Earnings Call Transcript - SUZ Q3 2022

Fabio Almeida de Oliveira, Executive

Thanks, Walter. Good morning, everyone. Let's turn to Page number 4 on the presentation. Last quarter, we had informed you that the Paper and Packaging business unit has had its best quarter ever. Well, we have done it again. Our well-executed commercial strategy, aligned with a healthy demand for paper products, delivered strong top and bottom line performance with a new best quarter EBITDA for the business unit. As discussed in the previous quarter, demand for print and writing papers and cartonboard has continued to be solid in the domestic and international markets served by Suzano. Latin America, our main export market, has been the growth engine in demand during Q3 with sound growth for both print and writing and paperboard papers. Demand in North America and Europe continues to be resilient with an imbalance on the supply side due to constraints in the supply chain. International logistics have shown signs of improvement at the end of the quarter with better availability of container shipments and lower prices. Raw material and energy inflation continues to pressure the cash cost of paper producers, but integrated producers are still benefiting moving forward. Figures for the whole Q3 from EBA related to print and write domestic demand are yet not published. Considering the first two months of the third quarter when compared to the same period of 2021, the available data shows an 8.5% demand increase, mainly due to the demand for paper linked with the Brazilian National Government Program and the Brazilian general elections. Given the strong demand from mainstream print and write obligations, volumes of uncoated paper sold into the containerboard market were not significant in the quarter. EBA's public data on paperboard demand shows a strong 11.7% increase in the first two months of the third quarter, even when taking into account the same strong comparison period in 2021. Regarding Suzano sales volumes in Q3, they were 2.5% higher when compared to the previous quarter and 2% below when compared to Q3 last year. Despite higher sales volumes in the domestic market on a quarter-over-quarter and year-over-year basis, our export volumes reduced due to supply chain restrictions and lower inventory levels. Domestic sales reached 71% of our total sales in the quarter, totaling 211,000 tons, a 1% increase on a year-over-year basis. Inflation has continued to increase paper costs during the quarter. Still, we managed our prices effectively, successfully offsetting inflation impacts during the period. Our margins have expanded by 6 percentage points on a quarter-over-quarter basis to an all-time high of 43%. Our average net price during the quarter was 13% higher than our average price in Q2 and 43% higher than the same quarter last year. As a result of revenue management and operational stability, our EBITDA has reached BRL 859 million, a 58% increase on a year-over-year basis. Our Q3 EBITDA and EBITDA per ton were also new all-time highs for the Paper and Packaging business unit. As informed during our Q2 conference call, our paper inventories have been reduced, and we are running below our optimum level and should continue to do so for the next months. We don't expect any impact while serving our strategic customers. Looking ahead, we continue to see improvements in International Logistics, which would ease some of the supply imbalance we have seen last year. On the demand side, we expect strong paper demand in Brazil during Q4, and we continue to see supportive demand for our products in our main export markets. Now, I will turn it over to Leo, who will present our Pulp business results.

Leonardo Grimaldi, Executive

Thanks, Fabio, and good morning, everyone. So please let's move to Page 5 of our presentation so that we can address the results of our Pulp business units for the third quarter of 2022, marked by a new record EBITDA for the third quarter. As you can note on the upper left graph, our sales volume was very strong, reaching 2.8 million tons in the third Q '22 with performance exceeding previous quarters, despite the historically lower seasonality period of the year. As a consequence of these positive sales figures, our inventories are still below optimum operational levels, and we kept withdrawing offering volumes to spot markets, therefore focusing on ensuring the effect of supply fulfillment to our customers. This third quarter was marked by a tight supply and demand balance, mainly based on continued supply disruptions, especially in Europe, some of which are weather-related and also due to a lack of birch for hardwood pulp production, as well as the effect of an absence of new volumes in stream from new projects, which, as a result, kept hardwood inventories low globally and throughout the whole chain. Demand and order entry levels for hardwood continued at a good pace during the quarter, which in addition to the low hardwood inventory scenario still places challenges in the management of supply chain for some paper and paperboard producers in order to keep their production rates unaffected. We continued S&D tightness led to new rounds of price increases in all markets in the beginning of the quarter, which were fully implemented and with absolutely no concessions, and price stability was later foreseen during August and September, with no reductions to the planned order intake levels. Coming back to the slide, our average price for export markets has increased to $821 per ton during this third quarter, which is 12% higher than the second Q in U.S. dollar terms and 20% higher in Brazilian real terms. This price still does not capture our full price increases during the quarter, due mainly to existing backlogs of shipping and invoicing to our order books, as we have yet not recovered the timing invoicing to Asia. Our EBITDA of BRL 7.7 billion, a new record for the third quarter, was mainly the result of higher prices and more favorable effects and higher invoice volumes, which led us to a 64% EBITDA margin. Now looking forward, I would like to highlight the following points: we continue seeing an unchanged scenario of low hardwood inventories throughout the chain as a consequence of persisting value-related events and war-related sanctions affecting hardwood production, especially in Europe, as well as no sizable volume from new projects coming into the market up to year-end with no additional tonnage being visibly marketed as we speak. On top of these factors, the planned and announced recovery by the retrofit of Suzano's Aracruz mill, impacting our pulp production in October and November, as well as new unlimited hardwood deliveries by some leading agent producers should constrain pulp availability in the market, keeping the supply side of the S&D balance tight in this next period. Diving deeper into unplanned downtimes in bleached chemical pulp, our new estimates bring us to 2.1 million tons year-to-date, an all-time record. We recognize a lower visibility for future midterm demand due to the macroeconomic environment, most of which is related to the Russia-Ukraine war. However, currently, the demand for pulp continues at strong levels in Europe and in North America, with pulp purchases and forecast trending at normalized set points of our key customers' contractual volumes. We have noticed that some market segments like the core and corrugated packaging have been reporting lower sales forecast, but the furnish of hardwood pulp for them is quite limited, being quickly compensated in other markets, mainly tissue. In China, paper production in segments, which are more related to BHKP, such as tissue, printing and writing, and ivory board, are expected to continue to post solid figures as producers are planning for a higher seasonality period and for the double 11 shopping gala, as well as the healthy recovery of paper exports. To illustrate that, Yicai consultancy reports that for year-to-date September '22 figures, production of tissue, printing and writing, and ivory board in China has increased 7% when compared to the same period of 2021. Due to low inventories of hardwood, China exports, and inland order intake in the region are expected to continue at current levels. Regarding Suzano's order intake, volumes were confirmed at unchanged prices in October. And during this week, we have announced to our customers an unchanged price for November globally with the strong expectation that sales orders will continue to come at current levels, dominated again, by still limited hardwood inventories and availability in major markets. With that said, I would now like to invite Aires to address with you the cash cost performance of the quarter.

Aires Galhardo, Executive

Thank you, Leo. Good morning, everyone. We are on Slide #6. The cash production cost, excluding downtimes in the third quarter, stood at BRL 18 per ton, a slight increase of 3% from the second quarter, coming in line with our operational plan and guidance shared with you on the last earnings call. The book of the hit can expect to on wood costs in turn due to the increase in diesel prices, third-party wood, and the forest-to-mill average distance. On input costs, we are mainly impacted by natural gas and caustic soda prices. The 7% average FX depreciation has also affected us. These effects were partially offset by a higher dilution of fixed costs, thanks to greater operating efficiency of mills and better results from utilities with higher export volumes from Tres Lagoas sites. When analyzing the year-over-year performance, cash production costs increased at a similar rate, as was presented on the last earnings call. The driver mostly came from commodities prices which, as you can see, explain 83% of the total cash cost pressure. Once again, branch-based products—mainly natural gas and diesel used in operations, as well as caustic soda, which is the most important chemical on the cash cost performance—were the highlights. On the positive side, the higher benefit of energy sales was due to improved operational efficiency and higher export volumes from the Imperatriz mill. Looking forward to the fourth quarter, cash production cost excluding downtimes, we currently expect a flattish performance over the last quarter. The downtimes impact on the COGS includes not all of the regular maintenance downtimes of pulp lines, but also the announced temporary shutdown at the same site should be below expectations. Now I pass the floor to Marcelo Bacci to continue the presentation.

Marcelo Bacci, Executive

Thank you, Aires. Good morning, everyone. Let's move to Page 7 and talk about our balance sheet. In the last 12 months, we managed to keep our net debt at a flattish level at $10.7 billion, in a period where we made $2.9 billion of CapEx, including maintenance and also the expansion CapEx. And also in a period where we returned $700 million of cash to our shareholders, including dividends and share buybacks. That was possible due to the $5 billion EBITDA that we generated over the period. That led our leverage ratio to 2.1% with very low concentration of maturities in the next 3 years as a period where the disbursements of the CapEx of the Cerrado project will be concentrated. We continue to have more than 90% of our net debt at fixed rates, which is a significant advantage in this period of increasing interest rates. Moving to the next page, we are announcing a slight change in our hedging policies, increasing the gap between 90% and 110% for the percentage of net debt that we can carry in dollar terms. That will give us more flexibility to take advantage of the increasing interest rates in Brazil. We have also increased the horizon of our cash flow hedges up to 24 months, also to take advantage of the increasing carry in our currency. Considering the old policy, we currently have 66% hedges on cash flow, 55% on the Cerrado project, and we will be working from today on the new limits, therefore changing this percentage for the future. Moving to the following page, we talk about CapEx. We made BRL 4 billion of CapEx in the quarter, very much aligned with our expectations, adding year-to-date, BRL 11.2 billion, and we reaffirmed the guidance for the year at BRL 16.1 billion. On the following page, I will start a new section on capital allocation, where we start by saying that in addition to the dividends already paid into the two share buyback programs that we have already completed, we are announcing a new one for another 20 million shares that can be bought in the coming 18 months. We have already bought close to 6% of our free float, and the new program will allow us to buy up to another 2.9% of the free float. Moving to the following page, a word on the Cerrado project: we continue to have the project on time and on budget, reaching 31% physical progress and 24% financial progress, very much in line with our expectations. With that, I will turn to Luis to continue the capital allocation chapter.

Luis Renato Costa Bueno, Executive

Thank you, Bacci. Good morning, everyone. Let's move to Page 12. We started the tissue business at the end of 2017 with the production of the Mucuri and Imperatriz mills. Throughout these five years, we have made the acquisition of a company focused on North and Northeast regions, enriched our maximum installed capacity in terms of production and sales, boosted by our latest conversion plant installed in Espirit Santo state. During Suzano Day in March, we discussed the trends in the Brazilian tissue market and highlighted the product premiumization and significant room for growth in tissue per capita consumption in Brazil. Just to mention, the domestic consumption is 7 kilos per person per year compared to 14 in Chile and 29 in the U.S. At that time, we also presented the growth optionalities for our business. On the organic side, we announced our intention to build a new tissue plant in Aracruz, still pending approval by our Board of Directors, and we are very happy to announce the acquisition of Kimberly-Clark's tissue business in Brazil. Let's move to the next page, please. This transaction involves both at-home and away-from-home businesses and includes one plant in Mogi das Cruzes with 130,000 tons of production capacity. The intellectual property for the Neve brand and licensing agreements for KC Global Brands are important to mention that this deal will bring complementarity of both product categories and regions. Suzano is focused on the North and Northeast regions, while KC is stronger in the Southeast region. The two operations combined will have a market share of 22%. We are currently focused on the regulatory approval over the next month. And last, but not least, it's worth mentioning that Suzano's financial robustness and discipline will allow this strategic move with no material impact on its financial leverage. We will now open for the Q&A session.

Operator, Operator

Our first question comes from Caio Ribeiro with Bank of America.

Caio Ribeiro, Analyst

So my first question here is on the scenario for Europe versus China, right, for 2023. We keep seeing recessionary fears and pulp demand destruction concerns building in Europe, while pulp demand appears depressed in China, given the continued impact of the Zero COVID policy. So I just wanted to get a sense from you on how you see this playing out in 2023, right? Do you see any potential catalysts that could trigger a recovery in China pulp demand to pre-pandemic levels? And is that enough, right, to compensate for potential demand weakness in Europe, in your view? And then secondly, on the tissue business, right? You recently announced the acquisition of Kimberly-Clark assets in Brazil. Do you see room to continue to consolidate this market further via acquisitions? Or would you now shift gears and focus on growth more via greenfields/brownfields?

Leonardo Grimaldi, Executive

Thank you for your question. This is Leo here to answer the first part related to demand in 2023. I will provide a more comprehensive answer addressing both supply and demand. We are aware of new pulp projects starting this year, but there is considerable uncertainty regarding how supply and demand fundamentals will develop throughout the year. On the supply side, potential delays in projects and the time to market for new pulp production may affect the timing and gradual arrival of these products in the market. Additionally, the risks of unexpected downtimes, which we have experienced this year, complicate our ability to predict how and when this volume will impact the market. While we anticipate a slowdown in Europe and acknowledge the reduced visibility in that area, some consultancies are forecasting global demand for hardwood pulp to increase by almost one million tons in 2023, aligning with historical growth trends, especially since tissue has proven to be quite resilient even in challenging circumstances. That concludes my answer to the first question. Luis, please.

Luis Renato Costa Bueno, Executive

Thank you, Leo, and thanks, Caio, for your question. We are currently focused on closing the operation. With all the pending analysis that will take place over the next month, we're going to be very busy integrating this company and also implementing the organic avenue that I just mentioned with the plant in Aracruz. So that's going to be our major focus over the next months.

Operator, Operator

Mr. Rafael Barcellos with Santander would like to make a question.

Rafael Barcellos, Analyst

My first question is related to pulp prices. So we have seen demand headwinds emerging over the past few months in both Europe and China. However, pulp prices persist at record high levels. So in your view, what continues to support pulp prices at these levels? And how do you see pulp affordability at the moment? And my second question is related to your long-term strategy, okay? So we have seen Suzano investing again in its paper division through the tissue segment, right? So how relevant is your paper division going forward? And which other investment opportunities do you see for this division?

Leonardo Grimaldi, Executive

This is Leo here again, to answer your question on the pulp price scenario. Our belief is that an unprecedented curtailment on the supply side of the equation, favoring the supply and demand fundamentals is enabling us to be very bullish for the months ahead of us. As I have said, already talking to our customers and confirming unchanged prices for November, as well as results up to now showing no displacement in our order entry levels and in our sales levels. Stocks are low throughout the chain. In Europe, we just received yesterday the statistics. There is a new reduction in stocks at European ports of roughly 6% to 7% when compared to August. In China, there were also new reductions in September compared to August, approximately the same amount, 7%. As I have mentioned before, it is our view, talking to market sources, that we have seen the stock in China is smaller, and the percentage of hardwood is much less than it was historically, meaning that hardwood is tighter in all major markets compared to other grades. So manufacturing the tightness of the supply side and the consistent demand that I have been reporting in Europe, in the U.S., in LatAm, and also in China, where customers are running actually above what they were running a year ago, we see a very supportive short-term scenario.

Unidentified Company Representative, Executive

Thank you very much for your question. I'd like just to mention to you and to our colleagues that our strategy is based on five different avenues for the future. One of them is competitiveness. The second one is the relevance of the pulp market in the world. The third one is verticalization. The fourth one is innovation. And the fifth one is sustainability. We have been working in all five different dimensions that I mentioned. Paper and packaging have been performing extremely well, and we could consider organic growth for the future as well as a conversion from our paper grade pulp to other applications such as fluff and dissolving, as you mentioned. Then we do have several options for the future, and this is the beauty of our strategy that we are building over many years. We could consider several possibilities for new investments in the near future.

Operator, Operator

The next question comes from Jonathan Brandt with HSBC.

Jonathan Brandt, Analyst

I first wanted to ask you about production and volume. Next year, you have a significant amount of downtime in the first half, concentrated mostly, I think, on the second quarter. And inventory at the moment is already very low, as you've mentioned. So I'm just wondering, are you going to start building inventory in the fourth quarter and first quarter, or should we think about maybe 2023 volumes being less than 2022 volumes given that you have more maintenance downtimes next year than you've had over the past couple of years? And then my second question, I guess, Walter, I mean, this is something you've talked about in the past. It would be great to get an update. Pulp prices continue to be volatile. I'd argue that your share price isn't reflecting the high pulp price and the record results we've seen on a consolidated basis. I think part of the reason is because there is an expectation that pulp prices weakened in 2023. So I guess the question is, as the market leader, is it your responsibility? Or how do you reduce this volatility in prices? Would that be a benefit, do you think, to your share price? Would you look to move more of your pulp volumes to an annual price agreement like they had 10 or 20 years ago? Or do you just have to accept the volatility in prices going forward?

Leonardo Grimaldi, Executive

Jonathan, this is Leo here. Thank you for your question regarding our planning for actually very intense downtime or planned downtime schedule that we have for the beginning of 2022. So for the remaining months of 2022, we do not expect to increase inventories as we have a very full order book to be delivered to our customer base. As I mentioned, we are still running late on Asia. So we have to really push hard to make sure that we deliver on time without affecting the supply chain of our customers who are running with low pulp inventories. Regarding 2023 and how we'll plan for this maintenance downtime season, this is very much a part of our commercial strategy, so this is something that we do not share, but we'll prepare accordingly so that our customers and the service levels we provide to them are kept unaffected.

Walter Schalka, CEO

Thank you, Jonathan. This is Walter here. I do recognize our ambition to reduce the volatility. The volatility is not performing well for our customers and not for us. The order chain is affected by the volatility. Our ambition is to reduce volatility over time. We have been working with different price schemes with an increased basis with our customers in the last years, and it's going to repeat the situation for the next year, whereas we are going to have, instead of fixed discounts and floating prices, we are going to have different schemes such as a cap and floor and fixed price that would be better for everyone. This is affecting our price realization when the price goes up, but we will protect our price when the price goes down. This is going to reduce our volatility. We recognize this number is not yet at the level that we would like, but it's improving year-over-year, and we will continue on this strategy in the coming years.

Operator, Operator

The next question comes from Daniel Sasson with Itaú BBA.

Daniel Sasson, Analyst

Congratulations on the record high results. My first question is on the Kimberly Clark acquisition. If you could clarify if the $175 million is related only to the equity value of the transaction, or if there is debt also involved that could increase that amount? If there are any numbers that you could share with us in terms of those asset's performance EBITDA in the last 12 months, volumes in the last 12 months, or anything like that would be great. What are the main challenges that you expect in regards to the incorporation of this operation? And my second question is on the cash cost—pulp cash cost. You mentioned last quarter that you expected a low single-digit increase versus the first half. Is this still the expectation? Or has anything changed at all? From the BRL 140 per ton increase in your cash cost, how much of that do you think could go back to falling normalization in the cost of chemicals and diesel? What do you think could be more structural and could persist looking ahead?

Marcelo Bacci, Executive

Thank you, Daniel. This is Marcelo speaking. We are not going to give much detail on the price of the KC deal, nor on the numbers because this—what we're buying is important to mention. What we're buying is a part of the operations they have in Brazil where the numbers are not public. This is part—there's going to be a drop down of assets segregating the part that we're not buying, which is the Personal Care business from the Family Care business, which is what we are bringing to poor numbers. What we can say is that, of course, this is a moment of lower profitability for the tissue business given the high level of pulp prices, but we are not in a position to share numbers in addition to what we already have shared, which is the capacity of 130,000 tons. The main challenges we expect in the incorporation of this operation should be smooth since we have already been in this business for 5 years, and we have enough experience to incorporate a new part of the business.

Unidentified Company Representative, Executive

Regarding the fourth quarter, we are providing a fresh scenario because every change in the commodity price has a lag implementation in our company, around 2 or 3 months. If the prices remain stable in the quarters ahead, you can expect to see improvements reflecting in our results.

Operator, Operator

The next question comes from Leonardo Correa with BTG Pactual.

Leonardo Correa, Analyst

So a couple of questions on my side. The first one on price realizations in the pulp business. I mean, it was clear from your speech that October was pretty much in line with prices at a very high level, still November is following a similar path, right? My question is whether there is a carryover effect still that you guys are expecting to extract heading into the fourth quarter? I mean looking at prices in the third quarter, you did something around $820 on the export side, so I can assume that there is still a gap to close. I just wanted to hear your thoughts. It could be high level, but just want to see if that makes sense that there is still some carryover effects on pricing. The second question, moving back to the discussion on the supply/demand scenario in China, right? I mean, we saw overnight that the pulp resale price in China suffered a bit of softness, right? I mean, we're seeing prices at around $800. So there is a gap of about $50, $60 right to, let's say, to benchmark. I understand all the issues and the low quality of reselling and the fact that it's very illiquid. I just wanted to confirm if the message still from China is that you're not seeing any cracks and that the supply-demand remains quite tight. Is that it?

Leonardo Grimaldi, Executive

Well, thank you for both questions. This is Leo here answering both of them. So first, related to our view for the next quarter's pricing. Obviously, we cannot share too much information regarding our pricing for the quarter, as this is key to our commercial strategy. However, I can share that our general view is that price realization dynamics on the pulp P&L should continue to be benefited, as you asked, from the price increases and levels of the past months. October business and order intake was concluded at unchanged prices at really normal order entry levels, and our view is that this scenario should not change for the upcoming months due to all factors which I have mentioned previously. Also related to our backlogs to Asia, mainly, as I had mentioned in the last quarter, we were running roughly 60 days or 2 months late. We were not able to recoup or recover this scenario during the third quarter, but there are plans to reduce this as we get closer to year-end. So we're still carrying these backlogs of roughly 2 months to Asia. Coming into resale prices, we have had a lot of discussions with our local sources to deeply understand the recent moves, including what was reported earlier today, Brazilian time. Our view is that this recent volatility in hardwood resale is mainly due to the fact of a concentration of arrivals of imported and domestic pulp to domestic Chinese traders. These volumes are being quickly depleted in the market as hardwood inventories are low, and they should be returning to a normal level. So my expectation, our expectations are that as we come into the next weeks, resale prices should recover in RMB terms, also to recover for the FX depreciation.

Operator, Operator

The next question comes from Isabella Vasconcelos with Bradesco BBI.

Isabella Vasconcelos, Analyst

I think most of the questions have been answered, but I have one on the paper side, if you could provide more color on what you're seeing in terms of domestic and export demand across different grades. And given very solid paper price realizations recently and several price hike initiatives, do you continue to see solid order books, or are you already registering some decline in demand?

Fabio Almeida de Oliveira, Executive

Isabella, it's Fabio here. Thank you for your question. Regarding paper demand, we continue to see solid demand in the Brazilian and also in Latin American markets, which are the main markets for Suzano. As you know, 70% of our business in Q3 was sold in Brazil. And as I mentioned in my speech, we have also high season for uncoated and also cut size business in the fourth quarter with the Brazilian books program and also for the return to school season that—which is preparing the stock during the end of the year now. So we continue to see resilient demand here, strong in Brazil and also in LatAm. In the other export markets, very solid demand in North America with imbalance on the supply side, and also in Europe, for uncoated paper. So on the demand side, no change, and we expect a good fourth quarter. In terms of pricing, we have realized all the price increases so far that we have announced to the market, and we have implemented all of them. We continue to analyze the market for price opportunities moving forward. So that's it.

Walter Schalka, CEO

Thanks very much for joining us for this session. I think we are very proud and pleased with the results they are delivering to the market right now. We recognize that, at this point of time, we are seeing some hidden value in our shares that is not yet captured by the market. I'm going to mention three issues. One of them is Parkia. Parkia was a very important acquisition for our future with lower CapEx on our forest business. It's the same with Caravelas, as we are not at this point in time recognizing the Cerrado project. By the end of this year, we are going to be invested roughly BRL 7 billion in this project, and its value is zero on our market analysis. Lastly, the cost of debt is another important factor. Our cost of debt is 4.5%—4.7%, sorry, with an average maturity of 7 years. For exactly the same maturity right now, the cost of interest would be 7.3%—7.4%. Meaning that we have a huge benefit from our fixed interest rate policy. This is not, at this point in time, being brought to the surface by the market. I would like to see—and these are just three examples of many—that at the right time, we will see more value in the Suzano shares. We are very pleased with what we are doing, and we look forward to the next steps of the company in the coming quarters. Thank you very much for the session. I hope you have a very nice day.

Operator, Operator

Thank you. Suzano's third quarter results conference call is finished. Have a nice day.