Edited Transcript of SAPJ.J earnings conference call or presentation 30-Jul-20 1:00pm GMT

In the other areas of the business, well, mainly in graphics, we saw prices coming off a little bit, but holding up reasonably well under the circumstances. We were able to take substantial costs out of the business — variable costs, obviously benefiting from lower raw material prices, and then fixed costs, a lot of that relates to labor and personnel costs. On this bridge, you can see it was down $49 million.

I know in the results announcement, we mentioned $67 million. The difference, the $18 million difference is in exchange — is exchange rate differential because, obviously, the rand and the euro was weaker against the dollar during that period. And then the net impact on exchange rates was a positive 17, giving us the $26 million EBITDA that we saw.

Slide 5 shows the product contribution. Now, obviously, the significantly lower volumes and profitability from dissolving pulp and graphics distorts this picture somewhat. And, interestingly, in this quarter, packaging has actually become our largest contributor. However, obviously, as the recovery continues, when we move ahead in the next couple of quarters, then this will normalize once again and packaging and — sorry, the dissolving pulp and graphics will be a bigger contributor.

Moving to Slide 6. I suppose there’s no surprises on this slide, the margins and volumes in the 2 big segments coming down. But we’re very pleased with the progress on the packaging front, volumes continue to go up, and also at a very reasonable margin as well and that’s something we would expect to continue.

Moving to Slide 7. It’s the debt maturity profile and I’ll just call out a couple of changes. Firstly, and I’ve already mentioned that we have — we still have $190 million of cash on hand. The — in the 2020 maturity, you’ll see a number of $144 million, which is the RCF. Now although it’s reflected in the 2020 block, that’s a facility that matures in 2023. Obviously, from an accounting perspective, it’s regarded as short-term in nature, so that’s why it’s included in the block, but it is in place until 2023.

So it’s slightly misleading that it’s reflected in that block, but the full maturity is 2023. Other bigger numbers to call out are the securitization facility, which matures in 2022. And that’s something we’ve had in place for a number of years, and we would expect to continue and well ahead of that maturity, we will look to roll that over.

Moving then to Slide 8, the CapEx. The number for 2020 is now down about $350 million. Earlier in the year, we were talking just under $500 million. So it’s come off substantially. And, obviously, that’s linked to the deferral of postponement or cancellation of some nonessential CapEx. The biggest number there is the Saiccor expansion, which has now been pushed out and will be completed in 2021. As a consequence of that, we expect the 2021 number to be about $350 million, which includes, obviously, the Saiccor deferral.

Turning to the segments, and I’ll jump to Page 10 in Europe. Volumes dominated by the decline in graphic paper. The — and you can see the overall volumes for the region were down 32%, but that’s almost entirely because of the drop in graphics. We were forced, as a consequence, to take production downtime of 369,000 tons.

That had the double benefit of ensuring we didn’t sit with inventory risk and also from a cash flow perspective, it obviously benefited the cash flow. You do have a P&L — a negative P&L impact because you have lower stocks. But net-net, it was the right thing to do.

The packaging continues to do well for us. Within the segment, there are different categories of goods. And I talked about this last quarter, the kind of more essential food hygiene-related products did well. Certain nonessential luxury goods did less well, and were impacted by the lockdown. That’s why you have the mixed performance. But I am pleased to say that profitability did increase here. We did benefit from lower costs, specifically in Europe, lower pulp, wood, latex costs. And then on the fixed cost front, we were able to take substantial cost side of the business and, obviously, benefit from some temporary unemployment legislation in some of the countries in which we operate.

We did have a fire during the quarter on Alfeld PM3, which was a bit of a headache because the product made on the PM3 machine goes into the Packaging & Specialty segment. That, ironically, is one of the — was one of the products doing very well. So it was a bit of a headache that that happened for us at the worst time. Pleased to say that the repairs have been done, and it’s operational again from the 20th of July.

Turning to North America. Similar story that we saw substantial declines in graphic paper, and we took 107,000 tons of commercial downtime. Packaging picked up significantly and it was close on 70% the volume increase. And that’s the ramp up that we’ve talked about for over the last few quarters as we continue to ramp up following the conversion at Somerset. It’s going very well for us. It’s increasing profitability, as we said it would and there will be further increases in the year ahead.

The dissolving pulp had an impact in the North American business. And we have use that opportunity to make more paper pulp for the Cloquet paper machines. We took out fixed costs and variable costs, again, once again, taking advantage of some of the following legislation in the U.S.

The South African business is summarized in Page 12. We were negatively impacted by the lower dissolving pulp volumes, and in that segment, again, we took commercial downtime. We did benefit from exchange rates as the rand weakened. Looking at some of the other — well, maybe just to call out one thing. One of the initiatives to help with liquidity and cash flow, we were able to push out some annual shuts, and we did have a $200 million savings benefit from that, predominantly at Ngodwana.

The packaging segment does — continues to do well, despite the COVID-19 and we’re positive about the outlook as we go forward. Unfortunately, some of the smaller segments or products, particularly in newsprint and uncoated office paper, were severely impacted by lockdowns and in fact, we saw 60%-odd declines in the quarter. The — like the other regions, the business took out substantial costs, both on variable and fixed costs.

Turning to Slide 13 and just some of the issues on COVID itself. Firstly, on financing, as you know, we negotiated covenant suspension to March 2021. We are — so the first time it will be measured is in June 2021. We’re well aware that the clock is ticking on that, and we will proactively engage with our bankers to ensure that we have a flexible arrangement following the expiry of that period. We did repay some South African debt that matured during the quarter. We put in place a bridge — that was funded through a bridge facility, and we issued a new South African public bond. So the appetite is still there.

The CapEx, I’ve mentioned a couple of times, but we, obviously, deferred CapEx as much as we could. The project recommenced at Saiccor on — in July. It’s going once again — it’s going well. Obviously, things appear to be on track. We expect to complete in the third quarter of the new financial year. But I do call out, obviously, with the rise in COVID cases in South Africa, that could be a risk factor for the construction firms as well.

We also deferred the shuts, and I mentioned that already, but it was predominantly in Ngodwana. Pleased that we did some — we continue to do good work on the procurement side. In earlier quarters, we talked about $64 million coming out for the year and we actually think now we can get to $100 million. And fixed costs, I’ve mentioned a couple of times, but we took $67 million out for the quarter.

Turning to the markets themselves and on to Page 14. Graphics, as you would expect, with the lockdowns’ significant impact on retail companies, not advertising, that caused a significant reduction in demand for graphic papers globally. Our volumes were down about 40%, followed the markets. The one thing I should point out is that certain of our export markets have been particularly weak. And I call that out because somewhere, like South America, has been even more impacted particularly as the COVID-19 has moved into that area.

The newsprint and office paper is in that segment. So that was also a negative factor and then we benefited from the lower costs. And as I said earlier, prices did drift downwards. I think I’ve already mentioned it, but just to repeat, if we look at the graphics segment, June actually was the worst month for us. Obviously, April slipped, and May was a bit worse. And then June, similarly so. But subsequent to that, as we’ve gone into July, things have been a little bit better. It’s not a V shaped recovery, but it is recovering and we would expect that to continue in the months ahead.

Packaging, I think, a great story. Yes, there were certain products negatively impacted, but overall doing well, and we will continue to ramp-up at Somerset and Maastricht, in the short term, lower raw material costs helping us as well. Dissolving pulp, once again, the retailers, the clothing stores did go into lockdown. It has a substantial impact on volumes right across the supply chain.

Obviously, you saw a growth in e-commerce, but that was not enough to offset the negative impact. I’ve mentioned that we were down 29%. We were at the low in late May. June, actually, was a bit better and, subsequently, July as well. At the same time, our customers, a lot of their plants recommenced production in June, they were in lockdown. So they had ceased production but that began once again in June. So that’s helping us a bit. Exchange rates have moved in our favor in South Africa. So that will entrench our leadership position from a cost perspective.

However, having said all of that, and things are picking up, but it is important to be mindful of the fact that when we went into this COVID crisis, that there was excess viscose production and because of that, dissolving pulp prices were weak. The long-term outlook is more favorable, but clearly we have to get through the worst of this COVID crisis.

In the segment, we also have the BCTMP that we sell from Matane. Pleased to say that it’s going well, albeit that pulp prices — all pulp prices are weak at the moment. We also sold a little bit of kraft paper pulp on our swing machines to ensure that we could fill them up somewhat.

Slide 16, we thought it was useful to include, but just 1 slide on U.S. retail building sales. And I know you guys — many of you will see these numbers. But we thought it was useful to include it because it does show the recovery path of clothing sales, and it matches how we’re thinking about the recovery in dissolving pulp. And I’ll talk a little bit more about that in another slide.

Slide 17. Just last quarter, we talked about our 2025 strategy, which we rolled out across the business earlier this year. And in summary, it covers 2 distinct phases. Firstly, on Slide 18, the short term. And as you would imagine, a strong focus on the balance sheet, reducing debt, maximizing cash generation and efficiencies and costs and all of those things. We’re not going to stop all the good work that we’re doing on future opportunities, but we’re certainly not going to be investing in those at this point in time. We need to get our balance sheet back in — back to the levels where we desire it to be. Slide 17 talks about beyond that period.

And in that period, provided everything is back on track, then we would start to look at further opportunities and it’s predominantly in the packaging space, where we’ve been very, very successful, and also in the biotech space as well. As you know, we’ve invested in some pilot plants in recent years and I would like to think that in time, we’ll be able to commercialize some of those opportunities. If you move to Slide 19, and it was mentioned on the previous page, but on 19, this is our strategy statement, and I’m not going to read it out to you, but 2 changes in emphasis as we move forward.

One is on sustainability. Like many industries, the sustainability story is growing in prominence and will be a big part of our strategy and it will allow us to give us a competitive advantage as we move forward and work with our customers. And then the other thing is, obviously, innovation and R&D and we continue to have a strong focus there. And as we develop new products for packaging and biotech, this will be an area where we will place great emphasis.

Slide 21, just to the various pillars and briefly touching on some of the initiatives, but on costs, we recognize it’s all about cost and staying at the low end of the cost curve, so a lot of focus on efficiencies and procurement savings. That will continue. Interestingly, the Saiccor expansion will help improve efficiencies and lower costs and as we get up to full volumes, which will be, obviously, after we finish in Q3 next year, but that will lower our cost base.

The rationalizing of declining business, you would have seen a recent announcement, whereby we closed the Stockstadt PM2 machine, which was something that we did talk about in earlier quarters. And then also Westbrook PM9, and that paper for Westbrook will now be made for the release business will now be made at our other mills in the U.S. So that — those combined will take out about $25 million of costs next year on an ongoing basis.

I’ve talked about the focus on the balance sheet. So I’m not going to repeat that. And then accelerating growth into the higher-margin segments. We still have further scope for ramp-up at Somerset and Maastricht. They were delayed a little bit because of lockdowns and some of our customers’ staff weren’t able to come to work. So we had to slow down some of the trials that we’re doing, but these are all recommencing again, and we’ll start to benefit from those. The — and the barrier coating is a big opportunity, and we’ll continue to work with customers and invest in that area.

So our outlook for next quarter on Page 22. We estimate volumes for this quarter to be around 75% for graphic — dissolving pulp and 70% for graphics. The 1 thing I would say about the number on dissolving pulp, is — as I mentioned earlier, we are making more paper pulp at Cloquet. So — and that’s a choice we’ve taken because of pricing. And if you were to back that out, the actual market for dissolving pulp is actually probably at a minimum of 80%. So the 75% doesn’t give you our view on the market. It’s just — that’s where we think our volumes will be.

The market — dissolving pulp is recovering a little bit faster than the graphics. The prices, obviously, still under pressure across all the pulp categories, and that’s something that we would expect to improve in time, but we need things to normalize in the market.

We do have a headache in South Africa at the port and with shipping issues and a lot of that, that’s obviously linked to the COVID. And as the number of infections, rises in South Africa that has impacted staff or labor at the ports and has reduced productivity. We are proactively working with the port management, and they are aware of the challenges, but it is a risk factor. If it does affect, it would be a short-term delay, but it is a headache that we have.

Packaging continues to grow and the categories that have been underperforming, we would expect to accelerate as the lockdowns ease. Graphics, slow, recovery underway as well. And I mentioned this earlier, we don’t think this is a V shaped recovery. We think it’s going to be gradual.

There will be improvements in Q4 and further improvements in Q1. Specifically with graphics, we don’t anticipate the volumes will get back to what they were pre-COVID, but I do want to stress to everybody that there is 20% of the market capacity coming out in both U.S. and Europe.

So we don’t need it to get back to 100%. If volumes can get back to 85%, then this market will be in balance once again, and certainly that’s a key number for us as we monitor the recovery path. So as we think about graphics and dissolving pulp, we think that the full recovery to the levels that I’ve referred to is only going to happen in 2021 in the middle of our financial year. In 2021.

The cycle expansion is going to be completed in the third quarter, as we mentioned, and that’s something that we’re excited about. Although prices are low, we — when we do get those incremental tons, because of our low cost base, that will make a significant contribution as we get into Q4 of next financial year and Q1 — and to the 2022 financial year, but as you would expect, in the short term, our focus on liquidity and cash flow. .

That’s the presentation, operator. I’m going to put it back to you now for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The question comes from James Twyman of Prescient Securities.

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James Twyman, Prescient Securities (Pty) Ltd., Research Division – Head of Fundamental Equity Research [2]

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Yes, a few questions. Firstly, could you — you’ve clearly been cutting your inventories in graphic paper. Could you just say whether they are now at a low level or at a very low level in terms of whether we’re likely to see many more of that?

Secondly, in the viscose market, that still seems to be weakening. What are you seeing there in terms of that market in terms of closures of players there? And then just finally, if you do another conversion or 2, what would be the cost of those very, very approximately?

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [3]

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Yes. Just on inventory levels on graphics, you’ll see from the numbers, we cut our inventory substantially during the quarter for graphics. I have been asked questions by others about, why didn’t the overall inventory not come down further. I’d just point out a couple of factors on that. Firstly, the packaging side, we — inventories did go up.

And secondly, because of the deferral of the shut, particularly in Ngodwana, we were carrying and some extra inventory for that, and when the shut occurs in Q1, obviously we’ll sell the product then. So that’s why it didn’t come down as much as the overall sales. But with regards to graphics, yes, we aggressively cut inventories. We do envisage a little bit of downtime in Q4, but not nearly to the levels that we saw in Q3. And maybe Berry and Mike, I’m just going to put it — just very briefly, you can just talk about your relative graphic inventory situation.

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Berend John Wiersum, Sappi Limited – CEO of Sappi Europe [4]

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Yes, Steve. As far as Europe is concerned, inventories went down very substantially indeed. And are now at a level which we would consider appropriate to a business if it recovers to the levels that Steve has said in the next quarter. At the moment, we still got a small amount to take out, perhaps 20% of what we took out in quarter 3. So we don’t expect that to have a major impact on the profitability in quarter 4.

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [5]

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Thanks, Berry. And Mike?

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Michael George Haws, Sappi Limited – President & CEO of Sappi North America [6]

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North America, we did bring inventory levels down quite a bit and expect them to come down slightly in Q4. Our Q4, we do expect to see some return as things in North America have been opening up. So we’re balancing customer needs and inventory levels going forward as things open up.

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [7]

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Thanks, Mike. Viscose, I’ll give you a little bit of a background. Then Mohamed, I’m going to pass it to you just to elaborate a little bit further. But what we’ve seen both in the dissolving pulp space and in viscose space, substantial capacity temporarily closed. However, things are — they have been progressively better in recent weeks.

On dissolving pulp, specifically, there’s still a substantial proportion of the producers not making product. However, obviously, viscose prices continue to be under pressure as suppliers look to recover from the situation. Mohamed, do you just want to briefly talk about the viscose market?

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Mohamed Mansoor, Sappi Limited – EVP of Sappi Dissolving Wood Pulp [8]

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Yes, Steve. What we have seen is because of the relatively high VSF stocks and the very low margins in the viscose side, a lot of the VSF producers, especially in China, have taken lines down temporarily to try and balance supply and demand and — but what we have seen of late is an increase in the operating rates. So we’ve gone from about, I would say, just under 60% operating rate for the viscose industry in China to today, around the 65%, 66%. So still low, but that’s where the industry is operating.

What we’re seeing on the — I should also add that this particular period, July, August, September, is also the seasonally slow time. So there’s also that impact on the viscose industry. Whilst a lot of viscose industry has taken out capacity temporarily, we’ve also seen in the last couple of weeks, I think, an intensified level of activity in terms of announcement from dissolving pulp producers taking out capacity as well. So that’s also bringing in some balance at this point in time.

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [9]

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Thanks, Mohamed. And then, James, on your third question on the conversion, I’m a bit hesitant to give a number. I don’t envisage us converting any machine in the next 2 or 3 years. Obviously, it will depend on how quickly we can get the debt levels back and profitability levels back to where we want them to be.

Obviously, when we converted Somerset PM1, we know that cost about $200 million. And we still have to do our investigations and one of the things that we would be mindful of is not to spend substantial amounts of CapEx. So as we evaluate opportunities, look, we strive to do ones that will cost less from a cash flow perspective. So there’s a lot of work that still needs to be done before we finalize and, ultimately, decide which route to go.

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Operator [10]

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The next question comes from Alexander Berglund of Bank of America.

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Alexander Berglund, BofA Merrill Lynch, Research Division – Analyst [11]

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3 questions from my side. The first one on your volume outlook to the — for the fourth quarter and specifically on graphics there. When you’re talking about 70%, is that is reflecting kind of your view on the underlying demand on the market? Or do you also expect to be able to gain some market share from competitors exiting?

Secondly, I wonder if there is anything more you think you can do on — to mitigate the operational gearing and the volume up through into the fourth quarter. And then finally, a question on working capital or in capital management and if we should expect any meaningful working capital cash inflow in the fourth quarter?

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [12]

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Thanks. I’ll take the first 2, Glen, and I will pass to you on the working capital. The volumes that we talk about in in the fourth quarter for graphics, there is a bit of market share gain. However, there is mixed performances in the market. There are certain countries where the recovery path is faster than others. And as you would expect, places like Germany and France, they eased lockdowns sooner, and their recovery is ahead of those.

Similarly, interestingly, in the U.S., that things are starting to pick up as well. However, there are markets which are lagging. Now if you think about our European business, about 25% of that goes into exports and that’s predominantly Asia, which is doing okay, but a lot of volumes do go into South America and Latin America and as you know, Mexico and Brazil still are deep in the crisis. So the volumes in those countries are as low as 20%. So that’s what’s lagging us.

So you have certain countries at 80%, and you have others at 20%. The blend of all of that is giving us the 70 that we talk about. And within that, we do think that with the closures, both in Europe and the U.S. of substantial capacity, we do think there’s opportunities out there for us to, hopefully, target further volumes and market share gains. But on balance, as we look at all the markets and the blend, we’re confident it can be at least 70%.

The operating gearing, look, we took substantial costs out of the business in Q3. Now — but unfortunately, when you take out volumes of — in the neighborhood of what we talked about, 40% on graphics and 30% in the dissolving pulp, you do carry those fixed costs. So it’s a substantial impact on the business. So our recovery is all linked to volumes. As these volumes recover and we get to the 70% and 75% that we talked about in Q4, and we would expect Q1 to be ahead of that, then you’re going to get the benefit and it flows to the bottom line.

In terms of actual initiatives to save costs, obviously, everything we were doing in Q3, we’re going to try and do in Q4. But we do expect better volumes. So that will help with the ratios. Glen, do you just want to talk about the inflows of working capital in Q4?

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Glen Thomas Pearce, Sappi Limited – CFO & Executive Director [13]

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Yes. Thanks, Steve. So we had an inflow of $20 million on our working capital for the quarter 3 fiscal. And historically our quarter 4 is — has been an inflow of working capital as the working capital levels at the end of September are the lowest across our fiscal. So we anticipate that same trend to continue this year, and we will be in excess of the $20 million inflow that we saw in quarter 3. It will have a further inflow in quarter 4.

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Alexander Berglund, BofA Merrill Lynch, Research Division – Analyst [14]

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Okay. But on the full year basis, should we expect an inflow or an outflow?

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Glen Thomas Pearce, Sappi Limited – CFO & Executive Director [15]

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We expect — yes, we do expect an inflow for the full year basis.

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Operator [16]

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The next question comes from Wade Napier of Avior Capital Markets.

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Wade Napier, Avior Capital Markets (Pty) Ltd. – Research Analyst [17]

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I’m interested to hear your thoughts on your European coated mechanical business and the uncoated woodfree business. I mean, in terms of the coated mechanical business, it doesn’t seem to be the same sort of level of supply side responses we’re seeing in the coated woodfree side of things. So how are you sort of thinking about your coated mechanical business in this environment and sort of for the next sort of 12 months or so?

And then the uncoated woodfree side, you’re obviously closing PM2 at Stockstadt, and that sort of leaves a stand-alone uncoated woodfree mill within Europe. I mean, how does that sort of fit into your portfolio going forward? And then I’ve got some questions on the fixed cost savings that we saw in Q3. And obviously, there were some benefits from the furlough schemes, et cetera. What should we expect going into Q4 and maybe even into Q1 next year? How much of those sort of benefits will sort of carry on through?

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [18]

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Okay. Thanks, Wade. I’ll briefly start on the coated mechanical and uncoated, Berry, but I’m going to allow you to just expand further. Obviously, through [current] selling our coated mechanical business now is predominantly now in the Kirkniemi mill.

We — that market, obviously, is under pressure as well, but we don’t have the same leadership position that perhaps we have in coated woodfree. So it’s, obviously, something that we continue to monitor, and we’ll manage going forward. But at least it’s now ring-fenced at 1 location. So Berry, I’m going to pass it to you and you can also just talk about the uncoated market as well.

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Berend John Wiersum, Sappi Limited – CEO of Sappi Europe [19]

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Yes, sure, Steve. As far as the coated mechanical business is concerned, the — what we saw was publishers still pretty anxious to keep the printed side going because it’s such a major part of their own income. What we did see was that pagination went right down and advertising went right down and advertising there was hit very hard in the East. And advertising industry is going through quite a tough period as well, but we have started to see coated mechanical in recent weeks order sizes beginning to pick up.

But that’s one of the rather important things is that if order sizes start to pick up, it means that there’s a bit more confidence in the market. So we’ve taken out a lot of coated mechanical capacity, of course, by exiting Lanaken. So the — and that’s — we exited there upwards of 300,000 tons of capacity, mechanical coated.

So that means our business is smaller. It’s also a slightly better quality business, whereas out of the basic LWC, we’re in the mechanical — the mid-weight sector and the very lightweight sector. These are slightly more niche like products. So we have there a business that should be okay in the next few years.

Then coming on to uncoated, we have a niche business in uncoated, where the capacity is around about 200,000 tons. That is all. We don’t make it anywhere else. We also have made that machine capable of making the very high-quality luxury coated products. So it will be a machine which is mixed. It’s highly integrated because it’s got its own pulp mill. It’s, obviously, in the middle of the German market. So we think by getting PM2 out, we have made that mill now viable.

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [20]

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Thanks, Berry. Then on the fixed costs and the continuation of the savings. Glen, over to you?

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Glen Thomas Pearce, Sappi Limited – CFO & Executive Director [21]

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Yes. Just as far as the level of fixed costs, if we compare quarter 3 to what we’re anticipating in quarter 4, we’re going to be marginally up in quarter 4, and that’s just from a seasonal adjustment for — relative to quarter 3. But as far as the total fixed cost savings are concerned, we expect it to be in line with what we saw in quarter 3.

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Wade Napier, Avior Capital Markets (Pty) Ltd. – Research Analyst [22]

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Great. Maybe just a follow-up question on the fixed cost side related to the closures at Stockstadt and Westbrook. Could you sort of quantify what you’d expect to take out from those closures in terms of cost?

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Glen Thomas Pearce, Sappi Limited – CFO & Executive Director [23]

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Yes. We, across the two, we’re looking on a per annum basis, obviously, they’ll be closed at the end of the financial year. But going forward, on an annual basis, we’re expecting between $20 million to $25 million.

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Operator [24]

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(Operator Instructions) Next question comes from Tom Elliott of Royal London Asset Management.

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Tom Elliott, Royal London Asset Management Limited – Assistant Credit Analyst [25]

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I have 2 questions and then a clarification. I just wanted to touch on something you alluded to earlier in the call when you talked about be proactively — you would proactively engage with your bankers to ensure flexibility at the end of your covenant waiver.

So I just wanted to ask, when you had your previous discussions with your banking group, what were they like? What were your banking group open to? Do you feel you’d be able to acquire another a 12-month covenant waiver if you had to? Was this discussed last time around? Just want to get a bit more of a flavor on sort of what you meant by that and how discussions went last time.

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [26]

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Yes. Thanks. I mean, firstly, I would say that the relationships with our banks are strong, and they go back a long way, and they understand our business, and we have very transparent relationships with them. The — we proactively put in place the covenant waiver period. Obviously, we did it early in the virus time line, and we were doing this in March and I think we were one of the first companies to put in place a covenant waiver.

We know that we still got a few months, but we don’t want to wait until the last minute. So we are proactively talking to them and discussing. With regards to a specific time line, that’s not something that I can give at this stage, but all I can say is that the bankers are supportive, and they understand the situation. And they understand that the specific quarters, obviously, the quarter that we’ve just had and probably the one we’re in at the moment, that has a substantial adverse impact associated with the virus.

So we need to figure out how we can bridge that gap before we get back to normalized levels. So we’ll update you as soon as we’ve got developments, but we’re encouraged by the discussions.

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Tom Elliott, Royal London Asset Management Limited – Assistant Credit Analyst [27]

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Okay. That’s very helpful. Second question, I know you’ve already talked about working cap, but I just wanted to get a sense. Now I think, please correct me if I’m wrong. I think — so the payables, there was a bit of an unwind quarter-on-quarter in payables. So I just wanted to get a better sense of your payment terms or payables. Has most of that unwind now occurred? Should we be expecting more of an outflow related to payables in the next quarter?

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [28]

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No. I think on the payables, we — you’ll appreciate that some of our suppliers were also under pressure. So we try to avoid lengthening terms. That was — obviously, that’s something we could fall back on in the end, but we didn’t implement that in the quarter. So I think that as we go forward from here, we would expect payables to normalize and follow the activity of the business. There hasn’t been any major adjustments in payables days.

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Tom Elliott, Royal London Asset Management Limited – Assistant Credit Analyst [29]

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Okay. And then just a clarification. I think in the call, you referenced some rand denominated issuance and I think that’s after quarter end. So I just wanted to clarify versus 2Q end — sorry, 3Q end, is there going to be any additional debt or any additional liquidity we should expect from those rand denominated facilities?

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [30]

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I’ll let Glen elaborate. But obviously, we had the one…

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Tom Elliott, Royal London Asset Management Limited – Assistant Credit Analyst [31]

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Or to ask in a different way, perhaps to simplify, was the rand denominated transaction purely refinancing?

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [32]

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Yes. Effectively, yes. That’s the right way.

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Operator [33]

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The next question comes from Brian Morgan from RMB Morgan Stanley.

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Brian Morgan, Morgan Stanley, Research Division – Equity Analyst [34]

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So just — can we just chat about the next 6 months’ outlook for graphic paper, where the last 3 months, we’ve had furlough schemes benefiting the industry, arguably defending prices and so those furlough schemes roll off in the next few months. We know that [story] told us that they’re going to be selling out of inventory until the end of the calendar year.

So I’m just trying to get a sense of how the industry is going to look as those furlough schemes roll off, is it going to be able to balance itself? Or could we see a better pricing pressure coming through the end of the year?

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [35]

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Look, I mean, firstly, obviously, competitors are taking out substantial capacity both in Europe and in the U.S. with the recent announcements. That’s — and then we are closing stocks at PM2 as well. So there is about 20% capacity coming out of each respective market. You’re right that some of the competitors that are closing machines are selling through their inventories, and that is a risk factor. However, I would combat that by saying that customers are looking for long-term sources of supply and they want to build relationships. They know that their options are getting less, and they want to be sure to secure sources of supply.

So that combats some of the risk factor that you referred to. I do think that prices have drifted downwards over the last couple of months. Some of that’s because of the weaker market and, obviously, lower raw material costs. But I think I’ve touched on it already, if the market can get back to 80%, 85% volumes of what it was pre-COVID, then markets are back in balance.

So that, for us, is the key number. Get it back to — that’s what we are targeting, getting it back to 85% of what it was previously. Now that’s not going to happen overnight. We’ve given you what we think Q4 will be. And I think Q1, you’re going to see progressive upward movement from there. To get back to the 85%, may take a little bit longer and we’re thinking about the middle of next financial year to get it back to those levels.

I know your question was specifically on pricing. So it’s drifted downwards, but it’s actually held up reasonably well under the circumstances. When you think volumes are down 40%, and you’ve got competitors trying to sell out their inventories. I think it’s actually done reasonably well under the circumstances. And we think that if that market balance remains, then we can continue to try and hold the prices.

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Operator [36]

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The next question comes from Sean Ungerer of Chronux Research.

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Sean Ungerer, Chronux Research Pty. Ltd – Research Analyst [37]

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And just 2 questions and 1 clarification. In terms of the 2025 strategy, could you just comment a little bit on ROCE. I didn’t pick that up in the slides. And then secondly, in terms of capacity closures in the U.S., could you maybe comment a bit more whether you think that will actually be permanent closure? Or is there a risk of those assets being purchased?

And then on clarity, in terms of working capital unwind, if you look at Q4, historically, there’s been quite a nice cash working capital above — averaging about $18 million. Is that the number we should be looking at rather than the $20 million?

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Operator [38]

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(Operator Instructions) We can hear you. Please go ahead.

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [39]

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Sorry, Sean, apologies. My line dropped here. Sorry, I lost my chain of thought. Do you just want to repeat your question?

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Sean Ungerer, Chronux Research Pty. Ltd – Research Analyst [40]

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Yes. Just in terms of the 2025 strategy, just how are you thinking about it from a return perspective in terms of ROCE? And then secondly, in the U.S., the capacity closure, do you deem that permanent? Or do you think there’s a risk that it gets purchased out and get up and running again? And then just in terms of clarifying working capital in Q4, normally, there’s an average inflow of about $80 million. Should we expecting that rather than the $20 million?

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [41]

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Yes. Sean, I think Glen gave you the number for Q4 on working capital, but I’ll let him elaborate further. Just, Mike, on the second question, I’ll start, and then I’ll pass it to you. In — Sean, with regards to 2025, I think primarily, our focus is, obviously, in the short term is getting the balance sheet right, getting that leverage ratio back below 2.

We still have our long-term targets of getting at least 12% return on capital employed for investment projects. And if the balance sheet is back to where we want it to be, I see no reason why we can’t strive to achieve those goals. Yes, it is unfortunate that our balance sheet is where it is because there are some very exciting projects out there and we’ve demonstrated that with the packaging side that we can grow the business.

But you have our assurances that we’re not going to commit large sums of capital until things normalize and we get the balance sheet back. We’ve done it before, and we’ll do it again. Mike, on the capacity closure, obviously, it’s a big opportunity for us, and we will be targeting some of the customers of the mills that are being closed, but with regards to the risk of somebody else picking up that mill and whether it’s permanent, Mike, I’ll put it to you.

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Michael George Haws, Sappi Limited – President & CEO of Sappi North America [42]

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Well, I can offer that it would only be pure speculation on our part. The track record of our competitor that’s shutting the mill down has a record of not allowing the assets to restart and compete in their markets. And I think that’s the only thing that I could speculate on at this point. There’s been no additional information surrounding what their intentions are, but that is what their history is.

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [43]

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Good, and then, Glen, just last one.

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Glen Thomas Pearce, Sappi Limited – CFO & Executive Director [44]

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Yes. Just as far as the working capital is concerned, we’ve had a net outflow on working capital for the 9 months of $70 million, and we expect for the year to be — to have a net inflow.

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [45]

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Okay. Sean, you can work that one out.

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Operator [46]

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The next question comes from Mikael Doepel of UBS.

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Mikael Doepel, UBS Investment Bank, Research Division – Executive Director & Analyst [47]

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So I just wanted to ask a bit about the dissolving wood pulp market. If you could just start there with the pricing that you see in China now for the hardwood import prices. What’s the level right now? What was it in June and May, just to get a feel for the magnitude of the price pressure that you’re talking about? We can start there.

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [48]

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Okay. Mohamed, I’ll start and then hand it to you. We saw a bit of a decline from where it was last quarter. It dropped from about 635 to — I think today, it’s 607. Under the — again, it’s a drop, and I know it’s off historical lows, but under the circumstances when we got volumes were at their worst and were dropping for textile around of 40%, 50%, it’s actually held up reasonably well.

Mohamed, I’ll pass it to you. And again, once again, you can talk about how things are kind of going on broadly on pricing and how things are restarting in the dissolving pulp market?

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Mohamed Mansoor, Sappi Limited – EVP of Sappi Dissolving Wood Pulp [49]

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Yes. Steve, I think what we are seeing is that the current prices are just not sustainable. We are seeing an increased activity level in terms of downtime announcements from a number of suppliers from the U.S., South America, Europe. And also in China, there’s been a significant amount of dissolving pulp capacity that has been taken up and those are either making paper pulp, hardwood or softwood or even unbleached kraft pulp or not running.

So for me, it’s signaling that the pricing is at a point now where it’s just not sustainable. But your numbers are correct in that currently, the index is at — the hardwood index is at 607. And the other thing that is changing is the exchange rate. The renminbi has strengthened over 2% to 3% in the last month or 2 and that should also help provide some support for U.S. dollar pricing.

In terms of the viscose market, again, what we are — this is a seasonally slow time. Operating rates have stabilized at around the 66% and because of the very low margins, I think a lot of the VSF guys that have taken the downtime are also trying to manage the supply and demand situation.

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [50]

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Thank you, Mohamed.

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Mikael Doepel, UBS Investment Bank, Research Division – Executive Director & Analyst [51]

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Yes. That’s helpful. And then can i just ask another question on the inventory situation. I mean, you touched upon that a bit earlier in your presentation. But how would you assess the inventory situation in the DWP in the whole value chain right now, both upstream and downstream? And when would you expect inventories to normalize?

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [52]

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Sorry, just to be clear, is that specifically with dissolving pulp?

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Mikael Doepel, UBS Investment Bank, Research Division – Executive Director & Analyst [53]

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No. I actually think both on dissolving and as well as viscose [state fibrous].

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [54]

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Yes. Again, I’ll let Mohamed elaborate further. But what we saw, obviously, when lockdowns commenced, everything just came to a standstill and customers stopped ordering and there was excess inventories in the supply chains. What you’ve seen in recent weeks is a reversal of that.

Suddenly, producers who had stopped production are now seeking to fill their pipelines once again. With regards to historical norms, overall inventories of viscose are above the normalized long-term levels, but they have come down substantially over the last few months. I’m sorry, Mohamed, I don’t know if you want to add to that?

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Mohamed Mansoor, Sappi Limited – EVP of Sappi Dissolving Wood Pulp [55]

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Steve, no, I think you’ve covered it. I would just add again that there’s a significant amount of capacity on the DP side that has been taken out. There was an article on RISI very recently, where they indicated for the first half 2020, they estimate about 780,000 tons that has been taken out. So I think that’s also helping bring the inventories back down.

So I would say inventory levels for DP are probably low because of the amount of downturn that’s been taken out. The inventory levels in the textile value chain is higher than normal. But as the lockdown eases and as the retail stores start picking up, and as we, I think, showed in one of the slides, buying activity is improving, and that’s also starting to bring down the inventory levels.

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Operator [56]

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Gentlemen, the final question comes from Ross Krige of JPMorgan.

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Ross D. Krige, JPMorgan Chase & Co, Research Division – Analyst [57]

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Just 2 last questions from me. Firstly, on the fixed cost savings, how much of that was related to the maintenance deferral? And when would you expect to incur that maintenance, specifically, by which quarters of the year, if you can give that sort of detail?

And then just on product and raw material prices. Obviously, you guys showing that bridge and there was a negative — net negative impact in Q3. Just thinking about where prices are for your products and raw materials in July and August, how do you expect that to pay off there? Do you see any improvement?

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [58]

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Yes. On your first question, the delay, $9 million, and that would be incurred in Q1. The second question with regards to — sorry, do you mind repeating the second question, Ross, apologies.

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Ross D. Krige, JPMorgan Chase & Co, Research Division – Analyst [59]

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Yes. No worries, Steve. Sure. So just thinking about sales, product prices and raw material prices in terms of revenue or price movements and variable cost movements, that was, obviously, a negative impact in Q3. Just thinking about where prices and raw materials have moved now in July and into August, how do you see that evolving those costs?

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [60]

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Yes. Look, the one thing I would say is that pulp prices across the board are low. A lot of that, obviously, is linked to the whole COVID thing. So whilst it doesn’t help with dissolving pulp, it does help our paper business and the pulp costs for our paper business. So things — we had expected prices cost to start rising, which has not happened so far. So that should be favorable for us and offset some of the pressure that we’re feeling elsewhere. On selling prices, we’ve talked about it, there has been a little bit of lower in recent quarters, but we think with the market coming in balance, we can try to hold prices as we go forward prices, selling prices.

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Operator [61]

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Gentleman, that was the final question. Do you have any closing comments?

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Stephen Robert Binnie, Sappi Limited – CEO & Executive Director [62]

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No, operator, thank you very much. I’d just like to thank everybody for joining us on the call today, and we look forward to discussing our year-end results in 3 months’ time. Thank you very much.

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Operator [63]

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Thank you, sir. Ladies and gentlemen, that concludes today’s conference. Thank you joining us. You may now disconnect your lines.