UPM-Kymmene Oyj

Jussi Pesonen - Chief Executive Officer Tapio Korpeinen - Chief Financial Officer

Mikael Jåfs - Kepler Cheuvreux Lars Kjellberg - Credit Suisse Justin Jordan - Jefferies International Ltd Mikko Ervasti - DNB Bank Mikael Doepel - Handelsbanken Harri Taittonen - Nordea Linus Larsson - SEB

Ladies and gentlemen, welcome to UPM's Second Quarter 2017 Result Webcast. My name is Jussi Pesonen.

I am the CEO of UPM. I'm here with our CFO, Tapio Korpeinen.

Good afternoon, everyone.

Let's start with the presentation. Q2 was another good quarter for UPM.

To start with, market demand was favorable and delivery growth continued in most of our businesses. Moderate variable cost inflation continued in Q2 which we have been able to mitigate with our own cost reduction measures as well as targeted price increases in several businesses.

As expected and as discussed three months ago in this call, this time Q2 was quite heavily impacted by maintenance activity in Biorefining, Energy and Paper ENA. Despite high maintenance activity this quarter, our comparable EBIT continued on increasing track in Q2.

And this was the 17th consecutive quarter of improved EIBT. Our cash flow was solid, although we had seasonally increasing working capital during the quarter.

We paid an annual dividend during the Q2 and ended the quarter with EUR 830 million lower net debt than year ago. Turning to Page 2, Page 3; market demand continued to be strong in Q2 for pulp and biofuels and especially the papers.

Self-adhesive labels and plywood was also strong. Even for Paper ENA, Q2 demand was relatively good with European graphic papers demand decreasing by only 2.5% from that of last year.

Our growth projects continued to have positive impact on our results. In Biorefining, our pulp deliveries grew by 2%, despite the maintenance shut at Pietarsaari pulp mill.

Also the biofuels business achieved clearly higher deliveries than that of last year. As the Lappeenranta biorefinery is now running well and producing close to the full capacity.

In Specialty Papers with the new specialty paper machine in China, we have been to grow our release liner business even faster than what we expected. This was visible in a significant improvement in product mix of H1 and particularly in Q2.

In Raflatac, our self-adhesive label stock deliveries grew by 6% from that of last year. In plywood, our deliveries grew 4%.

Energy had a weaker quarter with electricity deliveries down by 17% from last year. This is particularly and partly due to lower availability of hydropower and partly due to longer maintenance at the Olkiluoto nuclear power station during the quarter.

But ladies and gentlemen, at this point, I will hand over to Tapio to analyze our result more in depth. Tapio please.

Thanks Jussi. I'll start with some points around the maintenance activities during the quarter.

The second quarter was a pretty heavy maintenance quarter as we did guide three months ago. In the second quarter, first in Biorefining, we had the scheduled maintenance shutdown at the Pietarsaari pulp mill here in Finland.

In the Energy business area, the maintenance shutdown in Olkiluoto nuclear power plant was longer than last year or normally and nearly. And then in Paper ENA, we had the normal seasonal increase in fixed costs including maintenance activity that we typically have in the second quarter.

The maintenance impact is visible in temporarily higher fixed cost, also in lower production and deliveries and also during the quarter, lower operational efficiency. The total impact on the second quarter comparable EBIT from these items was approximately EUR 20 million as compared to last year's second quarter were about EUR 45 million compared sequentially to the first quarter of this year.

As you may recall, three months ago, we estimated the sequential impact on EBIT to be about EUR 40. The slight difference comes from the Energy business where Olkiluoto maintenance shut was prolonged and was longer than planned.

Of course maintenance is normal activity for our business and in all of our mills every now and then we have a need for a maintenance shut. However this can cause significant or let's say remarkable earnings variation between quarters.

This year for example the first quarter had very little maintenance whereas Q2 was a maintenance heavy quarter. So from that point of view, the H1 profitability figures as a whole are more representative for UPM's performance than either of the quarters separately.

Now this Page 5 shows the comparable EBIT by business area. As I already discussed Biorefining and Energy were impacted by higher maintenance compared with both Q2 last year and the first quarter of this year.

Paper ENA had the normal seasonal increase in maintenance and other fixed cost in the quarter compared to the first quarter. Pulp prices continued to increase in the second quarter.

As you all know higher pulp prices increased earnings for Biorefining but then also represented higher costs for Paper ENA and our Specialty Paper business. In the second quarter, our average pulp selling price was some 6% higher than in the first quarter or 10% higher compared to the second quarter one year ago.

As a result, Biorefining increase its EBIT, despite Pietarsaari maintenance shutdown. The Energy business had extraordinarily lower electricity generation in the quarter because in addition to the prolonged maintenance shutdown at the Olkiluoto nuclear power plant, also hydropower volumes continued to be below the long term average level in Finland.

In Paper ENA, comparable EBIT decreased sequentially from the first quarter due to the combination of higher fiber costs and seasonally higher fixed costs. Paper ENA deliveries are also seasonably the lowest in the second quarter before the high season from a volume point of view in the second half of the year.

And as Jussi mentioned, Specialty Papers made good progress with growing its release liner business. It also achieved some sale price increases.

Its EBIT increased from last year despite the increase in pulp costs. In Raflatac and plywood, profitability continued on a good level in the second quarter supported by good growth in deliveries.

Both business have also seen during the first half of the year some variable cost inflation only partly covered by the achieved price increases so far. In plywood, the product mix was less favorable than in the first quarter.

Here on Page 6, you can see second quarter EBIT as it has developed by earnings driver and by business area. Here you can see the impact of the higher maintenance activity particularly in increased fixed costs.

It also has a negative impact on delivery volumes and variable costs. Sales prices increased year-over-year particularly in pulp and timber, Specialty Papers and plywood.

As you can see in this comparison, the increase in sales prices is of similar magnitude as the increase in variable costs. The increase in variable costs comes mainly from fiber costs and certain chemicals, adhesives and films.

Our variable cost reduction program continue to generate savings, but it did not fully offset the changes the raw material prices. We have also increased our planting activity in the Uruguayan plantations and this is visible here as part of the increase in variable cost.

It is however neutral to comparable EBIT as the planting activity correspondingly increases the fair value of the plantations. In the first half of the year, five out of six business areas increased their comparable EBIT.

Here we have our cash flow on a trailing 12 months basis. In the second quarter, our operating cash flow was EUR 269 million including an increase in working capital of about EUR 59 million.

For UPM, the first half of the year typically rise up working capital. This year the first half increase in working capital was only EUR 24 million.

This includes some further positive results from our working capital improvement programs marked cash. Typically we release working capital during the second half of the year and expect to do so this year as well.

Over the latest 12 months, our operating cash flow totally a bit less than EUR 1.6 billion and the free cash flow before financing a bit less than EUR 1.3 billion. Our net debt decrease EUR 830 million from last and ended the quarter at EUR 1.46 billion or 0.68 times EBITDA.

And then in the second quarter obviously we also paid the dividend in total EUR 507 million. Our outlook for the year 2017 is unchanged.

We expect UPM's profitability to continue on a good level. Market demand for our products is expected to be favorable.

We expect the year 2017 to show moderate variable cost inflation and to mitigate this, we will continue our own cost reduction measures. I would say that perhaps we have seen the largest cost increases to take place this year as far as our product inputs are concerned and therefore the outlook for the full year is for modest input cost inflation.

If the second quarter was impacted by higher maintenance activity then the third quarter is again expected to be a clearly lighted quarter in terms of maintenance activity. And here I will hand it back to Jussi.

Thank you, Tapio. Ladies and gentlemen, let's look at the growth project situation on Page 9.

The focused growth investments over the recent years have been highly successful and they have been contributed and contributing well in our profits and even more evenly to our returns. We have a portfolio well performing businesses and I have no doubts that we can continue to grow and growth of them with similar good return focused investments in the future as well with similar CapEx level around EUR 350 million to EUR 400 million.

The next two projects to come to their startup phase or the second expansion of the Kymi pulp mill in Finland which will be completed during the fourth quarter of this year and then the Raflatac's label stock expansion in Wroclaw in Poland which will be then completed during the first half of the next year. So those are the next phases of implementation that are coming on.

But on top of that we have made new decisions. During the second quarter, we announced to focused investments and the startup time for those will be 2018.

Similar to Kymi pulp mill, our previous investment at Kaukas pulp mill opened some with the new - opened us some new opportunities to improve efficiencies and debottleneck of the mill. And so we have now decided to invest EUR 30 million to improve this competitiveness and increase the capacity another 30,000 tons again.

In Raflatac, we are expanding the attractive Specialty Paper and as far as specialty labels business with the new product line and production line investment in Tampere factory in Finland. In Uruguay, we continued the discussion with the government regarding the needed infrastructure development and other local prerequisites for potential pulp mill investment.

And I know that you would like to know more at this stage, but unfortunately we are not yet in the position to disclose further details at this point. Ladies and gentlemen, now I would like to conclude the presentation the prepared part of it.

First, UPM's comparable EBIT continued an increased track in Q2 even though the quarter was impacted by maintenance activity. Second very important point that the demand for our products has been brisk and continued in a good level.

And we have been seeing some variable cost pressure but the mitigation activities with the smart spend and all of those we have been able to mitigate that. During second quarter, we announced also two new investments as we - as I explained earlier and the continuation of the discussion with Uruguayan Government is moving on.

We expect that the good profitability will continue for this year as well. Ladies and gentlemen, this was the prepared part of the presentation.

We are ready to answer your questions. Dear operator, we are ready to start the Q&A session.

Yes, hello, good day, everybody. I have three questions.

The first one is around the maintenance. And then you were saying significantly less, could you perhaps give us a list of the projects that you are doing for Q3 and then if possible significantly you know a little sort of color and flavor on that?

And into that question also some of your competitors disclose let's say a table of the normal costs coming from maintenance activities, are you planning to do something similar? That was my first question.

And the second one is, you are in the process of selling three hydropower activities and if they are approved, could you say anything about you know the potential cash flow effects from these? I mean you've stated the potential capital gain in the report.

And then a housekeeping question on your Uruguay potential project, I know that you said that you cannot disclose more but just a housekeeping question, you are saying that you have these two phase ongoing and then you know these two preparation phases and then you say that once they are finalized, if they are finalized and you would start your UPM regular process of analyzing and preparing an investment position. And then my question is that normally how long would this regular UPM process be?

Those are my questions. Thank you.

Maybe if I'll start with the first couple of questions on the maintenance activities. As I said, in the third quarter, we don't have any significant maintenance that's what I meant by saying that it's light quarter from that point of view.

The next sort of bigger shutdown will be at our Kymi pulp mill which is scheduled to start at the end of September. And that pulp mill shutdown is also related to the investment project that we are finalizing in the Kymi pulp mill now.

There will be some impact also in the Energy business area form this Olkiluoto number two reactor shutdown that extended into the month of July. But maybe in round figures, one can say that there will be a sort of a EUR 40 million less in the sort of bottom line of the third quarter related to maintenance compared to the second quarter figures.

And then let's say any sort of table or other discloser on maintenance costs, we have sort of no plans at the time to discuss right now. This hydropower disposals, they are expected to be concluded in the third quarter.

So the cash flow impact should be coming around then as well if everything goes according to plan. But in terms of figures, we don't have further to disclose then what we have commented on the capital gains.

And I will then come to this Uruguay matter. First of all may I say that the kind of content of the agreements are all always more important than the timing.

And of course I understand that you would like to see the timetables for different things. Now we are in the discussion with the Uruguayan government the investment agreement which is more related to infrastructure and all the necessary things to consider of building a big bulk million Uruguay.

And that is ongoing. And of course from the government side but also from our side this is more important that you know we have the right responsibilities and liabilities clear rather than what they we come out with the agreement.

And then the second phase is of course lot of permitting type of things and infrastructure building, preparation and once again it needs to be firmly done. Once again timetable is important but also the kind of level over the work is most important.

And similar to the third phase, when you are way of coming to look at the kind of final decision for the investment, the content is so important not the timetable. Of course it is very much dependent on how we analyze the markets, how we analyze the costs and the kind of course at that point of time.

But of course then it is in our hands, you know the time is in our hands, so basically then it is more actually straightforward process then this early once where you have many parties to participate. So there is no timetable for that that how long it takes.

But of course we do not delay any of the decisions if we have all the firm good analysis on the table.

Okay, many thanks.

Thank you. I just wanted to follow-up a couple other questions.

You gave a delta for maintenance in the third quarter you know typically fourth quarter and you call that the Kymi investment project and maintenance, what sort of delta should we put in there? Also when you look at the hydropower divestitures, does that have any particular impact on the operating costs, I guess they were integrated into I guess the paper business?

And also if I could on this forestry side, you've divesting how this Tornator driving 23,000 hectares of land. What was the gain of you know included in the second quarter and should we expect - what sort of level should we expect in this - in the fourth quarter as part of the fair value from these divestitures?

Well if I will take these questions. On the fourth quarter, again we have the Kymi shut down there and I said it's related also to the investment, so it's a bit more extended shutdown than would have for pure maintenance.

But that perhaps one kind of a point of a point of comparison is that if in the second quarter, we had 45 million maintenance impact, the Pietarsaari which is obviously also a large pulp mill. The Pietarsaari share of that is about 20 million.

So it could be similar for Kymi as well in the fourth quarter. Then on the hydropower divestitures, I would say that the impact on EBITDA of paper business is marginal first of all because one of the hydropower plants that we are divesting and let's say relative to the others.

Very important one is in Madison main which was obviously connected to the Madison mill that was shutdown. And then the European once there are sort of EBITDA or bottom line impact on operating cost.

There is let's say quite sort of small compared to the Paper ENA business as a whole. And then the divestiture impact of on fair value, if you look at in the upper operation - other operation where we have the fair value change, normally the sort of a net change from kind of ongoing harvesting and growth of the forests is quite small.

So the divestiture actually - divestitures account for let's say most part of what is reported as a gain in the second quarter. And then we will see what kind of deals we are able to conclude during the rest of the year.

Okay. When you are taking about the cost savings, just a couple of more associated with investment closer to 30 million, when should we see that coming through in the numbers, it should have happen now in the second half or that be delay before you keep those cost improvements?

Well, they will start now impacting in the second half let's say on a kind of run rate basis.

Okay. Final question that I have, can you give us any sense of the cost inflation that you are talking about, where it's coming and where do you see it heading into the second half, areas do you see cost inflation?

Well, as I mentioned of course let's say two sort of important areas are in fiber cost, obviously pulp is cost backed for our paper making. And well we know what has happened to pulp prices during the first half of the year and then RCP recovered paper obviously for publication paper business in Europe input and there also we have seen fairly significant increases in the first half of the year.

And I would say that in those areas perhaps the kind of cost environment should be a bit more benign during the second half of the year. Oil price obviously is impacting many sort of components or as a cost input to many inputs that we are using like films, chemicals, adhesives.

And there again earlier we have seen increases during this year than the oil price has been sort of more stable. And again because of that one will expect that further increases will be more modest during the second half of the year.

So overall as I earlier said, our kind of expectation for this reasons is that perhaps the bigger increases we saw during the first half of the year and we would expect that sort of rest of the year will be a bit more benign or moderate from that point of view as far as input costs are concerned.

One final from me that I forgot. The dollar has of course weakened in the order past month and a half or so.

Can you share with us how you are hedged now when you seeing the dollar states what is now in the range of 1.16, when should we see that coming through into your numbers? Thanks.

How that’s expire -

Yes, there. We have let's say the same policy as earlier meaning that we look at our cash flow exposure 12 months out for each of this sort of currency pairs and U.S.

dollar is in a sense the biggest exposure that we have roughly a billion per year. And again we sort of hedge that on a rolling basis up to about 50%.

So that sort of smoothens out the impact of change in exchange rate.

Okay, very good, thank you.

Thank you, guys. Just two quick questions if I could.

Sorry to sort of keep going on on the maintenance issue, but Tapio, you call that maintenance rate being some EUR 40 lower than Q2, just on the year-on-year basis, can you give us some idea of the Q3 maintenance compared to Q3 of 2016 please in terms of year-on-year delta?

Well, I would expect it to be let's say similar to last year slight let's say difference there being again what I mentioned that we have some lingering impacts from this Olkiluoto 2 in July, and then perhaps some small impact from Kymi if and when it starts schedule in the end of September. But I would say roughly speaking in line with the third quarter last year, which again from maintenance point of view was a clean quarter and will run in the paper business as well.

Great, thank you. I'm sorry just on pulp prices, now appreciate as last shown FX has been a major movement fracture so we say in euro dollar exchange rates recently, but do you have a particular view on the outlook for U.S.

dollar pulp prices, whether itself for the hardware pulp in coming months to the back half of 2017 overall so we've seen strong grains year-to-date. But I'm just curious in terms of the capacity additions that we're seeing globally in pulp in the second half of this year whether you think pulp prices are flat lining or potentially declining from here?

That is something that we do not unfortunately do, we don't forecast the pulp prices publicly of course we do have some view on it. But there has been a lot of you know analysis all the time whether pulp prices have gone - if you're looking the business at only the business drivers first four quarters of pulp demand globally, the market pulp grew almost a million ton, so the demand for the first four quarter - four months was quite okay.

Producer inventories are, there's no change visible at this point of time. But like I said that that we do not - we do not forecast that in this way.

Let's see how it goes, there are some new capacity coming on stream on autumn, but like said you know demand has been million ton more already during the first half of the year.

And just one final thing, on Slide 23 of your deck you put in usual chart of the supply demand balance for European graphic paper, of course one of the impacts of rising pulp prices is declining margin in graphic paper. I'm just thinking in particular for the unnamed to greater producers in Europe represents minority, do you anticipate further closures or do you anticipate the industry overall in graphic paper in Europe will have to take further actions to given where costs are in relation to average prices?

It's not actually related to the pulp price or the chemical pulp price, see most probably you saw this morning that what was yesterday that wood harvest [ph] is supposed to be closed down, that for public information. So those is closures happening.

Then I'm always coming back to this cash cost of the marginal producer and that graph has been working quite nicely, and if there will be a reaction of the cost you know then there will be a reaction on the price as well. I guess that this is pretty much has been working quite in a way that you know the cash cost of the marginal producer is actually dictating many things.

I don't know you know this remains to be same.

Okay, thank you.

Thank you very much, and good afternoon to everyone. I want to ask about Specialty Paper volumes, this quarter you couldn't report the growth year-over-year, what is this related to, is it relates to mix shift that you're going through or something in the underlying demand?

That's my first question. And then on the plywood, now the high costs due to ramp up where there so should we be expecting this also in the third quarter or are they already completed?

Thanks very much.

Specialty paper demand is very good you know and that is to reason that we have been able to turn the Changshu to the - you know kind of targeted product mix, which is definitely positive for us. And therefore the number reported is sneak up, but you know the kind of outcome is absolutely positive that we have been able to make more release line or so.

So there's nothing wrong with the demand, it is excellent actually at this point of time.

Okay.

And then maybe on plywood, so in the second quarter, we did have somewhat higher costs including resin cost again as discussed earlier for the reasons mentioned also let's say some differences in the mix that sort of the impact the average price, but overall in the plywood business, let's say market environment this quite positive, so from that point of view, we would expect that we can sort of work on both the sort of cost and the top line side of the plywood business during the coming quarters.

All right, thanks. That's all from me.

Thank you. Just a couple of questions on the mix actually, you mentioned the report both for the plywood business as well as the rough pack division that there were some adverse mix impacts in the quarter, could you explain a bit what this is about, why this happened and also what you expect going forward should we see a reversal of this negative mix and going forward?

I would say in both cases, there's nothing special about it, I mean every quarter has a bit different mix, so in both businesses it's just an issue for this current quarter, but nothing sort of structural or particular trend in their background.

Okay, so we should assume that could improve. Then on the Specialty Papers divisions just to continue on the question there what is the split today in terms of office papers and in terms of label papers and what's the target when everything is in place?

You just take you know if you remember in our capital markets day that you know how do we review and look at the kind of split between the kind of specialty papers and the graphic papers on that that the area that is giving you a good picture it although it has been happening much faster than that of the plan and expressed on that view. But that's the way we don't actually disclose more in depth or how to split it between these two.

Okay.

There you have a good guidance look at that and that has been happening faster than expected.

Yeah, we'll do. Thanks a lot.

Yes, thank you and good afternoon. Just a sort of quick question on the paper and looking at the sort of average pricing delivered on it looks like those prices eroded a little bit about 1%, which is a bit surprising given that increases we have seen at least in the least prices for fine paper during the quarter.

But if there - was there something really to mix there or is it more like a sort of a geographical balance change or a currencies or what could you sort of a say on that one to elaborate a bit?

There are several factors behind there as you said fine papers that have been some increases, but then of course there is some impact on the average sales by price in Euros that has to do with the exchange rate as euro has been strengthening during the first half of the year and then let's say the mix changing as well.

Okay. Or maybe just staying in that business area, so depreciations also came down quite a bit, what would you say about the depreciation level this quarter and that are going forward or sort of - is that reflecting or the current level reflecting the future levels?

Roughly, roughly yes perhaps let's say there was again primarily in the Paper ENA step down in depreciation in certain assets, so then let's say going forward it should be pretty flat.

Okay, thank you very much.

Thank you very much and good day to everyone. First question on graphic paper in Europe from time to time we have discussed the potential consolidation, restructuring and so forth.

I want if you could please get an update on your stance in that matter and whether you see value in any participation in consolidation and whether in connection to those ENA constructive opportunities please?

This is Jussi. I guess that you know I'm repeating myself always with this question, I do see that the consolidation makes sense, let me look or key so great example of it you know the CapEx synergies have been now benefiting us for many years, now that we do not have to invest more than €50 million on our Paper ENA annually at this point of time.

And that's a lot of the do with the consolidation, so consolidation makes sense and if there will be you know opportunities that will create value for UPM shareholders we are interested on that. But you know time will tell you know if and when and if nothing happens.

Okay and that's fine. And then just one more question relating to Olkiluoto number three, whether you could maybe in somewhat more detail, share with us the timing of when it comes into your P&L and cash flow, and what sort of impact we should expect from that please?

Perhaps not a lot of detail yet that this point before again let's say the project moves on to conclusion, but as you know the time schedule that has been communicated by the supplier and by TVO is for the completion, commercial completion of the project by the end of next year, which would mean that kind of the impacts based on that on UPM balance sheet and cash flow would be then starting 2019 Monday sort of investment cash flow we do still have a remaining commitment for the equity increase that was decided some years ago, because of this current time schedule for the project. So there are still let's say before this 2019 there is about €25 million left for UPM from the sort of equity injection.

But in terms of P&L and operating cash flow that will be in 2019 based on the schedule of commercial start up at the end of next year.

And given today's market environment and pricing and so forth, how will that affect your EBIT in your Energy division?

Well let's say in principle terms perhaps you remember the way the model works with TVO and this so-called [indiscernible] is that the electricity that is generated then is so old to shareholders at full cost, which means that also the capital costs are covered and obviously then in the first years the capital costs will be the highest and higher so in that sense if you look at whether forward curves are currently then for circular the three of the full cost probably during the first years will be higher than that. But let's say there's no more detail to share on that at the moment.

And even from I mean - thank you very much and even if you look from a cash flow point of view, how would you answer the same question from a cash flow point of view?

I would say the same answer.

Excellent, good. Thank you very much.

That's very helpful.

Gentlemen thank you for your interest and have a very nice day. Thank you.

Bye now.