Smurfit Kappa Group PLC

F:SK3

Earnings Call Analysis

Smurfit Kappa Q1 Performance and Dividend Hike

Smurfit Kappa outperformed its peer group in challenging market conditions, showing resilience with its innovative and sustainable packaging solutions. The Return on Capital Employed (ROCE) stood at 19%, reflecting a solid financial performance, while EBITDA reached $1.13 billion, showcasing a slight decline yet an improved margin from 18.4% to 19.1%. Notably, Smurfit Kappa is on track to meet its 2030 sustainability goals, having reduced emissions intensity by 44% since 2005. Even as group revenue dipped by 9% to $5.8 billion, due to reduced box volumes and European earnings, the Americas saw higher earnings year-on-year. With a capital allocation framework aimed at investments and a disciplined approach to acquisitions, the company is confident about future prospects, underlined by a 6% increase in the interim dividend to €0.335 per share.

Strategic Capital Allocation Framework

Smurfit Kappa’s strategic approach to capital allocation is centered on generating long-term value for its stakeholders. The company has successfully maintained an integrated model, demonstrating leadership in innovation and sustainability, which has continuously delivered profitable growth. Their significant investment in assets not only enhanced operational efficiency but also leveraged growing consumer demand for sustainable packaging solutions.

Solid Financials and Shareholder Returns

With a robust focus on returns, Smurfit Kappa reported a return on capital employed (ROCE) of 19% by the end of June, meeting and surpassing set targets over recent years. The company has remained steadfast in returning value to shareholders, with approximately $2.4 billion in distributions, emphasizing their commitment to income streams for investors through a progressive dividend policy and other forms of shareholder returns.

Cost Control Measures and Operational Efficiency

Smurfit Kappa's efforts to control costs are bearing fruit, evident by the improved cost backdrop, particularly in energy, distribution, and labor, which are seeing less of a headwind than previously anticipated. They have emphasized reducing the cost base on their mill side while simultaneously enhancing their innovation offerings to customers on the box side, which has resulted in both market share gains and improved margins.

Working Capital and Investment in Growth

The management described high working capital as being for the right reasons, from adjusting inventory levels to potential increases with rising demand. The company's strategic capital investment program is targeted towards maintaining a balance between maintenance and growth, aiming to meet and surpass the 70% benchmark through the cycle.

Market Dynamics and Pricing Strategy

The tapering off of 'double ordering' by customers, as supply constraints ease, suggests a shift towards normalization of demand and stock levels in the foreseeable future. The company has gained market share, and despite the tendered corrugated pricing reflecting paper market conditions, the company is succeeding in executing inflationary price increases with many customers to mitigate prior costs and retain its market position.

Forward-Looking Investments and Shareholder Alignment

Smurfit Kappa is looking ahead with a focus on flexibility and the pursuit of opportunities that strengthen the company’s financial position and enable options such as acquisitions or share buybacks. The collective strength, stability, and commitment of the team align with shareholder interests, setting Smurfit Kappa up for continued progress in the future.

Earnings Call Transcript 2023-Q2

[Operator]

Good day, and welcome to Smurfit Kappa Group 2023 Half Year Results Presentation Call. My name is [indiscernible]. I will be your coordinator for today’s event. Please note, this call is being recorded. And for the duration of the call, your lines will be on listen-only. However, you will have the opportunity to ask questions at the end of the call. [Operator Instructions]

I will now hand you over to your host, Mr. Tony Smurfit, the CEO, to begin today’s conference. Please go ahead, sir. Thank you.

[Tony Smurfit, Chief Executive Officer]

Thank you, operator, and good morning, everyone, and thank you for joining us today. You will see from our disclaimer in the slides, so I will take that as read. And as you would expect, I am joined by Ken Bowles, our Chief Financial Officer. I am very proud of the performance we continue to deliver with our half one results, which is an excellent outcome set against the challenging environment. We delivered a ROCE of 19% and an EBITDA margin of 19.1% during the period. Many of you are familiar with our vision, which guides our approach in Smurfit Kappa to the way we do business. We in Smurfit Kappa have continually delivered for our local communities, and we are also doing our bit for the planet by providing our customers with innovative and sustainable packaging. And year in, year out, we have delivered excellent numbers that are superior to the vast majority of our peers.

One of the key aspects to our success in Smurfit Kappa is our continued agility. This is reflected in our business model, which is dynamically delivered over many years. Investment, innovation and capital allocation, combined with a performance-led culture has allowed us to adapt and to deliver across all market conditions. In the current period, we have again outperformed our industry peer group, both in terms of volume and value. This is a reflection of the model working in action. Ken will shortly take you through the detailed financials, but I would like to highlight that while the current environment is challenging from a volume perspective, during the second quarter, we encouragingly saw our shipments per day improve on the previous 3 quarters. This would lead us to believe that the significant destocking by our customers has abated and that when confidence returns to economies, we expect stocks to normalize and demand to come back.

Every company talks about its people; you have heard me say that past success is not a guarantee to future success. However, if you have experienced people who’ve done it before, it’s a pretty good measure of future potential. I am proud that in Smurfit Kappa, we have tremendous longevity of service at all levels in the company, which shows that our culture and living our values of loyalty, integrity and respect and safety at work is working. In return, Smurfit Kappa continues to significantly invest in its employees through advanced training and development programs and ensuring strong compensation opportunities. Our discipline and capital allocation decisions are and continue to be both disciplined and effective. Ken will take you through our [indiscernible] this team’s multiyear track record against our established performance measures.

While you have often heard me say that success is never a straight line, the trend line here has been inexorably upwards. Going back to history since 2012, we have spent some $6 billion to optimize our integrated system. Essentially, this has meant taking cost out of our mill system and making sure that our converting operations are optimally invested to ensure that we meet our customers’ expectations for quality and for innovation. While doing this, we have ensured that we continue to build balance sheet strength. In addition to optimizing our own system, we have allocated $2 billion of capital to bring acquisitions into the Smurfit Kappa family. In practically all cases, we have delivered or exceeded our expectations of these acquisitions, which have integrated seamlessly into our systems, delivering the expected synergies. This is what we mean when we say our business has never been in better shape strategically, operationally and financially.

We have always put forward the integrated model as the most effective operating system for our business. This has been proven by us as the most effective way of running our operations over many years. It provides security supply for our converting operations, which ensures our customers receive their products no matter what market conditions prevail. This was amply demonstrated during the COVID pandemic period. Our integrated system reduces cost in key areas such as transport and continually optimizes our stock levels.

While integration is a key aspect of our success, undoubtedly, this does not work unless our converting business have at their core, the USP of innovation. Our customer-led packaging business with an expanding network of some 30 experience centers or innovation hubs, if you will, across our regions reflect this focus. With over 1,000 designers across 36 countries developing unique packaging concepts to solve our customers’ pain and to provide thousands of sales executives with a competitive advantage in the market. You will see from our press release that in most markets, we have gained market share. Our gains were not at the expense of price, [indiscernible] results of this customer-led focus on delivering innovation and ideas to help our customers win in their own marketplaces.

I am also delighted to say that the number of industry awards we continue to receive is recognition of our leadership, the quality of our offering and demonstrates our unique innovation capability. Sustainability is in our very fiber, and we have always been committed to our sustainability journey, but I will be more focused on this over the last 16 years when we published our first sustainability report. On every metric we have improved. And while it is a never-ending journey, we continually showcase our success by the many awards and recognitions we received and have achieved. We continue to make significant progress on achieving our sustainability targets as outlined in our 16th sustainability development report published in March of this year. Compared to the baseline in 2005, the group has reduced its emissions intensity by 44% by the end of 2022, a 4% improvement year-on-year, leaving the group well on its way to reach its 2030 target of a 55% reduction in line with the EU Green Deal and another step forward on our journey to net zero.

Since 2005, Smurfit Kappa has invested $1.2 billion to make our operations more sustainable. Of this, approximately $1 billion has been invested in different energy efficiency and CO2 reduction projects. We in Smurfit Kappa remain very proud of our commitment to work towards an improving sustainable footprint, ensuring that our product continues to be recognized as the product of choice in a much – in a world that needs sustainable products.

With that, I will now hand you over to Ken, who will take you through some of the financials. Ken?

[Ken Bowles, Chief Financial Officer]

Thank you, Tony, and good morning, everyone. In a moment, I will be taking you through the group’s financial performance for the first half of the year. But I would also like to spend a few minutes this morning outlining how we think about capital allocation at Smurfit Kappa and what that means in terms of the delivery of our vision, which Tony has just discussed, and indeed its central role in the transformation of the business over the last number of years, but looking in a little more detail at our financial scorecard to date. What I think you will see is a structurally better business delivering outperformance across practically all metrics.

Turning now to Slide 13 of the group’s half year 2023 results, which set against a challenging macroeconomic backdrop continue to reflect the resilience of our integrated business model, the benefits of our investment program and, of course, the hard work and dedication of our people. Providing our customers with value adding sustainable packaging solutions, all of which, as Tony has articulated, have positioned us for current and lead future delivery. Group revenue was over $5.8 billion, down 9% on the first half of last year or 7% on an underlying basis. Group EBITDA was $1.13 billion, down 5% in the first half of last year or 3% lower on an underlying basis, reflecting lower earnings in Europe and higher earnings in the Americas year-on-year. The group EBITDA margin improved from 18.4% in the first half of 2022 to 19.1% in the first half of 2023. Our margin also reflects the benefits from our investment program.

Underlying box volumes of the groups were down 6% for the first 6 months of the year, with volume performance in the second quarter improving as anticipated on the levels we have seen in the preceding 2 quarters. We also saw market share gains not at the expensive price across many of the countries in which we operate. Pre-exception EPS was 11% lower at $1.972 per share, and the group’s return on capital employed was 19%, well ahead of our stated target. Free cash flow in the first half of the year was a net inflow of €119 million compared to a net outflow of €28 million in 2022, an increase of €147 million.

The EBITDA decrease of €61 million, combined with higher outflows for CapEx, tax and changes in employee benefits were more than offset by lower outflows to working capital. The working capital outlook in the first half of the year was a combination of a significant decrease in creditors along with an increase in debtors, partially offset by a decrease in inventory. The increase in debtors reflecting higher average box prices year-on-year and the decrease in creditors reflecting considerably lower recovered fiber, energy and other raw material prices. As a result, working capital as a percentage of sales was 11.7% at the end of June, and we do expect this to trend back down as the year progresses to with our normal guided range of 7% to 8%. It goes without saying that the management of working capital as ever is a key focus for us. And finally, reflecting the confidence both we and the lead [indiscernible] have in the group and the strength and resilience of our cash flow for future prospects; we are pleased to announce a 6% increase in the interim dividend to €0.335 per share.

Looking now at Slide 14 and a reminder of our capital allocation framework. It is a framework that you are familiar with. It’s also a framework that we have been consistent with over the last number of years. It is very much returns focused, flexible and agile at its core, and this continues to be a key underpin to our success. At Smurfit Kappa, we believe that capital allocated to internal projects has been central to that success. We are in the final years of our accelerated investment program, where we have invested in our asset base to improve our environmental footprint, remove costs, improve operating efficiency and to capture the long-term growth opportunities coming from the consumer’s desire for the most sustainable packaging solutions. The acquisitions we have made over the years are clear indicators of how we see M&A as a group. And as always, we have a number of projects in the pipeline focused on building out our strong geographic network or indeed further enhancing our product portfolio. We remain, of course, disciplined around M&A, and as always benchmark them against all other capital allocation alternatives.

The dividend is another cornerstone of our capital allocation strategy. Our dividend policy is a progressive one and aims to ensure that the allocation of cash flow to the dividend is proportionate to other forms of allocated capital over the long-term. Fundamentally, the strength of the group’s investment-grade balance sheet continues to secure a long-term strategic and financial flexibility. And the expansion of our capital allocation framework to now include other forms of shareholder returns underscores the flexibility and agility of this framework and ensures that all avenues to create return value to our shareholders are considered and benchmarked against all options. Ultimately, the framework at simple is by creating long-term value for all stakeholders.

Slide 15 shows how our integrated model and leadership in both innovation and sustainability provide SKG with a competitive advantage that drives consistent profitable growth through the cycle. As mentioned above, our capital allocation framework is both iterative and consistent, investing to improve the asset base, but that also has a direct impact on our margins and indeed its expansion. Through the integrated model, we are better able to deliver both security and quality of supply and it makes us flexible and responsive to our customers need by offering a wide range of customizable packaging solutions. In a world where more and more businesses are looking back to their value chain to partner with the world’s most sustainable suppliers, our integrated model provides our customers with responsible sourcing of renewable raw materials and our streamlined operations allows us to achieve economies of scale and optimize energy use and minimize waste. This means our customers get the most dependable chain of custody certified packaging solutions that leverage innovative designs that can drive revenue growth, reduce costs and help them achieve their own sustainability goals. Ultimately, in a business such as ours, return on capital employed is the key metric, and SKG targets return of 17% through the cycle.

Here on Slide 16, you will see that our ROCE targets have been repeatedly met and reset higher over the last number of years. At 19% at the end of June in a period of significant growth CapEx, it is by any measure an excellent outcome. I think this graph illustrates the management team’s proven stewardship of capital over the years. What essential to our success here is our performance and culture? This drives an ownership approach to investment decisions, which must deliver sustainable long-term returns. They have placed the capital into the hands of the best mill and plant managers in the industry, driving performance through teams to committed and dedicated to our customers.

Through both our 2018 and 2020 plans, we focus on investing and reinvesting in our paper mills, while also building out our corrugated system through expansion projects and adding state-of-the-art machinery. Today, more than ever before, we are seeing the benefits of having a world-class asset base with an integrated system of mills and box funds sitting low on the cost curve, a clear competitive advantage in the current macroeconomic environment.

Slide 17 is yet another example of the transformation of the group. With net debt to EBITDA of 1.4x, our investment-grade balance sheet continues to provide us with considerable optionality. This slide also demonstrates how the actions we have taken in the past have set it on a favorable path to the journey ahead. I would remind you, in September 2021, we launched our green finance framework with the lowest coupon bonds ever achieved for an issue in our rating grid with 8-year and 12-year bonds at interest rates of 50 basis points and 1%, respectively. The result is a strong balance sheet with no significant refinancing requirements until 2026, over 95% of our near-term debt fixed at an average rate of just over 3%. Again, capital structure decisions that have been well timed and well executed have been a hallmark of Smurfit Kappa group.

And finally, our track record of commitment to a secure and growing dividend can be seen here on Slide 18. The interest reinstatement in 2011, we have returned approximately $2.4 billion to our shareholders. And an important reminder did not cancel or offput our dividend during COVID. As I said before, our aim is to ensure that capital allocation decisions take into account all stakeholder groups, and we recognize the importance of this income stream to our investors, not least during these recent times of inflation.

Thank you for your time, and I will now hand you back to Tony for some concluding remarks.

[Tony Smurfit, Chief Executive Officer]

Thank you very much, Ken. I would like to think that our established track record of performance, as Ken has presented, is indicative of future potential from an ever stronger base. The quality of our team today and tomorrow will continue to deliver. We see ourselves as owner operators of this business and will continue to treat capital as our own. And please recall that all senior management are stakeholders and aligned with shareholders. Our market position was either number one or number two position in our chosen markets, together with continuing innovation allows us to provide our customer base with the most advanced packaging applications. Our core products own attributes also provide us with a competitive edge as the most sustainable biodegradable, renewable and environmentally friendly packaging medium.

Our ever-expanding geographic reach and integrated operating model will continue to deliver future performance. As our track record shows, our system increases operating efficiency and lower volatility, providing a consistent quality earnings stream. I want to take a step back to go forward. You’ve often heard us refer to the steps we’ve taken and continue to take to position Smurfit Kappa for long-term growth. In this slide, we’ve outlined the total available capital that we’ve had been able to allocate. As you can see, we have allocated very significant capital, $6 billion since 2012 to build a better business with very attractive prospects. Clearly, those capital allocation decisions are return focused, and they’re paying off. The return on capital employed is currently above our target of 17%. We’ve also sustained a progressive dividend with a CAGR of 22.5% since 2012 are returning close to $2.5 billion to our owners in dividends. And we’ve built the strongest balance sheet in our history.

Our choice has been to build a quality business consistently delivering superior performance and growth, and we’ve demonstrated we’ve been doing that. As we conclude this current capital cycle, our business has never been in better shape strategically, operationally and financially, and we’re confident and excited about the long-term prospects for our business. And as Kenneth said, the confidence is best reflected by our continued increases in our dividends over many, many years.

So with that, operator, I think we’ll conclude the formal presentation and turn it over to you to any questions from the audience. Thank you all.

[Operator]

Thank you, Sir. [Operator Instructions] We will take our first question from Charlie Muir-Sands from BNP Paribas. Please go ahead. Your line is open.

[Charlie Muir-Sands, BNP Paribas]

Yes. Good morning, gentlemen. Thank you for taking my questions. I’d just stay with two, please. The first is that at Q1, you were very kind to give us a few of the moving parts you envisage on your cost base for the year year-on-year, such as energy and some of the raw materials and labor and so forth. I wondered if you could just update us there? And then the second one is I see in the technical guidance, you’ve increased the cash tax guidance versus 6 months ago. And I just wondered if you could explain that. Is that due to a different view on underlying profitability or just a timing effect? Thanks.

[Ken Bowles, Chief Financial Officer]

Good morning, Charlie, Tony has thankfully given both of those to me. You’re right. I suppose what we’ve seen is that as most people have seen, the cost backdrop has got progressively slightly better as we’ve gone through the year. I think a lot of that is down to the work we’ve done internally on controlling those costs. But to give you some of those big buckets, I think at the start of the year, we probably would have seen energy something around a tailwind of $100 million. I think we’d see that close to $200 million now. I think we would have seen distribution as a headwind. I think it’s probably flat to a slight tailwind now. I think what equally would have been a headwind at the start of the year. I think we see that as a bit of a tailwind now, maybe in the order of 10% to 20%. And I think particularly on labor, where at the start of the year, we’ve seen labor the kind of $100 million to $120 million headwind. I think, again, to the good work done at ‘22 all through to ‘23, we’re seeing that as less of a headwind as we kind of move through the year, probably more in the 60% to 70% space. I think they’re probably the bigger book is Charlie, in terms of the cost we’ve outlined at the start of the year or if there’s any other business, you can catch up with Keren or Frank directly on them.

In terms of taxes, it is just a timing thing. I think when we gave the guidance at the start of the year, remember, coming off our best year of $2.4 billion EBITDA and the returns haven’t been finalized. And as you know, cash taxes are a combination of last year, this year and prospective next year. So it really is just a change in timing and finalization of returns over the last 6 months.

[Charlie Muir-Sands, BNP Paribas]

Many thanks.

[Operator]

Thank you. We will move on with Kevin Fogarty from Numis. Please go ahead. Your line is open.

[Kevin Fogarty, Numis]

Hi, there. Good morning, everyone. Thanks for the presentation and for taking the call. Just two, if I could – if I could just sort of pick up on working cap. Can you sort of flagged, obviously, it’s going to higher in the first half of the year than perhaps it may normally be sort of historically. The guidance obviously is for that to kind of unwind as the second half progresses. I just wondered, could you sort of help us with the sort of building blocks of that just in terms of if you see a better kind of demand environment, clearly, that sort of implies perhaps more investment in terms of kind of working cap. So just sort of what you see as a sort of building blocks to that in the second half of the year. And I guess in terms of the second one on the balance sheet, clearly, as you flagged it, sort of building the strongest balance sheet in the group’s history. I just wondered in that environment to share buybacks move up the agenda at all for you guys when you think about capital allocation?

[Laurent Sellier, Chief Executive Officer, Americas]

I’ll do the first one, let you take the second or we can take the second together. Kevin, Laurent here, I suppose working capital is high for the right reasons, the way I kind of characterize it. I think if we think about how we started this year, inventory is at quite a high level, and we’ve seen the inflow working capital from inventory is quite substantial in the first 6 months as we kind of manage down and the industry had to getting back to what those normal safe levels are. I think the big impact you’re seeing in terms of where working capital is at the end of June is more on the payable side. Think about where energy was this time last year in terms of price per kilowatt hour versus where it is now. That clearly has a significant impact on the payables, equally where recovered fiber sits.

And indeed, the more work we do internally on integration and the more tons we integrate actually had a negative effect on working capital because it removes third-party payables. So integration, particularly in the Americas, would help that. I think as we move forward, I suppose while sequentially box prices were down actually year-on-year for the first 6 months, box prices were up, which is why you’re not getting that kind of unlocked or unwind to working capital in the first 6 months of this year. I think though, as you kind of flagged before, as we move to the second part of this year and as you see some kind of either index resets or some kind of slight fall in box prices, you will begin to see working capital unwind against that backdrop. And that’s the reason why when we think about where we are now versus moving down towards a normal range of 7% to 8%, it really more likely is on the debtor side. But you are correct, too, if demand picks up, clearly, that will require some investment in working capital as demand comes back. But the – if you remember, too, in reality, the bigger impact on us is price rather than volume. So the impact of price would be bigger than volume in that environment anyway.

[Ken Bowles, Chief Financial Officer]

And Kevin, on buybacks. I mean we’ve never excluded buybacks. And indeed, we did a small buyback last year, which actually took us quite a very small one, it took us quite a considerable amount of days to do because of the rules under the London Stock Exchange. We don’t exclude them. Obviously, we have a capital investment program that we’re going through this year. Our debt levels are very low. It’s always an option for the Board, and we’ll make sure that we keep an eye on that in relation to how the world is looking and the uncertainty that’s out there.

But we’ve built a great balance sheet, and we intend to keep a great balance sheet. And clearly, if we’ve excess capital, we’ve always said that we would distribute it to our shareholders. We feel that our best use of capital has been to put it into the business up to this point, and we’ve proven with our returns that we’re able to get a good reward for our investment in the business. We still see that as being the case. I mean, clearly, as wages has been the real only increasing cost that we have significant cost increase that we foresee this year and next year. I think that it makes capital investment to reduce cost that much more – that’s more attractive. So we just have to think about as we go forward, what’s the best use of the capital for the owners of this business. And up to this point, our view has been always to invest in the business or acquire things, and we want to make sure that we have the powder – keep our powder dry to be able to do all of those things. But as we have shown last year, we’re not excluding buybacks, and we’ll keep an eye on that.

[Kevin Fogarty, Numis]

Great. That’s very clear and very helpful. Thanks a lot.

[Ken Bowles, Chief Financial Officer]

Thank you.

[Operator]

Thank you. We will move on with Justin Jordan from Davy. Please go ahead. Your line is open.

[Justin Jordan, Davy]

Thank you. Good morning. I’ve got two separate questions, if I can, please. Firstly, just on – Tony, you made a statement of destocking has abated, I think it was the phrase you used in Q2 2023.Am I right in inferring that it looks like Q1 European box minus 7% Q2 about minus 4%. So can you give us some sense of where both exit rate in June was or any color you want to give us on July in terms of box volumes just to give us some more granular detail on that on destocking. And then secondly kind of related to that. Just on – you mentioned I think it’s in Page 4 of your release about taking commercial downtime of 260,000 tons in H2 last year, a lower number in H1 this year. Can you give us a sense of where industry inventories are they sort of now at a normal level as it were helping that sort of more balanced industry picture as we look into the second half of 2023?

[Tony Smurfit, Chief Executive Officer]

Yes. With regard to the inventory situation, inventories are slightly above what we would consider normal, but only slightly where – so that has come much more towards the norm than we have seen for a considerable period of time. So the downtime that we’ve taken is much less than the industry downtime because of what the actions that we’ve taken to bring forward into our own system due to the fact that we had because of Vesola. So we brought in tonnage into our own system instead of purchasing in the third party. It’s not the most efficient tons that we have. So – but obviously, we’d like to be busier so that we can run all of our mills with optimum tons, but it’s better to run the mills with some tons rather than no tons. So I think our downtime is relatively low compared to the industry. And as I say, inventory levels are pretty well near norm levels. They’re not under normal levels, but they’re just a little bit above, I’d say. So that gives us a little bit of encouragement that the downtime has worked and by the industry. But ourselves, we’ve been taking less because of the things I said in my release, we’ve taken market share. We’re not being as impacted as perhaps others are.

With regard to volumes as we’ve gone through the month, I would say that it has got better as we have gone through the month we were down 3% or so in January or in June, circa 4% in May and 5% in April. So – and we sort of see July as being a similar number to June versus last year. So I think it’s better, it’s not strong. I wouldn’t like you to believe that it’s strong, but I think that it’s better than it was in the first quarter and even the last quarter of last year. When we think about volumes abating, the whole level of destocking abating. I think that’s the evidence that we see from our customers is you have to go back, I think, 15 months or so when there was no product around and everybody had double stocks and was double ordering and making sure that they had goods in the warehouse where they could have. And so we think that, that double ordering, of course, has stopped, and we think that our customers are keeping their stock levels because of the generally tepid demand out there from the consumer who has moved away from stay at home and durable purchasing towards travel purchasing and holiday and service purchasing. We think that the consumer – our customers are keeping their stocks at min levels, and so we would expect that when demand does return and your guess is as good as mine on that are things normalize, then I would suggest that stocks will – our customers will need to have normalized levels of stock, which will actually create some significant demand for us at some point. But when that happens, I don’t have a crystal ball for that, Justin.

[Justin Jordan, Davy]

Thank you.

[Tony Smurfit, Chief Executive Officer]

Thank you.

[Operator]

Thank you. We will now move on with Cole Hathorn from Jefferies. Please go ahead. Your line is open.

[Cole Hathorn, Jefferies]

Good morning, thanks for taking my question. I’ve got two, and I’ll take them one at a time. The first is on containerboard pricing and the related box pricing development. I’m just wanting to understand, are you feeling a bit more comfortable around where box pricing is going to be from here? Because I imagine after 3 months of test liner being stable, most of your contract negotiations with your index business, I’m thinking kind of the big FMCGs, you must be fairly pretty far down the chain to understand what box pricing you’re going to be giving back to those customers. And just as a reminder, could you call out, it’s not just about the paper price but also the non-paper clauses. So just trying to understand, as you look into 4Q and 2024, are you feeling a little bit more comfortable that you kind of know where your box pricing development is going to be all else equal on the paper pricing? Thank you.

[Tony Smurfit, Chief Executive Officer]

Yes. I think we are comfortable with where we think it’s going to be. We have gone for inflationary price increases with many of our customers to offset a lot of the inflation costs we had in the earlier part of this year and the latter part of last year. So we have implemented those into our customer mix. But we do have – we are seeing some price falls based upon what’s going to happen to box prices based upon our index. As is always the case, we tend to have – those tend to happen in 3 months, 6 months, 1 year, depending on the customer, sometimes their averages sometimes a point to point. Every customer is different, and we treat them differently. So we have a good sense of where box pricing will go. And clearly, our opportunities to continue to innovate for our customers to make sure that we are able to mitigate some of those effects as we go forward into the years ahead.

With regard to next year, I think it’s a little bit early to see what’s going to happen with regard to paper pricing. But I think from the point of view of where is paper pricing today and where do we think it can go, we don’t see, unless there’s a very large cost movement downwards. We don’t see any real downside movements going forward in paper, recycled paper certainly. And at some point, when demand does pick up, I think there’s scope for increases, but it’s a little bit early to say that, and that will obviously start that whole movement again in a different direction. In the meantime, Cole, as you’ll know, our whole emphasis has been to reduce our costs as mentioned by Ken and myself in the script is to really reduce our cost base on our mill side and really strengthen our innovation offering for our customers on the box side, and that has paid dividends and is paying dividends for us as we go forward, both the market share gains and in absolute margin terms.

[Cole Hathorn, Jefferies]

And then I’ve got a bit of a longer question on CapEx, and I want to link it to your Slide 9, which I really like of keeping your kind of mill rates high and kind of integrating into your box business. But if we go back to 2019, 2020, when you kind of called out a kind of a step-up in CapEx, you were probably ahead of the markets getting in and locking in kind of better rates on machineries, etcetera, before kind of costs went up. And you’ve been very clear in targeting not only kind of cost savings CapEx, which I think everyone agrees you do throughout the cycle, but also select growth in plastic replacement machinery where you thought there would be growth.

But from here, I’m just wondering, have there been any nuance changes to your kind of CapEx plans? Are you emphasizing or deemphasizing certain CapEx spending into 2024. So for example, focusing more on kind of the cost savings, which are clearer to you and maybe taking a bit of a foot off the gas on some of the growth projects and maybe you’d reallocate that into M&A, if that is looking more attractive versus kind of the CapEx. I’m just trying to understand if you’re emphasizing or deemphasizing certain areas on the CapEx side? Thank you.

[Tony Smurfit, Chief Executive Officer]

Thanks, Cole. Yes, absolutely. I mean, clearly, when we were investing in the last couple of years for growth, we needed – we were completely sold out. So we needed to make sure that our factories and our businesses had – were able to capture the growth that was there. We did an amazing job of supplying all of our customers during the pandemic when growth was, as we said at the time, way above the norm and was unsustainable. We now have plenty of capacity in most of our markets to meet whatever growth comes to us, and that gives us a real strong view about how we will be able to efficiently and effectively deal with any growth that comes in the future.

There are many pockets of growth still, Cole, that we will still invest in. I mean, for example, I was in a factory in a particular country where we are a smaller part of that particular region, we are completely sold out. And we have tons of demand which we will need to build another factory for to meet that demand. Equally, we’re starting up a new factory in Fortaleza in Northern Brazil next month that – where we have almost no market share in that region, and we believe we’re going to take a lot of market share as we go forward in that particular region. So we do see pockets of growth. The unfortunate thing is that the general market has – despite taking market share, the general market has taken a leg down for all the reasons that you’re familiar with. So therefore, we have the capacity to meet that general market when it comes back.

With regard to our priorities, we’ve always said that we’re going to be agile. And so while a lot of the bigger projects, the big paper mill projects do take a long time, the box projects are less – they’re much quicker. So clearly, we can decide where on the box side of things we want to emphasize our capital. And with wages going up, it makes it much more attractive for us to invest in cost reduction projects next year and the year after with regard to labor savings that we will attain. So – and again, for the agility point of view, we are spending $1 billion this year. We’ll spend close to $1 billion – or we will have spent close to $1 billion last year. Our current plan is to continue to keep ourselves as open as possible to be sure that our balance sheet remains strong, that we continue to generate cash for cash flow and continue to be able to continue to take the opportunities that present to us, whether they be acquisitions or share buybacks or whatever.

[Cole Hathorn, Jefferies]

Thank you.

[Tony Smurfit, Chief Executive Officer]

Thanks, Cole.

[Operator]

Thank you. We will move on with Ephrem Ravi from Citigroup. Please go ahead. Your line is open.

[Ephrem Ravi, Citigroup]

Thank you. Two questions. Firstly, you mentioned that you are taking share and that’s clearly visible from your volumes being better than your competitors. Can you give us a sense whether these are, on average, higher margin tons or higher-margin boxes compared to your current mix, and this follow-on is, are these more kind of opportunistic tons? Or is there more longer-term sort of sticky tons as a result of this? i.e., kind of can the share gains be expected to sustain for ‘24 and ‘25. And related to that, in terms of price cost spread, obviously, with testliner prices kind of stabilizing, okay, second half price are going to be lower, but your costs are also going to be lower. And arguably, those costs are probably going to be lower further in ‘24 if energy prices remain where they are. So should we look at price cost spreads improving into 2024 as it stands, if assuming testliner prices remain stable?

[Tony Smurfit, Chief Executive Officer]

Okay. Ephrem, I’ll take the first and I’ll let Ken take the second one. Our business model is built on selling innovation and selling – trying to solve what our customers’ pain is. Now I don’t want to be too pure about it and say that all of our business is like that. That’s not true. Sometimes we get opportunities because our customers need us to take over simple boxes because our competitors have let them down or something like that or sometimes we are opportunistic ourselves. But in the round, Smurfit Kappa sells on innovation and, as I say, solving our customers’ pain, whatever that is, that is the skill set of making sure that we get rewarded for that. And that’s why we’ve built all these innovation centers. They are a cost. Our designers are our cost. And if we don’t get well remunerated for that, we should definitely not do it. But the evidence is that we have done it and are getting well remunerated for it. And if evidence is that we’re gaining market share and not at the expense of price.

As I said, I don’t want to be completely pure because there’s sometimes that we do gain a piece of business that is basically call it, a commodity piece of business. But by and large, this company is selling on value for our customers and solving their pain, and that’s the mission that we’ve been on for many years. So when we talk about innovation, we live and breathe it. When we talk about sustainability and solving our customers’ problems, we live and breathe that. And that’s what allows us to gain market share because we’re good at what we do.

[Ken Bowles, Chief Financial Officer]

Ephrem, the second point, I probably need to get out my crystal ball a bit for ‘24 at this point to kind of maybe get slightly ahead of ourselves. But I think you referenced energy there being down. But remember, I think it’s important to realize that it’s not that long ago that energy was kind of €50 a megawatt hour, and now we’re looking at rates and kind of €40 to €50. So I think structurally, the kind of cost base of the industry has changed. So it’s – yes, some costs are going down, and we’ve seen that through ‘23 and some of that may pertain to ‘24, but as Tony referenced earlier, areas like labor or not. So we continue to invest to kind of reduce costs. That area is going to be important. Energy will probably remain structurally higher than it has in the past, while kind of normalizing around these levels. Eco-recovered fiber is probably higher than it has been in the past.

So when you look at some of the capacity that plays to come on, I think there are quite different backdrops in terms of cost market and price than it might have been when those projects were first anticipated or announced. So I think it might be a bit early to get into whether spreads will increase or expand into ‘24 just yet, but I think it’s important to kind of reflect on the backdrop as we move towards that in terms of change around either the underlying cost base and the input into it, the cost of running projects and rebuilding and building mills also has changed. So it’s kind of different it’s a different phase moving into ‘24, structurally higher. But as Tony said, for us, really, it’s about the integration and how we do on the box side and what we do for our customers will decide whether or not overall, we do better.

[Ephrem Ravi, Citigroup]

Thank you.

[Tony Smurfit, Chief Executive Officer]

Thanks, Ephrem.

[Operator]

Thank you. We will now move on with Lars Kjellberg from Credit Suisse. Please go ahead. Your line is open.

[Lars Kjellberg, Credit Suisse]

Thank you. Just a couple of questions left. Just to be clear, on Q2, you commented about sequential decline in box prices. Can you call that out for us, please, albeit being up year-on-year. But also in slightly longer-term, as [indiscernible] alluded to you’ve spent quite a lot of money and you clearly had demonstrably very high operating leverage. Volumes were good. As and when volumes do recover, what sort of benefits should we think about it in terms of operating leverage on the back of the current CapEx programs and what you’ve done in the past. I think in the past, you called out maybe $15 million, $20 million, $25 million per percent in volume. How should we think about that number going forward? And also this year, you did comment about the benefit of prior year spend in terms of removing costs. Any chance you can give us some help on how to quantify that in absolute EBITDA and a similar number for ‘24 based on what you’re doing in ‘23?

[Tony Smurfit, Chief Executive Officer]

I’m delighted to give all those questions to Ken. Lars, thank you.

[Ken Bowles, Chief Financial Officer]

Thanks, Lars. I think in terms of box pricing, sequentially, Q2 over Q1 was about 3.7% down. Year-on-year, Q2 over Q2 last year is about 2.5% down. They are the key numbers there. In terms of the price volume dynamic you’re right, in the old days, 1% of volume would have been about 15%. I think that’s probably more like in the kind of 20% space now given where we’ve seen things move. Equally, I think that 1% on the price, you can move up more towards 55% to 60% rather than the kind of 45% to 50%.

Then on the second part is how should we see things coming through, I think in the past, like we’ve always said that when we look at our capital investment program and our total CapEx of, call it, around that $1 billion, $500 million to $550 million is generally designed for maintenance CapEx and the rest is, although we’ll have some elements of growth and efficiency in it. But traditionally, the bit of Bob is the growth piece or certainly the bit that’s targeted in terms of where we’re thinking about the overall return. So – and generally is designed to meet and beat that kind of 70% rocket through the cycle. And I think then it’s about on average it takes on the box side, 12 to 18 months use those projects come through some of the middle projects slightly longer. So it’s hard to give you a kind of defined number, Lars, what we’re seeing coming through. But clearly, I think when we look through the margin performance and the resilience, you’re seeing a lot of that good work done in the previous years coming through, particularly, I think, on the mill side and cost efficiency and the kind of ever-increasing move towards more renewable sources in terms of energy and kind of been able to kind of offset that kind of volatility in energy prices you might have seen.

I think on the box side, I think it goes back to the answer Tony just gave, which is really – it’s about the staking of the customers and what we give to them. And I think what we’re seeing come through is not just the innovation and sustainability aspects of it, but also that CapEx that was put in, in kind of ‘19 and ‘20, which during those years as very high demand, our customers got there. I think we’re seeing the benefits of that as we come into this environment around that strength and relationship and how, if you like, very simply, they were not that down by Smurfit Kappa. And I think you see the benefits of that come through, too. But difficult in this kind of environment to kind of say to you x percent of that CapEx would deliver y, it’s kind of true. I think you see it more when you look through the margin build and performance, if you think about where we are and still delivering margins of about 19% and a return on capital employed of 19% with the free cash flow we’ve generated positive in the first 6 months and leverage to 4x, I think you can see that the capital is going in and working.

[Lars Kjellberg, Credit Suisse]

Sure. Just one more question, if I may. On the sustainable side, given the economic headwinds most companies would have at this stage, are you seeing any change in interest in investing in that, or does that momentum continue to build and providing a pipeline as we head into better times ahead, or how should we think about sustainable packing asset growth engine?

[Tony Smurfit, Chief Executive Officer]

I think, Lars, I haven’t seen any customers changing their view on what they have to do. And the reality is that the European Union is not taking its foot off the gas, so to speak, and they are continuing to move forward with new rules in relation to different types of packaging, and we are very happy so far that corrugated packaging and fiber-based packaging is considered an environmentally positive thing rather than other forms of packaging, and that is going to be pushed through legislation as we go forward. So, a lot of customers are actively working with us and obviously, with others as well, but to remove plastics where possible, polystyrene is getting outlawed in many countries and plastic punnets are moving away from plastic into paper-based. So, there is no real change. I mean sometimes the legislation is slower than we would like it to see, but that’s, I suppose, historical. But the move away from bottle based packaging towards renewable-based packaging or reuse-based packaging is very much there and alive, and we are well positioned.

[Lars Kjellberg, Credit Suisse]

Final question for me, Americas performance looks comparatively very strong, both versus European performance, of course, but also peers in that region. Can you share with us what you are seeing on the ground. There has been quite a lot of talk about onshore and near-shoring activity, in particular, in Mexico, etcetera. Is that a meaningful component of that or what is going on in that business versus a year ago?

[Tony Smurfit, Chief Executive Officer]

Well, we have – as you know, we have very strong businesses in the Latin American region. And those businesses operate differently in different countries and each have their own different dynamics. Sometimes, for example, 2 years ago, Brazil was very poor for us. This last year wasn’t so bad. This year is actually growing for us, and we have a lot of projects in the country that we are implementing to take advantage, as I mentioned about a new factory in Fortaleza. Mexico is benefiting from onshoring. And that is going to – but it has been also hurt by the durable move that I talked about in Europe. So, there is pluses and minuses in every country. I think what I would say is that we are very happy with our Americas business, but they didn’t go up as quickly as the European business did. And so their performance last year was very solid, very good as it is this year, very solid, very good and probably improving. So, I think it’s from a less explosive base upwards versus last year and we are taking advantage of some of the projects that we have done in the country. And we have a very large mill project that will come onstream mid next year that will benefit us in 2025, very significantly in Mexico. So, I think the future is looking very interesting and positive for our Americas business, but it just didn’t go up as much last year as Europe and it’s not feeling the same negative effects that we have seen in certain countries over Europe.

[Lars Kjellberg, Credit Suisse]

Thank you.

[Tony Smurfit, Chief Executive Officer]

Thanks Lars.

[Operator]

Thank you. We will move on with David O’Brien from Goodbody. Please go ahead.

[David O’Brien, Goodbody]

Good morning. Thanks guys for taking my questions. And firstly, if I could start on targeted pricing, and – has there been any irrational behavior from a pricing perspective from the non-integrated box makers out there, or what’s the backdrop been like? And secondly, the freely negotiated contracts and customers that you are talking to are usually a little quicker to come back to you on price. What have those negotiations been like? Are they rewarding the value add and the reliability that you brought them over the last 12 months, 24 months and beyond. But how has that experience been switching to CapEx. It’s clear the balance sheet is very strong. You are saying there is a lot of opportunity out there. Are you guiding us that the CapEx number is going to be €1 billion into 2024 as well, or how should we think about that going forward? And then finally, last one for me. Interested to see the entry into North Africa during the period, maybe you could talk to us about the ambitions or prospects for growth in North Africa overall or any other regions you could maybe enter?

[Tony Smurfit, Chief Executive Officer]

I will take the first and the last one, and then, Ken, you can think about the middle one. So basically, with regard to Morocco, we see that as an opportunity. We have been exporting to Morocco from Spain for a number of years and building up our base there. But obviously, there is a significant transport cost to do that from Spain to Morocco. And we have built enough of a base business to justify a factory. And given the fact that the market is very dynamic and growing and strong in agriculture and other things are very good in that market and as I say, growing. So, we see that as an opportunity. I don’t say that we are going to go into many other countries in Africa at this moment. But if there is an opportunity we will obviously look at it. There is nothing on the agenda right now. Morocco was just a specific case in point where we built up a pool of business that we could load a factory with initially and then build from there, but with our own sales force and our own management team. And so we have decided to take that opportunity. With regard to corrugated pricing, there is always sometimes irrational behavior in the corrugated business when business goes out for tender. That said, most of the time you are able to retain the business because the business is kind of sticky. So, I think overall, as we have said, we have been gaining market share and corrugated pricing tenders are reflecting some of the paper markets that are out there, but with a plus, I would say. With regard to the normalized customers, yes, we are getting rewarded for our service to them and our innovation and our design and our security of supply from both contractual customers and let’s call it free market customers. And so clearly, that’s something that we intend to maintain as best as possible.

[Ken Bowles, Chief Financial Officer]

Good morning Dave. On CapEx, not guiding specific on ‘24 at this stage, as you can imagine. But I think it’s fair to say that this is the third year of our 2020 CapEx from of the €1 billion. There is clearly capital in the 1-year cycle, a lot of projects kind of continue in 2 years, 3 years, 4 years. And as we look out, as we sit here today, clearly less committed capital of ‘24, even less so for ‘25. I suppose we go back to the framework we put in place, which is one of flexible and agile at its heart. So, there are certain projects that will continue through, if we think about some of the bigger projects like the machine that Tony talked about in Mexico or indeed Cali boiler for ESG or need some of the projects are in Europe in the mill system, we will retain a lot more flexibility on the box side. So, while not specifically guiding on ‘24 yet, I think you know us well enough to know that we take a look ahead, flexible and agile where we see that and complex up and down as the market demands.

[David O’Brien, Goodbody]

Great. Thanks very much.

[Operator]

Thank you. We will move on with our next participant, Andrew Jones from UBS. Please go ahead. Your line is open.

[Andrew Jones, UBS]

Hi. Thanks for the call. Just on the third quarter, we just talked through the moving parts for that because obviously, pricing is coming down. Are you seeing that kind of accelerating or decelerating versus the 3.7% down sequentially we saw in 2Q. On the volume side, it seems like you have seen an improving trend in July, but if we take into account seasonality and your belief that volumes do seem to be sort of improving from the weak levels we have seen in recent times, or are we seeing a quarter-on-quarter volume improvement? And if so, approximately how much do you think? And then just on the cost elements, I guess OCC is coming down, energy is coming down. Like can you give us some sort of guide for how much cost relief potentially we could see in the third quarter? And just for some clarification, those full year cost bridge numbers that you gave earlier, I heard the labor of energy number. Can you just remind us, what were you saying on distribution, wood and over raw materials? Thank you.

[Tony Smurfit, Chief Executive Officer]

Well, we never had to forecast the quarter ahead. Andrew, it’s not something that we try – I mean what we have said in July is that it’s a similar trend to June. And honestly, I am not going to forecast August and September right now because I just don’t have a sense of – we think it feels like it’s going to be the same in August and September, but we are not 100% sure it could be better, it could be worse or it could be the same, frankly. So, I think we – I mean we are trying to build a long-term business here, and we are putting in place all the plants to take advantage of business opportunities in various different markets. And while we need to think about every quarter and make sure that we report as best as possible every quarter, we are more of a long-term business than that, Andrew. So, what I guess we have put in place a lot of capital that will take advantage of opportunities when they are there, and we have people in the business that are dedicated towards making sure that we provide the best service for our customers, and that is leading to market share gains. And that’s what we are going to continue to do.

[Ken Bowles, Chief Financial Officer]

On the cost items, Andy, I mean I think you picked up on labor on distribution. I think we said it was about – initially at the start of the year, we talked about a €20 million headwind, probably €20 million, €10 million to €15 million tailwind there. What clearly, start of the year, probably about a $50 million headwind probably slightly positive now, maybe €10 million, €20 million. On all the other cost categories, we would have seen a lot of those as a headwind as we started the year and they kind of maybe 50 out space. They are probably trending out about between 75 and 100 as a kind of tailwind. But look, Karen and Frank can take you through that in more detail on that if you need it. But I think it’s fair to say that a lot of that work is done around our ability to control our own cost and the good work we have done around things like energy, where we are 76% hedged for the year. So, very little open position, irrespective of what happens in those markets as we move through the back half of the year.

[Andrew Jones, UBS]

Okay. Cool. And just one follow-up on the industry, I mean given the fact that obviously, volumes are clearly a lot weaker than people are thinking when they are adding a lot of the capacity that’s been coming through recent times. Do you think the industry has done enough so far to sort of balance the market in the medium-term? And as a leader in that, I mean in your view, how much capacity do you think needs to come out on the test liner side in the next sort of couple of years given capacity additions?

[Tony Smurfit, Chief Executive Officer]

I think the industry is – I mean as I think I mentioned earlier, the price levels that exist today for a non-integrated player are extremely challenging. And you have already seen a number of market sellers closing or shutting – or announcing shut of their mills. And that’s obviously going to be positive. If pricing stays where it is for much longer, you are going to see more, and that’s going to be positive. You also see very significant players who have announced increases of capacity to hold those capacity increases for either cost reasons or market reasons. And then you have seen other players delay the installation of capacity by upwards of 18 months at this juncture. So, I think there is – if you are not integrated right now, it’s a very challenging market, and that’s going to come to the form of people who are trying to sell their paper in this kind of markets. And I think that’s going to be – going to set the plan for a new upward movement at some stage in the future. The question is when, not if.

[Andrew Jones, UBS]

Okay. Thanks a lot.

[Tony Smurfit, Chief Executive Officer]

Thank you.

[Operator]

Thank you. We have reached the end of the Q&A session. I would like to turn the conference back to Mr. Tony for any additional or closing remarks. Thank you.

[Tony Smurfit, Chief Executive Officer]

Yes. Thank you, operator. And I would like to thank you all for taking the time to be with us today. I think Smurfit Kappa, as I mentioned, has really put itself in a fantastic position for the future. While we don’t like to have down results, it is still the second best first half in our history. And we have shown the resilience of our business model through the years and of course, through the first quarter where our performance has been better than practically any of our peers that we have seen reporting thus far. So, we feel pretty proud about that. We feel good that our business is in very good shape to take advantage of any of the opportunities that are going to be presented to us as we go forward. And so that’s what we intend to do. And I think that the team is stable. The team is strong. The team is committed and the team are aligned to our shareholders, and that’s what will eventually make sure that this company continues to develop forward in the years ahead. So, I would like to thank you all for your time and your questions and most of especially your support, both all through the years and hopefully into the future. So, thank you all and have a very nice day.

[Operator]

Thank you for joining today’s call. You may now disconnect. Have a nice day, everyone.