DS Smith H1 24/25 Earnings Call Transcript

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December 5, 2024

There are 9 speakers on the call.

Operator

Good morning, everybody. My name is Myles Roberts, the Chief Executive of DS Smith, and I'm joined by Richard Pike, our Group Finance Director. Today, we'll both be presenting the results for the half year to October 2024. The results for the half year came in as we expected. We saw a continued recovery in packaging volumes that reached plus 2% on a on a like for like basis, Whilst packaging prices were lower on a year on year basis, but they started to improve during the 6 months, really reflecting the initial recovery of higher paper prices.

Operator

But underlying this, we're pleased with our level of customer service, product quality, our sustainability performance, particularly on the introduction of new products and services to our customers. And our cost control, our efficiency work continues to deliver and underpin our results. And in terms of the recommended all share offer from International Paper, Again, we're making good progress, and we look forward to closing this transaction in the near future. I'll now hand over to Richard to take us through the financial results. Thank you.

Speaker 1

Thanks, Myles, and good morning, everyone. I think I'd like to start by reiterating that we're pleased with the performance during this half year, particularly given where we are

Operator

in the

Speaker 1

cycle. We saw initial signs of positive recovery in demand and paid pricing through quarter 1, albeit that we started to see paid prices falling towards the end of the half. What I think is really important though is the very strong performance around things within our own control, including customer centricity, cost control and operational efficiency improvement. All credits in this regard goes to the efforts of our teams across the business, particularly during a period of increased uncertainty as a result of the ongoing takeover process. We guided that the FY 'twenty four results this would be a second half weighted year, primarily due to box prices being lower than 12 months ago, reflecting the usual lag following the paper price falls that we saw during last year.

Speaker 1

We'd expect to see further box price recovery in half 2, but mindful of the ongoing paper price weakness due to the current supply demand dynamic. And I would like to highlight 2 other things on this slide. Firstly, we're recommending a 3% increase in the interim dividend, which accords with what we set out in the IP deal cooperation agreement. And secondly, to note, the statutory profit is marketed lower than adjusted profit due to the £75,000,000 of costs booked in the half related to the IP transaction. Moving to Slide 5.

Speaker 1

You can see the impact on revenue of the year on year box price declines, which have more than offset the combination of volume and paper price improvements. Moving to Slide 6, you can see that box price decline in turn feeds through to operating profit. And in simple terms, all of the year on year profit decline is a result of box price movements. What doesn't jump out from this page, but is worth noting, is that despite significant input cost inflation over the last 12 months, together with material OCC price increases and a near doubling of gas prices in the half, our cost reduction and efficiency improvement efforts have pretty much offset all of these headwinds. Turning to Slide 7 on cash flow.

Speaker 1

You can see that despite £130,000,000 of year on year EBITA decline, our free cash flow generation is essentially neutral, despite the ongoing elevated levels of discretionary CapEx due to the marked improvement in working capital performance. And finally for me, turning to Slide 8. You can see that while the leverage is slightly elevated versus last year, this is still very comfortable for a bottom of the cycle profitability position, bearing in mind that we're continuing to invest through the cycle, particularly when compared to our leverage covenant limit of 3.75 times. I'll now hand back to Miles who'll talk in more detail about our ongoing focus areas together with the status of the IP takeover.

Operator

Thank you, Richard. Against the challenging market backdrop, we're pleased to see continued progress with our packaging volumes. These increased at 2% on a like for like basis, which compares to plus 1% in the second half of last year and minus 4.7% in the first half of last year. We're very pleased with the continued progress in particularly in North America and Eastern Europe, where our like for like growth was strong. But some other markets were more challenging, principally in Germany and the U.

Operator

K. During the 6 months, we saw an increase in the price of paper. Whilst we do everything to offset this through efficiency and cost control, we have started to pass on those increasing costs to our customers. 50% of our customers are on index deals where the higher cost of paper automatically triggers higher prices, typically with a 3 month lag. And the other 50% of our customer base are on freely negotiated contracts.

Operator

And again, these tend to change after about 3 months, again, to reflect, historic increases in prices. So we saw the effect of the price increases coming through, where pricing in Q2 was ahead of pricing in Q1, and we expect this trend to continue into the second half of the year despite a challenging market. Our success in recovering increasing input costs is based on the value that we deliver to our customers. Our levels of customer service, product quality have never been better, and these are reflected in record customer satisfaction scores we continue to receive with our regular customer updates. And in turn into the relationships with our customers, the rate of innovation of new product introductions has been accelerating, and I highlight here just some of the areas of development with some of our large customers.

Operator

For example, with Nestle, where we continue to be recognized for our new innovation that is taking cost out of their supply chain. And with Procter and Gamble, awards for excellence, not only in their baby care division, but also in their home care as well. And turn to some other customers such as Mondelez and Carlsberg, new packaging solutions supporting their drive to net 0 emissions by 2,050. And these strong customer relationships has given us the confidence to continue to invest in our business. We've spoken previously about our investment in Rouen in Northern France for a new biomass boiler.

Operator

This boiler is expected to come on stream in Q1 of 2025, on time, on budget, with an excellent saving in CO2 emissions and a return on capital employed still expected to be in excess of 20%. And some other investments that we haven't talked about, all backed by our customers. A new example in Hungary, a €35,000,000 investment, resulting in significant capacity boost in one of our fastest growing regions and again with a very attractive return on capital well in excess of 15%. And turning to the combination with International Paper, combining 2 complementary businesses, building strong market positions to enable enhanced supply to our customers, the ability to unlock meaningful cost synergies as well as CapEx savings and revenue opportunities. The work on integration, planning and achieving the clearance from the European Union is well advanced and ongoing, with an expected completion in Q1 of 2025.

Operator

And turn to the outlook, we now expect market conditions in the second half to remain challenging. A lot of the trends we saw in H1 will continue into H2. Packaging volumes growing and at the same time recovering increasing input costs through higher packaging prices. But the fundamentals of the market remain strong and we're delighted and we look forward to combining with International Paper in the Q1 of next year. Thank you very much.

Operator

Either myself or Richard are now very happy to take any questions you may have.

Speaker 1

Just before we take questions, I'd just like to remind everybody that because we're in an offer period, we're limited as to the guidance we can give you in terms of the full year outlook in financial terms and also any detail in relation to the deal that's not already in the public domain. But we'll try and be as helpful as we can in response to your questions.

Speaker 2

We will take the first question from the line Charlie Muirsen from BNP Paribas. Your line is open now. Please go ahead.

Speaker 3

Good morning, gentlemen. Thank you for taking my questions.

Speaker 4

And just since this is

Speaker 3

maybe the last conference call for DS Smith as an independent company, I just want to wish you all the best for the future. The question I have is really around pricing and pricing outlook. Firstly, on the containerboard side, as you acknowledge, we're already seeing the European prices coming down. And next year there's 5 big new mills due to get switched on, one of which is yours. I just wonder whether you think that, that additional capacity can be absorbed by the market or whether we maybe are likely to see continued pressure on the board price?

Speaker 3

And then linked with that, given the direction that the board price is going at the moment, on those 50% of customers who are not on index linking, does that make it harder to get those box prices through when they can point to the fact that the ball price is certainly higher than it was, but it's directionally going back in the other direction now? Thanks.

Operator

Thank you for your questions and also thank you for your initial comment. The price of containerboard, you're absolutely right. It rose quite strongly during the summer and recently there's been some weakness. And that weakness I think has been accompanied by a reduction in the price of OCC. It remains volatile.

Operator

If we look ahead some people think it's going to go down, some people think it's going to go up particularly with some some of the recent increases in the price of gas and all we can say is that we should note that there has been some recent weakness. I think underlying it there is obviously a lot of commentary about the new mills that are due to come on. We do buy a lot of paper. We understand some of those mills will probably come on later than have been previously announced. We also have seen quite a bit of downtime being taken by other suppliers so ultimately this this capacity I think will probably be slightly rephased and will have to be bedded in.

Operator

We are seeing though quite a reasonable increase in packaging volumes. That hasn't fallen off. It's improved in this half compared to the second half of last year and we are expecting that to that to continue. So all in all, I don't think it's a particularly unusual situation that we're in, and we all we can really say is that we just note there has been some reduction recently in the price of paper, but how it goes in the future, I think is very uncertain. I certainly wouldn't assume it's going to go down.

Operator

But whether it goes up, we'll just have to wait and see. Thank you very much.

Speaker 3

Thanks. And just on the box, the open price?

Operator

Yes. On the, sorry, on the box. All of our pricing to date has gone through as we have expected. We really emphasized the point about the value that we're adding to our customers and we found our pricing has in the first half was all things considered it was it was resilient compared to a normal in compared to a normal cycle and I think we've tried to say you know we we do expect to really recover the increase in in in input cost that that we're seeing whatever they are we always have in the past in the last cycle we actually over recovered because the value that we're adding. And we're absolutely confident that we'll continue to recover increasing input costs, whatever they are.

Speaker 2

Thank you. We will take the next question from the line Cole Hathorn from Jefferies. The line is open up. Please go ahead.

Speaker 4

Good morning, Myles, good morning, Richard. Thanks for taking my question. I just like a follow-up on the demand side because I suppose the area that I've been most disappointed in is the promotional activity from some of the consumer goods companies. And I know that it's the consumer has been a bit weaker, but are you seeing any kind of green shoots or changing in some of their promotional activity to kind of support volumes either over this Christmas period or has that effectively been delayed into 2025? And then if I can have a follow-up on Charlie's questions around containerboard outlook.

Speaker 4

I know it's very uncertain, but you're one of the biggest buyers across Europe. Surely, at this point, after a bit of a decline, you're more incentivized to try and stop the bleed in containerboard pricing. And I'm just wondering, is there a market dynamic where the box makers are incentivized to try and put something underneath the container price at all?

Operator

Now on the demand side, some there's a regional and there is a sector bias to this and some regions North America for us has been extremely strong so is Eastern Europe actually Southern Europe hasn't been too bad either where we've had more of a challenge has been in Central Europe which is really the Germany and the UK. When we look at the overall level of promotional activity across our business by our end customers it's actually recovered quite quite strongly from the from the COVID period. Typically would average in the high 20% and that is more or less where it is at the at the moment. Where we've seen some weakness is a little bit less to do in the in the FMCG space it's been a little bit more in the industrial space for reasons that we that we know but our volumes have been probably not as strong as as you know some of our forecasts were at the start of the year but it has been coming through reasonably reasonably okay and we expect that like for like increase in our volumes to come through and that is underpinned with the resilience of the FMCG sector.

Operator

You know but it is you know we do expect that to we do expect that to continue and and there are various underpins with that lowering of inflation typically across Europe salaries take home salaries are now rising at a rate that is above inflation we do have lower interest cost coming through you've seen some of the reductions not only in the UK but also the ECB that's that's certainly having having an effect and on the containerboard side we do hear a lot of supplies taking more downtime and the and the difficulty of managing at current paper prices. And this is where I see now. I just it just remains it just remains uncertain I mean we've got to be a little bit careful we're not giving forecasts for our business as Richard has out has outlined but I I we see we see difficulty in the paper supply market we see some of those new mills being delayed some of them being delayed for the 2nd time we see downtime we see some reduction in the paper price but we've retained or the industry's retained a lot of the increase that was it was was achieved over the summer so it feels like we're bumping along the bottom that's what it feels like but I'm not saying that's going to continue we're not giving a forecast but it is it it does feel like we're bumping along the bottom at the moment Let's see where demand gets to.

Operator

Let's see what the what the downtime is. Let's see the delays in these mills and then we'll see the and see the paper price.

Speaker 2

Thank you. We will take the next question from Leland Lars Kiely from Stifel. The line is open now. Please go ahead.

Speaker 5

Thank you and thanks for taking my questions. I just want to come back to demand situation. You described your situation in North America as very strong. Can you sort of put some color on that? Because the industry statistics, of course, from the U.

Speaker 5

S. Have been not particularly strong at all. It's essentially flat year on year. So what are you seeing and what's driving that? I mean, if you can put any color on recent trading in North America versus what you're seeing in Europe in terms of directional changes.

Speaker 5

And that really feeds into the follow-up, I suppose. How do you really see sequential volumes as opposed to year on year changes in that component? Thank you.

Operator

Look, North America has been very strong and that's year on year but it's also sequential as well. We have been winning quite a bit of work. It's particularly in the in our solutions that offer a lower environmental footprint. It's all about performance packaging, it's about lowering the CO2 emissions, more on the shelf ready and the and the sort of the whole image of the packaging and we've been winning very well with some large FMCG clients and one of the reasons we're very excited about the acquisition or by international paper is we feel that that will provide us more capacity to take to take on these opportunities that are that are clearly that are clearly there. There have been you know the price of paper in the North America in contrast Europe has actually over the 6 months actually gone up and we note the announcements in the industry about further increases in the price of paper in North America certainly just looking at our business demand is strong good customers good quality products and we will see that coming through for our business in the first half you know we just noted that we did have a very large maintenance shut from in one of our our paper mills and obviously, there was a significant hurricane there as well.

Operator

So we're looking for the second half. I should probably just stop there on that. But that's where we are in North America. Thank you.

Speaker 2

Thank you. We will take the next question from the line Andrew Jones from UBS. Your line is open now. Please go ahead.

Speaker 6

Hi, just I'm not sure to what extent you can comment on this, but I'm just curious about where we are in the process and what we're actually waiting for before closure and where, if anywhere, you see any risks? And I'll let you answer that first and then just have a couple of questions on market. Thanks.

Speaker 1

So the situation, Andy, is that we've got the U. S. Anti competition clearances through. We obviously, as you know, both sets of shareholder approvals come through. So we're just waiting on the European Union competition clearance.

Speaker 1

The filing for that to get through Phase 1 is now in. And basically the timescales there's a 25 day working day timescale around that which expires on the 10th January if the EC requires known remedies. But actually, if there are remedies required, it's 35 days. So that on the shorter timeline, that's 20th January. On the if the remedy is required, that's 24th January is when the EC have to opine.

Speaker 1

After that, basically if remedies are required and the EC haven't actually ruled on that yet, it'll be whatever time it takes to undertake those remedies. And then once any remedies if they're required are done, then basically we can get a court clearance, which can be any time up to 30 days after the remedy is satisfied. So that's why we expect this to play out during the current month and the 1st few months of next year and to complete sometime in Q1 of calendar 2025.

Speaker 2

Thank you. We will take the next question from the line James Simon from

Speaker 7

Cressi. I've got two questions. The first one is the new capacity that you're bringing on, which I think is just under 300,000 tons, could you give some idea of the timing, the latest timing on that? And then what your sort of percentage self sufficiency of paper would be in recycled and kraftliner post that? And then the second one is you mentioned 2% box demand growth.

Speaker 7

Just checking the European number is I'm assuming is similar to that given that that's the vast majority of your business, but just wanting to follow-up on that. Thank you very much.

Operator

No, thank you. The new the new mill is actually a replacement of an existing mill in Northern Italy and we expect that to come on at the end of this at this calendar year the beginning of 2026. It's around it's around that that it's around that that time. You know it is that is our you know that's at our that's our that's our our choice and you're absolutely right you know given 2% and the vast majority of our business is in is in Europe so whilst the US was quite a bit stronger, it is a modest part of our overall numbers. Thank you.

Speaker 2

Thank you. We will take a follow-up question from line Kohl Hutton from Jefferies. The line is open now. Please go ahead.

Speaker 4

Good morning, Miles. Good morning, Richard. Thanks for taking the follow-up. Richard, I'd just like to follow-up on the CapEx programs that you've been delivering over time. Are there any contributions that you can call out or kind of progressions or items that you've that may have changed in those CapEx profiles?

Speaker 4

Because I noticed you lowered the CapEx number slightly. You just lowered the range to 400 to 450 from 400 to 500. So just wanting to know if there's anything to be aware of on the CapEx side.

Speaker 1

So we thanks, Karl. Look, we're delivering on the plans. I mean, Myles talked specifically to Ruan and also the recent sort of box plant upgrades we've had in Fuzhny in Hungary and in Poland. And those investments have been sort of on budget, on schedule and therefore definitely coming through in terms of the sort of performance in line with our expectations. But as the environment sort of weakened around us a bit and as we've said sort of we're seeing that continue into the second half, inevitably we're cutting our cloth accordingly.

Speaker 1

So we're bringing down the overall levels of CapEx in the remainder of the year and I probably expect that to continue into next year as well. So it's not a matter that there aren't the sort of returns there on the investments, but if we're not generating quite as high profit, then we will basically not spend quite as much cash.

Speaker 2

Thank you. We will take the next question from the line of Pernod Mital from Barclays. The line is open now. Please go ahead.

Speaker 8

Hi, good morning. Thank you for taking my questions. I have a couple. So firstly, can you talk about the progression of volumes in the first half? Have you seen any weakness in the last couple of months versus Q1?

Speaker 8

And are you seeing any signs of improvement in Germany? So that's the first one. And secondly, can you quantify the impact from the maintenance downtime and hurricane in the North America segment that you had in the first half?

Operator

Yes. No, thank you for your question. When you look at volumes, it's quite difficult. We don't get too sort of drawn into individual months you know just looking at we actually finished the half year quite strongly as it was quite good but I wouldn't read anything into that in particular All I'd note is that the second half of last year we grew on a like for like at plus 1, we've grown at plus 2 this time and and actually expect the packaging volumes to carry on to carry on growing on a on a like for like basis. It's it's I wouldn't but there's no particular trend I'd want to pull out between Q1 and Q2.

Operator

And then on the maintenance, we know in the North America the paper industry is very profitable and we did take an extended period of maintenance in our in one of in our largest mill there in the in the first in the Q1, and it's now back on stream and working very well and obviously benefiting from the higher higher paper prices, but that was quite given its profitability and the downtime and the nature of profitability in the paper in our paper assets that have a high fixed cost base. It did obviously have quite a significant effect on the performance in the first half, but it's every few years we just have to take a long shot. We've done that and and it's working very well at the moment, so looking forward to continued progress there. Thank you.

Speaker 1

The impact the impact of the mill shutdown and the extended Tantech come back plus the hurricane was high single figure millions.

Speaker 2

Thank you. We will take our last question from line Andrew Jones from UBS. The line is open now. Please go ahead.

Speaker 6

Hi, James. Just a quick question about the energy cost situation. I mean, in that $22,000,000 that you talked about, obviously OCC was probably up more than that, but by some offsets. You talked about year over year energy dynamic that we've seen in the first half. And can you remind us about your hedge position and broadly how we should think about the sensitivity to gas prices now?

Speaker 1

I'll maybe take that one. I mean, as Myles mentioned, if you look at from the start of the half to the end of the half, I mean, you've got a near doubling. We sort of ended the half at near €50 We came into the half in the mid- to high-20s. So that was the headline point. As you say, we have a rolling hedging policy.

Speaker 1

During the first half, we've been around about 80% hedged, so we haven't suffered the full impact of that. And that lasts into our second half as well. But on the amount that's unhedged, we still do have exposure to those higher costs.

Speaker 2

Thank you. I'll hand it back over to your host for closing remarks.

Operator

Well, firstly, thank you very much, everybody, for attending our call and for attending our call. I'd just like to just reiterate that our results have come in exactly as we expected. We expect the second half to continue to show the trends we saw in the first half, and we look forward to the closure of the acquisition by International Paper. Thank you very much for your time from Richard and myself.

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DS Smith H1 24/25
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