Earnings Transcript for SPPJY - Q1 Fiscal Year 2020

Operator: Good afternoon, ladies and gentlemen, and welcome to Sappi Limited First Quarter of 2020 Results Conference Call. [Operator Instructions]. Please note that this conference is being recorded. I'd now like to hand the conference over to Mr. Steve Binnie. Please go ahead, sir.

Stephen Binnie: Thank you. Good day, everybody. Thanks for joining us on the call today. As always, as I move through the investor presentation, I'll call out page numbers as I move through. And I'm going to start on Page 2, the highlights for the quarter. You can see some of the earnings numbers on the left-hand side. The numbers are lower than they were a year ago. EBITDA, $139 million, lower than the prior year and predominantly because of the lower dissolving wood pulp prices, which had a significant impact on profitability. I'm pleased to say that the packaging segment continues to grow, and the margins improved in that area and will continue to improve. And that's despite some pressure that we've experienced in our South African containerboard segment or business. And we'll talk a little bit more about that later. In graphic paper, I think, a pretty good quarter. In spite of market declines of double digit, we were able to gain substantial market share and maintain our profitability there. So pleased with that progress. And then the Matane integration continued in the quarter. We made the payment for the acquisition. The integration is going well, and there's no material surprises, no surprises. Turning to Page 4. The earnings bridge and just calling out a few things. Firstly, the sales volumes were lower than last year. And that's 2 areas, really. Firstly, the South African packaging containerboard side that I mentioned earlier. And the -- in Europe, our coated mechanical business volumes were less. However, obviously, offsetting that has been volume increases in the other packaging segments. Pricing, you can see a significant negative impact, and that's predominantly linked to the lower dissolving wood pulp prices. We've done some good work on costs, variable costs down. We've seen some savings there. Across the board, actually, but in pulp costs, chemical costs and the energy prices costs in Europe. Overall, the exchange rate impact negated itself. We've seen a stronger dollar, which obviously impacted our South African business and a European business with that exchange rate. But that offset itself. So there was no net material impact, giving you the earnings for the EBITDA for the quarter of the $139 million that I mentioned earlier. Slide 5 has our product contribution split, and this is obviously evolving. Packaging continues to grow. And obviously, because of lower dissolving pulp prices, the contribution for dissolving pulp has come down and will continue to come down because, obviously, this is on an LTM basis. So the lower prices will pull that contribution down as we move forward. But I'm pleased with the progress that we're making on packaging, and it will continue to increase its share and is now becoming a very meaningful contributor to overall profitability. Page 6 has the volumes and EBITDA margins by segment. I'm not going to call out all the numbers, but just obviously, it was a difficult quarter because of lower dissolving pulp prices and you can see its impact on the margins. But when you look at graphics and packaging, we actually did pretty well, and margins compared to historical norms at good levels. We're ramping up on packaging. And that was in spite of the softer South African packaging that I mentioned earlier. And then graphics, pretty good at just under 10%. Moving to Slide 7. The maturity, debt maturity profile. We've done a lot of good work over the years in pushing out maturity dates. The next key debt for us is that little block in yellow is some South African debt that's maturing in April, and we'll be obviously looking to refinance that as it matures. And we don't anticipate any problems there. Turning to Slide 8. The CapEx for this year, we're looking at about $460 million. A big chunk of that is the Saiccor expansion. Next year, as we look into 2021, and we said it in the results announcement, we haven't -- other than the Saiccor, we haven't committed any material Capex. Obviously, we're monitoring the situation. We haven't finalized our budgets yet for next year. We're monitoring where pulp prices are going to be and what that means for our available capital. But irrespective, we would expect it to be substantially lower than the current year and certainly much closer to the $300 million mark. Turning to the segments. And firstly, Europe, which is on Slide 10. I think it's fair to say that Europe had a good quarter. Obviously, we experienced market share -- sorry, market declines for graphic paper across the board of around about 10%. But we, in coated woodfree, have been able to give substantial market share. We did take some downtime, about 28,000 tons, but that's predominantly on the mechanical paper side. The ramp-up following the conversion at Lanaken will help us with that going forward. We're pleased to say that packaging across the major subproduct categories within packaging and specialties, all growing and we're making good progress there and we continue to believe there's further opportunities. We also did a lot of good work on the costs, managing our costs downwards. And that helped protect margins. And I'm pleased to say, with the headwinds that they were facing on graphic paper, the region was able to deliver a 5% improvement in EBITDA. North America. In the next page, 11, is firstly, on sales tons on the left, you can see that was up 17%, but we do include the Matane volumes, if you -- post the acquisition. If you back them out, volumes were still up 7%. And obviously, predominantly in the packaging space as we ramp up. Worth noting that from a segmental perspective, going forward -- product segmental perspective going forward, we include -- we will include the external sales from Matane in the DWP segment. And then obviously, the internal volumes are used in the packaging business. So that will move into that segment. Turning to the product -- the businesses underneath packaging, we're making very good progress. We are improving the product mix as we ramp up and that, obviously, boost machine efficiency. DWP pricing obviously had an impact also in North America. That's why you see the year-on-year earnings down on a year ago. But if you look at packaging and specialties and graphics, we've shown improvements on that side. Graphic demand actually was down 16% in the quarter. Our decline was substantially less and we're able to gain market share. We took about 20,000 tons of downtime in the quarter, managing to hold our prices pretty well. And again, the region was able to achieve cost savings in a number of the categories. South Africa, a tough quarter. But obviously, it's predominantly linked to the lower dissolving pulp prices. When you see a decline of $272 a ton year-on-year on that kind of volumes, it does have a severe impact. And unfortunately, at the same time, unfortunately, there was some short-term pressure on containerboard sales. There was a buildup of inventory towards the end of the last financial year, and there was a bit of a drought impact as well in parts of South Africa. So it forced us to take some downtime in South Africa itself. The domestic economy also not helping matters. And in addition, obviously, a little bit of impact on containerboard, but also impacting the other paper categories. We had some headwinds as well for higher energy costs. Turning to the product segments on Slide 13. Firstly, graphic paper. We have seen double-digit declines over the course of the last year. However, when we look forward and we look at longer-term trends, we continue to believe that, that will normalize at about 5% declines going forward. And then what -- we anticipate further big capacity reductions in the industry, which will also boost operating rates. There's some big closures expected in the next 12 months from competitors. Selling prices, we've seen small declines, but they're holding up pretty well. And our team continue to look for opportunities to lower cost, and they've done a good job over the last year or so. Pulp being the major one. Obviously, pulp prices are low, and that is benefiting input costs. Our strategy, ongoing focus on costs, managing our operating rates through taking downtime when we need to. But obviously, focusing on gaining market share as competitors close. We, on the capacity side, in Europe specifically, that -- we've talked in the past about an evaluation that we've done on our assets in Europe. And we're -- that is close to completion, and we'll be making an announcement very, very soon. Pulp integration is key here. And obviously, that's why we acquired the Matane Mill, to lower our costs and reduce volatility. Packaging, on the next slide is 14 -- Page 14. The -- we continue to believe that this is an exciting area of opportunities for us. And I mentioned it in the past, but brand owners are pushing for paper-based solutions to replace plastic. Innovation is key in this segment. And specifically, our barrier technology is very exciting, and we think we can grow further in that area. Selling prices have been pretty stable. And again, all the good work done on the costs is helping margins. The -- we need to continue to ramp up following those conversions that we've made. We're making good progress, but we now need to fill those machines with packaging, and we'll expect the volumes to increase going forward. Innovation is key and as you would appreciate in something like this. And sustainability is a key differentiator, which we believe puts us in a strong position. Page 15. Obviously, I've mentioned it already, but we need to ramp up at Maastricht and Somerset, and things are on track there. The South Africa, yes, I know there's a little bit of short-term pressure, but we continue to believe that there are containerboard expansion opportunities, and we'll continue to monitor that as we move forward. Our focus is on niche sectors where we think we can have a strong competitive position, and obviously, linking back to our innovation and sustainability. The -- we do invest in R&D in this area. And it's -- we believe, it's giving us a competitive advantage. Very excited by barrier coating. And we think in the short term, we can boost volumes on that site by between 5,000 and 25,000 tons. Obviously, taking advantage of the plastics to paper trend. Slide 16 is the DWP markets. Yes, it's been challenging in the short-term because of selling price pressure. The underlying demand for viscose and dissolving pulp continues to be strong and continues to grow at 6% per annum. Unfortunately, there was a lot of additional viscose capacity that came on board. It's lowered viscose prices put pressure on our customers and ultimately led to lower dissolving pulp prices. At the same time, on the supply side, with paper pulp prices being low, we haven't had any relief from swing producers moving back. However, hopefully, paper pulp prices are starting to rise, and that will create opportunities for some producers to move across. In the very short term now, we have the added uncertainty created by the coronavirus. It's fair to say that production in -- across China has stopped and it's impacting volumes and trade flows. It has been the Chinese New Year, so that holiday period is coming to an end this week. They did extend it by a week. It's uncertain what the impact will be, but clearly, adds another risk factor to volumes in the short term. Selling prices, they're at unprecedented low levels. The majority of viscose producers and a significant proportion of dissolving pulp producers are cash negative. So we continue to believe that, that will help pricing as we go forward. We are growing our capacity at Saiccor. That project is going well, 55% complete and is expected to be finished towards the end of this -- end of the year, again, October. Similarly, in this segment, the sustainability message is key, and we believe gives us a competitive advantage. We obviously have the wood certification, and we believe it gives us a differentiator there. Turning to the strategy. And I'll jump then to Slide 18, which talks about cost. And I've mentioned it a few times, but clearly, we've done a lot of great work over the last few years with ongoing continuous improvement initiatives and cost initiatives. And we will continue to do that. We've now identified $64 million of opportunities in the current year, and we're on track to achieve that. Pulp integration, I've talked about a few times. But that's -- obviously, that's why we've acquired Matane, and in time, obviously, the smaller debottlenecking opportunities in Europe, which will boost our integration. And the Saiccor expansion will lower the costs at the Saiccor Mill. Page 19, talking about graphic paper. Obviously, we have taken curtailment in recent quarters and we need to continue to ramp up on our packaging grades, and at the same time, manage our exposure to this market downwards, anticipating the market decline. The conversion we made at Lanaken will help us because that gets out of LWC. And obviously, the conversions that we've made will help us well reduce our exposure. I've already mentioned that we've been looking at our capacity in Europe, and we'll be making an announcement soon. Slide 20 has the balance sheet and the focus. Obviously, with the lower profitability, the leverage ratio has increased. We talked about it at the end of last quarter, I don't think there's any surprises there. We did push our covenants for 4.5, and we did anticipate that this would -- the leverage ratio would increase. Again, to stress, there's no major CapEx commitments beyond the Saiccor expansion. I've talked about $300 million next year and strong focus on working capital. And then 21, accelerating growth in the higher-margin growth segments. Yes, look, I'll concede, obviously dissolving pulp margins in the short term are under pressure, but we do think the long-term fundamentals are favorable and margins will recover. Packaging, I've mentioned a few times on the call, we -- significant opportunities on barrier coating and down in South Africa in the containerboard side. Slide 22 is the outlook. DWP prices remain under pressure. There's been a little bit of a tick up in January, but obviously, there's still -- pricing is still relatively low. The ramp-up of the conversions will continue, and that will provide us with more improved product mix and price realization and improved machine efficiencies. We believe we've got a strong innovative position and particularly in barrier technology, and that will help drive both in the packaging segment. Graphic paper markets remain difficult. However, we've demonstrated that we've been able to gain market share, and we think we'll continue to gain market share as closures occur. Given the current DWP pricing, and obviously, the short-term uncertainty around coronavirus, we're putting out an estimate of EBITDA to follow the trend in -- sorry, in Q2 to follow the first quarter trend. So operator, that's -- I've gone through the presentation, I'm going to put it back to you now for questions.

Operator: [Operator Instructions]. The first question comes from Brian Morgan of RMB Morgan Stanley.

Brian Morgan: I'll start with an easy one, if I may. So -- and Saiccor is 110,000 ton debottlenecking this year. Could you just give us an idea of how those -- how Saiccor's volumes are going to evolve over the course of the year? Are we going to see -- are we going to see a shutdown in the fourth quarter, perhaps for this -- for the debottlenecking or does it carry on seamlessly?

Stephen Binnie: There's no material impact on volumes. So essentially, it's seamlessly. And then, obviously, from Q1 in the new financial year, you'll start to see the ramp-up of the additional 110,000. But no material impact on volumes this year.

Brian Morgan: Okay, cool. That's good. And then the second one is just on DWP markets and supply side, and there's a lot of new capacity out there. You can't obviously comment on specifics but I can. So Raco's adding a lot, IGE's adding a lot, Lenzing have all -- they've all got projects out there in a market that looks very soggy. Could you just chat to us about how you're seeing things? What do you think they're seeing that we don't see, that it looks like the market is going to be very well supplied for a very long time. Maybe just chat to us about that?

Stephen Binnie: Yes. Look, clearly, Brian, we can't talk about individual competitors or customers that are adding capacity. But broadly speaking, amongst the ones you mentioned, they have some integration strategy and they have -- and they're adding significant viscose capacity and it's to meet their own demand. Sappi typically has long-term contracts in place with committed volumes, and that will continue to be the case. Broadly speaking, in terms of market balance, yes, there is additional capacity coming on board. But if you look out over the medium term, there's a significant amount of demand growth as well. And we believe, as you look out 3 to 5 years, the balance in the market looks reasonable, even with the additional capacity that we're adding. And again, maybe just one last comment. Some of the producers that you mentioned, they don't sell into the spot markets so it doesn't directly impact on pricing.

Operator: The next question comes from James Twyman of Prescient.

James Twyman: Yes. I've got a couple of questions. The first one is the Cloquet Mill in the U.S. is clearly starting to make losses. And my understanding is that that's probably piling up quite a bit. Any item? And any comments you can give on that would be helpful on the size of those losses. But surely, as the situation gets worse and worse, there must come a point where you actually say to our customers, we can't keep throwing dollar bills away to supply you. It seems like a situation that doesn't seem to be sustainable. And then secondly, on Capex. You were talking about CapEx of $350 million to $400 million. Now you're looking at $250 million to $350 million in 2021. Does that -- and that really means that you could hit $250 million in 2021 if things stay as they are, which they probably will? Those are my questions.

Stephen Binnie: Okay. I'll briefly answer the first one, and I'll hand it to Mike as well to elaborate a little bit further. And then I'll come back to the CapEx, your second question. With regards to Cloquet, I mean, obviously, we've got swing capabilities. And we have reduced our volumes a little bit on dissolving pulp, which has enabled us to make more pulp for the paper business and has lowered our costs and has helped margins on the paper side. We obviously don't give profitability by mill, but the mill is not making losses.

Michael Haws: Steve, very little to add. We're leveraging the ability to swing, which is helping us manage costs and maximize results from Cloquet.

Stephen Binnie: Yes, yes. I mean, we have -- and I think that's what you were getting at with your question. We do have certain long-term commitments on the dissolving pulp side. But in terms of where we have flexibility, we've taken advantage of that. The Capex, look, we've given a range. Clearly, as dissolving pulp prices are as low as they are, we have to be very cautious with regards to our CapEx levels. We haven't completed our budgets yet for next year. And we're monitoring the situation. If things -- and I know it's if and buts and all those things. Clearly, if prices were to remain very low and profitability continued to be under pressure, then it would be on the lower end of our guidance. However, if things improve and profitability starts to increase, that would give us more flexibility. We haven't committed any material CapEx. We continue to monitor the situation.

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

Wade Napier: You mentioned sort of wood certification being an advantage in your dissolving wood pulp business. Can you give us an idea of what the global certification levels are amongst your peers and whether you're able to extract a premium on pricing for that certification? Then secondly, I mean, you sort of speak about a lot of the DWP capacity going into integrated viscose producers. And I mean, it's well understood that Lenzing are bringing on dissolving wood pulp capacity. So in 3 to 5 years' time, how are you sort of strategically thinking about placing the increased volumes that, in dissolving wood pulp, that you are likely to bring online? Are you going to sort of target another third large customer as per Birla and Lenzing size? And my final question is just, could you map out Matane's external versus internal pulp sales over the next couple of years? I just want to see how that aligns to your sort of growth outlook in specialty packaging markets.

Stephen Binnie: Okay. I'm going to take the first one initially, and Mohamed, I'm going to pass a little bit more to you. Dissolving pulp increased capacity, I'll talk about. And then Matane, I'll say a little bit, and Mike will elaborate further. I mean, firstly, on your first question, again, we can't comment specifically on competitor's certification. But we do know that it does provide us a strategic advantage. There are certain competitors, which I'm not going to name, who don't have the -- that certification. In terms of a percentage, I don't know the exact percentage. Mohamed, I don't know if you know.

Mohamed Mansoor: I think, Steve, I think it depends really on the kind of certification, whether you're talking FSC or PFC. All I would add is that the advantage that the Sappi dissolving wood pulp product cash is, from a wood perspective, is around the location also. So not just only on the certification, but we don't sit and source our wood from areas that are considered sensitive, especially along the lines of ancient and endangered definitions that a lot of the NGOs are pushing. So that's a big part of the advantage that we have when we talk certification.

Stephen Binnie: And Wade, you'll see, our key customers have the -- they have the highest ratings from someone like Canopy, and it puts them in a stronger strategic position. And obviously, we support that. The DWP capacity being added, yes, a lot of it is integrated. Bear in mind that a high proportion, including the additional tons that we're adding at Saiccor will be committed on a long-term contractual basis. So we don't anticipate any problems with demand going forward through this additional capacity. We continue to look to extend long-term contracts, and we don't think it carries significant risk. The Matane, we -- obviously, the number will change as we ramp up further on our packaging grade because we use it for packaging. But in the short term, Mike, we're probably looking at about 100,000 tons used internally of Matane's capacity across Europe and North America.

Michael Haws: I think that's reasonable. And please remember that both North America, Sappi North America and Sappi Europe, were customers of Matane prior to the purchase. So internally, the numbers might go up suddenly over the next couple of years, but there will still be a significant portion that's sold to open market.

Stephen Binnie: Yes.

Wade Napier: Okay, great. Maybe just a follow-up on my second question. So I mean, sorry to harp on this, but Lenzing on bringing on 500,000 tons of dissolving wood pulp capacity, Saiccor is increasing their production by 110,000 tons. And you're not expected to see any sort of implications to that over the next 3 to 5 years?

Stephen Binnie: It's very difficult to comment on specific customers. However, we believe that the capacity that they're adding is to meet their increased viscous and lyocell capacity. The additional capacity we are adding, we will sign up on a long-term contract. So it will be committed volumes. I can't name customers, Wade, you know that.

Operator: The next question comes from Ross Krige of JPMorgan.

Ross Krige: Just one question on each product segment. In graphic paper, would you be able to provide some expectations around downtime into Q2? In the DWP market, you guys have talked about high-cost production at William viscose and DWP. Are you seeing any signs of capacity closing? And if not, do you have any understanding of why that would be the case? And then on specialties, volumes were down in Q1. It looks like you're expecting quite significant volume growth. If I look at Slide 33 -- sorry, Slide 31 in the appendix, does that suggest you're still expecting specialty volumes to grow at group level for the full year?

Stephen Binnie: Okay. Thanks for the questions. Mohamed, I'll come back to you on the second one. On graphic downtime for Q2, we -- in Europe, the -- it's predominantly on the mechanical space, mechanical paper. In coated woodfree, it's relatively small and not that material. On mechanical, we're probably looking at about 30,000 tons. However, and I know it's going to lead to another question, we all know about the strike in Finland at the moment. And maybe, Berry, I'll come back to you and you can just give a little bit on that after finish my answer. In the U.S., we're relatively small. Our latest estimates are somewhere between about 10,000 to 20,000 in terms of curtailment. The second question, viscose, Mohamed, did you want to elaborate a little bit further, we are seeing closures and curtailment happening in viscose across -- in China and outside. You want to just elaborate further there?

Mohamed Mansoor: Yes. There's public information around a closure in Canada, one dissolving wood pulp producer. There's lots of anecdotal information from the market about some challenges that a producer in Brazil has been having, they've been running on and off. And what we have seen more recently is a large number of Chinese dissolving wood pulp producers, and they're really sitting with the high cost structures largely because of the wood in China. If you look at the domestic Chinese dissolving wood pulp production, most of them are reliant on imported wood chips and wood makes up about 70% of their total production cost. And what we are starting to see in the last couple of months, more significant amount of dissolving wood pulp coming out of their production. So they're making less production, they're making other grades like unbleached crop pulp and also some paper pulp. So we're starting to see more of that happening in the last couple of months. One of the reasons I think the response of, let's say, more downtime to the very low prices has been delayed is largely because of contracts related to wood chips. These are annual contracts and a lot of these contracts have now run their costs. A lot of these producers are now starting up negotiations on wood chip contracts, so it's giving them the flexibility to start taking more downtime.

Stephen Binnie: Thanks, Mohamed. And your last question, just to clarify, the reason for the decline is actually because we had softer demand in South Africa. We took curtailment in our South African business. And I think, Alex, it was about 20,000 tons in the quarter. Just to quote, in terms of the regions themselves, North America's volumes were up 43% and the European volumes were up 6%. So we're making good progress there. It's not to do with the recent conversions that we've made. This is a ring fenced into South Africa because of the short-term challenges that we face here. Berry , just -- do you want to just briefly talk about the Finnish situation?

Berend Wiersum: Very briefly, the Finnish mill, Kirkniemi, has been down since Monday of last week. There is as yet no resolution to the strike though there is progress being made. We were due to take some downtime last week anyway. So the downtime, as a result of the strike, will more than compensate for the downtime...

Stephen Binnie: Sorry, Berry, just make it clear to everyone listening. It's an industry strike, not our strike.

Berend Wiersum: Yes, it's an industry strike, to make that quite clear. Yes, this is a collective agreement of an industry strike about the increased working hours that have been planned by the previous government's competitiveness pact and the 2 sides are still trying to resolve the differences. And Kirkniemi just happens to be part of that strike.

Ross Krige: Okay. Sorry, Steve, can I just clarify. So assuming -- I mean, I understand the South African issues on specialties. I mean, would you then assume -- I mean, is it fair to say you would expect growth in -- for the year, assuming things don't get materially worse in South African containerboard business within specialties?

Stephen Binnie: Yes. The U.S. and Europe, we expect to continue the trends and continue to grow profitability. In South Africa, and I'll let Alex elaborate further, we think there were short-term dynamics at play there, particularly with regards to inventory builds. But Alex?

Alexander van Coller Thiel: Seasonally, we have significant stock build in the last quarter of the previous financial year, so we've seen an impact in quarter 1. Our view is will sell as many tons in this fiscal year as we did last year. We'll catch it up in the next 3 quarters.

Operator: [Operator Instructions]. The next question comes from Sean Ungerer of Arqaam Capital Research.

Sean Ungerer: Okay. Awesome, great. Just in terms of the outlook for DWP prices to remain low, how does that sort of tie into your thinking on the ramp-up for Saiccor as well as a swing capacity at Cloquet? And then obviously, you rang that up with client commitments. And then secondly, just in terms of your aspiration to get back to 2x net debt to EBITDA. So the covenants have been adjusted for the next 2 years. Sort of maybe explain that a little bit of that unwind weighing up I guess, CapEx reductions with gross aspirations. Then just lastly, if you could just expand on the timing and maybe the quantum of investment related to potential containerboard in SA.

Stephen Binnie: Okay. Look, based on all the fundamentals that are out there, we do believe dissolving pulp prices will recover in the medium term. Obviously, the coronavirus has added a little bit of uncertainty in the short term. As we think about the outlook and pricing on dissolving pulp, and obviously, we talked to many external parties and we listened to their opinions. We believe that in the second half of 2020, we are going to see recovery. Various estimates out there are between $50 -- kind of $50 a ton type numbers. But clearly, that hasn't materialized yet, and we need to get through the short-term pressure. The specific question on swing capacity. Clearly, there's an opportunity at Cloquet because we can make paper pulp for our paper business, and we'll maximize that opportunity. At Saiccor, the -- you'll appreciate that you make commitments to third-party vendors and there's contracts in place, and you can't pull back on them because it would come at significant costs. So that project is ongoing. The -- by the time the product comes live, we would -- or the machine comes live, we would expect the dissolving prices to be off the bottom. As I say, we look to commit those volumes on a long-term basis, and profitability will improve as a result. It also lowers our costs at the moment at Saiccor. In terms of your question, as it rolls into then CapEx and our leverage and our net debt as we move forward, clearly, as I said earlier, there are no long-term other material commitments. After we finish paying for the Saiccor expansion, the CapEx will come down quite dramatically. And that means that your leverage ratio does come down considerably. And that's why we were comfortable to negotiate a 2-year increase in the leverage ratio. Because we believe that sees us through, with the higher CapEx levels. And then thereafter, if you do the math, thereafter, our leverage ratio will come down considerably. Just to reiterate the point I made earlier, the Capex, we'll monitor the situation. If dissolving pulp prices don't come off the bottom, then we'll be more conservative. If, however, things improves the way we think they will. Then that will open up opportunities after we complete the Saiccor project to do other initiatives. But as things stand, we are being very cautious. We're not committing large volumes, and we're monitoring the situation. Alex, do you want to just talk about the containerboard?

Alexander van Coller Thiel: I view that the containerboard market for agricultural exports is growing at about 5% a year. And we obviously want to maintain our market share there. The first investment will probably be a fairly small one, roughly 15% of our current capacity. And hopefully, we can build on that as CapEx becomes available.

Operator: The next question comes from Mikael Doepel of UBS.

Mikael Doepel: A couple of questions from my side. I would start with some questions on the dissolving wood pulp pricing. First of all, you mentioned in your press release that you have seen some slight improvement in the pricing right now. If you could just elaborate a bit on that, where are we now level-wise in January, February and what's the latest indication there? And then also, looking at the second half of the year, you mentioned market estimates pointing to recovery. So I was just wondering what would -- what will be the key drivers behind that assumption?

Stephen Binnie: Yes. On the first one, it's been a marginal improvement. It's only been a couple of dollars a ton. However, and you do look for the positives in this. The price has not dropped since -- I'm trying to remember now, it's probably October the last time the prices dropped because I think in November, that we're already at the current levels. So it certainly has flattened off over the last 3 months. And as I say, a marginal increase, albeit small, but it is a move in the right direction. Why are we confident about the recovery? As I said earlier, it's not that we think it's going to happen instantaneously, but we believe that with paper pulp prices already starting to rise, that will create opportunities for swing producers. We believe that with so much of viscose capacity, cash negative. And similarly, dissolving pulp, about 1/3 of dissolving pulp capacity is cash negative. So all those fundamentals combined cause us to believe that there will be a recovery. We can't say it's going to happen next month, but we do believe, as the year unfolds that everything points towards an improvement in pricing. Mohamed touched on it earlier. There's a number of producers already reducing capacity or -- and taking curtailment both on viscose and in dissolving pulp, and all of that will serve to boost pricing. Yes.

Mikael Doepel: Yes. Okay. And then just a follow-up on that in terms of viscose for fiber pricing. We saw another leg down there in December, have you seen any more movements downwards on that side as well in January or February or has it stabilized?

Stephen Binnie: No, we haven't seen any further declines. But obviously, now the coronavirus means that, again, it creates uncertainty. Interestingly, it could be both positive and negative for pricing. Because suddenly, now, you're not getting viscose producers out of China. A significant proportion of volumes come out of Indonesia. This could actually help short-term pricing and could be that trigger. But again, it's uncertain. So we have to see how things play out. It hasn't got worse. Things have been level in recent weeks.

Mikael Doepel: Okay. And then just a final question, switching to the U.S. coated paper market. It seems that the pricing held up surprisingly well there in 2019. And now we are seeing some slippage at the end of last year going into this year. How do you see that market evolving right now? Is it getting out of balance? Or are there enough closures? So how would you characterize that market now?

Stephen Binnie: Yes. I mean, obviously, you saw from our numbers that the market was under significant pressure. You saw volume declines last year of 16%. So that has put us under pressure. We believe that further capacity will come from our competitors. And then within Sappi itself, obviously, we're ramping up on Somerset PM 1, which means we will be taking capacity out of the market. So pricing -- when a market isn't declining like that, you do see some negative impact on pricing. Our goal in the short term, obviously, is to ensure that we keep our missions full and we don't take the impact of significant curtailments. So that's our tactics in the short term. It's very difficult to be specific on individual competitors and capacity reductions, but we continue to believe that substantial capacity will come out both in Europe and in the U.S., actually.

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

Alexander Berglund: Most of my questions have been answered. I just have a follow-up on Finland and the Finnish strikes. If the strike goes on for the full 4 weeks, do you think that, that could tighten the graphic paper market in Europe in any material way? And also, do you see this as an opportunity to continue to gain market share in graphic paper via your mills that are not in Finland?

Stephen Binnie: It's a good question. I mean, obviously, things are uncertain and they may play out differently. But I would say we have less exposure to Finland than our competitors. So that -- you can interpret that, that it could be an opportunity.

Operator: [Operator Instructions]. The next question comes from Senan Kiran of Muzinich.

Senan Kiran: Just on the previous question on the leverage covenant adjustments. Are you providing the new levels?

Stephen Binnie: Yes, we've included in the results announcement, and we'll continue to do that. Obviously, you've got the net debt number on the balance sheet, but that includes this new IFRS adjustment for operating leases. We back that out, and we do provide what the leverage levels are in terms of the covenants themselves. And it was 2.8x at the end of the quarter.

Senan Kiran: And what they are compared to? What are they tested against? You have that as well?

Stephen Binnie: The covenant level is 4.5.

Senan Kiran: 4.5. Okay. And that's flat for the next two years?

Unidentified Company Representative: Yes, that's correct. For the quarter 1, it was 3.75%. The quarter that we're in at the moment, quarter two, on quarter two, it's up to 4.5%, and it is at that level for the next two years.

Senan Kiran: And on the coronavirus issue, you have about 20% of your revenues that goes to Asia and other. How much of that is actually China on average?

Stephen Binnie: We don't have that specific number here. I mean, clearly, it is a material number. I mean, predominantly affects are dissolving pulp. We have volumes going into China. And in our release business, we have impact. And then on the paper side, the graphic and packaging, a little bit of volumes also going in. So we are exposed. And as I said earlier, it's very difficult to gauge what its impact will be because everything has been closed. Next week, the holiday season is over, and we'll be able to assess the full impact. But again, with things like this, there are certain markets that may tighten up and it may help pricing. But equally, short-term volumes could be impacted because of lack of flows of product.

Senan Kiran: Generally, a lot of news are coming from China, how much of that is accurate? How much isn't -- we are not too sure on us and either, but the impact potentially could be both on the demand and also production shuts, I guess?

Stephen Binnie: Well, look, we're still -- you've got to appreciate, we're still assessing the situation. As things currently stand, everyone stopped production. There's not a lot happening. We'll get a better assessment next week.

Senan Kiran: Okay. And in terms of your contracts with the two major customers for the DWP, when are those are up for renewal?

Stephen Binnie: They -- they're on a long-term basis, they're -- I don't want to give you individuals, but they're between three and five years.

Senan Kiran: From now?

Stephen Binnie: Yes.

Senan Kiran: Okay. And maybe I did not hear you well. Did you say that for quarter, the woodfree you're looking at your capacity in Europe and potentially can make announcements? Maybe I misheard you.

Stephen Binnie: Yes, that's correct. We'll make -- we'll make an announcement soon. Yes, what's the outcome of our assessment, yes.

Senan Kiran: Okay, okay. And lastly, on your guidance for Q2, I cannot remember exact wording right now, and I'm pretty sure it was purposefully made that way. But what do you mean by trends, trends in terms of margins or the year-over-year declines? You said it was in line with Q1?

Stephen Binnie: Yes, we were looking towards the year-on-year decline.

Operator: And the final question is a follow-up from Mikael Doepel of UBS.

Mikael Doepel: Yes, just a brief follow-up on the DVP and VSF market. Could you tell us where the operating rates are right now in the respective markets and where they are projected to be at the year-end?

Stephen Binnie: The viscose rates, viscose operating rates are low, Mohamed, in the low 70s?

Mohamed Mansoor: In China, yes. Coming out of Chinese New Year, it's been around the 75%, 76%. And as you go through the year, because you're going to get into a seasonally strong time, do expect that rate, if history is anything to go by, to lift a little bit, plus you've got underlining demand growth, which also help lift the overall operating rate as you go through the year.

Stephen Binnie: And that's viscose. Dissolving pulp is in the high 80s.

Mohamed Mansoor: Yes, dissolving pulp is in the high 80s, 85. I would say, in fact, more recently in China, the domestic guys have taken out a large amount of production, so even lower in terms of dissolving wood pulp.

Mikael Doepel: Okay. And again, moving towards the end of the year, same trend there, I guess, as in with growing?

Mohamed Mansoor: Sorry, I didn't hear you.

Stephen Binnie: Yes. I think in the very short term, we wouldn't expect those operating rates to change that significantly. The kind of volumes is relatively stable throughout the year. It's less seasonal than some of the other businesses. But we're still seeing volume demand increases, we're still seeing 6%, 7%, 8% type increases. So the demand side is -- overall is still pretty good. Obviously, to my point I made earlier, the big pressure point has been the excess viscose that's come onboard, capacity.

Operator: Gentlemen, we have no further questions from the lines.

Stephen Binnie: Great. Thank you, everybody, for joining us, and we look forward to discussing our results at the end of Q2. Thank you very much.

Operator: Thank you. Ladies and gentlemen, on behalf of Sappi, that concludes today's conference. Thank you for joining us. You may now disconnect your lines.