing our corrugated footprint to meet our customers' needs across our businesses, alongside large operational efficiency and light-weighting projects in our system.

Projects such as Townsend Hook, Roermond in Holland, Sanguesa in Spain and Mexico City in Mexico will in aggregate cost almost EUR250m and will strengthen the Group's integrated system into the future.

Similarly, we have been focused on growing the business through accretive acquisitions, and have delivered EUR370m of acquisitions across nine countries since the start of 2014. We will continue to focus on delivering operational and earnings enhancing acquisitions across our target markets.

In summary, we are pleased to report a good third-quarter result and a strong underlying business performance. Supported by continued volume growth, a consistent focus on cost take-out and steady delivery of accretive acquisitions, we have driven an EBITDA margin of 15% in the third quarter and 5% in EBITDA when excluding Venezuela in the year to date.

Based on our current operating conditions, we expect to deliver a full-year EBITDA result in line with market expectations and we remain confident into 2016 and beyond.

Thank you, operator. We're now happy to take any questions.

(Operator Instructions). Lars Kjellberg, Credit Suisse.

Thank you and good afternoon, gentlemen.

Hello.

Just to start off with, your guidance for the full year [has followed] consensus with around EUR1180m mark on EBITDA. That would suggest a very strong yearend quarter, which is typically a down quarter on Q3. Can you walk us through the bridge, what's going to drive a sequential improvement in the fourth quarter of the current year?

Yes. Basically, Lars, you've seen an improvement in our Townsend Hook operation; you've seen in quarter three we had two of our major mills down in Kraft, our Pitea mill and our Facture mill. You are seeing the -- we have still a little bit of restructuring to get by in Germany, but that is somewhat behind us at this stage, and in Sweden, where we've -- as you know, we restructured a number of plants during the year. We had three in Germany, one in Sweden and one in France, and they would be behind us.

And we're seeing a small bit of pricing increase as we get into the fourth quarter, relative to what we need to get. As you'll note, in the third quarter we took all of the increases in wastepaper and in purchased paper. As you know, we purchase some 600,000 tonnes on the outside per annum. And as the price goes up, we have to recover that in the marketplace and so that's what we're about doing and some of that will be coming into the fourth quarter.

And additionally, I think we're seeing in -- as we go into Q4, we're seeing relatively decent levels of demand from the second half of October onwards. And I think our American business is performing well and we would expect to see a good performance out of there for the last three months of the year.

Very good. And coming onto the Americas business, good margin improvement on a sequential basis; is that largely driven by pricing and if so is that momentum continuing into Q4?

I think we're seeing some improvement in certain of our operations in Mexico, in Northern Mexico and in the US. We're seeing the development of the acquisitions, which if you remember we've only made them in May and June and some of the synergies starting to come through a little bit in Q4. So it's a combination of many different things and some of the cost reductions that we've been working on. So it's a combination of different things, but led by decent demand and some of these synergies coming through and some of the acquisitions.

Okay. Just a couple of modeling questions, I guess. You've mentioned the one-off effects from various restructuring, Viersen and Townsend Hook, etc. Can you give us a quantum what that has cost you in 2015 and the benefit you expect in 2016 from these actions? And also, if you can walk us through that in terms of the M&A activity, where you have been quite active in 2015, what sort of EBITDA we should expect that to contribute in 2016 versus what we have in the books for 2015.

Lars, this is Ian here. In relation to just -- with regards to 2016, Lars, we'd stay away from 2016 because we're in the middle, as you know, of doing budgets and we're happy to give guidance once we've done that.

I suppose the big mover from a modeling point of view on 2016, though, versus 2015, as we've said before and Tony touched on it there very briefly, is Townsend Hook, and the cost of Townsend Hook effectively for 2015 will be in the order of about EUR18m to EUR20m. So that is the big move. The other one that we highlighted really is Fustelpack. We had a fire in Fustelpack which cost us in the order of about EUR7m. So they're the two big moves there.

If you take the nine months on nine months from an acquisition point of view, we've had a benefit of EUR27m on acquisitions. That's offset somewhat by some of the disposals and some of the closures hit us for about EUR9m. So, net/net, year to date about EUR18m, EUR19m. For 2016, we're happier once we've done budgets. We'll give you guidance then.

Fair enough. Thank you.

Thanks, Lars.

Matthias Pfeifenberger, Deutsche Bank.

Yes. Good afternoon. Thanks for taking my questions. Actually, two on corrugated. Just quickly on the pricing on the non-indexed volumes, maybe a bit more color in terms of what you're seeing. Is that okay in terms of timing, that you're targeting these price increases into 2016? And also, in terms of what you're facing on headwinds from maybe a bit weaker volumes, you mentioned Q3 on the sheet side, also OCC drifting a bit in the third quarter.

And then more strategically, maybe an update on your strategy in European corrugated, with a couple of competitors announcing quite ambitious plans. Thanks.

Okay. On corrugated pricing -- Matthias, hi there. Basically, on the corrugated pricing, we had been going for increases as from the first increase that was announced in July. We had expected to get another paper price increase in October. But as the perception, and I say the word perception, was that wastepaper was going to come off, following some degree of weakness during September wastepaper was going to come off, then the second price increase didn't go through.

And that has weakened the level of pricing that we will recover for the paper price that we had expected to put through, but we will be getting pricing into Q4 and into Q1. The order of magnitude will be obviously less than we would have expected had we had the second paper price increase.

With regard to sheet, we ourselves have been obviously aggressively moving on pricing to recover paper price increases. And in the more commodity orientated business, that's where you can lose volume fairly quickly because it is more commodity orientated. I'm not 100% sure whether that's the only reason, because I do think that sheet plants are more reactive to global economic worries and so there could have been some destocking, and as I say, our order books have recovered in the latter part of October.

So I think there could be some degree of market sensitivity to the outside world with things like Volkswagen, etc., that might have given many of our customers some cause for concern. So that's why sheet volumes might have been off, as well as our position of pushing on pricing.

On OCC drifting, to your point of drifting, it did drift a little bit in September, and hence the reason why that was one of the primary reasons why we didn't see the second paper price go through, but has since hardened and in fact is well bid at this moment in time. Whether it goes up or not is early to say, but it is well bid at a high level.

Our wastepaper prices are EUR25 a tonne above the start of the year, and that's clearly a major cost to our system on an annualized basis. That will be the guts of EUR100m to us, so that's a major cost headwind that we've had to deal with during this year. So we don't see at this moment -- but it is a volatile commodity, as you know, but at this moment we don't see downside movement on wastepaper.

Next question was on -- Matthias, can you remind me of the third question?

It was what your strategy would be in corrugated. You said that you see the business on a standalone basis; you don't need paper integration to consolidate more. And one of your competitors is also moving quite actively. So will the two of you drive European corrugated consolidation, or wouldn't you pronounce it like that?

No, I think what we've always said is if an opportunity is good that's going to be enhancing our shareholders and the asset is good, we would be actively looking at it. We are very long of corrugated at the moment. In other words we're buying 600,000 odd tonnes. And as we grow, we will continue to need more paper.

So adding corrugated plants, they'll have to be well situated good assets, good for the overall system. And at this moment in time, there are not that many that fit in that particular bill for us because, as you know, we're number one or number two in most of the European markets in which we operate. So there might be some spots where we could have a couple of box plants, but we're pretty well set in most of the European markets.

I think to just add to that, our focus would always be on the acquisition of box plants. That's our preference, over and above paper mills. Paper mills come in behind the box plants, and we are a packaging business and paper mills come in behind within the integrated strategy. We don't see ourselves going long, for example, on recycled in Europe. Our focus is broadly on the box side.

Yes, thanks for the clarification. Thanks.

Thanks, Matthias.

Colin Sheridan, Davy.

Hi, guys. You've addressed most of my questions there, but maybe just a couple of points of clarity, I suppose, on the Townsend Hook, given the loss in Q3. I know you said you expect that to improve and to be earnings enhancing in 2016. I suppose, are you expecting that to go to the right side of breakeven during Q4, or will that now be a 2016 story?

And then, just on the M&A side, I suppose you've made very good progress obviously on net debt. And in terms of the landscape there, have you seen any changes in vendor expectations over the last quarter?

Okay. I'll leave the M&A question to Ian, but on the Townsend Hook I would say that we are -- as I said in my note, we are firmly in ramp-up mode. The plant is now running well. We have still things to adjust. Whether we'll be breakeven or close to breakeven in Q4 is still an open question, but we'll be there or thereabouts in Q4 on Townsend Hook and then we should be in a much better position for next year. But we feel very comfortable that we're in the right direction now in that particular asset.

Ian?

Colin, in relation to the landscape, there's a reason -- we've a reasonable pipeline out there, as we've been saying, and we've been quite successful and we have spent in the Americas over about EUR200m at the moment. So our focus is on, as I said earlier, on the box side of things, integrated businesses. Some price expectations around the place have come down. Places like, for example, Brazil, they've changed the capital gains tax rules, etc.

So we look in all the markets that we're in and in the adjacent markets, but we won't be going off into new regions or anything like that. There's plenty of activity out there for us to pursue.

Okay. Thanks, guys.

Thank you.

Gerard Moore, Investec.

Good afternoon, gentlemen. Just a few more questions from me, please. In the statement you flagged that France was one of the weaker markets in Europe, while most other markets did well. But if you look at it from a slightly different perspective, if you look at product categories or end industries, were there particular areas that caused concern where they were slightly weaker towards the end of Q3, or was it generally across the board?

The second question then is just in relation to your commodity sheet business. Could you maybe explain to us a little bit more your general approach to this business? Is this something that it does absorb fixed costs for the overall business? Is it something where you manage the pricing quite, let's say, differently from one quarter to another quarter in order to suit your own needs? Maybe just talk us through your approach to this business.

And then the final question, if I can, just the outlook for the MG market and your decision there to do the conversion in Spain, maybe explain the rationale there to us. Thanks.

Okay. Let me take -- Ian, do you want to take the -- no, you don't. I'll take the French segmentation. We didn't see any particular segmentational issues in France or in any of the European markets. Obviously, you'd wonder if we're going to see something in the car manufacturing, based upon the current issues that some of them are having, but we have not yet.

I think there was -- probably, Gerard, if you're asking me for an opinion what -- as I said, our box volumes were up 4%, so they were still very good and against good comparisons last year. It just didn't feel quite as strong order intake and that has now, I would say, reversed and we feel back to normal, albeit that we are still against strong comparators in Q4 versus last year.

So I wouldn't say we've seen any segmentation of any particular area of slowdown. Country wise, the French market still lags. We see very strong growth in some of our markets, such as Eastern European and Italy. I'd say third quarter, the agricultural season got off to a little bit of a slow start. We expect that to be reversing. It was too hot. In the agricultural sector, it's either too hot or too cold or too wet or not wet enough, so we always have to bear that there are going to be some monthly shifts in that particular segmentation of agriculture.

So I don't see any particular segmentational issues, and country wise I think France still remains a weaker country. And in fact, the UK was not as strong as we would have anticipated, given the election result, but still not bad, just not as good as we would have anticipated.

On our approach to sheet feeding, what we try and do, we have a number of sheet feeders across the Company and they are typically targeted at partly our own sheet plant activity. And as you know, we've bought two sheet plants in the UK -- sorry, two sheet plant companies in the UK, Inspirepac and Beacon Packaging, and they will progressively use more of our sheets as we go forward into the rest of this year and into 2016.

Our approach to that business is we believe it's good for our mill system. It trims our mills quite well where we have mills in the proximity of the sheet plants. We tend to try and stay away from the pure commodity end of the market and we try and sell some more specialty sheets, albeit that there is a part of it that is pure commodity where you're competing against different parts of the market which are very either integrated, selling paper through sheets, or just trying to sell to individual sheet plants in certain markets such as Italy, where we have to be very cognizant that you don't want to get into the really rough end of the market.

So we try and sell at a slightly specialized area, but there is a part of it that is good for us but it's -- as a business, it's good for our mill system and integrated system.

And then our MG rationale, we've a very good mill in Northern Spain called Sanguesa. It had three paper machines, two in MG, the third in virgin containerboard producing about 60,000 tonnes of virgin containerboard which is sold into our system.

Making that third machine an MG machine, given the fact that we have very strong outlook and growth characteristics for MG on a global basis -- it's not a commodity for us. We're not in the commodity end of MG. We're not in envelopes. We're in more like tapes and bags and wrappings. And so we believe that longer term that's a better place than an inefficient 60,000 tonne containerboard machine, and so we're going to take out the capacity and put in a new MG machine.

That sounds very clear. Just maybe two follow-ups, if I can. Are you prepared to give us an idea of the cost of that investment of the MG conversion?

And secondly also, for the commodity sheet business, in the statement you say that it accounts for 13% of volumes. Is it fair to assume that it would be -- in terms of EBITDA, it would be much less significant, say less than 5% or so?

Yes to the second question, 13% and much less significant, and EUR27m I believe is the number for the MG investment.

That's great. Thanks.

Which will be starting up in the second quarter.

James Armstrong, Vertical Research Partners.

Good day, Tony and Ian. Thanks for taking my question. The first one I have is in the Americas you saw strong margins despite the currency headwinds and a rough operating environment, meaning your total costs are down significantly in the region. Is there anything reducing costs particularly in the region, or is it just broad based overall?

James, it's Ian here. If we can just look at currency in general, in the Americas -- total currency hit us for the year for -- nine months on nine months about EUR48m, of which EUR54m was in Venezuela, and the Americas [ourselves] with the strengthening dollar was a positive EUR6m. Those are net. So when you look at the Latin American business itself, it's more general across the board. There's nothing specific that I'd point to.

Okay. That helps. And then switching gears, as you approach the 2 times net debt to EBITDA, could you update us on your use of capital between dividend, share buybacks and M&A? And do you have any updated net debt to EBITDA target?

And finally on that, on M&A, which regions are you seeing the most opportunities right now?

In relation to just -- we're very clear on the metrics here. We are wedded to being a BB+ credit, and that's in the range where we've said that we'll -- that the net debt to EBITDA will be in the 2s. If you take the forecast number broadly, that would see us at the end of the year about 2.4. So our strategy will remain the same with regard to that and our focus is again we've been very clear on our capital allocation.

Within the M&A side of things, you've seen we've spent about EUR200m in the past nine months. Most of that effectively has been in the Americas. But we look, as I said earlier, in the countries that we're in and in adjacent countries, and you've seen that, for example, in the Americas, particularly in some of the businesses that we bought there.

So overall, box business, mills behind it, and controlling the cash flows in areas that we operate or adjacent areas in our core business.

That helps. Thank you very much.

Justin Jordan, Jefferies.

Thank you and good afternoon, everyone. I just wanted to -- I guess one or two slight modeling questions. Previously, I think you talked about tax rate for 2015 being somewhere in the neighborhood of 25% to 30% kind of thinking. Are we now potentially towards the top end of that guidance range? And does that have a flow-through impact on free cash flow potentially being down year on year from the EUR362m that you delivered in 2014?

And secondly, just obviously I guess following on from James' question on capital allocation going forward. If we think forward -- and I know you're not giving guidance on 2016 here, but if you think forward in terms of CapEx this year being around EUR430m or broadly speaking flat year on year on what you did in 2014, given the strength of the balance sheet and the success of Quick Wins and what you're doing in MG in 2016 already, should we think about CapEx in 2016 being at a minimum almost flat on 2015 or potentially being up year on year because of potentially more quick wins in 2016/2017 than you're already planning?

So, when you look at the tax expense first, the third quarter is not a great guide for the full year. When you see the third quarter, nine months on nine months, the tax is EUR126m, was EUR23m higher than 2014. And this reflects we've seen a higher increase -- the higher earnings effectively, and you see lower deductible interest expense in 2015.

But it's a hard one effectively to judge and there's no real change in the guidance with regard to the tax -- the percentage rate really, as such. But the pressure is on the upwards, as you can imagine, as countries around the world look for more and more tax.

The way I look at it on a more simplistic basis is when you look at the cash tax of the business, if you go back four years, 2012 it's EUR113m, 2013 EUR112m, 2014 about EUR107m, and we've given guidance of about EUR130m. So the underlying tax is affected in some shape or form by using up losses, etc., governments increasing tax rates overall, but what you're seeing is on balance cash tax would be up marginally year on year.

And with regard to the other question was -- sorry, your other question?

Sorry. Ian, just following on from the tax charge, just flowing through to free cash flow, should we be thinking about free cash flow being also slightly down year on year just because of the amount of tax and restructuring?

No. In relation to 2016, I think we haven't given any guidance in 2016 and we wouldn't until realistically -- until we know what we're effectively talking about ourselves, having gone through the budgets. So, no guidance at this stage.

Suffice to say, Justin, we always -- the guys always ask for more CapEx than they get. So, as Ian said, we will need to go through the budgets and decide what our plan is for 2016. We're just not there yet.

Okay. Thank you.

[Arielle de Chaussane], Pictet. And we've just lost the line of Arielle. (Operator Instructions). Now I've just been advised that in fact we have no further time for questions, so I'll return the call to our speakers for closing comments.

Sorry. Thank you, operator, and thank you everyone who's joined the call. I think we're pleased with the performance in the year to date. And as we've said before, supported by our increasingly focused product offering and our very targeted capital allocation strategy, we in Smurfit Kappa Group expect to continue to drive earnings growth and value creation for our shareholders in 2015 and beyond.

Thank you all for your continued support and I wish you all a good day and thank you again.

This now concludes our call. Thank you for attending. Participants, you may disconnect your lines.