UPM-Kymmene Oyj

Dear audience, welcome to UPM's quarter 1 2019 result webcast. My name is Jussi Pesonen, I'm the CEO of UPM.

I'm here with our CFO, Tapio Korpeinen.

Hello to everybody.

Ladies and gentlemen, let's move into the summary slide of the conf call. UPM's good performance continued in Q1, in line with our expectations.

Our sales grew by 7%, driven by higher sales prices in almost all businesses and the increased delivery volumes in several businesses. Sales prices increases continued to outweigh the impact of the higher variable costs.

As a result, our comparable EBIT increased by 5% to €374 million. Operating cash flow increased clearly from last year and was €320 million during this quarter.

We had net cash of €5 million in our balance sheet at the end of Q1, even after €495 million of leases were recognized in our balance sheet following the adoption of the new IFRS 16 standard. All in all, this was a good start for the year.

This also is 24th consecutive quarter of earnings growth. Furthermore, we look forward to our transformative prospects that are set to provide with us unique opportunities for significant long-term earnings growth.

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

Thank you, Jussi. Once again, here we have the analysis by driver for the EBIT increase.

And on the left-hand side, you have the year-on-year comparison. Sales prices increased in almost all businesses, Asian fine paper business being the only exception.

And the positive earnings impact was larger than the impact of higher variable costs. Delivery volumes made a small positive contribution to the EBIT increase.

On the right-hand side, you can see the same chart compared sequentially to the fourth quarter in 2018. Our first quarter EBIT came down by €30 million as compared to the fourth quarter.

This decrease was mainly due to a lower fair value increase of the Finnish forest assets. The profitability of the six business areas combined was on the same level as in the fourth quarter.

You can see a clear decrease in fixed costs, a modest increase in variable costs as compared to the fourth quarter. The decrease in fixed costs is mainly seasonal, and the increase in variable cost, also partly seasonal by nature.

The adoption of the IFRS 16 standard had a decreasing impact on variable cost and fixed cost in the first quarter of 2019 and, respectively, an increasing impact on depreciation. On this page, you can see the comparable EBIT development by business area.

Biorefining reported another excellent quarter. Our average pulp price in euros was 6%, higher year-on-year or as compared to the fourth quarter -- compared to fourth quarter, it decreased by 6%.

Pulp, Biofuels and Timber all enjoyed good customer demand and were able to grow delivery volumes, as we had an operationally successful quarter. Communication Papers had a strong quarter as well.

We achieved price increases in all paper grades at the start of the year, and comparable EBIT increased both year-on-year and compared to the fourth quarter last year. This was the best Q1 since the business area was formed and the second best quarter overall despite the continuous decline in market demand.

This clearly shows the results of the consistent work to improve cost competitiveness and to adjust capacity to the profitable customer demand. To ensure long-term success, we continue this work, as the latest news we announced in April, our plan to close down paper machine #10 at the Plattling mill in Germany, which would reduce our coated magazine paper capacity by 155,000 tonnes.

In the Specialty Papers, comparable EBIT decreased clearly from the first quarter last year, but we saw a slight improvement compared to Q4. Here, good demand continued in label paper and release liner businesses.

Destocking appears to be over also in the Asian fine paper markets. Margins are turning, but profitability is still low.

We aim to restore profitability in the business area with cost-efficiency measures, growth projects in the release liner business and with the product development initiatives. At this point, it is also good to note that our two paper businesses have not yet seen any significant cost relief due to the decreased pulp prices, which has taken already place.

There is typically a 2, 3-month lag from a change in pulp market price to a fast change in the two paper businesses. Demand growth continued in the self-adhesive label markets.

Raflatac regained growth momentum in sales and earnings after the challenging last year. Sales prices increased both from the first quarter last year and from the fourth quarter, and deliveries grew compared with the very low comparison base that we had in the first quarter of last year.

To further improve earnings, we started a fixed cost reduction program in March. Energy had a good quarter, supported by increased electricity sales price.

However, our hydropower volumes were still held back by the dry hydrological situation. Plywood maintained healthy margins, compensating for the higher wood costs with the increased prices.

Solid market demand for plywood products continued in the first quarter. Our deliveries decreased from last year due to the timing of LNG tanker projects as well as tighter competition in the birch trading business.

These points we already covered, I believe. So then let's move to the next slide.

And here we see that cash flow were -- as Jussi already mentioned, our operating cash flow increased from last year and reached €320 million. Working capital increased seasonally by €111 million.

And then to our outlook. Our outlook for 2019 is unchanged.

As we discussed 3 months ago, there still are uncertainties related to the macro environment, which may have an impact on the economic growth in the different regions and on UPM's product and raw material markets during the year. However, we expect UPM's business performance to continue at a good level in 2019.

We expect favorable demand to continue for most of our UPM businesses, while demand decline is expected to continue for Communication Papers. In the early part of 2019, pulp prices are expected to be lower, and graphic papers prices are expected to be higher as compared to the fourth quarter of 2018.

Input costs are expected to stabilize after the significant increases seen during 2018. And finally, fair value increases of forest assets are not expected to contribute materially to comparable EBIT in 2019.

And now I will hand it back over to Jussi for an update on our growth prospects.

Thank you, Tapio. Not only we have had a very good performance in the past 3 to 5 years, as Tapio was explaining, we have a solid growth prospects for the future.

In the coming years, UPM seeks significant growth in 3 focus areas, i.e., the pulp business or the fiber -- high-value fiber business, specialty packaging materials and molecular bioproducts. These spearheads have 3 -- all of these 3 have key factors in common.

First, they all have an attractive long-term growth outlook, supported by global megatrends. All of them provide sustainable solution for growing consumer demand.

Second, these are growth areas that have a clear barrier of entry. And finally, UPM really has unique competitive position and valuable know-how and IPR in each.

We are growing in the specialty packaging business, Raflatac, our Specialty Papers, mainly through focused growth projects that we have been reporting, and they will be shown later; the potential new pulp mill in Europe where would be a large growth step for our pulp business, but also for UPM earnings. The molecular businesses, biofuels and biochemicals, could provide a large new growth platform for UPM for the coming years and the gates.

These businesses are all about replacing fossil-based fuels and fossil-based chemicals with much more sustainable drop-in alternatives. If we can do that in a competitive way, the market potential is absolutely huge.

Let's go to Uruguay. In Uruguay, the second preparation phase for the potential new world-class pulp mill is ongoing.

The implementation of the investment agreement between us and the government of Uruguay is currently in a very intensive phase. To give you an update, progress -- a lot of progress has been made in many areas.

The port concession in Montevideo is awarded to UPM in March. The mill engineering design, tendering and the permitting process are proceeding.

The free-trade zone for the mill has been granted and where environmental permitting processes for the port and the mill are in their final stages. And the first construction contract for the railway has been signed.

However, important conditions stated in our investment agreement are not yet to be fulfilled. Those needs to be fulfilled before we actually move on.

If the ongoing second phase is concluded successfully, as we think, we will initiate the regular process of analyzing and preparing an investment decision of the pulp mill project. As you can see, our estimate for the duration of the second preparation phase is unchanged, between 1.5 years to 2 years starting from signing of the investment agreement in November 2017.

Let's then move on into the biomolecular businesses. The preparation is proceeding in our attractive biomolecular businesses as well.

In biochemicals, we are working for making an entry into a chemicals market in the commercial scale. We have now completed the basic engineering of the potential 150,000-tonne biochemicals refinery in Germany.

During the process, our project has attracted interest from alternative places and sites, which, from our perspective, there has been a very good situation. So currently, we are assessing two final alternative industrial parks in Germany, one in Frankfurt and then in Leuna, to select the optimal setup for the facility.

In addition to the site selection, the commercial studies need to be concluded before starting our regular process of analyzing and preparing an investment decision. In biofuels, the Lappeenranta biorefinery has been a success.

In the potential Kotka project, our ambition is to scale up the biofuels business with the next-generation, the higher-level technology in terms of production, product and feedstock. We have completed the environmental impact assessment for the possible 500,000-tonne biofuels refinery in Kotka here in Finland.

Development work is still expected to continue into next year. Page 11 shows our list of focused growth projects.

As you can see, most of them are supporting our growth in the specialty packaging businesses, i.e., Raflatac and Specialty Papers. Ladies and gentlemen, I would like to summarize my presentation by saying that Q1 was the 24th consecutive quarter of earnings growth.

We expect our business performance to continue at a good level in 2019. We have cost competitive measures, capacity adjustments and focused growth projects underway supporting our performance.

And finally, we continue the preparations of our transformative projects. With these projects, we are aiming for significant long-term earnings growth.

Ladies and gentlemen, this was the prepared part of the presentation. Dear operator, we are ready for questions.

I just wanted to start off with the Communication Paper division, which, of course, you are doing quite well. When do we start to get concerned about how seemingly extremely weak demand is?

And yes, I guess, there's various talks about some of the overseas export volumes starting to decline and some exports coming into Europe. Is that something that you're seeing?

And how would you expect pricing? I guess, that's a difficult question to ask, but condition's generally moving as we head into the second half of the current year.

Lars, I guess that this is nothing new. We do have kind of view that the markets are going 5% down as a trend line.

Some other years are having destocking and then somewhat higher decline in the markets that varies where I think from the qualities and crates. But on the other hand, there are quite many exits as well.

If you take LWC, you take fine papers, there will be quite a lot of capacity adjustments coming on. So basically, this is going to be the trend for the coming years, that the trend decline is 5% on average, plus minus.

And then we are trying to kind of play the game based on that, keeping our costs down and running our capacity on that level that we are efficient and making good money. And if you just take the page where we have the Communication Papers long-term profitability, even if the declining markets have been occurring last 10 years, now the profitability last 5 years has been improving.

So our game plan is to keep the profits and play the game based on that fact that we are, yes, making solid good return for our shareholders.

Yes. You certainly are managing that very well.

You mentioned Raflatac that it had been a bit of a drag last year. And when looking at your main competitor, Avery Dennison, they saw a sort of moderation in the Q1 and you were seeing an acceleration.

Why are you seeing the improvement in your business? And what has changed from what you were seeing in 2018?

Basically, you answered yourself. The first quarter of 2018, we lost quite a lot of volumes.

And now you're comparing that to quarter 1 2019 volumes, and therefore, we have been -- if we are looking, our market share of the business, we are pretty much on that level where we were before end of 2017. So basically, now, we are comparing a quarter where we indeed have a tough quarter, which was the Q1 2018.

Therefore, our volume report is somewhat looking more positive.

So there's no particular change in the market, positive or negative? It's a steady market and you gain share?

No, it is actually now we are just highlighting again that we actually did have a quite tough quarter in 2018, first quarter of 2018.

Understood. Final question for me would be, you have, of course, a host of projects, growth projects, as you spoke about.

Your CapEx levels have been comparatively low and targeting growth CapEx for a little while, and you have clearly a very strong balance sheet. When should we see or expect a more material increase in your CapEx?

And what sort of levels, as you start to execute this big project, should we expect per annum?

That is actually very much related to that. I guess, that our -- I don't guess, I know, that our kind of typical CapEx will be on the similar level that it has been year in, year out, around €300 million to €400 million.

And that will not change at all. And then when these projects are then kicking in, when the decisions are made, the kind of order of -- the kind of priority is that, of course, the Uruguay pulp mill is #1 in our minds, and then the biomolecular business is coming thereafter.

But I do not have an allocation of how much of CapEx will be used this year or next year on these transformative investments. So we will guide you more when those decisions are then made.

So the base load is €300 million to €400 million, and then we can make our own assessment, is that what you're saying?

Yes.

I was just wondering about the biochemicals and the biofuels investment in Kotka, whether those projects have been, in fact, postponed, albeit -- when do you expect to make a final decision whether to go ahead with these projects or not? Is it fair to assume 2020 or will it be later on?

I don't think that we do have a guidance for you. I guess, that I was trying to actually, in my speech, to say that the -- when it concerns biochemicals, the basic engineering has been done now, and now we are in the final stage of selecting the site.

And we have done a lot of commercial studies as well before we are ready to move on. In the biofuels, my last sentence was, if I remember correctly, that development work is still expected to continue until next year.

Is that development -- are you ready to comment a bit what -- in terms of biofuels, what that development work is about? Is it...

All kind of technology. It is all kind of raw materials, all kind of things.

Because we are not going to make just a similar plant that we have in Lappeenranta. We are having ambition to put a lot more IPR on it and, therefore, to make even actually more lucrative investment in Kotka.

And in Kotka, as I understand, bio-oil would only be a small part of the raw material base. Is that correct?

Absolutely. It will be multi-feedstock, and there will be new technologies implemented as well.

Good. Then in terms of Specialty Papers, I mean, the fine paper market has been very tough in Asia and especially in China over the past half year.

I think Tapio have called the market bottomed out -- bottoming out at the moment. Are you now seeing increasing prices?

Or is it still stable at a low level? And also, what is the pricing out of the kiln in Raflatac?

Yes. Maybe to comment on the Specialty Papers part.

So there, when it comes to the fine paper market in Asia there, that sort of destocking phase, as we see and feel, it seems to be over. And therefore, in a sense, we see sort of volumes moving positively.

The sort of demand side has been good there. And let's say, of course, both in Asia and, let's say, for the label paper in general, the sort of volume and demand situation has been good as it is.

And this sort of a margin squeeze, as you know, came from the fine paper business in Asia. And there has been some, let's say, modest movement on prices upwards.

As we also mentioned here already, the pulp cost will help, but it's not seen in the bottom line yet. So that is sort of coming.

So those are the reasons why we are sort of seeing that turning of the margins for the specialty paper business.

I think my comment to Raflatac, I need to, once again, disappoint you. We are not commenting any of the future price scenarios and pricing kind of things in this kind of way than talking about the past.

Sorry.

All right. I understand.

I understand. And then just on the pulp market, what is the current dynamics?

What -- first of all, what kind of inventory levels are you running at the moment? What kind of deliveries are you having at the moment?

I guess, almost 50% of, what, 30%, 40% of your sales is to China. So what is your inventory level?

And what is your view of your customers' inventories at the moment?

UPM doesn't have any kind of changed inventories. We are operating with the customers that are long-term relationship.

And therefore, our volumes have been moving quite with a solid base. If you are only looking at the statistics, as you can see, the statistics of the last 2 days, the whole global market is now on one point -- is 1.1% or 1.2% growth comparing that of first quarter of last year.

So basically, there's -- already, we are seeing a growth. How strong it will be remains to be seen.

Stocks, inventory stocks of the suppliers has been going down 3 days, even if they are still on a higher level than that of last year. So basically, that is the situation where we are.

UPM is kind of a different player. We don't use third-party sales at all.

So basically, we have only long-term customer relationships, where it is based on volumes, and then following the market when it comes to pricing.

Sure. And then just finally on -- you have a very strong balance sheet, and it's clear you have a clear investment agenda for the next, what, 5 years.

But are you looking at M&A, potential M&A targets at this stage. My evaluations have, in this industry, come down quite significantly?

Or it's all focused on organic growth at the moment?

At the moment, our focus is clear. It is actually with the spearhead of growth prospects that we have.

But of course, the balance sheet is strong enough for making an M&A if that kind of situation appears. But our focus is clearly on these three areas of specialty packaging materials, high-value fiber and molecular businesses.

A couple of questions here. Just briefly first coming back to Raflatac.

You already talked about that a bit, but as mentioned, you had a quite strong growth there. And the margins went up from Q4 last year, but still lagging on a year-over-year basis.

So going forward, I know you don't want to comment on pricing and your specific volume. But if you talk about the market growth, what would you expect that to be for the labels business?

And also, in terms of your margins, do you expect to see some further recovery there going forward?

Of course, it is related to general economy. What the trend growth globally has been, it has been more than the GDP growth, and that we expect to continue for the reasons that are well-known in the kind of megatrends, whether it's e-commerce or whether it is other things.

So basically, we see a quite solid growth even if -- when the GDP goes down, of course, the demand on that particular moment goes down as well. So basically quite positive outlook for the longer-term, and that's what we do.

On the margin side, we do a lot of things that are related to our costs. So we do run the programs of taking costs down.

And thus, the margin improvement is in our focus on top of that what we do on the markets.

Okay. And then switching to the -- to your Plywood business.

How would you describe the outlook there, both in terms of demand and pricing?

Pricing, unfortunately, we are not commenting the future prices. But the demand outlook is quite solid at this point of time.

But once again, repeating that it is not immune to any other megatrends of the world and the global economy. So far, it has been pretty solid.

We have a quite good market. And then we have a good position, especially in some of the segments like the LNG tankers, even if those volumes have been somewhat lower this year, not because of the kind of global economy, but because of the projects.

A quite solid outlook.

Okay. And then on the paper business, the European paper price in particular, do you see foresee any changes there when you head into the second quarter?

Or is it more or less stable compared to Q1?

Can I repeat again? I'm sorry.

We do not kind of comment any of the future prices, unfortunately.

Okay. Then a final question.

In terms of maintenance costs in the quarter, if you think about Q2 compared to Q1, what kind of delta should we expect to see there?

We have now for -- as is pointed out in the quarterly release, we have, let's say, the normal maintenance as far as Energy business is concerned in Olkiluoto. But then we have the major maintenance shutdown in one of our pulp mills in Kymi this year.

So -- for the second quarter. So I would say you can sort of expect about €35 million impact overall in the second quarter.

Obviously, in the first quarter, we did not have any major maintenance.

Tapio, I wonder if you could just give us a little bit of color on the outlook for the Energy business and the impact from the Olkiluoto 3?

Yes. Well, let's say, to start from the latter part, Olkiluoto 3, as we have, I think, discussed earlier as well.

If you look at where the markets are today or where the sort of the forward curves in terms of pricing are at the moment, the sort of what you have been asking us earlier is what is the impact for the bottom line of our Energy business of Olkiluoto 3 once it starts up, and the answer has been and still is that it will be, let's say, quite a small or not very materially impact as such. So therefore, let's say, this further delay that TVO announced, which is to be sort of more precisely known in June that, as such, directly, everything else being equal, will not have much of an impact on our sort of bottom line.

Whatever it might have as an impact on the market and at the market price, then this is kind of a secondary possible effect, which you have to kind of look at them from the markets, how they react to the news. Otherwise, obviously, let's say what we have seen so far is that the prices have been on a -- sort of an increasing trend, which also, obviously, is seen in our first quarter result than in our average sales price for the first quarter as compared to the first quarter last year.

And in that sense, if you look at the sort of, again, prices going forward in terms of the commodities, and particularly the CO2 price, EUA price, that has been, let's say, volatile, but more on the sort of bullish side lately.

Question is about the new -- sorry, the investment plans in biochemicals and biofuel. And I was wondering if you can help me frame the sort of risk reward profile of these investments.

I understand that the reward can be huge, but also the risk, I guess, is high as well. We're talking about, if I understand correctly, new technology, new processes.

I think I've asked this question in the past in terms of your sort of capital allocation to these projects. I'm trying to understand whether, given the risk reward profile, you're willing to play a sort of small chip on these investments or, indeed, that the risk reward profile is not -- that these projects are not as risky as I might think.

And so you might be willing to invest more, given the financial flexibility you have achieved. So anyway, in general, I'd like to understand a little bit better the risk reward profile and how much capital you're willing to commit.

I guess that it is something that we do all the time. And maybe the best way of explaining how do we think about the risk when Lappeenranta refinery was made.

The final decision was made 2012, and the initiative of the development started 2006. So 6 years later, we made the investment decision of investing a 100,000-tonne facility in Lappeenranta with the new technology to refining crude tall oil, which is a residue of our own pulp process to make high-quality renewable diesel.

And then people were asking this question as well that, what is the risk of not getting into the production and not having the quality or the IPRs are not valid and somebody will challenge you on those IPRs? 2012, we made the decision to invest.

And we were able to do the mill at time, started to operate it 2014, '15. The first operating year was challenging, but the next one, we were already on the nominal capacity, which I think that is remarkable achievement.

Quality was already from the beginning there. And then finally, '16, '17, we made the commercial optimization.

And now the returns of the investments are better than UPM on average if you take the 2018 return on capital employed or EBIT margin, which are 14 point something. This is turning better today.

And therefore, I think that this is maybe the kind of best way of describing, yes, there are risks always, but the UPM way of dealing with the risk is to prepare ourselves into the position that when we take the step, they are firm steps. And that's our way of operating.

And therefore, like the Uruguay, we have been developing almost 7, 8 years to be able to then make a very profitable business. Same happens with the biochemicals, where their first initiative or stake in 2010, if I remember correctly.

And gradually, we are getting there to be secure in the profits. And then now, with the biofuels, it's much easier with the experience that we have, which is, I have to say, that they are surprisingly excellent.

Also, those kind of experiences, we have the IPR, we know the technology. We have been able to utilize the bio -- forest biomass into a product that nobody else has been doing.

So basically, yes, there are always risks at our own technology or in IPR or in product quality. But UPM is making steps that are firm steps.

And therefore, I regard more the opportunities rather than the risk. But it's -- you need to be humble always when you develop this kind of businesses.

But in -- for both projects, are we talking about new technologies for both or it's just for the biochemicals? And the biofuel is more like a development of something that is already existing and commercially proven?

Exactly, right you are, that biofuels we do have a kind of concrete steps. And we will implement some of the technology on top of that.

It is an improvement, right you are, in that respect. And biochemicals is more a new setup of technologies.

Even if the technologies are very commercials technologies, we are not putting too much of unknown technologies. There will be some that will handle the kind of forest biomass into the products that we do.

I say that this is a step when -- and if we are making breakthroughs on this, the entry barrier is enormous for many others.

Two questions for me. First one on with regard to Stora Enso's conversion of coated wood-free at Oulu, is that anything that you can kind of benefit from, from a volume point of view?

Or you're already kind of fully sold out, that it's more about maybe kind of helps balance the market a bit? And then -- and the second question was I saw in the news that Metsä Board might be considering -- or Metsä Fibre considering building a new pulp mill in Finland.

How do you think about kind of the potential that will have for security of supply of wood in your region? And do you think that going forward, you might need to increase your direct ownership of forest?

Or does it work fine with all -- with more of these kind of long-term supply agreements that you have?

I guess that I do not have very many comments, especially on all the conversion. Obviously, it will take quite a lot of capacity out of the fine paper market, which is, if I remember correctly, it is close to 20%, in between 15% and 20% of the total market.

So basically, yes, that will trigger a higher operating rate for the whole business for the time being, when the markets are going down, down 5% of the year. So that's something that will definitely be there.

In Metsä Fibre investment plan, I think that that's a concrete plan that has been there. Our pulp mills are in southern part of Finland and western part of Finland.

So basically, we have no operations in northern part of Finland after Kajaani closure. And therefore, it is not directly on that area.

But of course, it is exceptional volumes that are required on the pulp wood as well in Finland. But basically, our position is a bit different on that.

And I think that we're a long-term operator and having our own way of dealing with that.

Maybe I'll add to your question there that we do own 0.5 million hectares of forest land in Finland. Having said that, given that we here in the Nordic part of the world operate on a different sort of a cycle as far as the growth of forest is concerned than we do in Uruguay.

Therefore, you cannot own such vast areas of forest land that you could rely on your own forest for the majority of your wood for an operator of our size. So let's say, with the full ownership that we have and with the sort of partners that we work with, we're quite comfortable in the Finnish market.

I wonder if you could basically talk a little bit about the midterm prospects for the pulp market. I mean, when we look on potential pulp projects coming on stream between 2021 and potentially 2024, there's actually quite a lot of projects.

And potentially, your Uruguay project would end up there in that same time period. Could you -- I mean, it's a difficult question, but could you elaborate a little bit on how you sort of view this?

Very difficult to really elaborate that even if there would be kind of a willingness to do so because you don't know what are really the real pulp projects. There are plentiful announced ideas, and then only those that are then realizing will be affecting kind of supply side.

We do have a quite solid view on the demand side that it will grow as it has been growing quite steadily the trend growing, with trend growth being in between 2% and 3%. It's absolutely something that we believe on.

But then supply-side is something that you have a lot of ideas, and then only those that are having a financial kind of a solid nest or grounds to be then implemented will be implemented. And there, I do not have any better visibility than you have.

But only after that, that we don't need to be the only pulp project out there. Certainly, there will be others that will come as well, but we believe that the supply-side for wood raw material will, as it has in the past, determine how many of these projects will actually move ahead in which time schedule.

And so from that point of view, even if there will be projects other than ours, we still believe that the demand-supply balance will be healthy.

Ladies and gentlemen, thank you for joining us today, and have a nice weekend.