Suzano S.A. Q2 FY2022 Earnings Call

Ladies and gentlemen, thank you for holding, and welcome to Suzano's conference call to discuss the results for the Second Quarter of 2022. Please be aware that any forward-looking statements are based on the beliefs and assumptions of Suzano's management and on information currently available to the company. They involve risks, uncertainties and assumptions because they relate to future events and therefore depend on circumstances that may or may not occur in the future. You should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of Suzano and could cause results to differ materially from those expressed in such forward-looking statements. Now I would like to turn the floor over to the company's CEO. Please, Mr. Walter Schalka, you may proceed.

Good morning, good afternoon, good evening to our colleagues around the world. Welcome to the second quarter results discussions of Suzano. I'm pleased to have with us all the C-level executives in the organization for the Q&A session. Feel free to ask us about anything regarding the company. I have learned in the past that happiness is equal to results minus expectations. I would like to note that despite the reviews from sell-side analysts indicating we are in line with the results, we are very pleased to announce outstanding results. I'm happy to highlight several KPIs of the organization over the last quarter. First, in terms of pulp volumes, we had almost 2.7 million tons of pulp sales. Leo will address this issue in his part of the presentation. On the paper side, we saw excellent volumes, around 290,000 tons. Fabio will share more details on that. We reached BRL 6.3 billion in EBITDA this quarter with an operating cash flow of BRL 5.1 billion. Aires will discuss our efforts as well. Despite facing inflation, we maintained cash costs in line with the previous quarter. Our liquidity position stands at $5.2 billion at this time, supported by a robust balance sheet. Even with dividends paid out and cash returns from our buyback program, net debt remains at BRL 10.5 billion. Our leverage stands at 2.3x. We won’t provide further details on the Cerrado project today, but the good news is that we are on time and on budget, having physical progress at 21%, in line with our expectations. We still forecast commissioning in the second half of 2024. Now I'll pass the floor to Fabio to share our view on the Paper and Packaging business.

Thanks, Walter. Good morning, everyone. Let's turn to the next page of the presentation. Today, I'm glad to share that the Paper and Packaging business unit, through a combination of operational excellence and assertive pricing management, has had its best quarter ever. As we have seen in previous quarters, demand for print and writing papers and carton board has remained solid in both domestic and international markets served by Suzano. However, paper supply has been limited by logistics bottlenecks, imposing continuous operational challenges in shipping, terminal operations, and inland logistics. In most markets, demand recovery has been capped by limited supply for certain paper grades. Moving forward, we continue to see inflationary pressures affecting paper producers' cash costs. Figures for the whole Q2 from the IBA regarding print and writing domestic demand are yet to be published. However, during the first two months of the second quarter, there was a 4.6% decline compared to the same period in 2021, primarily due to a 29% drop in imported paper and a reduction in sales directed to the containerboard market. When considering print and write applications alone, local sales have increased by 11% year-over-year. IBA's public data also shows a 3% decline in paperboard demand in the first two months of Q2 2022 compared to a strong comparison period in 2021. Focusing on Suzano's sales volumes, Q2 performance was 9% higher than the same period last year, achieving record volume for the second quarter. Domestic sales accounted for 68% of total sales in the quarter, totaling 198,000 tons, a 9% increase year-over-year. Although inflation has continued to negatively impact paper costs during the quarter, we successfully managed our prices to more than offset inflation’s effects. Our margins expanded by 2 percentage points year-over-year and quarter-over-quarter. Our average net price during the quarter was 11% higher than in Q1 and 34% higher than the same quarter last year. As a result of strong volumes, pricing, revenue management, and operational stability, our EBITDA reached BRL 633 million, a 52% year-over-year increase and a 20% increase compared to the last quarter. Our Q2 EBITDA and EBITDA per ton are new all-time highs for the Paper and Packaging business unit. Due to strong sales in the first half of 2022, paper inventories have been reduced, and we are currently below our optimal level, a trend expected to persist for the remainder of this year. Looking ahead, our major short-term challenge resides in minimizing the exogenous pressures of inflation while overcoming the continuing logistics disruptions in maritime shipments and ports. On the demand side, the second half of the year is typically the strongest season for paper demand in Brazil, and we continue to see supportive demand for our products in export markets. Lastly, sales from our innovation pipeline have progressed well in the first half of 2022, and we are on track to achieve our goals for this year. Now I will turn it over to Leo, who will present our Pulp business results.

Thanks, Fabio, and good morning, everyone. Let's move to Page 5 of our presentation to discuss the performance of our Pulp business unit for the second quarter of '22, which was marked by record EBITDA. As noted in the left graph, our sales performance was very strong, totaling 2.7 million tons in the second quarter '22. Despite ongoing logistical challenges affecting both international shipping and internal logistics in key regions and markets, our strong performance reflects Suzano's capability to navigate this adverse scenario, taking advantage of our differentiated supply chain setups to ensure effective fulfillment for our customers. Given our inventories remain below optimal operational levels, we continue to refrain from offering volumes to spot markets. The second quarter was characterized by ongoing tightness in the supply and demand balance, largely due to disruptions around the world, including unplanned downtimes and the effects of sanctions on Russian wood, impacting European hardwood pulp production alongside persistent logistics constraints. Consequently, pulp inventories across the chain are trending at low levels, particularly concentrated on softwood pulp, leading to tighter availability for hardwood grades. This scenario continues to present challenges to global paper and paperboard producers, who are also running low on hardwood inventories. Their production figures remained strong and steady throughout the quarter, even amid COVID-related lockdowns in China. The persistent tightness in the supply and demand balance has led us to announce round after round of price increases across all markets throughout the quarter, which were fully implemented without concessions or reductions to our order intake levels. Our average price for export markets rose to $732 per ton during Q2, representing a 15% increase compared to Q1 '22. Given that this price basis does not fully reflect all our price increases during the quarter and considering the lagging invoicing of our order books, it is worth noting that our order intake has been strong in recent months, and lower production figures in Q1 due to planned maintenance downtimes have generated backlogs. The ongoing tight logistics scenario has hindered timely recoveries in deliveries, meaning we are currently approximately 60 days late on invoicing to Asia. Our EBITDA of BRL 5.6 billion, a new record for Q2, was primarily the result of higher invoice volumes and prices, despite foreign exchange appreciation and ongoing cost pressures. Looking ahead, I want to highlight a few points. We continue to observe a scenario of low hardwood inventories throughout the chain, driven primarily by logistic constraints, decreased European hardwood pulp production due to war-related sanctions, and no significant new project introductions expected for 2022. Additionally, there are perpetual risks due to potential unplanned downtimes. Examining the trend of unplanned downtimes, our year-to-date estimates have now reached 1.9 million tons of bleached chemical pulp losses, quite similar to the historic annual figures for '20 and '21. We acknowledge the lowered visibility regarding midterm demand, largely due to macroeconomic developments linked to the conflict between Russia and Ukraine. However, we can firmly state that pulp demand remains robust in Europe and North America, where customers report solid order books for the quarter with pulp purchases and forecasts at elevated or even higher contractual volumes than before. In China, paper productions connected to bleached kraft pulp are expected to maintain solid figures as paper producers gear up for the higher seasonality period of the year while simultaneously recovering paper and board exports. We anticipate a continuation of strong order intake based on recent trends, as the main concern of paper producers globally remains ensuring raw material supply chains, despite rising costs. I will now invite Aires to present our cash cost performance for the quarter.

Thank you, Leo. Good morning, everyone. We are on Slide #6. Cash costs, excluding downtime, in the second quarter stood at BRL 854 per ton, reflecting a 2% decrease from the first quarter, which performed as expected based on previous communications. The primary positive highlight was the increased dilution of fixed costs attributed to the production increase of mills following maintenance downtimes in the first quarter. Average FX appreciation during this period also contributed positively to cash cost performance. Energy sales rose in the second quarter, linked to the higher operational rates of our industrial assets, including a turbo generator at Imperatriz mill reaching full capacity. Looking at the factors that pressured cash costs upward, we observed increases primarily due to longer wood transport distances and rising Brent prices, which affect harvesting and transportation operations. Input costs have also absorbed pressure from higher chemical prices, particularly caustic soda and Brent price impacts on energy consumption, notably natural gas. The commodity price pressure of BRL 44 per ton was partially offset by the higher operational performance. On a year-over-year comparison, cash production cost excluding downtime was 26% higher than Q2 '21 due to well-known and unforeseen inflationary pressures predominantly on commodities, chiefly Brent, impacting both industrial and forest operations and caustic soda costs. While this cost impact was especially offset by shorter average transportation distances and lower shares of third-party wood during this period, increases in fixed costs were spurred by labor costs and maintenance expenses. As we look toward the second half of 2022, we anticipate ongoing pressure on cash production costs due to exogenous inflationary factors primarily connected to commodities, as previously detailed, while also relating to some lagging effects on inventory turnover. This suggests our performance going forward, considering the currently available macroeconomic data, could hover at low single-digit increases over the average of the first half of the year. I will now pass the floor to Marcelo Bacci to continue the presentation.

Thank you, Aires, and good morning, everyone. Moving to Slide 7. We managed to keep our net debt stable at $10.5 million despite significant capital expenditures, acquisitions, dividends, and share buybacks during the quarter. This is a direct result of our strong cash generation. Consequently, leverage decreased to 2.3x, while our liquidity remains solid with $5.2 billion in cash and revolving credit facilities. Our debt schedule is light over the next three years, with an average tenor of seven years, and over 90% of our debt is at fixed rates, insulating us from rising global interest rates. Moving to Page 8, we illustrate progress in our FX protection strategy. The curve today is much steeper than last year, presenting attractive hedging opportunities. We now carry more than $4 billion in operational hedges, with an average put of 5.53 and an average call of 6.55. Additionally, we have a portfolio of Cerrado project hedges approaching $700 million at quarter-end, with an average put of 5.98 and an average call of 7.43. This strategy has led to a cash inflow of BRL 400 million in Q2, considering FX remained below 5 most of the quarter. On Page 9, we are revising our CapEx guidance to BRL 16.1 billion for 2022, reflecting the recently announced Parkia and Caravelas acquisitions, which account for most of the change. There will be ongoing changes in sustaining CapEx, allowing us to make early payments to leverage our solid cash position and decrease financial costs. We are making many discretionary investments to maximize our current situation. We executed BRL 7.1 billion year-to-date and anticipate executing BRL 9 billion in total CapEx during the second half of 2022. On Page 10, we will highlight our advancements in strategic areas, benefiting from this excess cash generation in line with a favorable market scenario. Initiatives include land acquisitions to boost our cash competitiveness over time, an increased share buyback program to 40 million shares, successful execution of the Cerrado project on time and within budget, already achieving 21% completion, the potential new tissue plant in Aracruz to monetize tax credits and deepen our vertical integration, and the launch of Suzano Ventures to support expansion into new markets alongside various other initiatives, all while respecting our financial integrity. Finally, we wanted to emphasize four important points regarding the pulp market. We believe pulp significantly differs from other commodities in four fundamental aspects: first, there is structural demand growth; second, most of our pulp supplies tissue producers, creating a resilient market that endures economic cycles; third, the marginal cost producer of pulp faces significant cost pressures due to inflation, limiting price decline potential; and fourth, pulp price volatility has historically been lower than other commodities, as depicted in the chart. Hence, our decision to enhance the share buyback program is precisely rooted in these fundamentals. With that, we conclude the presentation and open the floor to Q&A.

And our first question comes from Daniel Sasson from Itau BBA.

Congrats on the strong results. My first question is on pulp demand, mainly in Europe. Leo, you mentioned that the backlog for which you have visibility is strong, which is great. But how concerned are you about potential paper capacity shutdowns in the region given that we've read about some tissue producers having to shut down due to rising energy costs in Europe? This is the region where we've seen more resilient demand. So I'd like to know if you are concerned at all or if you see pulp demand from that region weakening ahead. My second question is related to the synchronized global deceleration. The U.S. just reported negative GDP for the second quarter. Europe could struggle with rising energy prices. China is aiming for a GDP growth target that is looking more challenging by the day. Could we potentially see the second half that is slightly weaker than seasonality suggests?

Daniel, this is Leo here. Thank you for your questions. Before diving into demand, let me explain our forecasts and planning for the second half of '22. We always plan considering not just demand but also the supply side of the equation. Initially, during the year’s early months, supply was a critical component we monitored. However, at this point, it is no longer a concern for us, particularly regarding pulp supply. The reason is straightforward: as the year progressed, we have experienced unprecedented downstream circumstances resulting in almost 2 million tons of downtimes year-to-date. This situation created tight market conditions. Coupled with restrictions affecting European pulp production, delayed upcoming projects, and ongoing logistic constraints, supply is expected to stay tight in the coming months. Moreover, price differentials between softwood and hardwood are causing our customers to maximize their hardwood consumption more than historically. Given that the supply side has been the primary concern, demand uncertainty has now taken over as our main variable to monitor, especially due to war-related energy restrictions in Europe and potential recession risks. I’d like to emphasize two points. First, the demand, especially during recessionary periods, is partially or mostly sustained because tissue and essential paper products account for over 60% of hardwood pulp demand, proving to be quite resilient. Second, while gas curtailments pose risks for both demand and supply, we are closely monitoring our customer relationships to ensure effective responses. However, it's noteworthy that gas curtailments not only impact demand but also the production process. Gas is essential for specific processes at pulp mills, so it may also affect production capacities in the upcoming months. For now, as I mentioned earlier, our customers are reporting strong books for Q3, trending at historical highs for purchases, and most of them plan to continue honoring the maximum levels of their purchasing agreements with us.

Our next question comes from Thiago Lofiego, Bradesco BBI.

So I have two questions for Leo. Leo, continuing to look at downside risks for pulp prices, which are definitely at their highest levels now. In the next six to twelve months, you mentioned the 1.9 million tons of unplanned downtimes this year, how much do you think will return in 2023 or in the next 12 months? My second question concerns China resuming paper and board exports. Do you believe this poses a risk to paper production in Europe and subsequently pulp demand in Europe and, of course, pricing?

Thiago, thanks for your question. Addressing the downtime issue, it's quite interesting to see that year-over-year downtimes are on the rise. Historically, these downtimes added up to about 700,000 tons annually; however, in 2021, it peaked at 2 million tons. Right now, we've reached close to this level in about six or seven months. It is challenging to forecast how much of this will surface in the market. As producers grow, each downtime event has a significantly larger impact on market supply than previously observed. Regarding the question on China resuming exports, they have indeed made strides, particularly in print and writing papers and ivory boards. We are monitoring the situation closely, but due to high container and logistic rates, most of this volume is being directed toward other Asian markets, with little impact on European, North American, or South American markets.

That’s clear. If I may add, you mentioned low inventories across the board. There's discussion regarding floating inventories due to logistics issues. Can you share insights into the broader pulp inventory situation?

While examining inventories in producers' and ports' hands, numbers are trending low or, in some cases, below historical levels, particularly in Europe. When we analyze our customer base and paper producers, we understand their stocks also sit low due to logistics delays, meaning some global stock must be on the water. Yet forecasting this is complex. On the other hand, we expect limited return to the market in the short term due to ongoing logistics challenges. Moreover, any logistical improvement will not be widespread and simultaneous across all markets. Thus, we don't foresee any significant relief in the near term as logistics remain tight.

Our next question comes from Leonardo Correa, Banco BTG Pactual.

Yes. My first question is for Bacci. Regarding the buyback, it seems small compared to other companies, but when it was announced in May, there were no expectations. Now I see there are renewed prospects for buybacks. Can we view this buyback program as potentially indefinite due to undervaluation? My second question pertains to the concerns around cash costs experienced by Suzano and the industry. Last quarter, you indicated that cash costs could see a peak and stabilization. With recent commodity price fluctuations, is there a clear path for declines instead, or high levels will be maintained?

Leo speaking. As for the buybacks, we executed approximately 75% of the initial program. We decided to scale it up because we believe it yields some of the most accretive returns based on market fundamentals. We have been generating more cash than anticipated while navigating capital allocation challenges, so we believe the share buyback poses high returns based on our current assessment of the market and pulp fundamentals. This decision combines simply short-term tactics and strategic moves given our robust cash position.

To add to the previous points, given the current macroeconomic context, especially concerning Brent and caustic soda pricing and our wood supply strategy in Mato Grosso do Sul, it will be challenging to forecast significant reductions in cash costs. However, we anticipate a structural reduction over the years as we reduce forest-to-mill distances. We hope for falling prices for Brent and caustic soda, which will facilitate substantial reductions in cash costs in upcoming years. However, for the second half of this year, we expect cash production costs to remain steady, perhaps with a minor single-digit increase.

To summarize, we foresee lower structural cash costs over the long term due to our retrofitting activities enhancing wood supply, but in the short term, fluctuations depend on commodity prices as well as the potential implications of the recession on these commodities.

So just to clarify, you're saying that pulp cash costs will likely stabilize at current levels over the second semester, resulting in 2% to 5% inflation quarter-over-quarter?

Yes, exactly.

Our next question comes from Carlos de Alba, Morgan Stanley.

To confirm, are you saying you expect a lower single-digit increase in costs in the second half compared to the first half? Can you comment on selling expenses, which increased due to supply constraints? What is the outlook for selling expenses for the rest of the year? Also, in light of the current spread prices, do you think the high spread that benefited hardwood consumption is done?

Yes, our average cash cost growth will likely be low single-digit compared to the first half. Regarding selling expenses, the increased selling prices are mainly due to higher bunker costs related to elevated oil prices. As for softwood prices versus hardwood, we have observed increased pressure on consumer markets, and we anticipate that any ongoing price spreads will favor hardwood pulp substitutions.

Regarding product viability during recessionary phases, it's difficult to make direct correlations, especially in relation to tissue demand, where the relationships appear much more resilient than printing paper. Historical observations indicate some tissue demand reduction during downturns, though it recovered quickly the following year. Therefore, since tissue accounts for a significant volume of hardwood pulp clients, we suspect that this durability may cushion the impact of any recession on hardwood demand.

Our next question comes from Rafael Barcellos, Santander.

My first question concerns the new tissue plant that you mentioned, which will be incorporated into your operations in Espirito Santo. Should we anticipate continued integration or even shifts towards niche products such as dissolving pulp? Furthermore, could you outline the main opportunities related to production changes on your footprint? My second question pertains to pulp affordability. Do you believe current pulp price levels will start to undermine demand, representing a real risk to prices in the short term?

Rafael, thank you for your question. Vertical integration is a cornerstone of our long-term strategy. Although this doesn’t mean we plan to implement it across every plant, we’re currently hitting full capacity within our tissue business. We are considering expanding tissue operations, leveraging favorable tax credits in Espirito Santo. Presently, this project is not finalized—including certain precedents such as Board approval—but we project onward movement with investments that will generate value for shareholders.

To address your question on pricing, pulp affordability is a central concern. However, we don’t view pulp as being the only concern for paper producers analyzing their cost structures. Energy-related expenses have taken precedence. Indeed, we've seen sustained price increases for paper in various markets due to heightened costs, predominantly energy. In China, although there have been some fluctuations in prices and margins, larger paper producers still show solid margins owing to prior lower-cost pulp supply dynamics. Importantly, demand should remain steady for essential grades including tissue, as these are inelastic. Should we face higher pulp prices, it might influence certain paper grades but by no means is it expected to lead to significant destruction in tissue, specialty papers, and packaging grades. Overall, we are optimistic regarding demand resilience.

Our next question comes from Caio Ribeiro, Bank of America.

My first question pertains to in-transit pulp inventories. Certain industry consultants estimate that there is around 1 million to 2 million tons of pulp inventory in transit, and once logistics normalize, we might perceive broader supply availability. Is that a potential downside risk for prices ahead? My second question is about forestry asset acquisitions, particularly with your recent transactions with Parkia and Caravelas. Do you foresee additional transactions of this nature? As you assess your forestry asset requirements for the Cerrado project, where does that stand?

Caio, thank you for your question. Regarding the stocks in transit, we acknowledge that longer lead times may create floating stocks. However, we perceive this as a minuscule downside risk to our model. The global availability of breakbulk vessels has not increased, therefore influencing market supply minimally. Even if logistics improves, we don’t expect simultaneous improvements across all markets. Hence, we don’t see significant downside risks from that aspect.

Caio, we have been analyzing opportunities to enlarge or collect our land bases. This focus has already been factored into the CapEx guidance we recently presented.

It's essential to emphasize that the Parkia and Caravelas transactions were reacquisitions of assets that belonged to the company before and were sold due to strategic situations in the past. We merged Fibria and Suzano to regain essential land banks. While we don’t foresee major land buybacks, we do anticipate some opportunities factored into our CapEx to expand our land banking for future needs.

Our next question comes from Marcio Farid, Goldman Sachs.

My first question is for Marcelo Bacci. When analyzing second-quarter numbers, free cash flow after expansionary, maintenance CapEx and buybacks yielded zero, right? It appears the excess cash was directed towards buybacks. Given the company’s solid balance sheet, can we expect excess cash to be deployed for returns, buybacks, or potentially dividends in upcoming quarters? My second question is for Leo. We’ve discussed price realizations in previous quarters, but I suspect investors seek clarification. How should we consider price realizations compared to benchmarks in the upcoming quarters?

Marcio, this is Marcelo speaking. Correct—free cash flow stood at zero primarily attributed to our CapEx activities. We accelerated the Cerrado project and settled the Parkia acquisition, which was an extraordinary expenditure, alongside dividends that impacted cash flow. Moving forward, we expect most excess cash generation to head toward CapEx related to the announced buyback program. Discussions around dividends will revisit 2023. By generating significant cash in Q3 and considering the backlog with favorable pricing, we’ll yield strong results.

As I discussed earlier, our second-quarter pricing has not fully captured all our increases, primarily due to the lags in invoicing order books. We've reported price increases to all markets during the quarter, with full implementations occurring without concessions on order intake. Order intake remains firmly strong, with a backlog from lower Q1 production due to maintenance downtimes, which we are now managing. We’re about 60 days behind invoicing our Asian customers due to logistics. Looking at future price realization, we aim to see improved realization in Q3, as indicated.

Our next question comes from Jon Brandt with HSBC.

Marcelo, could you clarify the BRL 2.6 billion tax benefit recorded this quarter? Is it primarily tied to exchange rate losses? Assuming no major exchange rate fluctuations going forward, how should we anticipate tax rates in future quarters? Secondly, Leo, we have seen pulp volatility increase over the years. How do you foresee this moving forward, especially with Asia growing its market share in pulp? Would you consider locking in long-term prices with longstanding customers to mitigate volatility?

Jon, the BRL 2.6 billion refers to deferred tax assets, which stem from the timing differences between FX variations and their realization during transactions. These are recorded as deferred tax assets, and it’s important to understand that they are not strictly benefits but variations due to timing discrepancies.

As for increased pulp volatility, we recognize the heightened uncertainty present in other commodities. However, pulp showcases resilience observed historically in downturn cycles due to its strong connection with downstream consumer demand. Furthermore, speculative actions manifest in the market; any increased price fluctuations will place added pressures on consumers reliant on pulp. Should customers need pulp, they will inevitably turn to alternative higher market prices as insulating mechanisms. We believe that insight is vital for long-term strategies. Lastly, our existing customer price agreements are being revised, catering to the new pricing dynamics and potentially alleviating volatility moving forward.

As there are no further questions, I would like to turn the floor back over to the company's CEO for final remarks. Please, Mr. Walter Schalka, you may proceed.

Thank you very much for participating in this session. I would like to thank our 17,000 team members as well as the 20,000 indirect employees who contribute to our continuous improvement. We are pleased with our results but recognize the need to work hard to deliver value for our shareholders and stakeholders. Thank you, and have a good day.

This concludes Suzano's conference call for the second quarter results. Have a nice day.