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Hello, and welcome to the DS Smith Q3 Trading Statement Call. My name is Rosie, and I'll be your coordinator for today's event. Please note this call is being recorded. [Operator Instructions] I will now hand you over to Miles Roberts to begin today's conference. Thank you.
Hi. Good morning, everybody. And firstly, thank you very much for joining us today. I'm Miles Roberts, the CEO of DS Smith. And I'm here, as always, joined by Adrian Marsh, our CFO. Our statement today covers the trading period since the 1st of November. So trading continues to progress well, despite some of the macroeconomic uncertainty. Our group like-for-like corrugated box volume growth has increased during the second half of our financial year, fully as expected, with particularly good performances in Iberia, Eastern Europe and the U.K. It's also been very pleasing to see the ex-Europac packaging operations performing so well and our leading FMCG and e-commerce businesses growing strongly over the important Christmas period. Although some countries with exposure to export-led markets, including Germany do continue to be subdued. Our North American business, so we're pleased with the initial -- very pleased with the initial customer reaction and operational progress from our new box plant in Indiana, which opened in November. Our domestic U.S. business remains robust, although the negative impact of lower U.S. paper export prices remains ongoing due to reduced demand from China. However, our increasing packaging capacity in the new site will progressively reduce our exposure to that market. We've continued to focus on pricing, cost and cash, with limited box price erosion, testament to our resilient business model and strong customer offering. And we expect to deliver a margin in the full year in line with that achieved in the first half. I'm pleased to say that we recently completed the sale of the Plastics division. This reinforces our commitment to fiber-based packaging solutions for our customers. The net cash proceeds were approximately GBP 400 million have been used to reduce financial leverage. In summary then, the group has delivered a robust performance during the period, a challenging environment. Our sustainable packaging offering, including the replacement of plastics, is becoming ever more important to our FMCG and e-commerce customers, and we continue to gain market share. With regard to coronavirus. Whilst we continue to monitor events and work closely with all our suppliers and customers, we have not, to date, seen any material impact on our business. Our production is spread over 200 sites across Europe and North America and we have a diverse customer base. And as such, we are -- we believe we have a robust business model albeit we're not immune to the event of a widespread macroeconomic slowdown. So despite continued uncertainty in this environment, our focus on pricing discipline, enhanced cost and efficiency programs and cash generation supports our expectation of further good progress in the year. Thank you. And now myself, and Adrian are very happy to take any questions people have.
[Operator Instructions] Our first question comes from the line of Alexander Berglund from Bank of America.
Three questions from my side. The first one is on containerboard. Did you get anything on your recycled containerboard hike in February? And if not, how is it looking into March? My second question is on your potential containerboard disposals. I wonder if you can give an update on the progress here and if there's any chance you can give a range of the size of these disposals, either in value, tonnes or EBITDA contribution? And my final question. If you do get a cash inflow from these potential disposals, will you use that mainly for deleveraging? Or would you look to further expand your downstream capacity in addition to what you're already doing now in the near term? Those were my questions.
Yes. Thanks very much. Yes, on containerboard, looking at March, we're looking at plus 30 to 40 on recycled. I think it's pretty clear now, prices are going up, and that's what we are paying. But that's really coming through in, as said, in March. If we look at some of these disposals, as we said, we're looking to reduce our paper exposure, in -- particularly in and around Central Europe. There's work ongoing there. It's exactly where we expected it to be. We said we would come back over this year and explain exactly what we want to do, et cetera. And that's progressing pretty much as we expected.Now look, any disposal proceeds from this, as we said, we're looking at about 10% of our paper capacity, could be maybe a bit more than that but it's in that range. And that is -- any proceeds that come in would initially be used to reduce leverage. I think with plastics, as we said here, we're going to be around 2x with the plastics. And again, any cash flow will just reduce that slightly further again.
Just maybe a follow-up on the containerboard side. Given you said 30 to 40 on recycled, are you seeing anything on the virgin side? Or generally in the market, you see any potential for virgin containerboard to increase as well in March?
No. Absolutely, yes. Both are going up.
Yes. It's quite tight isn't it, stock is tight.
Yes. Stocks are tight. Demand is fine. Stocks are tight. And yes, so we're seeing that pretty much across the board. Yes, absolutely, absolutely.
The next question comes from the line of Justin Jordan from Exane.
Sorry to sort of belabor the issue at the moment, but just on coronavirus. According to your 2019 annual report, DS Smith had some 11% of revenues from Italy. Can you update us on just the extra measures that I'm sure you're taking at the moment, I mean particularly with your Lucca Mill and box plants in Northern Italy just to keep employees and customers safe?
Oh, absolutely. I mean, our primary focus is obviously on our employees. And we have very well-worked procedures in the event of these sorts of events, although they obviously adapted to this particular coronavirus. We're very much following the guidance of the World Health Organization. We're working with our unions and employee representatives again there. So really, all the measures that the World Health Authority has put out are the ones that we're following with a few extra precautions as well. I mean, I have to say, with our customers and talking to them to date, we haven't really noticed any particular change. We're not saying we're immune from anything because who knows what's going to happen. If you look at some of the forecasts and for general economic slowdown, et cetera, and of course, would have to assess that. But we do have a number of plants. We are able to move production around, move from middle Italy up to Northern Italy, if that was the case. Yes, I mean, food and drink, et cetera, we're servicing. So at the moment, it's been okay. But as you can imagine, we're watching it very, very carefully indeed.
Yes. I mean, we've got a task force on it Justin, all staff are advised on the precautions to take. Provision is made for relevant hygiene precautions at all of the plants. And as Miles said, one of the advantages of us and similar types of businesses to us is you do have a fragmented manufacturing base, so we're not concentrated in one specific area. But we had a Board meeting yesterday. It was one of the top issues on the agenda, just how prepared are we and what are we doing.
Sure. Okay. I appreciate you've got a large mass of FMCG customers, but I know you've also got some luxury brands as customers. Just specifically for those luxury brands, are they seeing a downturn in activity in particularly sales to Asian customers?
Yes. I mean, we do have some luxury. As you know, our packaging is of the very highest quality you can get in Europe. And therefore, we do work for some of these big customers, we're actually exclusive to them. They only want to work with us, as you can imagine. But yes, there has been, in the Chinese market, there has been an effect. We're talking to one particular ultra-premium sells a lot of sort of high-end spirits, et cetera, and of course people aren't going to bars and clubs in parts of China, and that has hit their production, their demand and that obviously comes on to us, I should say, these are relatively modest volumes. Not everybody is consuming sort of ultra-luxury products all the time, as you can imagine. And indeed, China is one market out of many markets in the world, but it is having an effect. But really, for us, it's minimal as these customers are also very, very important, it's obviously a very modest amount of overall demand. But we're watching the situation very, very carefully. I mean, interestingly some of our customers are actually increasing their demand because there's more of a focus on them. So we've got one company, a very important customer, actually based in Italy, that makes sort of hygiene products. Well, as you can imagine, their orders have ballooned and I think that's part of our sort of diverse customer base, focusing very much on these sorts of customers. While one has gone down, the others go up. But as said, we're really just seeing what happens, just in terms of overall demand. We think we are reasonably resilient, but it's uncertain.
Yes. I think the most obvious thing at the moment, Justin, when you look at it from a general business perspective, and again, we'll be no different to anyone in this respect, is what it's doing to global shipping rates at the moment where you're seeing containers are being stockpiled effectively in China because no one's collecting them. And I just think that we need to play out, over time, what that would do for not only our logistics cost, but anyone's. And you can see it. I mean, the shipping rates are definitely rising. Clearly, on packaging, you don't move a lot by that route. However, you see opportunities. People in distribution, I mean, their cost base is going up.
Yes. Good point, Adrian. So just one follow-up question. I guess, Miles, in December, you talked about box prices for contractual customers being, I think it was down 2% to 4% at that point. Here we are, now 3 months later, where are those sort of contracted box price conversations currently?
I mean, look, I think one of the things which we've always -- what we try to do as an organization in building our capability with our customer is about the value-add setting, the service, the quality, the innovation, the security supply, trying to show you how we've demonstrated why we've been able to increase our value-add and therefore, our margins. And the box price erosion, has -- it has been coming through but really, we are a year on, we talked about sort of 2% before, we're talking about 3% now from where we were around that. But it's been...
It's definitely was trending into that range, Justin. I mean, the unknown, unknown at the moment is the paper price rise that's just going through, which one would anticipate starts to put a ceiling on that. But it's certainly no different to how we described it before when Miles gave the range. That was an anticipation of where it will get to, and we're seeing it sort of middle moving through that range.
I think we're quite pleased with seeing this volume increase, which we talked about really coming through in the second half as well as we've just repositioned ourselves a bit more even more into the -- and we're -- today we are really pleased with the margin tension, I have to say. And also, the volumes coming through in the quarter.
Okay. Just one final thing for me. To Adrian, look, I know I've given you a hard time on occasions over the last 7 years. But clearly, best wishes on your imminent move to William Hill.
Thank you very much, Justin. I've never noticed the hard time you've ever given me.
The next question comes from the line of David O'Brien from Goodbody.
And if I could just start on box pricing again, sorry. You did give the range of 1% to 2% for total pricing in the first half. If you're saying that 3% number now, is that the year-to-date? Or is that what happened in Q3? Just to be clear.
Yes. So the 1% to 2% was what we experienced. Miles gave a view on the contract, so the indices where we knew they would start biting. And we thought the range would be more like the 3% to 4% going forward. First half is exactly as we said. Second half, you can say that the run rate is closer to where the middle of that range is, around the 3%. So there's obviously been an increase in Q3. And Q4 remains unknown. I mean, at this stage, I mean, with prices going up, our anticipation at this stage is no further significant erosion. So the retention has been very good.
Okay. And in terms of you noticed the step-up in corrugated volumes. Can you quantify what type of growth you're seeing at the moment, where the improvement has come from maybe on a sector basis? And also, has there been any evolution of that growth you're seeing that has been a pretty good November-December Christmas period. Look, from January onwards, how has demand trended into March? And then fine -- another one for me. You do note your margin is going to be stable sequentially into the second half. How does margin look year-on-year on an organic basis? And if I could tie that into your guidance for further progress in the year, should we be looking at organic profit, it was down in the first half, should that be flat or up in the second half?
If we -- just taking the volumes first. In the first half, we noted how we had a difficult period in the industrial volumes, particularly in some markets like Germany.And we've also noted how, whilst we can obviously chase that volume, we felt that we are just going to focus -- continue to focus the group in much more resilient categories. And we have a number of opportunities to really grow there, as you can imagine, with our product developments, service, quality, et cetera. And therefore, it caused the volumes in the first half to be a little bit lower than we would normally expect. But we did say that we will be recovering into the second half. We could see the timing of new awards coming through, slightly reposition our business. We could see the Europac business, where we've had a negative growth or we had a decline in the first period as we were working through the pricing changes and then we started to see an improvement with the ex-Europac packaging. They're now firmly in growth. In the U.S. as well, we've run at our full capacity. We've got the new Lebanon site. We can clearly see that coming on. We're very pleased with how that's gone. So all of that means in the second half, and don't forget, this is building, we're looking at a higher run rate. Now for the -- if we look at the second half, I think we'll be around about the sort of maybe 1.5% to 2%, something like that, in terms of the second half growth, bringing the whole year up into, again, that sort of -- it's difficult to really say precisely, but it's in sort of the mid-1s to 2s, something like that. But we're just clearly seeing the run rate improve. And indeed, that run rate is improving during the second half. It's really as we've repositioned. As I said, what we are pleased about is the margins. And we say, if we look at the second half, the second half traditionally is a little bit quieter than the first half for a number of reasons. We see a -- it's -- you've got sort of a January period, which traditionally is a little bit quieter after New Year. But even so, we're seeing the margins come through. Now we do have the Europac business. But clearly, in the second half of last year, we had a good period of the Europac business. So just in the first half, if we look at our European business, we're seeing the margins improve organically in the core business. In the U.S., we commented there. We've -- the U.S. domestic business continues to go well. We're pleased with that. We're bringing paper back onto the U.S. Mainland that used to be sold in China. But just as we comment here, we still sell paper to China. The market remains subdued and not particularly better or worse, it just remains subdued in terms of pricing, which affected us in the first half. But very broadly, all the things that we talked about, about margin retention, about growing our volumes, about bringing the paper back on domestically and disposing of plastics those are things we talked about at the half year. Where we are today, we're absolutely all on track with those, maybe some of them are being completed as well.
The next question comes from the line of Barry Dixon from Davy.
Gentlemen, a couple of questions from me. Just in terms of OCC costs. You might just give us a sense as to what's happening there. There were some talk of an increase or some evidence of an increase earlier in the year and then just in the context of what's going on in terms of logistics and transport costs, what's happening on that front? And then secondly, on the containerboard price increases. I mean, you talk about that as far the weakness in U.S. export prices. How realistic is it, do you think, that European price increases can be maintained in an environment where U.S. export prices to Europe continue to fall?
Right. So just on that -- for us, we're saying that the U.S., in terms of our U.S. business has continued to export to China. It hasn't gotten any better or worse. I mean, quite interestingly, there's a...
Yes. I was just going to -- just interrupting him. I mean, I think it's fair to say we were expecting at Christmas time export prices to China would be getting better, which they were showing signs of until the coronavirus.
It remained the same. Yes, it remained the same, yes.
They're going up into Europe at the moment.
Yes. I was coming on to say containerboard prices into China, the second half has been pretty much as we saw in the first half. Prices of export from the U.S. into Europe have gone up for kraft, and that's effective for this month.The big sort of unknown is what's happening in China because you probably noticed, and this affects OCC as well, OCC prices in Europe over sort of December, January fell and they fell because they sort of import into China, it just wasn't happening, so there's an excess of supply. Recently, we've actually seen an increase in demand from China because the domestic collections in China are obviously struggling with all their restrictions on gatherings and transportation, et cetera. I mean, it's really some statistics about how 300 million people in China are displaced, and they haven't come back from after the Chinese New Year. You see, it's incredible. And obviously, this affects municipal collections, et cetera. So you've actually seen an increase in demand from China for OCC. It's too early to call it, far too early, but also some indications on paper have been actually quite positive. We're not calling it. This is really just as we're seeing things on a weekly basis, and it all comes from this sort of restrictions on mobility in China. We've also seen a relaxation in some of the import tariffs, et cetera, on OCC from the U.S. They've been lifted from China. So there's clearly -- yes, there's clearly something going on in China, sort of looking to pull from Europe and the U.S. with their sort of domestic production capacity and collection being down. We also hear things about very low stocks in China because they've been used. They've been -- the supply chain there is looking a little bit bare. So everybody can have their own views on it. At the moment, demand seems to be increasing because of our sort of existing resilient manufacturing base. But it's too early to tell. So OCC down in the 1st, sort of December/January. More demand coming from China, a little bit on pricing there, we've seen in a few places starting to edge up. U.S. kraft exports in Europe, up. U.S. pricing into China flat, first half/second half. However, we are seeing some signs of demand. But it's too early to -- it's too early to call it.
And then the data is so unreliable. I mean, I heard something yesterday that saying half the paper machines are shut in China. I don't know whether that's true or not.
No, no. But our people, yes, our people who are out there permanently are saying that certainly, the OCC collections are affected and there is quite a bit of downtime on the mills in China at the moment. That's what I'm...
And just a follow-on on that, Miles. I mean, so there's increased demand -- or is there increased demand for containerboard from China as well as for OCC, given that we're hearing that the plants are running at 50% capacity? And maybe just a cheeky one to follow on is that are you seeing good demand for your paper mills in Europe? And could Chinese buyers be potential buyers of those?
Yes. I mean look the -- with -- all that we can say is what we see. And it's very difficult to get sort of industry-wide information there. However, if we sit here and say and we are not calling it. This is literally these things are moving very quickly. We are seeing there's an increased demand for OCC from China, and there's a lot of interest in taking more paper from the U.S. and from Europe. That's just what we see from the people we interact with although we do have quite a big sort of network into the -- it's interesting what you see on the papers, there is obviously interest from a number of sources. And as you've seen, Chinese buyers have been looking to get more capacity in pulping and paper, particularly pulping in Europe and in the U.S. because of their import restrictions on OCC. That's been a long-term trend, and that remains the case today. We can see interest in there as they -- China really look to close the gap between their demand for OCC and paper and basically, their domestic collection rate of OCC, which is plateaued for a while now. And there's a gap. And I'm not surprised to see the increase in demand as they seek to close that gap.
Yes, but it is really -- there is no reliable data, is the problem, David. I mean, you go from your -- from one day to the next, you can get totally different views on what you think is happening. But the reality is we don't know.
[Operator Instructions] And our next question comes from the line of Cole Hathorn from Jefferies.
Adrian, a question for you on the integration that you've done for paper within Europe. Could you just give a little bit of color of how that's kind of helped the margins, bringing kind of more paper internally within DS Smith? And then secondly, I'm just trying to get some more color on the difference between your U.S. and European businesses from a box pricing perspective. You've always talked about Europe 40% indexed and the various other items to support pricing. Whereas in the U.S., it's always been more of a correlation with the paper price. I was just wondering if you could give a little bit of color on the differences you see between box price mechanisms in the U.S. versus Europe at the moment?
Okay. In terms of the way the integration will affect margin is purely mathematical, Cole. In as far as if we're not selling paper into the external market rather using it internally, i.e., increasing our integration level, then you simply are reducing the revenue line by the effect of not having to have the gross up of a sale and a purchase. And we have been increasing -- I mean, not massively, but we have been increasing integration levels in the last 6 to 9 months, probably. In fact, probably over -- moving from 9 to 12, probably. And we can change that at any point in time. We're still -- our model is to be short paper, but where you have capacity to make it is not always where you need it. And hence, we have the make/buy/sell and we operate that quite effectively. And we buy the papers we need in the open market, and we sell into the open market. Where prices are volatile, economically, you look to integrate more, particularly when they're volatile on the downside. And we will manage economically to optimize our results. The effect of that will simply be that you do have a net improvement of margin when you take your profit compared to your revenue line because the revenue line will have come down by that. In the same way as with -- where we sell OCC into the open market. If the price of OCC has come down, that has a net effect of reducing our revenue, but the profitability may have stayed exactly the same. However, mathematically, a couple of basis points potential improvement on margin, for example. So there is that mathematical trend, and you can see that and you can work that through. In terms of box pricing in Europe and the States. I mean, I'm sure Miles can give a more definitive answer on that, but it does operate quite differently. In the States, it's still largely a mark-to-market. So if the price of paper moves, classically, the price of a box will move with a relatively short lag, maybe 1 to 2 months. And it's set on -- and they tend to get fixed based on pulp and paper weekly prices of paper. So if paper comes off $10 a tonne, likely it is box prices could classically, you're talking about a market that's largely made up of standard brown boxes. Now going forward, one would expect, over a period of time, and it may well be a significant period of time that it will follow more like in Europe, where you're selling on value and you're selling on innovation and you're selling on service. And what it is -- you're willing to get more into the shelf ready areas and the high print areas, your ability to retain prices and manage prices is much greater, as we're seeing in Europe. But at the moment, U.S. is mark-to-market very quickly. Europe, which was that, probably even when I started 7 years ago, we're just seeing is a lot less so now as the market consolidated as the type of packaging and the value of the packaging has increased is less driven, entirely dislocated from the price of paper. Miles, you've got any thoughts to that? That's what we see. And I dare say, if you talk to our big competitors, they probably say the same. It's certainly what we've seen.
Great. The comments on the box prices very much echo what WestRock were saying recently. So appreciate that. And then just one follow-up on cost inflation that you're seeing at the moment or deflation. Is there anything that you can call out there or any programs that you've got in place to kind of take out extra cost where you can?
Yes, absolutely. So if you park the individual element of paper and OCC, and you know those as well, if not better than me, where they'd be moving. If you then take into what cost drivers one will have as a business outside of those 2, I mean, labor. Labor will inflate every year. If you're in Europe, you're pretty much tied into -- in a lot of countries that have mandatory inflationary price -- labor cost rises. So you can pick a number, but you can say, on average, you're inflating your labor base by 3% a year, roughly, roughly, if you do nothing else. Other costs that we've had, logistics have gone up; energy has gone down; starch has gone up and it's come down and it's forecasted to go up again, who really knows? All we can do is try and optimize our efficiency, and we've always done that. That's never changed. I think it would be fairly honest for me to say, we've stepped up our efforts this year, particularly as we've seen, paper prices coming down. We've absolutely looked at every single line of optimizing efficiency and we've got a number of programs in place to deliver on that over the next 2 to 3 years, in the same way as we've had in the past. Obviously, through some of the acquisitions, we've grown the business and we've got opportunities there to improve their operational efficiency. But in -- there's no stone that doesn't get unturned within the business. I mean, within the U.K., which is a very successful part of our operations, we're consistently driving operational efficiencies there. We've got a very, very strong procurement function that delivered a number of benefits over the years. They're tasked with driving not only the price that we buy raw materials and various direct and indirect cost for, but also the volume. I mean, how people are consuming, particularly on indirect. And I've always said, since I've been here, one of the biggest advantages of having a company where you've got a large number of fragmented operations is there's always opportunities for improvement, and they continue to be so.
We have no further questions coming through. So I'll now hand the call back to Miles for any concluding remarks.
Great. Well, thank you very much, everybody, for your time this morning. I just note that trading, we've seen the increase in volumes. We're seeing the effects on our full year on the margins, and we look forward to the rest of the year to continue making good progress. Thank you very much for your time.
Thank you.
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