Q&A with the CEO
"A steadfast focus on operational excellence and innovative problem solving underpinned our FY2021 strategic objective to return the business to profitability."
Covid-19 continues to evolve and is likely to remain a material risk in FY2022. How has the pandemic impacted Sappi in FY2021 and what actions have you taken to mitigate these effects and build resilience?
There is no doubt the Covid-19 pandemic dominated our business environment in FY2021. However, we are grateful for the adaptability of our workforce and the resilience of the global economy, which rebounded much faster than we could have anticipated a year ago. Although we are optimistic the worst is behind us, we also recognise there are significant ongoing challenges and risks for our markets and operations due to recurring waves of infection. Our Covid-19 action plan to ensure safe working conditions for all of our employees has been successful and we entrenched a new way of socially distanced working. The roll out of vaccinations across all our operating regions was a major highlight for the year and we encouraged all our employees to vaccinate for their safety and that of their families and colleagues. In South Africa we established vaccination sites at our major operating units and offer vaccination for employees, contractors and their family members. A steadfast focus on operational excellence and innovative problem solving underpinned our FY2021 strategic objective to return the business to profitability. Market demand across all our major product segments improved progressively during the year as global economic activity resumed and despite the significant headwinds including unprecedented supply chain challenges and cost inflation, we were able to achieve our objective in the second half of the financial year.
Logistical challenges created havoc with global supply chains in FY2021 leading to escalating raw material costs and constraining your export sales. Do you expect these problems to be resolved in FY2022 and what is Sappi doing to mitigate the impacts?
The unprecedented logistical issues we faced in the past 12 months began with the economic upheaval of the pandemic. The situation was aggravated by the strength of the economic rebound as lockdowns eased, combined with container and vessel dislocation. In principle there are sufficient containers and vessels to handle global trading volumes, but the sudden onset of the pandemic stranded large numbers of containers and vessels in the wrong geographical location, thereby substantially reducing availability in several parts of the world. Additionally, ports around the globe struggled with increased shipping volumes and vessel berthing delays, resulting in ports and shipping lines not being able to clear backlogs, which created even more bottlenecks and congestion. Our exports from South Africa were further impacted by significant events including civil unrest and a cyber-attack which exacerbated the existing inefficiencies at the Durban Port. But it is not only ocean freight that is a problem. In every region where we operate, domestic transport systems were also under pressure due to surging demand and a shortage of drivers during Covid-19 waves. Consequently, costs for rail/road freight increased considerably. These logistical disruptions contributed to the global surge in inflation as lower inventories and significantly increased lead times for deliveries of raw materials led to shortages of certain key supplies, which of course drove prices upwards.
To mitigate the impact of raw material shortages and cost inflation, we have optimised product recipes to manage usages of constrained input materials, fast-tracked R&D efforts to identify material substitution opportunities and implemented price increases across all our product categories. Despite the challenging shipping environment, we managed to consistently secure space by leveraging our extensive global logistics network and contracts. We also negotiated spot deals where possible to secure additional capacity and engaged directly with senior leaders of our principal shipping lines. These are global logistical issues affecting all industries, so we are not unique in our challenges and there is significant pressure on shipping lines and ports to address the issues. The sheer scale of the problems suggest it will take time to resolve. However, we are seeing encouraging signs of improvement that indicate that the worst is over, and in South Africa, we are working directly with shipping lines to gain access to additional capacity and dedicated vessels and planning more direct routes to expedite delivery of our backlog of DP volumes to our customers.
DP market prices surged well above the long-term average in 2021. Can you explain some of the drivers that were responsible and do you think these high prices are sustainable given the new capacity entering the market in 2022/2023?
The impact of Covid-19 on the textile, apparel and fashion industries was extreme as retailers were forced to close down during initial lockdowns, which led to a chain reaction of order cancellation through the entire value chain. Many DP producers, including Sappi, curtailed production and those with swing capacity shifted to market paper pulp production. Some smaller DP producers completely shut operations and furloughed employees. However, as soon as economic activity resumed after the first wave, global retail apparel sales rebounded dramatically. Inventory levels through the entire value chain, which were already at low levels, came under severe pressure as supply chain challenges hindered restocking.
With DP capacity reduced due to the temporary closures and lead times for global deliveries at all-time highs, the supply of DP was severely constrained. Additionally, rapidly climbing paper pulp prices incentivised swing producers to continue producing paper pulp which intensified the DP supply shortage. The constrained DP supply, combined with resurgent VSF demand and prices, fuelled the DP market price and we saw a meteoric rise from a low of US$624 per ton in October 2020 to a peak of US$1,106 in April 2021. A weaker US$/Renminbi exchange rate and surging textile fibre prices further supported the DP market price. Gradual restocking of VSF, yarn and grey fabric through the supply chain and resumption of DP production at the temporarily shut mills eased the supply/demand imbalance and both VSF, and consequently DP, prices started to subside from the third quarter of our financial year. At year end the DP price was at US$1,000 per ton, which is still above the long-term historical average. Currently there are short-term challenges in the textile value chain in China due to energy curtailments which are putting pressure on the DP market price. However, the DP demand outside of China remains buoyant and underlying global textile demand is strong. Cotton prices soared in recent months, and the differential between cotton and VSF is the highest in over a decade, which should incentivise yarn producers to shift from cotton to VSF in the coming months. All of these factors create a positive outlook for DP in FY2022 and therefore we are optimistic the elevated DP pricing will continue for some months. Long term, we believe a more sustainable price will be around US$850 per ton. The new DP capacity entering the market in 2022/2023 is from integrated pulp/fibre producers and we expect the pulp to be absorbed into their own fibre production. Globally, retail apparel sales are still below pre-Covid-19 levels, and we anticipate that the combination of value chain restocking and resumption of further textile demand growth will absorb this additional capacity and therefore supply/demand will be balanced as we move through the next two years.
The packaging and specialities segment delivered record sales volumes and EBITDA ex SI in FY2021. How was this achieved and can we expect further growth in this segment in the year ahead?
Our investments of recent years into packaging and speciality papers are bearing fruit. We are particularly pleased with the progress of our Somerset Mill PM1 conversion. The machine can make both coated woodfree and paperboard packaging grades and this hybrid swing capability has worked exceptionally well for us and allowed this machine to run at maximum operating rates as we have ramped up the packaging volumes in the past couple of years. From our second quarter, we achieved our target volumes of packaging grades and the focus is now on optimising the product and customer mix to maximise margins. Within the US we have some additional opportunities to make label grades on our graphic paper machines at Cloquet and on PM2 at Somerset and we will pursue every opportunity to maximise these volumes. In Europe we experienced good growth in our packaging and speciality papers volumes and there is further opportunity for additional containerboard at Ehingen and paperboard at Maastricht in FY2022. We are also exploring opportunities for wet-glue and self-adhesive labelling at Gratkorn alongside existing graphical grades. Robust demand for containerboard in South Africa was supported by buoyant fruit exports. South Africa is the world’s second largest exporter of citrus and fruit exports remain the main contributor to positive agricultural trade balance for the country. The outlook for the agriculture exports sector in South Africa is promising, and there are exciting opportunities to expand our containerboard capacity in the future to meet the growing demand in this segment.
Graphic paper demand seems to have recovered to pre-Covid-19 levels, but margins are still below the long-term average. How do you see demand in this sector developing in FY2022 and what actions are you taking to improve profitability?
Pre-Covid-19 the decline in demand for graphic paper was especially noticeable in developed countries, where there has been a clear correlation between reducing paper consumption and economic advancement, driven by digitisation. The Covid-19 pandemic had an immediate and devastating impact on paper demand and accelerated some of the previously existing declining trends. The closure of retail stores and restrictions on travel due to strict lockdowns impacted advertising demand. Additionally, the shift to remote working and virtual meetings led to a significant reduction in office-paper consumption such that in 2020 we were predicting a 20% permanent reduction in graphic paper demand due to Covid-19. Over the last two years, graphic paper producers reacted to the dampened market outlook by taking drastic steps to curtail production. Numerous closures and conversions resulted in 10-20% of the production capacity exiting the market, including our Paper Machine 2 (PM2) at our Stockstadt Mill as well as PM9 and the energy complex at Westbrook Mill. However, the steady recovery of paper demand through 2021 combined with the market capacity closures resulted in a restoration of market balance in Europe and North America as we begin our 2022 financial year. While some of the demand may be temporary restocking, we are encouraged by the fact that globally, economic activity, particularly travel and entertainment, is not yet at pre-Covid-19 levels. We are therefore optimistic about the short-term outlook for the segment. Unfortunately, cost inflation is negatively impacting our margins and we are focusing on operational efficiencies and offsetting rising costs through announced price increases. Longer term, we expect the demand decline to continue at 5-6% per annum. We will endeavour to reduce our cost base through smaller investments in efficiency improvement projects where appropriate and maximise cash generation through FY2022 as we look for further opportunities to diversify into higher-margin packaging grades.
ESG seems to be the latest buzz word in the sustainability space. What does ESG mean to Sappi and how are you integrating sustainable business practices into your operations?
Institutional investors are increasingly committing to sustainability as a core driver of financial value. While financial metrics were the primary tools for investment selection in the past, this new wave of socially and environmentally responsible investing requires a completely new framework for evaluation incorporating environmental, social, and governance (ESG) factors into the financial analysis. Investors are increasingly applying these non-financial factors as part of their analysis process to identify material risks and growth opportunities. We are experiencing a significant increase in investor requests for ESG discussions and there is no doubt these factors are becoming more critical to our shareholders. At Sappi, our commitment to sustainability is based on being a trusted, transparent and innovative partner in building a biobased circular economy and we welcome these ESG engagements as opportunities to share our sustainability journey and values.
One of the key challenges we face is that ESG disclosures
are not commonly part of mandatory financial reporting and
currently there is no standardised approach to the
calculation or presentation of different ESG metrics. Various
rating firms have developed ESG frameworks which tend to
rely on multiple criteria to evaluate each of the individual E, S
and G components and provide an overall score for
companies. Since most ESG evaluations are based on
information that is available in the public domain, the
pressure on companies to disclose more and more
information is escalating. While we fully support the
underlying principles of ESG and the drive for sustainable
value creation, we question whether there is a good
understanding of the relative merits and limitations of the
different metrics. For this reason, we view every opportunity
to engage with stakeholders on ESG matters as an
opportunity to contexualise our sustainability performance,
targets and action plans. We recognise that as an industry
that utilises renewable resources, there is both great
opportunity and an ethical obligation to reduce adverse
impact inherent in our business. Value for Sappi is not only
about delivering returns to our shareholders, it is about
maximising the value of every resource along our value chain
to ensure those returns are sustainable and embedding
sustainable business practices and innovation into our
overall business. This is the foundation of our