Smurfit WestRock PLC (SW) 2017 Q1 法說會逐字稿

Hello, and welcome to the Smurfit Kappa 2017 First Quarter Results Call. (Operator Instructions) And just to remind you, this is being recorded.

Today, I'm pleased to pass you over to Tony Smurfit, CEO. Please begin.

Thank you, and good afternoon to everyone. And thank you for taking the time to join our 2017 first quarter earnings call. I'm joined today on the call by our Group CFO, Ken Bowles; by Paul Regan, Group Treasurer; and Irene Page, our Group Financial Controller.

Before commencing, I would refer you to the note on forward-looking statement set out in our press release, which also applies to our discussion today. I expect that you will have been through the release at this stage. So rather than go through our performance line by line, I will provide a brief summary and then take your questions.

Today, we're pleased to report revenue growth of 6% year-on-year to over EUR 2.1 billion or 3.7% on a days adjusted basis. We reported EBITDA of EUR 278 million, with a margin of 13% against the backdrop of higher recovered fiber costs, up approximately EUR 30 million year-on-year. We recorded group corrugated volume growth up 3%, positively impacted by good demand in most markets and the benefit of additional working days. We also reported return on capital employed of 15%, which is in line with our current targets and improved free cash flow during the quarter.

This quarter saw the successful implementation of containerboard price increases across our operations. In Europe, we implemented a EUR 60 tonne increase in recycled containerboard in the first quarter, with a further EUR 20 a tonne implemented in April. In kraftliner, we successfully implemented a EUR 50 tonne increase across our many European markets in March, with a further EUR 50 a tonne announced for May, which we expect to go through. We are increasingly well positioned to capitalize on this positive pricing environment.

For the group, innovation remains a key business driver, and we continue to far and away lead the industry with our award-winning design and solutions-based products. In the last 3 months, we have won a number of awards across Europe. Our Pack Expert, InnoBook and Shelf Smart applications allow us to provide our customers with the broadest and most innovative range of paper-based packaging products in the market, which, of course, ultimately enables our customers to succeed in their own marketplaces.

Today, our balance sheet is strong, with net debt-to-EBITDA now down to 2.4x compared to 2.5x in the same period last year. We continue to build our balance sheet strength, which provides us with considerable financial strategic flexibility, subject to the stated leverage range of 2x to 3x through the cycle. We have completed the investment stage of our Quick Win capital expenditure program in 2016, the benefits of which have been delivered consistently since 2014 and we expect to deliver a total incremental EBITDA of EUR 75 million by the end of this program. The evidence of this is apparent in our Q1 numbers, helping to offset a hit of some EUR 4 million in our kraftliner mill in France and the huge wastepaper price increases that we suffered. The dividend is an important component of our capital allocation process and as we reported in our 2016 full year results, we are due to pay a final dividend of EUR 0.576 per share, which is payable on the 12th of May this year. This 20% increase of dividend underpins the board's confidence in the continued strength of the business. The group's strong free cash flow delivery enables us to continue to invest to support profitable growth while sustaining an attractive dividend stream for our shareholders.

To conclude, we are happy with the business performance in the first quarter and as I've outlined, while we operate in an environment of significantly higher recovery fiber input costs as well as other markets, environmental and political challenges, the quality of our people, the strength of our integrated business model, our industry leading business applications and our portfolio of geographically diverse operations means that Smurfit Kappa Group is increasingly well positioned to deliver value for our shareholders in all market conditions.

Thank you, Hugh, and now we are happy to take any questions from those listening.

(Operator Instructions) Our first question is from the line of Lars Kjellberg of Crédit Suisse.

Tony, in your statement today, you seemed very confident in shifting those high containerboard prices into boxes. Can you give us a sense what sort of percent you need in the box business in terms of price increases to fully compensate for those prices? And also, considering that you had, of course, a downward trend in testliner pricing last year and so I guess, you need to recover that before you really started to pass that on. And also in the Americas, the margins now, of course, quite compressed in account of that surge in OCC and inflation, I suppose, in some of those markets, do you think it's doable to return to that sort of customary 17% margin business that it used to be?

Yes, I'll take the second question first, Lars. I mean, I think the answer to the second question is yes. I mean, obviously, we need all the markets to cooperate and we are actively moving forward with the price increases in the Americas, in all of the markets which we operate. Some of the markets are little bit more tricky such as Argentina, which has had a very difficult first quarter and probably will have a difficult second quarter. But we actually remain very comfortable and confident of Argentina because the government there is doing a lot of good things. So there should be no reason why we would not get back to our historical margins in the Americas given some time to push the price increases and price recovery through. Because we absolutely need it as you saw from the margins that we have there. So yes is the answer to the second question. With regard to the first question, I'd say that success is never really a straight line, but I think we are committed to getting our box prices up. And when we look at our volume growth expectations for the year around 2%, 2.5%, I suspect that we may have some issues on some margin as we push our prices up -- sorry, on volume. So we might -- we'll have to see how well we do on the 2%, 2.5%, albeit that the market is strong at the moment. So I think we will be successful in getting our box prices up as we go into the second half of the year. We're already started, we're already seeing some indication of some sheet feeding prices going through. And assuming nothing dramatic, which doesn't seem to be out there at the moment, we would be reasonably confident that we will get a decent increase. What that level of increase really depends on the customer and where they are at the moment in time. Just to give you an example, we actually have some price decreases to a number of customers based on formulas and what happened last year in the first quarter, which is counter thinking to when you see paper prices going up. But that's part of the formula game that we play. Those will reverse in the second half, maybe into the last quarter as paper prices are reflected in the indices, which they are now. So I don't want to put a percentage on it, but obviously, we are going to try and recover at least all the paper price increases into the boxes.

And just two follow ups for me, before I pass on. The performance in Europe was quite extraordinary to your point where it's significant OCC pressure and manufacture issues and, of course, lower index prices. Can you walk us through what enabled you to actually see moderate EBITDA growth in that environment? The volume is one component for sure, but in terms of what pockets were you offsetting the outside pressures to get there.

I could give you some of our non-extraordinary performances that we had in Europe. We've done well in Europe because, as I said in the statement just a few minutes ago, we have been investing in the business. And as you see some of those investments whether it's Townsend Hook ramping up a bit better, whether it's Sangüesa, whether it's Roemond, some of our paper assets, which we've invested a lot of money in not performing better than they did at this stage last year, that gives you a lot of positive uplift. And yes, we shouldn't lose sight of the fact that our costs of COGS in Europe around EUR 20-odd million and in the Americas around EUR 10 million in wastepaper, which have to be transferred into our corrugated business. And I would say that it is a very good performance out of Europe, but it's due to the self-help that we've done and the capital that we've employed in the business. And obviously, now we need to make sure that the business is remunerated for getting back to historical level of margins, which -- it's a mixture of many different things, Lars. It's self-help, it's improved productivity, it's customer wins, it's innovation. We're very comfortable with the way our European business is moving. And of course, I do believe that the European economy feels a lot better in absence of major political shock on Sunday. I think we look reasonably good for the rest of the year and in the demand side.

Okay. On Page 8 in today's presentation, you see a nice evolution of Quarter 1 EBITDA. Would you expect that to be the same charge in Q2, which is clearly more challenging? And just a little minute question, DNA was quite high in the quarter. Is that the level we should expect, going forward?

I'll give this call over to you, to Ken.

I'll take the DNA first, Lars. I think what you're seeing in Quarter 1 is a little bit of phasing and a little bit of timing, I think. When we look across the year, I think we see depreciation, amortization broadly in line with last year for the full year. So that 100% depreciation, call it approximately EUR 400 million. I think on the first question, I think it's -- yes, we are in the early days of trying to recover that paper pricing. I think as you know, although the announcements for paper in Jan, Feb are in, we really didn't see those implementations late in March into April and even to May for kraft. So it's about now getting back on, but as Tony said, the reality here is, we have to recover those margins. So whether we see a significant step up in Quarter 2, I'm not quite sure yet. But certainly I think as the year progresses, you definitely see some of that margin recovery.

Our next question is from the line of David O'brien at Goodbody.

Just a couple of questions for me, please. Firstly, just on the volume performance in Europe up 4% and you make reference to trading days having a benefit there. Could you just give us a sense what the adjusted number is? And I assume we will reflect that in Q2 volumes as we move into that period. And then on that point, if you're looking to Lars' point, the margin performance in Q1 in Europe specifically has been quite stellar. Given that maybe trading days come off a bit in the second quarter, how confident are you that you can achieve the same level of EBITDA margin that was achieved in Q2 '16 and Q2 '17? Thirdly, absent M&A, where do you see your net debt-to-EBITDA panning out for the year and if you can give us a comment maybe on the M&A pipeline, overall?

I'll do the first one on the volume. I mean, what we're saying is, I always think that when you look at Q1, it's -- looking at quarters in isolation because of days is really difficult, Dave. I mean, what we're saying really for the year is, we would expect to have -- without losing any major customers, which we're probably going to lose some, but without losing that, we see growth of between 2% and 2.5%. And that's where we're sort of consistent on that. We are seeing strong order books in the first quarter. For example, when I looked at it, we were practically sold out on all the working days, but we had more working days than last year, and yet when you compare it to the day on day, it was a worst performance, which is kind of strange for me to look at. And then February, which was the core month, was because of holidays -- and it sort of meant that the February number was actually better than last year. And it was -- when I look at the numbers of a quarter, I think you always have to bear in mind that there could be bridge days in Europe and there's going to be days that actually people don't work even if they say they're working. And people come back late from Christmas and factories don't start up well. So I would just tend to at least from my side look at it and say, what is the overall volume growth we expect for the year, and I'm still going to say 2% to 2.5%. Because we do feel that the order books are very, very strong in most of the markets in which we operate. And that's pretty well on across the globe. And as I say in the statement, absent something political that would derail things, then I don't see Europe having a particular issue or indeed in the Americas where we see strong markets with the exception of Venezuela and Argentina. On the second point?

Hey, David, it's Ken here. On the second point, Q2 margin last year, remember, the margins from last year include a significant credit in relation to the closures in DB pension scheme. So I think you'd have to exclude that first and then get back down if you want a normal run rate for that margin. But I think as you sit here today, it's really about recovering that margin as you go through the year to the extent which that matches that gets to where it would have been if you like adjusting Q2 '15, will depend on the rate of success of one, the input cost pressure and two, recovering price across Quarter 2.

And what was your third question, David? Sorry.

Absent M&A, where do you that net debt-to-EBITDA level panning out for the year-end? And in that light, what kind of pipeline are you seeing in Europe? How’s economic evolution in terms of opportunities rising?

As the last thing, M&A, David, we've got 2.4x at the end of quarter 1. You start to see it below that by the end of the year. Still probably above 2 but less than the current levels. In terms of M&A, I think it's fair to say that this year has started off with a healthier pipeline than we've seen in the last 6 months and certainly in the European space some opportunity that have appeared in the horizon, which -- not everything comes off but certainly look attractive at this stage. But as we sit here and kind of early May, yes, the pipeline is quite healthy both in Europe and indeed in the Americas.

And in terms of just the European business, opportunities and leaving aside maybe watching the pipeline, what type of gaps do you see in the portfolio that you'd like to fill out in Europe?

I would say that we have a couple of bolt-on things that we're looking at in Europe and there's a couple of other things that may or may not be interesting, depends on as we evaluate them, whether or not we think we can get the integration and synergies that would make sense. We don't really have gaps per se in the European sphere, David. I think what we have is opportunities in the sense that we talked about our Quick Win program now being completed, and we are working on trying to come up with a new program for next year and onwards. And we would probably communicate that in the third quarter release as to what we're planning to do. And I think that -- we have a lot of internal cost-reduction opportunities to look forward to. And also, a lot of development opportunities to look forward to within our existing business. Obviously, M&A in something that's really good on top of that. And so -- and we do in the Americas, we do have 2 relatively sizable projects, which would be completing in the course of the third quarter this year in Colombia and Mexico. That will benefit into 2018 by not an inconsiderable amount of money if we start them off okay.

We are now over to Barry Dixon at Davy Research.

Just a couple of questions for me. Just on the demand outlook in Europe and the performance on the outlook for the full year of 2%, 2.5%, could you give us some sense, Tony, by the main markets, France, Germany, U.K., Iberia in terms of what growth rates you're seeing, because I think Germany was a little bit sort of flattish in the fourth quarter. And also in any end markets in particular that would be driving that sort of outlook for 2%, 2.5% growth on corrugated? And just secondly, on containerboard and that sort of supply-demand tightness that you alluded to in both presentation and the statement this morning, just maybe give us some sense as to how tight actually those markets are and whether or not you think that as the year progresses, there may be potential for further increases in testliner or kraftliner prices. And then just finally, just on the recent sort of management changes. We've seen some changes around in the European business. You might give us just some sense as to how you're dealing with that and how the business is going to be structured from a management's perspective in Europe from here.

Well, Barry, let's start with the demand outlook. I mean, as I said, we are seeing very good order books. It is true that Germany in the first quarter, for some reason, and last quarter, last year was not particularly going down. We can't really explain it, we didn't lose any customers. But the order books right now are, I would say, more than healthy in our German market. And that should translate into obviously higher volumes as we go through the rest of the -- at least the quarter as we look at it right now. I wouldn't -- I'd say the Eastern European markets have done very well. Our Dutch market is doing well. France started to improve a little bit and did weaken off a little bit in April. But we'll have to wait and see. I think it's more of a French election issue than anything, because I think assuming the right result there, then I would suspect that the general bit of recovery we saw in France will continue. So -- I mean, with regard to the individual markets, we've had a slow start certainly in some of our hydroculture markets down in Spain and Italy due to weather and I never want to use weather as an excuse because I think that's -- but anyway, I never want to use it. But we did have a lot of rain and that slowed start, which was conversely actually good news in the sense because we were running out of kraftliner board, which comes on to your second question and we were able to continue to meet the demand that we have despite having factor down for 14 days due to recovery-boiler incidents. And with regard to the markets, Barry, I mean, the kraftliner and some of the ancillary markets like sack paper, like MG papers, the kraftliner -- those virgin markets are, I would say, very, very tight. And we're delayed in orders. We find it very difficult to get paper when we need it in kraftliner from wherever it happens to be. And one of the great things we've been able to do during this year is actually export some kraft fusing from our Venezuelan operations to our business in Dominican Republic, El Salvador, America and Mexico, which has really helped us meet our customer requirements. But those markets have been extremely tight and continue to be extremely tight. The stock level after Easter, as you would expect, have improved a little bit in recycled containerboard, but they are still extremely tight. And I would say that as you would have seen from (inaudible) there, today, it does look like the wastepaper markets, which had a little bit of a wobble in April looks like it's improving again as to China as we look into May and into June. With regard to the management changes, clearly, Roberto decided to move on to other pastures, and as I said in my statement, we wish him well. I'm very happy to report that we were able to internally find all of the various replacements. We moved Saverio up to take over Europe. Saverio Mayer, who's over 30 years' experience and a guy who used to run our German business for 10 years and is now running -- was running our Mexican business. Edwin Goffard has taken over from Saverio, so great experience there coming back to Europe. And we've moved our Argentinian, Brazilian and Chilean manager up to run our Mexican business, again, 30-plus years' experience in there and we've replaced the other 2 markets fairly seamlessly. So I mean, the management changes issue has been done, I think, by the company very seamlessly. And I think we're certainly no worse off and I think that the company will only go to better and better things with the current management that we put in place in those operations.

We are now over to Gerard Moore, Investec.

Couple more questions for me, please. Just sticking with Europe, you spoke there a little bit about how strong demand is for sack kraft and MG paper. Could you maybe just remind us what type of production levels you have for those grades? And I guess, more generally, what your strategy is towards them? Is there any potential there to increase your exposure to these 2 grades to a greater extent? And secondly, just switching over to the Americas, you indicated that Brazil performed better year-on-year, but how does this stack up now relative to your initial expectations when you acquired that business for you in terms of its absolute EBITDA or its EBITDA margins, for example, are these EBITDA margins in Brazil now getting closer to the kind of historical average level of 17% for the region?

I'll take the first and I'll give Ken the second one. On the MG, they're relatively small operations. They operate within our virgin cluster, which is 3 kraftliner mills, sack paper mill and MG. We do about 80-odd thousand tonnes of MG papers. To give you an extent of how that market is, we have 4.5 months of order book in that particular market and could, obviously, sell a lot more. We -- as you know, we took out an old containerboard machine and put in a new MG machine in last year, and that is still not 100% running right, albeit in April it did exceptionally well. These machines sometimes just -- all machines take longer than you ever expect, but the MG machine is now running well and the market outlook, it's a relatively small business for us, is extremely strong. And sack paper, the same, we've about 2.5 months of order book there which is extremely strong for that business. We have about 150,000 tonnes in sack, 160,000 tonnes of sack paper. It's a small business for us, Gerard. Nicely profitable, highly cash generative, both businesses now. And we just wait and see. I mean, we don't necessarily have any particular wish to add to those businesses, but if an opportunity came up, we would. Because we have the skill set, because we have knowledge, we certainly take a look over it. But it's just good businesses operating within our virgin cluster and it works well for us, with regards to (inaudible).

Gerard, we don't break out individual profitability, but I think it's fair to say, Brazil had a tough time last year predominantly based on significant drive in OCC and the country and that's the basis. So it must -- still have to guide levels. I think it's fair to say that the integration is ongoing and ongoing very, very well. So the situation is much better as you see that. Margins on the back of that are improving. We're seeing some consumer gains in the area, pan-America sales. As the organization looks back into the rest the Smurfit Kappa network, all the signs are good for that business. So impact of the full pro forma, probably not yet because you said there's been an OCC headwind and a little bit ago and margin but in better shape than it was last year.

We're now over to Justin Jordan at Jefferies.

Three good questions, if I may. Firstly, just on OCC, benchmark European OCC prices of 4% or so over the last month. Do you have a particularly view on what that may do going forward? And secondly, of course, if they were to continue easing, what does that do for your very delicate negotiations with customers on potentially securing box price increases from Q2 onwards? And thirdly, just on Slide 11 of your deck today, you talked about capital allocation review and results update by the end of the year. Is that a reference to potential Quick Wins Part 2? Or is that something more material that we should be thinking about?

Let me take the first question there. On OCC, I mean, the driver for increases in recycled paper was twofold: first of all, very good demand; and secondly, very high OCC and both work together. We still have very good demand. OCC has come off, as you say, a little bit, and that has basically meant that -- if you remember, we announced EUR 40 for April to -- in the industry -- some others in the industry, I believe, were out looking for EUR 40. But as the OCC came off, EUR 20 was deemed sufficient. So I would say that with the outlook for OCC, we don't see it going much lower. And as I indicated already, the signs are as of now that there seems to be a bit of firming. Obviously, that can change. Predicting OCC is like predicting foreign exchange rates. But the current view from our guys is that it's going to firm from here or at least stay at these levels and that will not have any impact on our negotiations with customers because, frankly, we have had the increase of EUR 80 into our box system and if you look at the numbers, our box stance, which would typically have decent margins, right now in Europe, they're not very good at all. So we need to recover that increase. Ken?

Justin, on the -- I think we need a much broader idea. I mean, the reality is that the Quick Win program is part of the overall strategic process. And that strategic process not only brings us at the Quick Win program but where we see ourselves in terms of returns over the next 5 years as well. So I think as we get towards the back end of the year, I think it's either as a broader set of outcomes rather than just a Quick Win project.

We are now over to Kevin Fogarty, Numis Securities.

A couple of quick ones for me. I guess, just firstly, if we look at headwind during the Q1, not much talk about energy costs and what they might have done in Q1. I just wondered if you could provide any color there in terms of what that might have been in terms of headwind. Secondly, working cap improvement in Q1, just any more detail on that in terms of lending significant going on there? Is it down to better working capital management and maybe a comment on sustainability of that improvement as you move to the year? And just finally, I mean, whilst it's difficult to look at one quarter in isolation, given the performance in Europe relative to the Americas, I just wondered, has that changed your view as to the sort of balance of the business for the remainder of the year, sort of, swinging I guess towards a greater proportion in Europe versus the Americas?

Thanks, Kevin. I'll take the second question and then Ken the first.

In terms of energy, Kevin, flat year-on-year for the first quarter. But I think we still see that as a headwind for 2017 above something in the order of about EUR 30 million. In terms of working capital, I think our focus on working capital is almost legendary at this stage. I think it's something that's very much part of our DNA. And we've always kept it within kind of that 7% to 8% range or 6% to 7% sometimes. I think the first quarter you saw, again, it's right for you to focus on, it's slightly vivace, which is normal for the first quarter and we expect to see that come back down as we trend through the year back down to kind of that -- in between that 7% to 7.5% range. So yes, sustainable and indeed should probably progress to a slightly lower number as we move on.

Kevin, on the America -- we're still very comfortable with that. Most of our Americas business -- we obviously like our Venezuelan business to be doing better in volume terms. But actually, in production and sending our paper through our own operations, it's actually performing remarkably well. The 3 core markets: Colombia; Mexico; and the U.S.-centric market that we have are doing very well, indeed. Where they have suffered from is purely costs of waste paper, which have in sense rocketed up more than in Europe and have come down a little bit quicker in the United States, Mexican and Colombian markets. So they go up higher and that's what's caused the very severe margin compression in Year 1 and we haven't yet got many self-help measures going on in the Americas. But as I mentioned, we have 2 relatively substantial ones, which we've been investing in for the last 2.5 years, which will come onstream towards the summer -- back end of the summer, which will benefit into 2018, which would be considered not necessarily Quick Win. One of them is a Quick Win and the other one is just a decent project of 100,000 tonnes of paper, which we already have sold to ourselves because -- so we already know what the potential of that margin is based upon where exchange rate will be and all that sort of stuff. So America remains a key -- the Americas remain a key focus for us if we can find decent acquisitions, we will invest in them there. And we have a lot of exciting opportunities to grow our existing business and we intend to take it.

We now go to the line of James Armstrong of Armstrong Investment Research.

A few more on OCC, in general. First, could you remind us of the lag of the flow-through of pricing in the boxes by region and really just talking average lag? Second, with China coming back to the OCC market, are you having any trouble sourcing OCC yet or is your supply chain still looking good? And finally, what are you seeing in terms of demand for innovation in the high OCC environment. In other words, are there any changes in product mix?

There is no change -- I mean, there's always the change in product mix, James, as you know, because customers, as they learn what Smurfit Kappa can do for them with regard to the applications that we have, they realize that they can actually save a lot of money and help themselves sell more by looking to our innovation to improve their whole system. And as much as we can take it away from transactional-type of arrangements into innovation, which we're doing more and more of is, obviously, extremely beneficial to the customer and also beneficial to us both from way of retention and also by way of development and, ultimately, by way of improvement. With regard to sourcing OCC, we have -- we continue to source our OCC without any great difficulty. It's always just a matter of price. We have to go with a market price and the first question on...

Box price lag.

Box price lag. I think the box price lag is longer in Europe than the Americas. I would say that typically in the Americas it goes through quicker, depending, obviously, in the markets in the Americas, somewhere between 1 and 4 months. Whereas in Europe, it's more like 2 to 6 months, would be the general view of where -- I mean, obviously, there are different customers and different -- it can be longer, even sometimes shorter. But I would say that would be a good guide for you to work off.

That was the final question in today's call. I will transfer back to you for any closing comments at this stage.

Thank you very much, Hugh. I'd like to thank everyone for taking the time to participate and support Smurfit Kappa in today's call after continuing to support us over the years. I think we have proven that we have a strong management team and a very, very unique franchise, which will sustain our performance in all market conditions. And leaves us well placed to continue to deliver superior returns for our stakeholders and shareholders.

Finally, I would like to thank all of our employees across the businesses for their hard work and their continuing dedication to Smurfit Kappa. Thank you all very much for joining, and I wish you a good afternoon, wherever you are. Thank you very much, operator.

This now concludes the call. Thank you all very much for attending. You may now disconnect your lines.