Sateri's profit for full-year 2012 drops to US$55.6M from US$154.7M for full-year 2011; net revenue in 2012 down 10.7% year-over-year to US$720.3M as 26% decline in average selling price undermined 13% increase in sales volume

Debra Garcia

HONG KONG , March 15, 2013 (press release) – The board of directors (“Board”) of Sateri Holdings Limited (“Sateri” or the “Company” or collectively together with its subsidiaries referred to as the “Group”) is pleased to announce the
audited consolidated results of the Group for the year ended 31 December 2012 as follows:

HIGHLIGHTS
• Reduced profitability amidst continuing weak pricing for rayon-grade pulp and viscose
staple fiber in 2012
• Increased penetration into specialty-grade pulp market, although progress slower than
expected
• Continued focus on improving cost competitiveness to maintain Sateri’s position as a
leading, sustainable low-cost global producer of specialty cellulose
• Ongoing progress in execution of our dissolving wood pulp – viscose staple fiber integrated
strategy, including continued investment in our greenfield viscose staple fiber project at
Fujian
• Recommended final dividend of HK2.5 cents per share

MANAGEMENT DISCUSSION AND ANALYSIS

Business Review
Sateri is a leading global specialty cellulose company. The Group produces dissolving wood pulp (“DWP”) at its Bahia Specialty Cellulose (“BSC”) plant in Brazil using wood resources grown from its captive eucalyptus plantations; and viscose staple fiber (“VSF”) in Jiangxi, China using DWP as its main raw material feedstock.

In 2012, market conditions continued to prove challenging and the product pricing environment for rayon-grade pulp and viscose staple fiber remained weak. The rayon-grade pulp industry has experienced a significant wave of new supply since the second half of 2011, coming from new mills, upgrades or conversions. From late 2011, this led to a significant drop in spot market prices as the market needed time to digest the new supply. Spot market prices of rayon-grade pulp declined from the peak of above US$2,600 per metric ton in March 2011, to approximately US$1,100 at the end of 2011, and further to under US$900 at the end of 2012. As a consequence, our profitability was significantly impacted. However, our scale, cost competitiveness and high product quality enabled us to compete effectively in a challenging market environment faced by all rayon-grade pulp producers.

In respect of our specialty-grade pulp products, we saw an increased market penetration, albeit at a slower rate than we expected. Nonetheless, we are fully committed to our ongoing strategy to penetrate further into this segment, due to its lower pricing volatility and superior positioning in the value chain. We have made progress, and we will continue to refine our product quality according to stringent customer specifications in order to enlarge our market share.

In 2012, the average selling prices (“ASP”) for the Group’s rayon-grade DWP and VSF were 38% and 20%, respectively, lower than those achieved in 2011. The ASP for specialty-grade DWP, on the other hand, remained fairly stable.

During the year, the Group continued to focus on improving cost competitiveness to maintain its position as a leading, sustainable low-cost global producer of specialty cellulose. Production volume of DWP and VSF in 2012 increased by 4% and 20%, respectively, whilst sales volume to third party customers increased by 13% and 22%, respectively. Total cost of sales increased modestly by 4% as a result of the Group’s continuing cost control measures.

During the year, the Group continued the ongoing construction of its greenfield VSF project in Fujian, China, which is expected to be operational by the end of 2013, with a design capacity of 200,000 metric tons per annum. Total investment is expected to be approximately RMB3.5 billion (approximately US$550 million), supported by committed project finance facilities of RMB2.0 billion. This will more than double our downstream capacity, further increase the integration between the Group’s upstream and downstream operations, move us towards capacity balance along the viscose-rayon value chain, and position us to capture the long-term demand growth in one of the fastest-growing economies in the world.

On the financing front, on 15 February 2013, the Group completed a US$500 million senior secured trade related facility agreement consisting of a five-year term loan of US$440 million
and a committed revolving credit facility of US$60 million. This demonstrates the strength of the Group’s ability to raise financing even during difficult market conditions.

The Group’s DWP Business segment results comprise rayon-grade pulp and specialty-grade pulp sold to third parties.

Rayon-grade pulp
Rayon-grade pulp is the principal raw material used for the production of VSF. In 2012, China continued to be the largest rayon-grade pulp market by demand and BSC remained its largest offshore supplier by volume, according to RISI (a leading information provider for the global forest products industry), PCI Fibres (a specialist consultancy to the global fibers and related industries) and China Customs data.

The weak pricing environment of the rayon-grade pulp market persisted in 2012. The industry has experienced a significant wave of new supply since the second half of 2011, coming from new mills, upgrades or conversions. From late 2011, this led to a significant drop in spot market prices as the market needed time to digest the new supply. Spot market prices of rayon-grade pulp declined from the peak of above US$2,600 per metric ton in March 2011 to approximately US$1,100 at the end of 2011, and further to under US$900 at the end of 2012.

In spite of current over-supply throughout the rayon-viscose value chain, demand growth for rayongrade pulp continues to be robust. Current world demand for rayon-grade pulp is approximately 4.3 million metric tons annually, which grew by approximately 10% per year from 2010 to 2012, mainly from China, and is estimated to grow at similar rates per year from 2012 to 2014, according to RISI. In 2012, the Group sold 191,646 metric tons of rayon-grade pulp to third parties, an increase of 17% compared to 2011. 143,979 metric tons were sold internally from BSC to Sateri Jiangxi, representing a 44% increase.

A large proportion of the Group’s sales of rayon-grade pulp to third parties are derived from spot, rather than long term contracts. Therefore, the business is inherently more cyclical than the market for the specialty grades. Accordingly, the Group’s strategy is to increase its exposure to the specialty-grade pulp market, and optimize the production and sales mix of rayon grades and specialty grades of pulp in light of prevailing market conditions and customer demand.

Specialty-grade pulp
Specialty-grade pulp is the natural key ingredient of a wide array of everyday use consumer products. Sateri’s products are manufactured to a high degree of purity, and are mostly used for applications such as acetate for cigarette filters and eyeglasses frames, and pharmaceutical tablets and tire cord.

Total global demand for specialty grades is currently approximately 1.5 million metric tons annually and is estimated to grow at 4% to 5% per year from 2012 to 2014, according to RISI.
Barriers of entry into this market are high due to the advanced technological know-how required to produce the high purity products, and the detailed customization required by customers. Market prices of specialty-grade pulp have therefore been more stable and less susceptible to market volatility.

In 2012, the Group sold 97,115 metric tons of specialty-grade DWP, representing a 5% increase from a year ago. The Group’s penetration into this market has been slower than expected.
Nonetheless, we are fully committed to our ongoing strategy to penetrate further into this segment, owing to its more stable pricing, which is also at a significant premium to rayon-grade pulp. We have made progress, and we will continue to refine our product quality according to stringent customer specifications in order to enlarge our market share.

VSF Business
The Group’s VSF Business segment comprises sales of VSF to third parties. VSF, produced from rayon-grade pulp, is a high purity, high absorbent and biodegradable material typically used in a variety of textile products to enhance comfort and add a silky touch and colour brilliance.

Against the backdrop of global macroeconomic weakness and slower economic growth in China, market prices of VSF fell from a record high of US$3,700 per metric ton in March 2011, to
approximately US$2,200 at the end of 2011, and further to approximately US$1,900 by the end of 2012. Realized ASP of VSF for the Group dropped by 20% year-on-year to US$2,059 per metric ton in 2012. This resulted in a 23% drop in gross profit.

Amidst the difficult trading environment, the Group continued to focus on improving its operations, cost competitiveness and product quality so as to enhance its competitive positioning within the VSF industry in China. Access to a captive, low-cost DWP supply from our Brazil mill also gives us a distinct competitive edge over VSF producers who need to acquire feedstock from the spot market. Production volume increased by 20% to 168,383 metric tons and sales volume increased by 22% to 170,634 metric tons.

Rising disposable incomes and the resulting growth in demand for comfortable clothing and absorbent non-woven products make China both the largest producer and largest consumer of VSF in the world. The majority of customers for Sateri’s VSF production are textile manufacturers located in China, South East Asia and Europe. Global demand for VSF grew by 8% per annum in the past decade according to Fiber Organon, a statistical journal published by Fiber Economics Bureau in the United States, and by approximately 15% in China according to China Chemical Fibers and Textiles Consultancy (“CCF”).

The Group’s strategy in the VSF Business segment is to increase integration with the Group’s rayon-grade DWP operations by building a new greenfield VSF plant in Fujian; and also to increase  penetration into the specialty VSF markets, which will further enhance Sateri’s competitive  positioning in the fragmented VSF market.

Future Development Plan
In 2013 and beyond, the Group will continue its strategy to produce and target to sell more  specialty-grade pulp, in view of its lower level of pricing volatility and superior positioning within the value chain. The Group’s strategy is to become one of the global leaders in this market, particularly in the acetate segment.

As part of our DWP-VSF integration strategy, the Group’s greenfield VSF project in Fujian, China is scheduled to be operational by the end of 2013, with a design capacity of 200,000 metric tons per annum. We believe that the inception of this new state-of-the-art VSF mill will not only enable the Group to increase integration with its rayon-grade DWP business, it will also increase the scale and improve the competitive positioning of our VSF business in China, thereby placing us in a good position to capture the long-term demand growth in one of the fastest-growing economies in the world.

Total investment in the Fujian project is expected to be approximately RMB3.5 billion in total (approximately US$550 million), of which RMB2.0 billion will be funded by committed project
finance facilities, including a working capital loan of RMB0.3 billion, and the remainder will be funded by equity. The Group incurred US$107 million capital expenditure on this project in
2012 (2011: US$38 million) and total capital expenditure up to 31 December 2012 amounted to US$152 million. As at 31 December 2012, the Group had approximately US$157 million of capital expenditure contracted but not provided for relating to this project.

The Group will continue to manage dynamically the production and sales mix of its DWP and VSF products in order to optimise profitability from its integrated business platform. We will continue to penetrate into targeted segments for specialty-grade pulp and increase our market share in VSF.

We will also continue to explore the feasibility of further greenfield or brownfield expansions,  particularly at our existing manufacturing locations, and/or acquisition opportunities, if they meet our stringent strategic and financial return targets.

Outlook
Current trading conditions in the rayon-grade pulp market remain challenging. Though we are currently seeing clear improvement in the pricing environment compared to the fourth quarter
of 2012, current spot prices for rayon-grade pulp remain below the average levels achieved for the whole of 2012. Looking forward, continued demand growth should be supported by signs of economic recovery in China and other parts of the world. However, new capacity additions can be expected to exert continuing pressure on the market at least in the near term.

Nonetheless, in spite of the current abundance of supply throughout the rayon-viscose value chain, demand for our products continues to grow strongly. The Group is well-positioned to emerge stronger from the difficult current trading environment owing to its sustainable source of wood supply from its freehold timberland in Brazil and competitive cost structure. The Group is focused on the execution of its business strategy – to further penetrate into the specialty-grade pulp market which has more stable and premium pricing than rayon-grade pulp, and to further integrate its operation in Brazil into its VSF business in China by completing its Fujian VSF plant. We believe this two-prong strategy together with our conservative cash flow and balance sheet management will support the Group’s ability to grow further in future, and deliver attractive long-term shareholder value.

FINANCIAL REVIEW

Consolidated Results
The Group’s total revenue decreased by 11% to US$720 million for the year ended 31 December 2012 from US$807 million in 2011. Total cost of sales increased by 4% to US$500 million from US$484 million. Gross profit decreased by 32% to US$220 million and EBITDA decreased by 31% to US$200 million. Profit attributable to shareholders decreased by 64% to US$56 million from US$155 million, and earnings per share decreased to US 1.6 cents from US 4.5 cents.

The 11% decrease in total revenue was mainly a result of the lower ASP achieved in 2012 whereas the 4% increase in total cost of sales was mainly attributable to an increased proportion of VSF within overall sales. Gross profit margin, therefore, decreased from 40% to 31% and EBITDA margin decreased from 36% to 28%. Net profit margin decreased from 19% to 8%.

Cost of Sales
Cost of sales primarily consists of the cost of planting and harvesting wood, DWP purchased from  third parties for the Group’s VSF business, chemicals, and conversion costs including energy, labor  costs and depreciation.

The Group’s cost of sales increased by 4% to US$500 million for the year ended 31 December 2012 mainly due to an increased proportion of VSF within overall sales, which in turn gave rise to increased input costs such as chemicals and labour costs. The increase was mitigated by reduced conversion costs and a lower amount of dissolving pulp procured from third parties used in the production of VSF as the Group continued to improve its manufacturing processes and operational efficiency.

The Group also benefited from a weaker average exchange rate between the BRL and USD during the year which lowered reported cost of sales. The average exchange rate depreciated by 16% from US$1: BRL1.68 in 2011 to US$1: BRL1.95 in 2012.

Other Profit and Loss Account Items

Selling and Distribution and Administrative Expenses
Selling and distribution expenses increased by 18% to US$61 million for the year ended 31 December 2012, from US$52 million in 2011, mainly due to an increase in sales volume of DWP and VSF by 13% and 22%, respectively. Administrative expenses, by contrast, decreased by 25% as a result of lower professional and consultancy fees, reduced provisions and tighter cost control within all Group companies throughout the year.

Finance Costs
The Group’s finance costs decreased to US$30 million for the year ended 31 December 2012 from US$42 million in 2011 as a result of lower levels of total debt and a tight rein on working capital. The Group commenced repayment of its US$470 million international syndicated loan facility (the “Old Facility”) in the fourth quarter of 2011. In February 2013, the Old Facility was fully repaid and refinanced by a new US$500 million international syndicated loan facility. See “Events after the Balance Sheet Date” for more details.

(Loss)/Gain on Settlement of Derivative Financial Instruments and Decrease in Fair Value of Derivative Financial Instruments
The Group mitigates the currency fluctuations affecting its operations mainly through a hedging program using plain vanilla non-deliverable forward contracts. A small loss of US$1 million
was recorded in the consolidated income statement for settlement of such derivative financial instruments for the year ended 31 December 2012, compared to a gain of US$12 million in 2011.

Effective from 1 July 2012, the Group adopted hedge accounting for its currency hedging risk management program under International Accounting Standards 39 whereby the changes in fair value of derivative financial instruments are recorded in the consolidated statement of changes in equity. As at 31 December 2012, these changes in fair value of derivative instruments amounted to a gain of US$1 million. As at 31 December 2011, these changes in fair value of derivative instruments amounted to a loss of US$31 million and were recorded in the consolidated income statement.

Decrease in Fair Value of Forestation and Reforestation Assets
Fair value of forestation and reforestation assets is estimated using a discounted cash flow model with reference to estimates in growth, harvest, sales prices and costs. The volume of forest harvested and recoverable as estimated by the Group is based on statistical information and data obtained from physical measurements and other information gathering techniques.

The Group assumes a six-year harvest cycle of trees within this model. Such information gathered and data used requires, to a certain extent, estimates and judgments in determining the amount of forest to be harvested and recoverable in the future. If future expectations at any given period end differ from original estimates, the difference will impact the carrying amount of such forestation and reforestation assets in the balance sheet, and be taken in the consolidated income statement in the period.

Revaluation of the Group’s forestation and reforestation assets is conducted semi-annually at each reporting date. The Group recognized a decrease in fair value of forestation and reforestation assets of US$15 million in 2012, compared with a decrease of US$8 million in 2011, due primarily to the prevailing exchange rates of the Brazilian Reais against the US Dollar at the respective year ends.

Income Tax Credit
The Group recorded an income tax credit of US$4 million for the year ended 31 December 2012, compared to a credit of US$7 million in 2011. The Group is subject to taxation at the rates
prevailing in the jurisdictions in which each of the Group’s entities principally operates. The Group enjoys certain tax exemptions and concessions granted by the appropriate competent authorities in Brazil, Macau and Singapore.

Capital Expenditure
The Group continued to exercise careful control over capital expenditure and to constrain expenditure as appropriate during the year.

Overall, the Group incurred US$206 million in capital expenditure for the year ended 31 December 2012, compared to US$188 million in 2011. Of the US$206 million, US$91 million was incurred in Brazil, including US$37 million spent on forestation and reforestation assets, and US$8 million was incurred in Jiangxi.

As set out in “Future Development Plan” above, the Group continued the construction of its new VSF mill in Fujian and incurred US$107 million on this project in 2012 (2011: US$38 million). The Group expects to increase its capital expenditure on the Fujian project significantly prior to its commencement of operation before the end of 2013.

Cash Flow, Liquidity and Financial Position
The Group continues to be adequately capitalized and fully capable of funding its foreseeable capital expenditure requirements with cash flows from operating activities and banking facilities.

As at 31 December 2012, the Group’s cash and cash equivalents (including bank balances and cash and pledged bank deposits) amounted to US$195 million, compared with US$329 million as at 31 December 2011. Net debt as at 31 December 2012 amounted to US$302 million, compared with US$249 million as at 31 December 2011. The Group’s net gearing ratio (which is calculated by dividing (i) long-term and short-term borrowings minus pledged bank deposits, bank balances and cash by (ii) total equity (including non-controlling interests)) was 18% as at 31 December 2012, compared to 15% as at 31 December 2011.

As at 31 December 2012, the Group had total banking facilities available for draw-down of US$528 million.

Operating cash flows before movements in working capital decreased to US$199 million for the year ended 31 December 2012 from US$314 million in 2011, mainly due to the lower operating profit arising from the weak business environment.

Treasury Policies and Risk Management
The Group has a prudent approach towards treasury management and risk management. Most of  the Group’s receipts are in US dollars and Chinese Renminbi. Its main costs are denominated in Brazilian Reais and Chinese Renminbi where it has its main production facilities. As above, its approach to currency risk is to mitigate the currency fluctuations affecting its operations mainly through non-deliverable forward contracts. The Group does not issue any put options.

The Group’s cash is generally placed in short term deposits denominated in US Dollars and Chinese Renminbi. Most of its borrowings are in US Dollars and Chinese Renminbi and largely
carry floating interest rates, except that the Group entered into interest rate swap agreement to swap its floating interest rate into a fixed interest rate for its Old Facility.

Events after the Balance Sheet Date
On 6 February 2013, the Ministry of Commerce of the PRC (“MOFCOM”) announced an antidumping investigation against pulp products imported into the PRC originating from the United
States of America, Canada and Brazil. BSC has been included in the MOFCOM announcement as one of the manufacturers under consideration in the investigation. Please refer to the Company’s announcement dated 14 February 2013 for more details. The Company’s position is that BSC has at all times acted in accordance with all applicable laws, and any allegations of product dumping are entirely without merit.

On 15 February 2013, the Group completed a US$500 million senior secured trade related facility agreement, consisting of a five-year term loan tranche of US$440 million and a committed revolving credit facility of US$60 million. The proceeds were used to prepay the outstanding balance, as at both 31 December 2012 and 15 February 2013, of US$336 million of the Old Facility, as well as for general working capital.

CORPORATE GOVERNANCE
The Company is committed to achieving and maintaining high standards of corporate governance, as the Board believes that good and effective corporate governance practices are key to obtaining and maintaining the trust of our shareholders and other stakeholders, and are essential for encouraging accountability and transparency so as to sustain the success of the Group and to create long-term value for the shareholders of the Company (“Shareholders”).

The roles of the Chairman and Chief Executive Officer are segregated. The Chairman, who is an Independent Non-executive Director, is responsible for leadership of the Board, for ensuring that the Board functions effectively and independently, and for providing expert advice so as to create value for the Shareholders. The Chief Executive Officer is responsible for leading the operations of the Group’s businesses to achieve their business and financial targets, proposing strategies to the Board and ensuring effective implementation of the strategies and policies adopted by the Board.

The Board has established the Audit Committee, the Remuneration Committee, the Nomination Committee and the Executive Committee with written terms of reference approved by the Board. Terms of reference of the above Board committees were made available on the websites of The Stock Exchange of Hong Kong Limited (“Stock Exchange”) and the Company as appropriate. As at the date of this announcement, each of the above Board committees is chaired by an Independent Non-executive Director.

Corporate governance practices adopted by the Company during the year ended 31 December 2012 are in line with those practices set out in the Company’s 2011 Annual Report.

AUDIT COMMITTEE AND REVIEW OF RESULTS
The Audit Committee met four times in 2012 (with a 100% attendance rate) to review with senior management, the Company’s internal auditor and external auditors the Group’s significant internal controls, risk management and financial matters as set out in the Audit Committee’s written terms of reference. The Committee’s review mainly covers the audit plans and findings of the internal auditor and external auditors, external auditors’ independence, appointment of external auditor, the Group’s accounting principles and practices, the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (“Listing Rules”) and statutory compliance, internal controls, risk management, financial reporting matters and the adequacy of resources, qualification and experience of staff of the Group’s accounting and financial reporting function, and their training programs and budget.

The consolidated financial statements of the Company for the year ended 31 December 2012 were audited by Messrs. PricewaterhouseCoopers while those for the year ended 31 December 2011 were audited by Messrs. Deloitte Touche Tohmatsu. The consolidated financial statements of the Company for the years ended 31 December 2012 and 2011 were reviewed by the Audit Committee.

ANNUAL GENERAL MEETING
The AGM will be held on or about 21 May 2013 at 3:00 p.m.. The notice of AGM will be published on the designated websites of the Stock Exchange and the Company and despatched to
the Shareholders in due course.

PUBLICATION OF ANNUAL REPORT
The 2012 annual report will be despatched to the Shareholders and available on the Company’s websites at www.sateri.com, www.irasia.com/listco/hk/sateri and the HKExnews website at  www.hkexnews.hk in April 2013.

By Order of the Board
Sateri Holdings Limited
John Jeffrey Ying
Chairman
Hong Kong, 15 March 2013

Industry Intelligence editor's note: In an omitted table, Sateri reported 2012 profit attributable to owners of the company of US$55.561 million in 2012 and $154.713 million in 2011, and revenue of $720.285 million in 2012 and $806.574 million in 2011.

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