Smurfit Kappa's Q3 net income up 34.1% year-over-year to €55M, sales up 10% to €1.9B; company cites growing box demand, strong Latin America performance
November 9, 2011
– Smurfit Kappa Group plc (‘SKG’ or the ‘Group’) today announced results for the 3 months and 9 months ending 30 September 2011.
2011 Third Quarter & First Nine Months | Key Financial Performance Measures
EBITDA before Exceptional Items and Share-based Payment (1)
Operating Profit before Exceptional Items
Basic EPS (cent)
Pre-exceptional EPS (cent)
Free Cash Flow (2)
Net Debt to EBITDA (LTM)
Gary McGann, Smurfit Kappa Group CEO, commented: “We are pleased to report a strong EBITDA of €264 million for the third quarter. As expected, our free cash flow generation accelerated in the quarter, delivering further net debt reduction of €82 million in the period, or €189 million in the year-to-date. Lower net debt, combined with continued earnings progress, reduced our net debt to EBITDA ratio to 2.8x at the end of September 2011.
In the third quarter, box demand continued to grow, albeit at a slower pace than in the first half, and higher inventory levels generated some downward pressure on paper prices in Europe. Against that backdrop, our EBITDA margin of 14.1% primarily highlights the increasing efficiency of our integrated model, continued box price recovery, and a sustained strong performance in our Latin American business. Return on capital employed was 12.5% for the third quarter, compared to 8.5% in the prior year.
Over the past four years, we have strengthened our business platform through significant debt paydown and unrelenting cost reduction actions, which will sustain the delivery of strong cash flows and improving returns through the cycle. We are committed to continue building our strong market credentials in the areas of packaging innovation, customer service and sustainability.
In that context, despite softening demand, we expect to deliver a full-year 2011 EBITDA performance in line with current market expectations, and re-affirm our target to reduce net debt to €2.85 billion by the year end.”
About Smurfit Kappa Group
Smurfit Kappa Group is a world leader in paper-based packaging with operations in Europe and Latin America. Smurfit Kappa Group operates in 21 countries in Europe and is the European leader in containerboard, solidboard, corrugated and solidboard packaging and has a key position in several other packaging and paper market segments, including graphicboard and sack paper. Smurfit Kappa Group also has a good base in Eastern Europe and operates in 9 countries in Latin America where it is the only pan-regional operator.
2011 Third Quarter & First Nine Months | Performance Overview
Following €107 million of net debt reduction in the first half of the year, free cash flow generation accelerated in the third quarter as anticipated, allowing the Group to deliver a further €82 million of debt paydown in the period. This strong performance was achieved despite €30 million of adverse currency movements, which primarily resulted from the strengthening of the US dollar against the euro in the quarter.
Since the Group’s IPO in 2007, SKG’s net debt has reduced by approximately €630 million, thereby materially improving its capital structure and financial flexibility. This debt paydown demonstrates SKG’s ability to generate strong cash flows at all points in the cycle.
Compared to the 2% underlying demand growth experienced in the first half, SKG’s European box shipments increased by 1% in the third quarter. The somewhat weaker demand environment, combined with high operating rates through the summer, led to a rise in recycled containerboard inventories in Europe. At the end of August, recycled containerboard inventories in the market were approximately 20% higher than prior year levels. Inventories have remained generally stable since then, primarily due to a number of open-market containerboard players taking commercial downtime.
The higher level of inventory generated downward pressure on European recycled containerboard prices, with indices reporting a decline of approximately €55 per tonne between June and October 2011 (the equivalent of just over 10%). A €30 per tonne reduction in OCC costs in the period was not sufficient to fully offset the paper price decline, thereby leading to margin compression for recycled containerboard producers.
In comparison, SKG’s EBITDA margin of 14.1% in the third quarter highlights the earnings stability of the integrated model, and benefits from the Group’s own actions, with a further 2% rise in box prices, as well as €36 million of cost take-out delivered in the period. SKG’s third quarter earnings were negatively impacted by extended maintenance downtime at the Group’s kraftliner mill in Piteå, Sweden, which reduced its output by approximately 90,000 tonnes.
The Group’s margin in the third quarter also reflects a sustained strong performance in Latin America, resulting in an EBITDA margin of 19.6% in the period. This outcome primarily highlights a good performance from SKG’s operations in Colombia and Venezuela, while earnings in Mexico and Argentina eased compared to the first half run-rate due to weaker local economic conditions.
Through the cycle, SKG’s focus is to generate consistently strong financial returns. This objective is underpinned by the Group’s integrated business model and disciplined capital allocation decisions, which together with a unique broad geographic coverage and superior design capabilities, provides SKG with a particular ability to support its customers in promoting their products through innovative and sustainable packaging solutions.
2011 Third Quarter | Financial Performance
At €1,868 million for the third quarter of 2011, revenue was 10% higher than in the third quarter of 2010. However, allowing for the impact of currency and hyperinflation accounting, as well as acquisitions, disposals and closures, the underlying increase in revenue was €154 million, the equivalent of approximately 9%.
At €264 million, EBITDA in the third quarter of 2011 was €21 million higher than the third quarter of 2010. Allowing for currency and hyperinflation accounting, and for a modest impact from acquisitions, disposals and closures, underlying EBITDA increased year-on-year by €13 million, the equivalent of 5%.
Revenue and EBITDA in the third quarter were stable compared to the second quarter of 2011. However, allowing for the impact of currency and hyperinflation accounting, underlying revenue and EBITDA in the third quarter were €27 million and €7 million lower respectively.
Earnings per share was 22.2 cent for the quarter to September 2011 (2010: 16.9 cent).
2011 First Nine Months | Financial Performance
Revenue of €5,538 million in the first nine months of 2011 represented a 12% increase on the first nine months of 2010. Allowing for the impact of currency and hyperinflation accounting, as well as acquisitions, disposals and closures, revenue shows an underlying year-on-year increase of €619 million (13%).
At €771 million, EBITDA in the first nine months of 2011 was €124 million, or 19% higher than in the comparable period in 2010. Allowing for the impact of currency and hyperinflation accounting, as well as acquisitions, disposals and closures, underlying EBITDA increased by €112 million (17%).
Exceptional items in the first nine months of 2011 amounted to €36 million and almost entirely related to the permanent closure of SKG’s Nanterre mill in France in the second quarter. In the first nine months of 2010, exceptional charges amounted to €56 million, approximately €40 million of which related to the asset swap with Mondi in the second quarter, while the balance related to the currency devaluation and associated hyperinflationary adjustments in Venezuela, which were booked primarily in quarter one.
Adjusting for exceptional charges, pre-exceptional EPS was 69.7 cent in the nine months to September 2011 (2010: 25.1 cent).
2011 Third Quarter & First Nine Months | Free Cash Flow
Compared to the €59 million reported in the first nine months of 2010, the Group’s free cash flow of €195 million in 2011 highlights SKG’s continued focus on maximising cash flow generation for debt paydown. The year-on-year increase in free cash flow primarily reflected a 19% increase in EBITDA as well as lower cash interest expense, somewhat offset by higher capital expenditure.
The working capital move in the first nine months of 2011 was an outflow of €91 million, mainly reflecting improved volumes and higher raw material and end-product prices. In the third quarter the Group generated a €28 million working capital inflow, as reflected in the reduction in its working capital to sales ratio from 9.3% at the half year to 8.9% at the end of September 2011. Additional working capital inflows are expected in the fourth quarter.
Capital expenditure of €196 million in the first nine months of 2011 equated to 75% of depreciation, compared to 53% in the first nine months of 2010. For the full year 2011, SKG’s capital expenditure is expected to increase to approximately 90%.
Cash interest of €183 million in the first nine months of 2011 was €13 million lower than in the first nine months of 2010, primarily reflecting a lower average interest cost year-on-year.
Tax payments of €47 million in the first nine months of 2011 were €7 million lower than in 2010.
2011 Third Quarter & First Nine Months | Capital Structure
The Group’s net debt reduced by €189 million to €2,921 million in the first nine months of 2011, mainly reflecting SKG’s positive free cash flow performance of €195 million, somewhat offset by a deferred payment relating to the disposal of SKG’s loss-making Rol Pin operation in 2010. While currency had a relatively modest impact in the first nine months of the year, in the third quarter the relative strengthening of the US dollar against the euro negatively impacted net debt by €30 million.
Compared to September 2010, net debt at the end of September 2011 was €202 million lower, the equivalent of a 6% reduction. It is worth bearing in mind that this year-on-year reduction in net debt was achieved despite a cumulative working capital outflow of €100 million over the period, generally reflecting higher volumes and prices year-on-year.
The Group’s average debt maturity profile is 4.6 years, with no material maturities before December 2013. In addition, at the end of September 2011 SKG has €692 million of cash on its balance sheet, as well as committed undrawn credit facilities of approximately €525 million.
At the end of September 2011, the Group’s net debt to EBITDA ratio reduced to 2.8x, its lowest level since the Smurfit Kappa merger in 2005. The Group’s main priority for 2011 continues to be one of maximising free cash flow generation for further debt paydown. Reducing net debt levels, combined with strong liquidity, a good maturity profile and diversified funding sources, provide SKG with continuously improving financial flexibility.
2011 Third Quarter & First Nine Months | Operating Efficiency
In addition to its continued focus on cost efficiency and operating excellence, SKG’s margin performance through the cycle is strongly linked to its commitment to provide customers with innovative, sustainable and cost efficient paper-based packaging solutions. SKG will continue to invest to meet and exceed customers’ requirements.
To support customers and retailers increasing demands for high-quality printed packaging, in 2011 the Group finalised investment programmes of over €25 million in new printing equipment. Projects included the installation of state of the art 5-colour printing capacity in the Group’s Italian packaging operations, a new 6-colour flexo folder gluer in its German operation, as well as offset printing capacity in Belgium and the Czech Republic. Those investments significantly enhance SKG’s offering to the local value-added packaging markets.
In 2011, SKG also finalised a 3-year modernisation programme in its corrugated plant in Pruszkow, Poland. This initiative is part of a broader €30 million investment programme for Poland, and demonstrates the Group’s commitment to follow its customers’ developments and grow its market share in Eastern Europe.
The Group’s efforts to enhance its innovation and service capabilities are being recognised by the market. For example, in September 2011 SKG won two awards from the German print association, in a competition that included over 300 packaging designs from 90 different companies. In addition, six SKG companies across Europe and Latin America have been short-listed for the annual Pulp & Paper Industry (‘PPI’) Awards, to be decided in November, including three in the area of environment and sustainability.
Overall, the Group is particularly well equipped to provide industry leading customer service, supported by its unique geographical footprint, its superior design capabilities and its broad-based product offering. In 2011, these attributes resulted in SKG winning significant incremental business from key multinational Fast Moving Consumer Goods (‘FMCG’) customers.
Corporate Social Responsibility (‘CSR’)
In its fourth annual sustainability report, released during the third quarter of 2011, SKG highlighted its continued progress and commitment to social and environmental best practices and cited tangible evidence of this. A number of sustainability awards were received this year from major customers and institutions.
SKG considers the drive for sustainability to be a key differentiator in the marketplace.
Cost take-out programme
In 2011, SKG commenced a 2-year initiative, with a target to generate €150 million of cost savings by the end of 2012. This programme generated €75 million of cost savings benefits in the first nine months of 2011 (including €36 million in quarter three), which partially mitigated the impact of materially higher input costs year-on-year. The Group is confident of exceeding the target number by the end of 2012.
Reorganisation of Specialties segment
With effect from 1 September, 2011 the Group transferred its Specialties businesses into its existing European Packaging segment. This reorganisation will increase the focus of the Group’s commercial offering, and will create a platform for SKG to become a “one stop shop” for paper-based packaging solutions.
This initiative will also enhance the Group’s overall cost efficiency, and should contribute to improving the margins of its solid, graphic and carton board businesses.
From quarter three 2011 onwards, the segmental reporting for the Group reflects the new organisational structure. Comparative periods have been re-stated to reflect the new structure.
2011 Third Quarter & First Nine Months | Performance Review
Following the 2% underlying demand growth experienced in the first half of 2011, demand for SKG’s corrugated packaging solutions grew by 1% year-on-year in the third quarter. While demand growth in July and August was broadly in line with the first half average, September volumes were flat compared to September 2010. Overall for the first nine months of 2011, SKG’s underlying corrugated volumes were 1.6% higher year-on-year.
As is usual within the Group’s business, it takes three to six months to fully pass through higher containerboard prices to box prices. As a result, box prices continued to recover throughout the first nine months of 2011. The Group’s European box prices in the third quarter were on average 2% higher compared with the second quarter, leading to a cumulative 6.5% corrugated price increase during the first nine months of the year.
Higher box prices, together with the Group’s strong focus on cost efficiency contributed to deliver a European EBITDA margin of 13.6% in the third quarter, despite a generally tougher operating environment, and the extended downtime relating to the recovery boiler rebuild at its Piteå kraftliner mill in Sweden.
At industry level, recycled containerboard inventories rose in August, as most paper producers ran at full capacity during a seasonally weaker month for box demand. The inventory build did not reverse in September as a result of somewhat softer demand, in both domestic and export markets. Higher inventory levels led to a €55 per tonne reduction in European recycled containerboard prices, to an absolute level of €440 per tonne in October.
On the cost side, pressure from European buyers combined with somewhat lower Chinese demand, has led to a €30 per tonne reduction in European OCC prices from June to October. Other variable costs, however, have remained generally stable throughout the third quarter.
Although somewhat mitigating the impact of lower paper prices, the reduction in OCC costs was not sufficient to avoid margin reduction for recycled containerboard producers in the quarter. Sustained margin pressure should inevitably lead less-efficient producers into financial difficulties. In comparison, following the permanent closure of 10 less efficient containerboard mills since 2005, together with significant investments in its “champion” mills, SKG is equipped today with an efficient and fully integrated recycled containerboard system. Its system should allow the Group to outperform in any operating environment.
On the kraftliner side, in the first eight months of 2011, US imports into Europe were 33% higher than in the prior year, although this was somewhat offset by a 7% reduction in imports from other regions. This led to an increase in net imports of approximately 170,000 tonnes in the period. Kraftliner inventories remained relatively stable through the nine months however, reflecting good demand levels in Europe together with material maintenance downtime in the summer, mainly at SKG’s Piteå mill.
However, lower priced US imports have created downward pressure on domestic kraftliner prices, which have declined by approximately €50 per tonne since the beginning of 2011, to a level of approximately €590 per tonne in October.
In the third quarter, Latin American EBITDA of €66 million represented a 19.6% margin on revenue, slightly below the second quarter of 19.9%, but higher than the 17.6% reported in the third quarter of 2010. In the first nine months of 2011, Latin American EBITDA of €177 million represented 23% of the Group’s total.
SKG’s corrugated volumes in Colombia experienced strong year-on-year growth of 6% in the first nine months of 2011, a trend that was sustained through the third quarter. Pricing in the quarter was relatively stable year-on-year however, highlighting moderate inflation in the country, a strong currency and aggressive price action from both domestic and external competitors. Following extensive maintenance downtime at its Cali mill in March, SKG’s earnings grew sequentially in the second and third quarters.
In the Venezuelan market, SKG’s corrugated volumes were 2% lower year-on-year in the first nine months. Continuing high inflation in the country was more than offset by SKG’s cost take-out and operating efficiency actions, as well as by increased pricing. In July, the Venezuelan authorities issued precautionary measures over a further 7,253 hectares of the Group’s forestry land, with a view to acquiring it and converting its use to food production and related activities. Discussions are continuing at local level in an effort to find an optimal solution.
In the first nine months of 2011, SKG’s Mexican EBITDA in US dollar terms was higher than in 2010. Third quarter EBITDA was lower year-on-year however, reflecting a 4% reduction in volumes due to a slower economy, and with lower US containerboard export prices constraining paper and box price initiatives in the Mexican market.
High inflation continues to prevail in Argentina, which is increasingly affecting demand. Due to lower consumer spending power, after a 1% demand growth in the first half, the Group’s corrugated volumes in the country were 8% lower year-on-year in the third quarter. Increased average prices in 2011 compared to 2010 supported good EBITDA growth in the first nine months in US dollar terms.
Despite some country-specific challenges from time to time, the Group believes that the geographic diversity of its business in the Latin American region, together with the proven ability of its local management to drive the business, will continue to deliver a strong performance through the cycle.
The Group's primary sources of liquidity are cash flow from operations and borrowings under the revolving credit facility. The Group's primary uses of cash are for debt service and capital expenditure.
At 30 September 2011 Smurfit Kappa Funding plc had outstanding €217.5 million 7.75% senior subordinated notes due 2015 and US$200 million 7.75% senior subordinated notes due 2015. In addition Smurfit Kappa Treasury Funding Limited had outstanding US$292.3 million 7.50% senior debentures due 2025 and the Group had outstanding €177 million variable funding notes issued under the new €250 million accounts receivable securitisation program maturing in November 2015.
Smurfit Kappa Acquisitions had outstanding €500 million 7.25% senior secured notes due 2017 and €500 million 7.75% senior secured notes due 2019. Smurfit Kappa Acquisitions and certain subsidiaries are also party to a senior credit facility. The senior credit facility comprises a €132 million amortising Tranche A maturing in 2012, an €819 million Tranche B maturing in 2013 and an €817 million Tranche C maturing in 2014. In addition, as at 30 September 2011, the facility includes a €525 million revolving credit facility, none of which was drawn.
Market Risk and Risk Management Policies
The Group is exposed to the impact of interest rate changes and foreign currency fluctuations due to its investing and funding activities and its operations in different foreign currencies. Interest rate risk exposure is managed by achieving an appropriate balance of fixed and variable rate funding. At 30 September 2011 the Group had fixed an average of 77% of its interest cost on borrowings over the following twelve months.
Our fixed rate debt comprised mainly €500 million 7.25% senior secured notes due 2017, €500 million 7.75% senior secured notes due 2019, €217.5 million 7.75% senior subordinated notes due 2015, US$200 million 7.75% senior subordinated notes due 2015 and US$292.3 million 7.50% senior debentures due 2025. In addition the Group also has €1,110 million in interest rate swaps with maturity dates ranging from April 2012 to July 2014.
Our earnings are affected by changes in short-term interest rates as a result of our floating rate borrowings. If LIBOR interest rates for these borrowings increase by one percent, our interest expense would increase, and income before taxes would decrease, by approximately €10 million over the following twelve months. Interest income on our cash balances would increase by approximately €7 million assuming a one percent increase in interest rates earned on such balances over the following twelve months.
The Group uses foreign currency borrowings, currency swaps, options and forward contracts in the management of its foreign currency exposures.
Industry Intelligence Editor's Note: In an omitted table, Smurfit Kappa reported Q3 net income of €55 million. For the same period a year ago, the company recorded net income of €41 million.