MONDF - Mondi plc (MONDF) Q4 2022 Earnings Call Transcript

Mondi plc (MONDF)

Q4 2022 Results Conference Call

February 23, 2023 04:00 AM ET

Company Participants

Andrew King - Chief Executive Officer

Mike Powell - Chief Financial Officer

Conference Call Participants

Lars Kjellberg - Crédit Suisse

Cole Hathorn - Jefferies

Justin ordan - Davy Research

Joffrey Meller - Bank of America

Brian Morgan - Morgan Stanley

Andrew Jones - UBS

David O'Brien - Goodbody

Presentation

Andrew King

Good morning, all, and welcome to the Mondi Full Year 2022 Results Presentation. I'm Andrew King, your Group CEO, and I'm joined by Mike Powell, our CFO. I will be providing some highlights of the year before passing on to Mike for an overview of our financial performance. I will then give you an update on Mondi's operating performance and wrap up with our strategic positioning. After that, Mike and I look forward to taking your questions.

However, before we get going, I would like to take a moment to reflect on the tragic events affecting two of the countries where we have operations. Firstly, the ongoing war in Ukraine. Tomorrow marks the first anniversary of the Russian invasion of Ukraine. Beyond the devastating humanitarian tragedy that continues to unfold, the geopolitical ramifications are profound.

Our thoughts remain with the people of the Ukraine and all others impacted and we continue to urge a peaceful resolution. We remain in regular contact with our colleagues in our paper bag plant near Lviv, which continues to operate, a testament to the courage and commitment of the team. I also extend my thanks to our colleagues from the surrounding countries that are continuing to offer their support.

I would also like to acknowledge the tragic situation in Turkey following the recent earthquakes. As you all know, we have 12 plants in Turkey, including one in a Adana, near the epicenter of the earthquakes. I'm relieved that all of our people and their close families are safe, although many have been left homeless. Again, thanks to the commitment and bravery of our people, all our facilities in Turkey are currently operational. We are providing support at various levels, including donating our corrugated boxes to local relief efforts and providing funding through the UN World Food Programme, with whom we have an existing partnership. Our thoughts go to all our colleagues in Turkey as they deal with this unimaginable tragedy.

Returning then to our performance in 2022, and I'm pleased to report that despite all these headwinds, it was another strong year for Mondi. As Mike will explain shortly in more detail, we delivered strongly on all financial metrics, supported by our excellent operational performance in what was a very challenging environment. Importantly, we continue to make good progress on our sustainability journey with sustainability now truly embedded in all we do as an organization. I must again thank all our people for their resilience, commitment and agility in delivering such a strong performance in the face of the many challenges posed by macroeconomic uncertainties, the geopolitical turmoil and natural disasters.

Importantly, we also continue to develop the business for the future. We have made organizational changes, are accelerating cross-functional innovation in our unique portfolio of sustainable packaging solutions and investing in support of the growth we see in our markets. This is of course facilitated by a strong balance sheet and through-cycle cash generation. I remain very excited by the growth options available to the Group.

I'll now hand over to Mike to take us through the finances in more detail.

Mike Powell

Thanks, Andrew, and good morning. Let me take you through the Group's continuing results. And to be clear, all the numbers that I talk to exclude Russia. Russia, as most will be aware, is separated out in the accounts and shown as discontinued and held for sale.

It's clear we had a great year. We have delivered strong results across all metrics, financials seen here and non-financials seen later in the slide deck, all reflect our employees working with our customers, suppliers and other stakeholders to drive the long-term strategy forward whilst delivering in the short-term. These metrics give the board confidence to propose a final dividend of €0.4833 per share, meaning that the full year dividend of €0.70 per share is up 8%.

Here you see the progress on EBITDA, and Andrew will give you a little more color by business units in a few minutes. On the left-hand side, you see the financial year '21 results of €1,157 million. And on the right-hand side, showing this year's actual of €1,848 million. Let us not forget it was a year that started with supply chains in turmoil, then the war in Ukraine, all alongside inflation levels not experienced in a generation.

The sheer scale of the selling price and the input cost bars have not been seen before, reflecting the challenging environment, yet confirming how well the business reacted in this volatile setting. Owning well-invested assets that are at the low point on the cost curve, driving operational excellence through experienced, talented employees and making products that customers desire remains key and delivers for the Group in all business environments.

So taking the bars in turn, selling prices were up across all business units and more than offset input costs as our integrated business model helped to manage inflationary pressures and expand margins through price increases. Input costs increased materially across the board and supply chain volatility was well managed. Wood markets tightened throughout the year, impacting both cost and availability, driven by the increasing demand for firewood as an alternative energy source to fossil fuels and reduced supply due to less calamity wood being available and the impact of the sanctions on Russian and Belarusian timber.

Whilst wood prices rose consistently through the year, they are now stabilizing, albeit at high levels, though I would expect to see some softening of wood prices as this year progresses. Energy costs also rose through the year, peaking in Q3 with an easing into Q4, and most recently, both spot and forward curves for natural gas coming down quite markedly. We've seen supply chains normalize towards the end of the financial year and most input cost categories are now showing some sign of pricing softness.

Sales volumes were marginally down, some decreases in the box and UFP businesses and the lost volumes of the disposed PCC business were in the main offset by volume increases in kraft paper and containerboard. Currency gains were predominantly due to the U.S. dollar strengthening. The South Africa forestry fair value gain of €169 million is €176 million movement year-on-year, clearly somewhat higher than the usual €20 million to €60 million that we would normally estimate. And this is unusually high due to the sharp increase in wood prices, particularly in the second half and off a low base of the year before.

The strong cash characteristics continue to be a key quality of the Mondi business. And here, you see the opening net debt position of €1,689 million, then we show the cash generated from the EBITDA, which I have just taken you through. The working capital investment ensured we looked after our customers in volatile times. At year end, stocks were slightly higher than normal, but within our overall working capital 12% to 14% of revenue guidance. Our organic investments remain on track, continue to be well executed. We have leading market positions in growth markets and we will continue to consistently invest behind their potential to deliver value accretion.

Whilst the cash CapEx number is a little lower than I expected in financial year '22, that's only due to the timing of cash flows. I'd expect us to have cash CapEx somewhere in the region of €800 million to €850 million in financial year '23 and again in financial year '24. Tax and interest in line with guidance, interest reflecting the increased cost of funding across the economies, and in particular, Eastern Europe and South Africa. These rate increases appear to have stabilized now and best guess for financial year '23 is somewhat similar for both interest costs and tax.

The dividend payments to shareholders, just over €320 million. And as a reminder, there is no change to our ordinary dividend policy of 2x to 3x cover. The forestry and other column backs out the non-cash items, with the PCC disposal being a good example of portfolio management and capital discipline and really allows us to focus our investments into the sustainable packaging businesses. All that leaves us with a strong balance sheet, levered around 0.5 turn with approximately €1 billion of net debt, which is a good place to be at this point in the cycle. At the year end, the Group had a strong liquidity position of around €1.8 billion, credit ratings remain unchanged and there are no material short-term debt maturities.

So when I said at the beginning of all the numbers exclude Russia, now let me talk briefly about the Russian businesses. In August, we had entered into -- we announced we entered into an agreement to sell our most significant assets in Russia, being the Syktyvkar mill to Augment Investments. And in December, we announced an agreement with Gotek Group for the sale of our three Russian converting operations. Upon conclusion of these two transactions, we will have completed our exit from Russia. The regulatory approval process for the two separate transactions is ongoing and we're awaiting the buyers obtaining the required regulatory approvals. And as such, there is no new news. As soon as there is, we will of course inform the market.

Our capital allocation framework and discipline has not changed. We can invest organically and deliver ordinary dividends. M&A opportunities in line with core strategy continue to be evaluated and opportunities may well increase in the current economic climate. As ever, if we believe we have surplus capital, we'll distribute that capital back to shareholders on a timely basis, all of that whilst retaining a strong balance sheet with investment-grade credit metrics.

So let me wrap up. We have a strong financial performance, good progress with expansionary investments into growth markets and continued good cash generation with a strong balance sheet that provides strategic flexibility.

With that, I'll hand back to Andrew.

Andrew King

Thanks, Mike. I'll now take you through the business unit performance before coming to some thoughts on our strategy delivery. Going first then to Corrugated Packaging, as you can see, we delivered a very strong performance, underlying EBITDA up 22% and ROCE at over 25%. While we saw materially higher costs, as Mike has already referred to, we were able to offset -- more than offset these with significant price increases.

Following a stable first half, industry demand was down on the prior year in the second half impacted by the macroeconomic slowdown and reduced consumer confidence. However, pricing was supported by the sharp rise and steepening of the industry cost curve due primarily to the surging energy costs. We were able to mitigate these cost pressures, thanks to our high levels of backward integration into biomass energy and general operational efficiencies, delivering the significant margin expansion you see.

Into the fourth quarter, lower input costs for the unintegrated recycled containerboard producers did see an erosion in this cost support, leading to pricing pressures across our range of containerboard grades from the highs that were seen towards the end of Q3. This has continued into early 2023, exacerbated as we see it by supply chain destocking. In the short-term, we are likely to see some margin pressures, particularly as wood costs remain at elevated levels.

As Mike did already mentioned, however, we do expect wood costs to reduce as demand for wood as an energy source declines. Similarly, on the demand side for Corrugated, the current period of destocking will come to an end and we remain very confident in the long-term structural growth drivers. As we said before, Mondi's Corrugated Packaging business does remain very well positioned with leading positions in structurally growing markets, supported by our highly cost competitive production base.

If I then go into Flexible Packaging, as you can see, we also delivered a very strong performance here with EBITDA up 41% and ROCE just under 21%. Again, we achieved volume growth here in kraft paper, supported by our recent investments, while volumes were stable to moderately positive in our converting businesses despite the softer macroeconomic backdrop. Our consumer packaging offering does remain extremely resilient, serving mainly consumer in non-durable end markets with primary packaging. Our paper bags business continues to benefit from new demand sources such as e-commerce packaging, in addition to market share gains in the traditional industrial applications given our extensive plant network and leading quality and service proposition.

We were able to achieve significant price increases across all segments, allowing for margin expansion despite the material input cost pressures. Good demand in the first half, coupled with industry supply disruptions in kraft paper, mainly as a consequence of the Russian volumes being sanctioned, supported these very strong price gains. Demand started to soften in the second half, exacerbated again by destocking, leading to pricing pressure in some markets in early 2023.

Overall, Mondi's Flexible Packaging business remains uniquely positioned to benefit from long-term growth drivers around the demand for sustainable packaging solutions. Coupled with our global leading production and distribution footprint, ongoing investment program and deep technical expertise, the business again remains very well positioned for future growth.

Coming then on to our Fine Paper business, I'm very pleased to report a strong recovery in this business. The successful ramp up of our Richards Bay facility following the major recovery boiler rebuild project was evident in much stronger performance from our South African operations in particular. Our European business also benefited from significantly higher prices and good operational performance, more than offsetting the generally higher cost base. As Mike has already explained, the numbers did benefit from a significant forest fair value gain, although this does reflect the value inherent in our forestry holdings, which provide a hedge against the sharp rise in global timber prices.

Uncoated Fine Paper volumes were impacted by production problems in South Africa in the second quarter following extensive flooding of our Merebank facility as well as selected downtime in our European operations in the second half in response to a generally weaker trading environment. Going into 2023, with less cost support and ongoing demand softness, we are seeing some price weakness in European markets, while pricing in Southern Africa remains stable.

Mondi strategy in Uncoated Fine Paper remains consistent, which is to be the supplier of choice in the two regional markets we serve of Southern Africa and Central Europe. We continue to invest in our mill infrastructure to maintain the competitiveness of these assets, while also seeking opportunities to expand their capabilities in support of our plans to continue growing in our chosen packaging markets.

Coming then on to some more thoughts on our key strategic priorities. Firstly, I think it's really important to remind everyone that our focus for growth remains very clearly in our two packaging verticals, Corrugated and Flexibles. Currently, we generate over 80% of our revenues from these segments. And I would expect this to increase as we continue to invest for growth. Within these verticals, we enjoy strong market positions across the value chain from our strength in upstream containerboard and kraft paper production to our leading positions in our chosen markets in converting.

Importantly, these segments offer both structural growth, supported by trends such as the growth of e-commerce and sustainable packaging and resilience. Around 80% of Corrugated is used in consumer applications with a significant proportion of this being in non-durables such as food and beverage. In Flexibles, around half of our portfolio is directly exposed to consumer end users, mainly in primary retail packaging that you find on the supermarket shelves. This proportion is also likely to grow as we find increasing demand in consumer applications for our paper-based packaging. I'll come on to some recent examples of successes in this area later in the presentation.

We of course have been and will continue to support this growth in our packaging business with investment. As you can see from this slide, over the past five years, our net investment of over €1.3 billion has been focused almost solely on these businesses. Although we will continue to invest appropriately in our Uncoated Fine Paper business to remain competitive, the lion's share of Mondi's future expansion investment program will continue to be directed to our packaging businesses.

We're also prepared to exit businesses that do not fit our growth strategy. At the half year, we reported that we successfully completed the sale of the Personal Care Components business for an enterprise value of €615 million. As Mike already said, this simplifies our portfolio and allows us to focus our efforts and resources on growing in our chosen packaging markets.

Looking to our future capital investment pipeline, what I really like about it is that it touches all aspects of our packaging businesses, providing diversification and further increasing the optionality inherent in our business. I won't provide a recap on all the projects we have underway, but suffice to say that they all look to leverage the value drivers we believe are key to success in our markets. As an example, we are investing €400 million in a new paper machine at our flagship kraft paper mill in Steti in the Czech Republic. This will enable us to produce an extra 210,000 tons of highly cost competitive kraft paper to meet the growing demand for sustainable paper-based packaging solutions, leveraging the existing infrastructure and know-how of this world class facility.

Similarly, the expansion of our converting facilities touches a number of different end markets and increases our distinct strengths in vertical integration, while also leveraging the existing plant network. We continue to guide to mid-teen returns on our expansion in CapEx when in full operation. As again, Mike has already indicated, we see consistent investment in our business on a through-cycle basis as a key pillar of our investment story that will continue to drive significant value-enhancing growth.

Coming then to some of our products, and we are seeing exciting opportunities to develop innovative new solutions to meet our customers' sustainability goals and drive the transition to a circular economy. I want to explain in broad terms how we support our customers on this journey before sharing some recent success stories with you.

Our focus is on taking packaging that is not recyclable or could be made more sustainable in other ways and then working with our customers to find the most appropriate solutions using our philosophy of paper where possible and plastic when useful. We recognize that there are many CapEx trade-offs when making this transition from functionality and cost through to things like the adaptability of current production lines. And of course, the brand appeal of the product we are helping our customers to sell.

We discussed these trade-offs with our customers in an open and collaborative way using tools such as our life cycle analysis and product prototypes to validate our recommendations. Given our unique platform of paper, plastic and hybrid solutions, we believe we are well placed to be that single source of truth for our customers as they seek to make more sustainable choices.

Turning then to some of our recent examples. I'll select a few of these on the following slides to talk in more detail. On the right of the slide, you can see a great example from our Flexible Packaging where we collaborated with our customer, Fiorini International, to create new fully recycled paper packaging for a premium Italian pasta brand. The innovative design of the bag also includes a transparent, recyclable and biodegradable cellulose window that allows the end user to see the pasta. When rolled out across the full product range, it is estimated that this solution alone will eliminate up to 20 tons of plastic every year.

I then look at some of our hybrid solutions, which combine paper and plastic, but are designed to be fully recyclable in the paper value chain. On the left here, you'll see we partnered to create a clever new paper-based packaging for dishwasher tablets. Using paper-based packaging for these applications has traditionally been challenging as it needs to be sealable, durable and water resistant. Working with records, we were able to create a solution that replaces 75% of the plastic with responsibly sourced paper. The remaining plastic layer is used to strengthen the paper structure and provide the necessary barrier protection to ensure the quality and safety of the product. Once rolled out, it is estimated that the solution will save more than 2,000 tons of plastic every year, which is equivalent to roughly 50 million one-liter bottles.

Finally then some mono-material plastic solutions, which are designed to be fully recyclable in the plastics value chain. On the right of the slide, we have a pet food packaging for a leading Norwegian pet food producer using our mono-material FlexiBag Recyclable solution. FlexiBag Recyclable provides excellent product protection, preserving the pet food, thanks to its high barrier material, but it is also designed for recycling and the solution replaces the previously unrecyclable multi-layer alternative, helping to keep materials in circulation and avoid waste.

I mentioned earlier, hard is the commitment and fortitude of our people that drive the performance of the business. It is only with a diverse, skilled and committed workforce that we will be able to continue to thrive as an organization and deliver our long-term growth objectives. Here are just a few examples of the many initiatives we undertake to support the development of our people in a diverse and inclusive workplace, while most importantly, ensuring their safety and well-being.

Similarly, as I'm sure you've picked up throughout this presentation and in our various communications, sustainability is and remains at the core of our strategy. We have a long and proud track record in driving sustainability initiatives across the organization. Here, we list just a few successes built over many years in our MAP2030 areas of circular-driven solutions created by empowered people taking action on climate.

I'm delighted to report that we continue to make progress in all these measures in 2022 despite the many sometimes competing priorities, such as the cost of living crisis and energy security concerns. While we understand the priorities may shift in the short-term, it is our firm belief that sustainability remains an imperative and will be a key driver of successful organizations into the future.

As such, of course, I'm delighted that we are consistently recognized as a leader in our industry in the field of sustainability. I believe I can say without contradiction that we rate consistently higher than any of our peers across the range of external ratings and recognition bodies. Again, we list here only example of a more high profile and recognized ratings. As a further example of our determination to lead in this area, we are among the first in our industry to get our net zero targets approved by the science-based target initiative aligned to a 1.5 degree scenario.

So to summarize, Mondi is well positioned to drive value-accretive growth sustainably. We delivered a strong performance in 2022. And while we see some short-term headwinds going into 2023, we have conviction in our ability to continue delivering attractive returns. We enjoy leading positions in structurally growing markets with an exciting pipeline of investment projects to drive growth. Our unique portfolio and deep expertise, offering paper where possible and plastic when useful, makes us a trusted partner to our customers in the transition to a circular economy. No one understands the complexities better than we do. And sustainability is firmly embedded in our organization with continued progress made on all key facets of our Mondi Action Plan 2030 roadmap.

With that, I thank you for your attention and hand you over to Mike to facilitate the Q&A.

Question-and-Answer Session

A - Mike Powell

[Operator Instructions] We have the first question. The first question is coming from Lars.

Lars Kjellberg

I just have a couple of questions. You continue to have a really strong performance in your Flexible Packaging business, while Corrugated of course saw a material deterioration in H2. Can you talk a bit what are the different drivers there? What really makes one tick and the other one not so much? And what are you seeing in the near to medium term? The next one really comes to the balance of your cost items. Of course, wood costs have been on the rise. You called it already after Q2 and has continued to rise through the year. But how should we put in the perspective other input costs coming down? And ultimately, if you can communicate what your view is on the price over cost relationship for the current year? And the final point, which I'm not sure you can respond to, but it's -- you called out this long stop date, May 12 for the agreement from Augment. Do you have a contingency plan if you get to that long stop date and it's not approved?

Andrew King

Maybe I'll take the first and last questions and Mike can deal with the cost question. I mean, on the -- taking the last first question first. Clearly, our priority is to continue to work with Augment to get the deal over the line. That remains our primary focus. They are working hard to achieve that, and that remains our goal.

On the first question, I think I might take some exception to your comments around the relative performance of the 2. I think our Corrugated business remains an extremely strong franchise. Yes, the second half profitability came under some pressure relative to extremely strong first half performance, but it remains an extremely strong franchise.

I think if you look at the relative performance, Q2 versus Q1 -- sorry, H2 versus H1, which I think is what you're referring to. And clearly, as you well know, our Corrugated business has a long paper position. And of course, there's more virgin paper based. I think what that means is that what -- as you know, what happened over the course of the second half was you saw prices start to come under pressure in the back end of the second half. And of course, that immediately translates into top-line pressure for the open market paper position. Whereas, in our Flexibles business, we have a more integrated position. We have a lot more downstream converting both in the paper side and also obviously the consumer flexibles.

We've always said, as I'm sure you know from history that, that consumer flexibles is a highly resilient business because this is the stuff that makes primary packaging that you find on the supermarket shelf that is used for pet food and human food and all those key household ingredients. So I think that naturally has a huge resilience in a softer economic environment and that is coming through.

And of course, our franchise in kraft paper and bags is extremely strong. We have a global network. And I think very excitingly, we continue to see new demand sources for our products there. I alluded to some of them in the presentation, but obviously, things like the e-commerce applications are growing very strongly there in the mailer bags for e-commerce and other consumer applications for our kraft paper.

So I think that has all contributed to the ongoing resilience there. But I think that shouldn't diminish the quality of the Corrugated business. As you well know, Lars, our focus there is always to be focused on our highly cost competitive upstream assets, supporting a strong integration into the regional markets that we choose to operate and those -- that remains extremely strong franchise. I think it's just the cyclical point that has affected it in the short-term.

And on the wood situation?

Mike Powell

So the wood situation, wood sort of continued to increase through last year, as I said, and into the year end in fact, and this has been pretty stable through January. All other input costs, I mean energy in particular, as I said, peaked Q3. You can see that from the index, it then sort of fell off slowly through Q4 and has fallen off quite markedly since the start of the calendar year. And therefore, the other energy-related input costs, Lars, are also falling not quite as volatile as energy, but the plastics, the chemicals, the transports. Those are the sort of three big categories continue also to soften.

And as we have also said, we'd expect wood to therefore softened, but maybe a bit delayed compared to the others as the year goes on. I think you then try to sort of relate it to selling prices. I think, as you know, I mean, they don't fall in tandem or go up in tandem. Hence, you saw the good outperformance last year. I think from our perspective, as Andrew said, owning those cost advantaged integrated assets at the low point on the cost curve is exactly where we'll continue to play. And therefore, what happens in the short-term actually doesn't change our mid or long-term strategy and we'll continue to invest through that.

Lars Kjellberg

Just one follow-up, if I may. Just on the wood cost increase versus the other cost easing that you're seeing, if you can provide some sort of net balance of cost deflation versus inflation, just where we sit today in, call it, Tier 1 and H1?

Andrew King

Difficult to tell because the costs are moving all the time. So I mean, I don't want to get into in each cost category for the next six months because we're working hard clearly with our suppliers to take advantage of any price movements down. So we don't have that even six-month visibility, Lars. So I think the trajectory and the momentum that I'll give you is our best call at the moment.

Mike Powell

Next question comes from Cole.

Cole Hathorn

Apologies for that. Just following up on the commentary that you made around demand and destocking. Is there any color you can give us here? I mean, we've seen a lot of destocking in the back end of last year as people kind of rightsize inventory levels and supply chains. I'm just wondering what you're seeing at the start of 2023? Could you give any color by -- into Corrugated as well as into the Flexible packaging businesses? Are we effectively at the end of the destocking cycle into Q1? And any color there would be useful.

And then the second one is on your capital allocation and what you could do with the proceeds from Russia if that comes through. You said you'd return it to shareholders. Is there any decision from either well thought from yourself whether that would be in either special dividends and buybacks?

And then the final question is to focus on the point that you've made on kind of your cost advantage assets. Could you just put that into perspective? I mean, you've invested a lot on energy projects and cost savings over the years. And I mean, I look at your Swiecie mill in Poland, for example, I mean, that is a 1.6 million ton facility, well bigger than 300 million to even 0.5 million ton paper mill that you might see somewhere else. What gives you that kind of cost advantage? How beneficial is that scale and leveraging those wider overhead costs?

Mike Powell

We've captured those. Let me take the Russian net proceeds question first. Cole, our focus is very clearly to get the deal closed, get the net proceeds and then we'll communicate how we get that back to shareholders. What we have been very clear on is that we will repatriate those net proceeds. Andrew?

Andrew King

Cole, on the demand picture, I think it should be recognized that demand -- and I'm talking about industry demand, you can see it in the industry stats that are published across. I mean, obviously, Corrugated is the one -- is the biggest market there. The second half generally was softer if you look at the year-on-year numbers throughout the period. So the softer demand picture is not per se a new phenomenon that just happened at the back end of the year. It was fairly soft throughout the second half of the year. As I say, if you just look at the industry data on a year-on-year basis.

So roughly speaking, we were kind of flat as an industry I think in the first half of the year. And by the time of the end of the year, I think the industry analysts will tell you it's like 3%, 4% down. So it would indicate an acceleration of the sort of softening over the course of the second half. Clearly, what is then also happened is, as I mentioned in the presentation, pricing was held up because of the cost support because you saw a surge in energy costs, which as I said, steepened the cost curve.

As you recall, there was a lot of capacity that was simply taken out of the market at the height of the energy price surges because people couldn't make money at those levels. And that supported pricing. Obviously, pricing then subsequently started to come down as the energy cost support eroded. And that's given rise then to some price erosion. Of course, what happens when people feel that prices are turning is that then that gives rise to destocking because people -- any buyer would say, well, I'd rather wait for the next price reduction than continue to hold stock.

So I think that's accelerated some of this destocking into the -- what was I think started at the back end of last year and has continued into the first quarter. Obviously, it's extremely difficult to predict exactly when all of that starts and finishes, but one suspects it will be the course of the first quarter, at least before you see, call it, an end to that destocking phase. But again, I think we should -- the underlying demand picture remains robust.

Clearly, in the very short-term, you're always going to have some effect of the macroeconomic outlook, and of course, it's anyone's guess where that goes. But all the structural drivers we see and we like around Corrugated remain very much intact and no doubt will shine through as and when both the destocking sort of is behind us and similarly when we get some clarity, I guess, on the macroeconomic situation.

Just in terms of the question on the cost-advantaged assets, yes. I mean, as you know, it's always been our philosophy, particularly in the upstream business and even more specifically, in what -- in the virgin fiber-based businesses that our -- the key focus has to be leveraging those highly cost-advantaged assets. As you say, Swiecie is a, by any standard, a world-class facility, both in terms of its scale, but also its efficiencies, which I think shouldn't be underestimated. I mean, it benchmarks -- as you would imagine, we benchmark religiously across both our own business, but also with the external data. The efficiencies we get there are frankly phenomenal and the team does a fantastic job with really deep expertise in running that mill. In addition, obviously, there's also input cost advantages.

Clearly, the wood situation has impacted the cost base in Swiecie like it has in all the other Central European mills. But what's interesting is obviously Scandinavia, which was a bit late in seeing wood costs go up, those are now going up. I think if anything, the next move I suspect will be down in our wood costs. But at the moment, they remain innovated and that's a factor in the short-term. But these big integrated mills where you have the ability to incrementally expand them, which of course, becomes a bit of a virtuous circle because then you get further economies of scale and the like is -- remains a highly attractive place for us to invest. And that's why you see the bulk of our brownfield or our investment in our capacity expansion is around exactly that, leveraging those world-class facilities.

We're doing an investment in Swiecie, another 50,000-odd tons of highly profitable business. Also, obviously, the biggest step in Steti, which has the same characteristics, which allows us to leverage that with another 200,000 tons of low cost kraft paper production, where of course, we are the global market leader.

Mike Powell

Next question comes from Justin.

Justin Jordan

Firstly, I just want to commend you on what is a phenomenal profitable 2022 given clearly incredible inflationary pressures and global uncertainties. So phenomenally well done in 2022. But clearly, investors analysts were all forward-looking.

So I've got three questions really just regarding 2023. Firstly, on Flexible Packaging. Andrew, in your prepared remarks, you talked about pricing pressure in some of our markets in 2023. Can you just elaborate a little bit on that? What's -- where exactly you're referring to within your end markets?

Secondly, within Uncoated Fine Paper, not a surprise we've clearly seen the volume decline year-over-year. But clearly, you seem to have seen excessive destocking in Q4. And certainly, statistics from Europe roughly backed that up. I'm assuming you're taking further commercial downtime in Austria and Slovakia in that business. And I'm just trying to understand what your plans are for that business in 2023, presumably just more downtime?

And then clearly, we're awaiting what may or may not happen in terms of cash proceeds in Russia. But even despite that, the business has never been in better shape financially. You ended the year with very modest 0.5% net to EBITDA. Have the board given any thoughts to special dividend or buybacks? I remember, clearly, you gave €1 special dividend back in 2018. Is there any thoughts for that in 2023 given the strength of the balance sheet?

Andrew King

I'll take the first two and then Mike will comment on the dividend question. I mean, in terms of pricing pressure in the Flexibles that we referred to, clearly, you always see the pressure in the sort of upstream business first. So what we're referring to there is obviously in the kraft paper business. As you well know, I mean, you would have seen the numbers from the industry data that the pricing held up extremely well through the course of last year.

We got meaningful price increases through the whole of the first half. And thank you for the recognition on the results because I think sometimes people just think price increases just happen. It's thanks to all our people out there who are going proactively to their customers and working with the customers to make these things happen. And we've got a series of price increases through the first half, fairly stable in through the back end of the year. And now we're giving up a little bit of pricing in certain markets as we enter the new year. I mean, this is obviously a market, which is well consolidated, but obviously also, we have a very strong integration offering. And as a consequence, we are very well placed there. But undoubtedly, there is a bit of downward pressure on the kraft paper pricing just at the moment.

On the issue of the UFP positioning, clearly, we're always looking at optimizing the portfolio in terms of the market dynamics relative to our production. And one obviously has to look at the profitability of every ton we send out. And obviously, we want to make sure that we're making money on every ton we produce and sell. We're not in the business of sending out a check with our production.

So clearly, if we see the opportunity, it's better to take downtime as opposed to sell into marginal markets. We will do that. We've always proactively done that. We did do that to some extent particularly in the second half of the year in those European mills you referred to. It's something we would always look to do if we feel that we can't make a decent profit on the production volumes.

On the buyback's question?

Mike Powell

Yes. On the buybacks or capital return, I mean, the board always consider the capital allocation framework and the components. As I said, there's no change to the framework at all, Justin. It is good to have a strong balance sheet at this point in the cycle. That allows us to invest. We haven't touched today particularly in any detail on the investment program, but I have commented that we will continue to invest through-cycle CapEx, €800 million to €850 million, both in FY '23 and '24. And of course that balance sheet allows us the confidence to do that.

I think importantly, in the current climate, we might expect some more M&A opportunities. And clearly, we want to be in a position where we may well be able to take advantage of any of those that come along quickly. And therefore, clearly, if those opportunities don't come along and we believe we move to the last part of that slide that I always show, which is if we believe we do have surplus capital then we'll repatriate that on a timely basis. But clearly, at the moment, we believe having a good balance sheet at this point in the cycle is a good thing.

Next question is Joffrey from Bank of America.

Joffrey Meller

The question actually I have is coming back to your investment program that you just mentioned. Could you remind us the returns you expect on the current CapEx program you announced at the full year results of 2021? And then when do those returns start to materialize in your EBITDA? And when do you expect to see the full run rate of return?

Andrew King

Joffrey, it's Andrew here. I mean, we referenced mid-teen returns at the time beginning of last year I think when we were speaking about a lot of these programs. We remain committed to that sort of return environment. We don't -- when we calculate the return expectations on future CapEx, as you could imagine, we look at it through the cycle basis at these things. We're clearly of the view that those return -- that return guidance remains extremely robust.

In terms of when the contributions come through, I would say, 2023 is a relatively, call it, I don't want to say fellow year, but it's -- the returns are largely coming from optimizing stuff we've already commissioned. For example, the big new machine in Slovakia and various other projects. A lot of the latest -- I mean, the pipeline that we've been working on over the last couple of years will kick in 2024 and beyond. And yes, we remain very confident in the returns there. And this is really targeting growth markets with a highly cost-effective production and that's normally a winning combination.

Mike Powell

Brian Morgan.

Brian Morgan

Can we just go back to the kraft paper business. You're adding quite a bit of capacity at Steti now, just 210,000 tons there. It seems like quite a lot in the context of the kraft paper business, but then you saw 4% demand growth or volume growth in 2022 in what was a pretty soft year. First of all, is that a kind of -- would you regard that as a normal sort of demand growth number in today's context for kraft paper? And then secondly, we have fairly limited visibility of kraft paper because it is a fairly small grade. Just some comments around the outlook for industries with capacity utilizations perhaps over the next two to three years, just to give us a sense of whether it's getting looser or titer?

Andrew King

Yes. I mean, I think we've said in previous presentations that we think on a through-cycle basis this is -- I mean, generally, our Flexibles is more -- is in the sort of 2% to 4% growth range. So I guess, 4% is towards the higher end of that range, which of course, as you say, is encouraging in what has been a less than helpful macroeconomic environment.

Why are these products growing? It's because, as I said earlier, we are in addition to resilience in the traditional end users around the more industrial applications, cement aggregates, building materials, et cetera, we continue to develop out new applications, particularly in the consumer area, in the e-commerce area and the like, which simply didn't exist before. So that's -- and we are very much at the forefront of driving that.

As I said in the presentation, we've also reorganized ourselves to make sure we can really leverage that fantastic platform we have to get into those consumer markets. And there's any number of examples we can provide of the type of new product that we are developing there. So it's a very exciting area for growth for us. I remind you that that 200,000 tonnes, while the machine itself will be dedicated to sack kraft machine, and we have that luxury because we are the biggest converter of sack kraft.

When you -- we will then also be optimizing our other machine parks in our mills to produce 100,000 tons of what we call specialty kraft. So actually, what happens is, net-net, you produce incremental 100,000 tons of sack kraft and 100,000 tons of these different specialties, which is a unique capability we have, again simply because of the extent of our machine park in these different kraft paper applications and our downstream integration and simple knowledge of the converting of the end customer.

It also brings into play our hybrid solutions, which -- where we provide extra barrier properties typically to kraft paper, which integrates that business very closely with our kraft paper offering. So I think there's a fantastic platform there. I mean, we talk about a unique platform in our Flexibles business, I mean, it truly is. And this gives us the opportunity, and of course, the confidence to invest behind it. So I have every confidence that this is a market where we will continue to be at the forefront of where we continue to see good structural growth. And yes, it is a relatively small overall sort of global market, but we're very much at the forefront of it and we're determined to remain at the forefront.

Mike Powell

Next question on the phone is from Andrew Jones at UBS.

Andrew Jones

A couple of questions from me. First of all, just on Russia. I mean, you've given a long stop date in the release of the 12th of May. If you can't reach an agreement or can't get the approval through, what do you consider to be the potential fallback options? And secondly, just on the industrial exposure or construction exposure in Flexible Packaging, just curious about sort of what proportion of revenue derived from the more cyclical elements like specifically construction and industrial uses? But I guess, I can see the pie chart on Page 15 that you've downplayed some of those numbers in the past talking about the proportion of DIY exposure within that building and construction chunk of the pie. So how much of revenue would you consider to be truly cyclical? And how does that break down in terms of the split of EBITDA given I would assume that's a lower margin on average?

Andrew King

I think firstly, Andrew, on the first question, I'll reiterate. I think the question was asked a bit earlier. I mean, our priority remains to work with Augment who we have a deal with to acquire that business. They are working to get the necessary approvals and that is our focus.

In terms of the Flexibles business, I mean, in terms of what is cyclical, what isn't. I mean, you're right in the sense that when we talk about, I'll call it, industrial exposures there, a lot of the European markets is more DIY, home use, et cetera, rather than bulk cement delivery. But of course, it's always a difficult question as to whether how cyclical or otherwise that is. I mean, people also hunker down when they're not feeling wealthy and don't add that extension to their house, but it is a slightly different cycle to, call it, the bulk infrastructure projects.

In our export markets, the non-European markets, that demand is typically much more focused on cement. So North Africa, Middle East, these kind of markets, which are important to us, a lot of those are more dominated by cement. But it's a very difficult thing to say. One is more or less cyclical than the other.

I think what is -- to your question on the relative profitability, it's not true to say that one is more profitable than the other. We have extremely profitable business in our industrial applications. And I think one has to recognize we are the global leader here. We have an extremely strong franchise. We have quite a diversified portfolio in terms of our geographic exposures everywhere from North America, Central America, Middle East, North Africa, Southeast Asia in addition to the core European markets. So you have a lot of geographic diversity in that end use sort of exposures as well.

So yes, I mean, these businesses, just like every other, I mean, people also believe it or not, eat a bit less in difficult times as well. So those applications will also be impacted to some extent by the macroeconomic outlook. But nonetheless, these are all products that people need on a through-cycle basis as I think was amply demonstrated in the COVID period, where of course, a lot of the world closed down, but people still needed our packaging in good quantities. So yes, I mean, there's always an element that will be impacted by the macroeconomic backdrop, but these businesses remain extremely robust.

Mike Powell

I have one question online, which we'll take, and then I'll take one last call from the phone line. So let me Andrew just ask you the online question that's come through is, whether there is any impact from the reopening of China?

Andrew King

Yes. I think that's a very good question. As you know, we don't have a lot of direct exposure to China. I mean, we do sell a bit of pulp into China. That's really the only direct exposure that we have typically had over the years. But having said that, China is of course, a major player in the global markets. As we well know, I mean, there has been a lot of product exported to China either by way of the paper for recycling, the containerboard itself and also some of our other grades like kraft paper as an industry have exported to China. And I think the China reopening has to be a good thing for both for the global economy in terms of the overall stimulus for -- on the macroeconomic growth. And of course, I think for our industry, it's no doubt a positive, but not a direct impact per se on us, but certainly indirect in terms of tightening up global markets for the products we make, which no doubt could have an impact on pricing in due course.

Mike Powell

Last opportunity goes to David O'Brien at Goodbody.

David O'Brien

A lot have been asked, I'll go through them quickly. Firstly, just on the kraft bag business, you talked about pricing pressure. But I think during 2022, you spoke about moving away from annualized contract pricing to shorter term pricing mechanisms. I wonder if I picked that up right or if you can just talk us through that pricing set-up there? And secondly, look, I'm sure you're sorry, you put the long stop date in the statement at all, but I guess, that's the question I'd like to ask. Were you obliged to put the date in or why has it been included in the statement at this stage? And then finally, just on the three slides you put in, in terms of the new products of reducing plastic content or increasing paper packaging. From the customer point of view, is there a material cost difference in the solution that you're providing versus the old products that they were using?

Mike Powell

David, let me close off Russia and then I'll pass over to Andrew. A long stop date in a sale and purchase agreement is a total normal -- totally normal clause to having. So there's nothing particular around this.

Andrew King

And as to why we disclosed it, we believe disclosure is a good thing. So we like to tell you all the facts we have at hand. And in terms of -- just your other questions, in terms of the pricing contracts on the bags, you're right in the sense that -- and this really just applies to that paper-based value chain of kraft paper and paper bags. Historically, there was quite a lot of annual and semi-annual business.

Typically, over time, because the world has been more volatile, I think both from a customer and a supplier perspective, there's been a push to more shorter-dated contracts. So you're correct. In the old days, we would have said it was kind of 1/3, 1/3, 1/3 between spot 6 and 12 months, you'd probably have only 10% of our volume nowadays contracted on an annual basis.

It's partly, as I say, because of shifts in the way the industry has operated and also a shift in the way our portfolio has evolved, because typically, where we've seen a strong growth in those consumer applications. Those are different customer bases, different end users where typically they're not familiar with these longer term contracts. It's more your cement and industrial bags, industrial sort of applications where you had those longer-dated contracts.

Yes, in terms of the question on the sort of cost differential on, call it, the sustainable versus the less sustainable product solutions. Yes, I mean, typically, the incumbent solution has been there for a reason, either because of the functionality and/or cost and/or a combination of those. So in a number of cases, you often have to sacrifice something to achieve a more sustainable outcome.

In some cases, it's the functionality. So for example, the shelf life might be a bit shorter, but do you really need a three-year shelf life for a snack bar or something or would it be a year or 18 months or something be perfectly sufficient, in which case, we can provide a solution which is fully recyclable, but might not have quite the same barrier properties as the product it's replacing.

And yes, in certain cases, it's also -- there's a cost element, it does cost more to have the more sustainable solution. Clearly, over time, as you get volume in the more sustainable option then the cost per unit can come down. And so that makes it progressively easier. And so I think we are very conscious that in the very short-term, you might see the most cost conscious, should we say, customers, the ones who -- where you've got a very low-value product in the packaging.

There might be a concern to shift because they're having to fight to keep their costs down to their end customer. But I think that, to my mind, that is a temporary thing. And of course, on the other hand, people are using the drive for sustainable packaging as a differentiator. And I'm sure you're seeing that a lot in the supermarkets around often more the higher value products or the higher end product ranges and the like. So it's an evolution.

And I think just the last point on that of course is regulatory changes can also have a big impact because if you either regulate out a product, for example, single-use plastic carrier bags or you internalize the true cost of the kind of environmental impact through tax, et cetera, that can accelerate the change to sustainable packaging. So I think we are extremely confident that the trend around sustainable packaging is deeply entrenched even though there might be some cost implications for the customer in the short-term.

Mike Powell

Very good. Listen, thank you all for your ongoing interest interaction. If you have any follow-up, please do come back to us, you know Fiona and myself are please do use all channels as usual. Thanks very much.

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Mondi plc (MONDF) Q4 2022 Earnings Call Transcript