Group performance review

The Group’s underlying operating profit of €222 million was 61% up on the comparable prior year period and 42% up on the result of the second half of the prior year.

Order inflows and sales volumes continue to improve and price increases were achieved across all key paper grades. Furthermore, the benefits of the significant restructuring actions and cost reduction initiatives implemented through the economic downturn supported the strong recovery in profitability. Ongoing profit improvement initiatives have yielded a further €75 million during the first half which, at 2.9% of our cost base, continue to exceed targets. Rising commodity input costs partially offset revenue gains.

Currency movements had a mixed impact on the Group’s results. The stronger rand eroded export margins in South Africa whilst exports from Europe benefited from the weaker euro against the dollar. Other emerging European currencies strengthened against the euro in the first quarter of the year placing pressure on the export-focussed operations in Poland and the Czech Republic, although this trend reversed in the second quarter.

Underlying earnings per share was 20.3 cents, an increase of 145% on the comparable prior year period. An interim dividend of 3.5 euro cents, up 40% on the prior year interim dividend, will be paid.

During the first quarter, Mondi concluded the sale of the 170,000 tonne Frohnleiten recycled containerboard mill in Austria. During May, the Group’s western European corrugated packaging and recycled containerboard restructuring programme concluded with the sale of its corrugated box plants in the UK to Smurfit Kappa. The Group also acquired Smurfit Kappa’s industrial and consumer bag operations in Spain, France and Italy. These operations will be restructured and some of the plants may be rationalised with our existing plants.

The sale of the Europapier paper merchant business to the Heinzel Group announced in early May 2010 remains subject to approval by the relevant competition authorities.

Net debt at 30 June 2010 increased from 31 December 2009 by €115 million to €1.63 billion. Robust EBITDA generation was offset primarily by an increase in working capital (in line with growth in revenue), ongoing funding for the €545 million Russian expansion project and foreign exchange movements. In March 2010, the Group issued a seven year Eurobond of €500 million at a coupon of 5.75%, the proceeds of which were used to settle existing short and medium term debt and consequently increased the average maturity of the Group’s debt.

The Group’s financial position remains robust with net assets increasing to €3.1 billion on the back of higher working capital and exchange impacts on translation into euro. The Group retains adequate borrowing facilities.

Europe & International Division

€ million	Six months ended 30 June 2010	Six months ended 30 June 2009	Half-yearly change %
Segment revenue	2,372	2,063	15
– of which inter-segment revenue	61	53	15
EBITDA	336	238	41
Underlying operating profit	201	108	86
Uncoated Fine Paper	98	71	38
Corrugated	48	1	n/m
Bags & Coatings	55	36	53
Capital expenditure	159	272	(42)
Net segment assets	3,822	3,620	6
ROCE	12.2%	7.3%	67

Underlying operating profit of €201 million was 86% higher than that of the comparable prior year period with ROCE, on a twelve month trailing basis, increasing to 12.2%. The improved result was due to good demand across all businesses, higher prices in all paper grades and the benefit of previously implemented profit improvement initiatives.

Profit improvement initiatives have yielded €59 million to date, partially offsetting increased input costs, particularly wood, pulp and recovered paper.

The extended shut at the Syktyvkar plant in Russia as part of the final integration of the expansion project, together with the planned maintenance shuts at a number of the pulp and paper mills in the traditionally slower European summer months, will impact results in the second half of the year.

Uncoated Fine Paper

The operating profit of €98 million was 38% up on the comparable prior year period, giving a very strong ROCE, on a twelve month trailing basis, of 17.5%. This excellent performance, following a strong second half in the previous year, reflects a continued positive trading environment with both prices and volumes increasing. This was supported by a pleasing operating performance with all mills achieving record production volumes. The Russian operation, Syktyvkar, performed particularly well, supported by a positive contribution from the recently rebuilt uncoated fine paper machine.

Selling prices have increased with benchmark cut-size office paper prices increasing by around 5% from 31 December 2009 levels. Further price increases have been announced in the second half, supported by continued input cost pressures particularly for the non-integrated producers, and the weakness of the euro relative to the dollar.

With average pulp prices increasing during the period, by 24% for softwood and 32% for hardwood in US dollar terms when compared to the second half of the previous year, the larger mills benefited from their backward integration. The nonintegrated mills, despite achieving price increases, could not entirely offset the higher pulp prices.

The major capital project in Syktyvkar, Russia is expected to be completed and integrated into the existing mill during an extended shut in the second half. The impact of the shut on the second half operating profit contribution from Syktyvkar is estimated at around €20 million.

Corrugated

The Corrugated business achieved a significant improvement in underlying operating profit to €48 million, benefiting from the new recycled containerboard machine at Świecie, restructuring and cost reduction initiatives, and improved product prices and volumes. Average increases of around 23% compared to the second half of the prior year were seen for benchmark recycled containerboard prices, supported by significant input cost pressures (recovered paper prices increased by 52% in the period).

Although sales volumes increased, price increases achieved in the corrugated box plants were not sufficient to recover the increased paper input costs. Further box price increases are anticipated in the second half of the year.

The restructuring of the Corrugated business was concluded during the first half with the sale of the UK box plants to Smurfit Kappa in May 2010 and the recycled containerboard mill in Austria to the Prinzhorn Group. The business is now well positioned to focus on its core central and south eastern European markets, with leading market positions in the high growth markets of Poland and Turkey. The containerboard mills in Poland, Germany and Turkey provide the Group with a competitive paper asset base serving the Group’s integrated converting network in these regions.

Having started up in September 2009, the 470,000 tonne recycled containerboard machine in Świecie, Poland is performing ahead of plan, with production of 197,000 tonnes in the first half, and full year production from this machine expected to be around 400,000 to 410,000 tonnes including the impact of a maintenance shut in the second half.

Bags & Coatings

The Bags & Coatings business achieved an underlying operating profit of €55 million, an increase of 53% on the comparable prior year period. This reflects both improved sales volumes and increased kraft paper prices.

Significant kraft paper selling price increases of around 10% on average compared to the second half of the prior year were achieved in the period, more than offsetting the sharp rise in input costs, particularly wood costs. Further selling price increases have been announced and are expected to be implemented during the third quarter. While demand in the Group’s core European markets has recovered from a low base, supported by some restocking, very strong demand growth is being seen in export markets. In response, the 80,000 tonne Stambolijski kraft paper machine was restarted in June 2010, having been mothballed during the previous year.

Volumes remain strong in the Bag Converting segment, up 12% on the comparable prior year period. However, more than half of the sales volume is sold under annual fixed price contracts, leading to short-term margin pressures in this segment as paper input costs increase. The acquisition of the Smurfit Kappa bag plants provides the Group with stronger market positions in Spain, France and Italy. Although these newly acquired plants are currently operating at a loss, restructuring and potential rationalisation with our existing plants is planned for the coming months and they are expected to contribute positively to the Group’s performance from 2011.

Robust volume increases in Coatings, Consumer Bags & Films have resulted in a significant increase in underlying operating profit, although Consumer Bags & Films remains under some pressure from rising polymer prices.

South Africa Division

€ million	Six months ended 30 June 2010	Six months ended 30 June 2009	Half-yearly change %
Segment revenue	276	249	11
– of which inter-segment revenue	107	113	(5)
EBITDA	44	48	(8)
Underlying operating profit	18	28	(36)
Uncoated Fine Paper	14	13	8
Containerboard	4	15	(73)
Capital expenditure	9	13	(31)
Net segment assets	932	868	7
ROCE	3.1%	13.5%	(77)

A decrease of 36% in underlying operating profit on the comparable prior year period reflects somewhat disappointing results, partially due to the strength of the rand, and consequently lower export margins. ROCE, on a twelve month trailing basis, at 3.1%, remains well below targeted levels. The results are however significantly better than the weak second half of 2009.

Sales prices improved across all products with pulp being the main contributor during the period. Increasing labour and input costs, particularly electricity, will impact results in the second half.

The decision has been taken to exit the uncoated fine paper export market due to poor profitability and to focus on the domestic and African markets. The mothballing of the 120,000 tonne uncoated fine paper machine and related equipment in Merebank, along with a restructuring programme, is expected to be concluded during the second half of the year.

This restructuring and the associated increased sales of pulp are expected to result in an improved second half performance, notwithstanding an apparent weakening in global pulp markets.

Mondi Packaging South Africa (MPSA)

€ million	Six months ended 30 June 2010	Six months ended 30 June 2009	Half-yearly change %
Segment revenue	298	227	31
- of which inter-segment revenue	16	13	23
EBITDA	33	23	43
Underlying operating profit	18	11	64
Capital expenditure	14	6	133
Net segment assets	368	342	8
ROCE	12.9%	7.3%	77

MPSA achieved a 64% increase in operating profit to €18 million off the low base of the comparable prior year period giving a ROCE, on a twelve month trailing basis, of 12.9%. The improvement reflects an approximately 10% increase in sales volumes and the benefits of significant cost savings. The euro result was also enhanced by translation at a stronger rand exchange rate. In local currency terms, the increase in underlying operating profit was 37%. With its exposure to the agricultural sector, coupled with price increases expected to take effect during the second half, the second half of the year is expected to be stronger than the first.

Newsprint

€ million	Six months ended 30 June 2010	Six months ended 30 June 2009	Half-yearly change %
Segment revenue	271	254	7
– of which inter-segment revenue	–	–	–
EBITDA	8	16	(50)
Underlying operating profit	1	8	(88)
Capital expenditure	2	2	–
Net segment assets¹	108	218	(50)
ROCE	2.2%	2.9%	(24)

Note:

¹ Excluding assets of Europapier business, classified as held for sale.

The Newsprint business reflected a significant decline in underlying operating profit to €1 million mainly due to a disappointing performance at Aylesford Newsprint. Aylesford Newsprint experienced reduced sales volumes and prices and an operating loss resulted. Sales price increases of around £20/tonne are being implemented during the second half of the year, although this is not likely to lead to a significant improvement in profitability due to ongoing input cost pressures. Mondi Shanduka Newsprint’s underlying operating profit was marginally lower than the comparable prior year period mainly resulting from increasing raw material costs. The European merchant business, Europapier, performed well, benefiting from increased selling prices and volumes. The sale of Europapier is expected to be concluded in the second half of the year, pending competition clearance.

Input costs and currency exposure

All fibre input costs have seen significant increases in the first half of the year.

• Procured pulp wood prices in central Europe are up significantly versus the comparable prior year period on the back of increased demand from bio-mass energy producers and reduced supply due to the closure of sawmilling operations in the region.
• Average US dollar pulp prices, exacerbated by supply disruptions due to the Chilean earthquake, have increased by 24% for softwood and 32% for hardwood during the period when compared to the second half of the prior year.
• Strong Chinese demand in the first quarter drove rapid price escalations in European recovered paper markets. The average benchmark price of recovered paper increased by 52%, when compared to the second half of the previous year.

Mondi benefits from its structural position in South Africa and Russia due to integration into wood supply. The Group’s integrated pulp and paper mills reduce the impact of pulp price escalations, with the Group, on an annualised basis, being net short of around 135,000 tonnes of pulp following the recent restructuring announcements. Restructuring initiatives and a relentless focus on cost reduction and productivity improvement further mitigate the impact of input cost pressures.

Financial review

Special items

The special items, as more fully set out in the notes to the half-yearly financial statements, include:

• closure of the paper machine and related restructuring provisions in South Africa;
• reversal of previously recognised closure provisions no longer required following the sale of the Szolnok site;
• reversal of impairment and related closure provisions of the Stambolijski mill following its start-up in June 2010;
• partial impairment of underperforming kraft paper assets in Lohja and Ruz¡omberok;
• gain on acquisition of the industrial bags plants in western Europe which will be subject to future restructuring;
• loss on disposal of the corrugated packaging plants in the UK;
• profit on sale of forestry assets in South Africa; and
• write-down of assets and recognition of expected loss on disposal of the Europapier business.

Finance costs

Net finance costs of €48 million were lower than those of the comparable prior year period, mainly due to exchange rate gains on foreign currency debt and a reduction in interest rates in some locations. The higher interest rate of the Eurobond when compared to existing short-term facilities, as well as a reduction in interest capitalised to major projects, will increase finance costs in the second half of the year.

Tax

A reduction in the underlying effective tax rate from 32% to 26% is realised primarily due to the improved profitability enabling the use of previously unrecognised tax losses carried forward; increased profitability in regions with lower tax rates; and benefits of tax incentives granted in certain countries in which the Group operates, notably those related to the major Polish and Russian capital projects.

Cash flow

As expected, cash flow generated from operating activities was negatively impacted by an increase in working capital attributable to the significantly increased revenue. Working capital, as a percentage of annualised revenue, moved up from 10.0% at 31 December 2009 to 10.7% at 30 June 2010. Despite this, cash generated from operating activities amounted to €235 million.

Capital expenditure of €184 million, including €75 million on our major project in Russia, was incurred. Outside of our major projects in Russia and Poland, capital expenditure remains at 51% of depreciation reflecting a continued conservative approach to investment.

Treasury and borrowings

Net debt at 30 June 2010 was €1.6 billion, an increase of €115 million from the prior year end. Excluding the impact of exchange rate movements, net debt was largely unchanged from the year end position, despite the ongoing major capital expenditure project in Russia and the investment in working capital.

The net debt to trailing 12 month EBITDA ratio was 2.2 times and the headroom in the Group’s syndicated €1.55 billion facility increased to €1.2 billion. During March, Mondi successfully launched a €500 million, seven year Eurobond, further strengthening the Group’s already robust financial position as evidenced by the long-term corporate credit ratings received of Baa3 from Moody’s Investor Service and BB+ from Standard & Poor’s, both with a stable outlook. Following the launch of the Eurobond, a large proportion of the Group’s debt, 78%, is at fixed rates of interest for varying terms.

Interest rates have remained largely unchanged in the period under review.

The average maturity of committed debt facilities is 3.1 years (compared to 2.2 years at the end of the previous year) and drawn committed debt facilities maturing over the next 12 months amount to €83 million.

Dividend

A dividend of 3.5 euro cents per share has been declared by the directors and will be paid on 14 September 2010 to those shareholders on the register of Mondi plc on 27 August 2010. An equivalent South African rand interim dividend will be paid on 14 September 2010 to shareholders on the register of Mondi Limited on 27 August 2010.

Outlook

Despite cost pressures, the positive pricing momentum witnessed in Europe since the beginning of the fourth quarter of 2009 in most of the Group’s key grades should see the business continue to deliver a strong performance in the second half. The South Africa Division should benefit from the further management actions taken to improve profitability, although much depends on the outlook for the rand and export pulp prices. While the sustainability of the economic recovery remains uncertain, we believe the Group is well positioned to continue benefiting from the current positive trading environment.

Supplementary information

Going concern

An improvement in trading conditions is evident although some risks remain in specific locations and business segments. This is mitigated by Mondi’s geographical spread, product diversity and large customer base. Through ongoing initiatives of cost management, prudent capital investment, stringent working capital targets and restructuring and rationalisation of assets where appropriate, Mondi has a leading cost position in its chosen markets.

The Group maintains adequate undrawn borrowing facilities (€1.4 billion at 30 June 2010) and the average maturity of its debt is approximately three years, thus providing sufficient short and medium term liquidity.

The Group’s forecasts, taking into account reasonably possible changes in trading performance, show that Mondi will be able to operate well within the levels of its current facilities and related covenants.

After making enquiries, the directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. Accordingly, the going concern basis continues to be adopted in preparing financial reports.

Principal risks and uncertainties

It is in the nature of its business that Mondi is exposed to risks and uncertainties that may have an impact on future performance and financial results, as well as on its ability to meet certain social and environmental objectives. The Group believes that it has effective systems and controls in place to manage the key risks identified below. The key risks identified remain consistent with those presented in the Business review (PDF - 52KB) of the 2009 annual report .

• Mondi operates in a highly competitive environment
  The paper and packaging markets are highly competitive. Mondi is flexible and responsive to changing market and operating conditions and the geographical and product diversification provides some measure of protection. Uncertain trading conditions may impact the carrying value of goodwill and tangible assets and may necessitate further restructuring.
• Input costs are subject to significant fluctuations
  Significant fluctuations in raw material costs, particularly wood, pulp and recovered paper, have been experienced during the first half of the year. The Group’s relatively high level of integration and access to its own fibre in Russia and South Africa, coupled with the focus on operational performance, serve to mitigate these risks.
• Significant capital investments including acquisitions carry project risk
  The capital investment programme in Russia is largely completed and indications are that the project will be completed during the second half of 2010. The acquisition of the industrial bag operations in Spain, France and Italy will require some restructuring in order to generate the required returns.