Earnings Transcript for SMDS.L - Q2 Fiscal Year 2025

Miles Roberts: Good morning, everybody. My name is Miles 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 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. But underlying this, we're pleased with our level of customer service, product quality, our sustainability performance, particularly on introductory 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.

Richard Pike: Thanks, Miles, 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 in the cycle. We saw initial signs of positive recovery in demand and paper pricing through quarter 1, albeit that we started to see paper 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 '24 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. We'd expect to see further box price recovery in half 2. We're 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 of course is 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 million of costs booked in the half related to the IP transaction. Moving to Slide 5. 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 it's worth noting, is 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. You can see that despite £130 million of year-on-year EBITDA 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 3.75x. 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.

Miles Roberts: 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.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. 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 then turning into the relationships with our customers, the rate of innovation of new product introductions has been accelerating, and I'll highlight here to some of the areas of development with some of our large customers. For example, with Nestlé, where we continue to be recognized for our new innovation that is taking cost out of their supply chain. And in Procter & 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 zero emissions by 2050. 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 Northern France for a new biomass boiler. 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 million investment, resulting in a 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 two 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. And turning 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 first quarter of next year. Thank you very much. Either myself or Richard are now very happy to take any questions you may have.

Richard Pike: 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 and 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.

Operator: [Operator Instructions] We will take the first question from the line of Charlie Muir-Sands from BNP Paribas.

Charlie Muir-Sands: And just since this is 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 acknowledged, 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 wondered whether you think that, that additional capacity can be absorbed by the market, whether we maybe are likely to see continued pressure on the board price. 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 board prices is certainly higher than it was, but it's directionally going back in the other direction now?

Miles Roberts: 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 has been some weakness. And that weakness, I think has been accompanied by a reduction in the price of OCC. It remains volatile. 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 of the recent increases in the price of gas. And all we can say is that we just 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 capacity, I think, will probably be slightly rephased and would have to be embedded in. 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 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 that 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. Whether goes up, we'll just have to wait and see. Thank you very much.

Charlie Muir-Sands: And just on the box, the open price.

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

Operator: We will take the next question from the line of Cole Hathorn from Jefferies.

Cole Hathorn: 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 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. 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 containerboard price at all?

Miles Roberts: On the demand side, some -- there's a regional and there is a sector bias to this. In some regions, North America for us has been extremely strong, so as 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 U.K. When we look at the overall level of promotional activity across our business by our end customers, it's actually recovered quite strongly from the COVID period. Typically, it would average in the high 20%, and that is more or less where it is at the moment. Where we've seen some weakness is a little bit less to do in the FMCG space. It's been a little bit more in the industrial space for reasons that we know. But our volumes have been probably not as strong as some of our forecasts were at the start of the year. But it has been coming through 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. But it is -- we do expect that to continue. And there are various underpins to 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 costs coming through. We've seen some of the reductions, not only in the U.K., but also the ECB. That's certainly having an effect. And on the containerboard side, we do hear a lot of supplies taking more downtime and the difficulty of managing at current paper prices. And this is where I see -- it just remains uncertain. We've got to be a little bit careful. We're not giving forecast for our business, as Richard has outlined. But we see difficulty in the paper supply market. We see some of those new mills being delayed, some of them being delayed for the second time. We see downtime. We see some reduction in the paper price, but we've retained -- or the industry has retained a lot of the increase that 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 the forecast, but it is -- it does feel like we're bumping along the bottom at the moment. Let's see where demand gets to. Let's see what the downtime is. Let's see the delays in these mills, and then we'll see the paper price.

Operator: We will take the next question from the line of Lars Kjellberg from Stifel.

Lars Kjellberg: Just want to come back to demand situation. You described your situation in North America is very strong. Can you sort of put some color on that? Because the industry statistics, of course, from the U.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? If you can put any color on recent trading in North America versus what you're seeing in Europe in terms of directional changes. 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?

Miles Roberts: 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 is 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, but more on the shelf-ready and the sort of the whole image of their 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 on these opportunities that are clearly there. There have been -- the price of paper in the North America in contrast to Europe has actually -- over the 6 months, has 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'll see that coming through. For our business in the first half, we just noted that we did have a very large maintenance shut from one of our paper mills. And obviously, there was a significant hurricane there as well. So we're looking for the second half. Actually, I should probably just stop there on that. But that's where we are in North America. Thank you.

Operator: We will take the next question from the line of Andrew Jones from UBS.

Andrew Jones: 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 I just have a couple of questions on the market.

Miles Roberts: 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. The filing for that to get through Phase 1 now in. And basically, the time scale, there's a 25-day working day time scale around that, which expires on the 10th of January if the EC requires no remedies. But actually, if there are remedies required, it is 35 days. So on the short time line, that's 10th of January. On the -- if the remedy is required, that's 24th of January is when the EC have to opine. Then after that, basically, if remedy is required and the EC haven't actually ruled on that yet, it will 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 to 30 days after the remedy is satisfied. So that's why we expect this to play out during the current month and the first few months of next year and to complete some time in first quarter of calendar 2025.

Operator: We will take the next question from the line of James Twyman from Prescient.

James Twyman: I've got two questions. 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. Just checking, the European number, 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.

Miles Roberts: No, thank you. 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 calendar year, the beginning of 2026. It's around that time. That is our choice. And you're absolutely right. You've given 2% and the vast majority of our business is in Europe. So whilst the U.S. was quite a bit stronger, it is a modest part of our overall numbers.

Operator: We will take a follow-up question from the line of Cole Hathorn from Jefferies.

Cole Hathorn: Richard, I just like to follow up on the CapEx programs that you've been delivering over time. Are there any contributions that we -- you can call out or kind of progressions or items that you -- that may have changed in those CapEx profiles? Because I noticed you lowered the CapEx number slightly. You just lowered the range to £400 million to £450 million from £400 million from £500 million. Just wanting to know if there's anything to be aware of on the CapEx side.

Richard Pike: So thanks, Cole. Look, we're delivering on the plans. Miles talked specifically to rewind and also the recent sort of box plants upgrades we've had in infusion in Hungary and in Poland. And those investments have been sort of on budget, on schedule and, therefore -- but 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. So we're bringing down the overall levels of CapEx in the remainder of the year, and I'd 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 profits, then we will basically not spend quite as much cash.

Operator: We will take the next question from the line of Pallav Mittal from Barclays.

Pallav Mittal: 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? And are you seeing any signs of improvement in Germany? 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?

Miles Roberts: Yes. No, thank you for your question. When you look at volumes, it's quite difficult. We don't want to get too sort of drawn into individual months. Just looking at -- we actually finished the half year quite strongly. 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've grown a like-for-like at plus 1%, and we've grown at plus 2% this time. And actually, we expect the packaging volumes to carry on growing on a like-for-like basis. I wouldn't -- but there's no particular trend I want to pull out between Q1 and Q2. 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 first quarter, and it's now back on stream and working very well and obviously benefiting from the 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 every few years, we just have to take a long shot. We've done that, and it's working very well at the moment. So looking forward to continued progress there. Thank you.

Richard Pike: The impact of the mill shutdown and the extended time to come back, plus the hurricane was high single-figure millions.

Operator: We will take our last question from the line of Andrew Jones from UBS.

Andrew Jones: Just a quick question about the energy cost situation. In that £22 million that you talked about, the 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?

Richard Pike: I'll maybe take that one. As Miles mentioned, if you look at from the start of the half to the end of the half, and 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. During the first half, we've been around about 80% hedged. So we haven't suffered the full impact of that, and that lasted into our second half as well. But on the amount that's unhedged, we still do have exposure to those higher costs.

Operator: I'll hand it back over to your host for closing remarks.

Miles Roberts: Well, firstly, thank you very much, everybody, 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.