Chief executive’s review
The 2009 financial year was both challenging and rewarding for Mondi. The impact of the global recession on Mondi’s business has been significant, with difficult trading conditions prevailing particularly in the first half of 2009. These were first evident in Europe in late 2008 and, following a delay of about six months, profitability in South Africa was impacted. However, European trading improved as the year progressed, with the benefits of price increases in key grades starting to take effect in the final quarter, ensuring that Mondi’s performance for the year exceeded expectations.
Throughout this period, the Mondi Group has risen to the challenges we faced, taking decisive actions to reduce capacity, lower the overall cost base and optimise cash flows, while still continuing to invest in our two major projects in the lower-cost, high growth markets of Poland and Russia. As a result, Mondi is now a better quality business than it was a year ago and we believe that we are very well positioned to deliver enhanced shareholder value in the future.
Group revenue of €5,257 million
Results
The Mondi Group is pleased to have delivered financial and operating results for the year that were ahead of expectations, with Group revenue of €5,257 million and underlying operating profit of €294 million. Although down by 17% and 33% respectively compared with the previous year, these figures still signify a very sound performance given the difficult trading conditions. The fourth quarter brought volume improvements across all main paper grades, price increases in most of the key packaging grades, and a stable pricing environment in the European uncoated fine paper (UFP) market. Results were also boosted by a strong performance by Mondi Packaging South Africa (MPSA). However, the South African export focused businesses continued to suffer under the weight of a strong South African rand and low product prices.
Good progress was made with the restructuring of Mondi’s cost base and the implementation of additional cost savings initiatives. The bold cost savings target of €180 million was exceeded, with €251 million of cost savings being delivered. We exited or mothballed around 930,000 tonnes of high-cost paper capacity in just over two years and closed or sold 18 converting sites.
Average return on capital employed, a key measurement of Mondi’s performance, was 7.6%. While this is a disappointing outcome in relation to the Group’s target of 13% across the cycle, it nevertheless represents a resilient performance given the backdrop of an extremely difficult business environment. Importantly, we are confident that the actions taken over the past year place the business in a stronger competitive position than it was when it entered the downturn, allowing it to take full advantage of any improvement in the business cycle.
Furthermore, the focus on cash flow optimisation was extremely successful, with working capital inflows for the year amounting to €248 million and capital expenditure, outside the two major projects, reduced to 63% of depreciation. As a result, net debt declined by €173 million to €1,517 million, despite capital expenditure of around €300 million on the two major expansion projects in Poland and Russia.
Mondi enjoys a strong liquidity position and, as at the end of December 2009, the Group had nearly €1 billion of undrawn committed debt facilities, €0.8 billion of which is available in terms of a €1.55 billion facility which expires on 22 June 2012.
The Group proposed a final dividend of 7.0 euro cents per share to give a total dividend of 9.5 euro cents per share for the year.
Delivering on our strategy
The year under review has reinforced the validity of our Group strategy. Three pillars continue to underpin our strategy:
- building leading market positions in packaging and UFP, particularly in high-growth emerging markets;
- delivering a high-quality, low-cost asset base, through maintaining our position as a low-cost producer in our markets by selectively investing in production capacity in lower-cost regions and exploiting the benefits of upstream integration, including forestry; and
- focusing on performance, especially continual productivity improvement and cost reduction, delivered through business excellence programmes and rigorous asset management.
Building leading market positions
Our focus has been on achieving the right product mix and geographical focus, and by doing this we have continued to increase the quality of our earnings. There have been several initiatives in this regard. These include reducing our lower-margin exports of paper from Merebank in South Africa in favour of higher-margin exports of pulp from Richards Bay, while at the same time removing costs. In our European UFP business we have increased our sales focus on our home markets of central and eastern Europe, while in our European Corrugated business we have also changed our product and geographical mix by exiting from a number of western European markets. Cumulatively these actions have reduced the Group’s revenue by €484 million, removed €107 million of fixed costs and enhanced underlying earnings for the year, compared to the prior year.
While we have taken steps to reduce capacity, we have maintained our ability to take advantage of any upswing in the market as the economy improves. Certain assets have been mothballed, rather than permanently closed, and we have expanded our capacity in the higher growth eastern European and Russian markets. These actions position the Group well for the long term, with the structural maturity of some of our products in the north-western hemisphere markets increasingly evident. Among other things, this is driven by the shift in the manufacturing base (with its impact on packaging requirements) from the west to the east – into eastern Europe, Turkey, Russia and China. This trend is also supported by the structural growth that is being experienced in emerging economies, which means that our packaging products and office paper enjoy a much higher growth rate in these markets. The lower cost base in these economies adds momentum to this shift.
By the end of 2009, 75% of our net operating assets were located in emerging markets, in line with our vision of focusing on low-cost, high growth regions and on businesses offering leading market positions and operational synergies with existing businesses. While our strategy clearly focuses on emerging markets, Mondi enjoys a uniquely strong market position in the bags & specialities segment in both eastern and western Europe, where specialities continue to enjoy very attractive growth rates. We will therefore continue to support our market position in bags & specialities with our existing western European assets. In our European corrugated business, our only remaining assets are in Austria and Germany which are integral to our Polish corrugated operations. In our UFP business, the only remaining western European asset is the Neusiedler mill in Austria, which makes speciality products that achieve higher selling prices to compensate for the higher costs.
These products are an important part of the overall UFP product offering.
New 470,000-tonne recycled containerboard machine producing well ahead of expectations
Delivering a high-quality, low-cost asset base
The Mondi Group’s vision of developing a modern, high-quality, low-cost asset base has been supported by management resolve and a rigorous approach to asset management. In just over two years we exited some 930,000 tonnes of high-cost paper operations (Europe & International, 810,000 tonnes; South Africa, 120,000 tonnes), amounting to around 14% of the Group’s global capacity. In total, 18 converting sites were rationalised over the same period.
Our actions in 2009 in particular will, we believe, prove to be prescient. While some of these assets might have survived the next cycle, this downturn has been sufficiently severe to warrant our decisive actions. In addition, the resultant improvement to the supply/demand balance is favourable to industry fundamentals.
This is a very visible demonstration of the implementation of our strategy and our rapid response to the challenging global environment. It bears repeating, however, that for our industry, this challenging environment has been some time in the making. The global paper industry has struggled for some years to recover from overcapacity, with resultant low prices and weak earnings, thus heightening the need for consolidation and closures. Our approach, combined with numerous cost savings initiatives, has brought about a significant decrease in our cost base. We believe that the increased level of industry rationalisation that has taken place over the past year as a result of difficult conditions has improved the underlying fundamentals of the industry.
Despite financial constraints, Mondi has continued to invest in large-scale, low-cost, high-quality assets to complete our long-term modernisation programme, with the ultimate aim of shifting the Group’s production base further down the cost curve. An excellent demonstration of the success achieved is to be found in the recycled containerboard market segment where, in less than three years, our average cost position relative to other producers has improved from the third quartile to the lowest quartile.
We are particularly pleased to report on the substantial progress made with our key projects, which will further secure the Group’s position as a cost leader in its chosen markets.
- In September 2009 Mondi saw the first saleable production from the new, 470,000-tonne lightweight recycled containerboard paper machine in Świecie, Poland. We anticipate that this installation will have the lowest operating cost of its type and up to 50% of its production will be accounted for by physical integration with our surrounding box plant network. Start-up of the machine was ahead of schedule and the project is expected to come in around 4% (€20 million) below budget.
- The project to modernise the Syktyvkar mill in Russia continued to make good progress and is on track for completion in the second half of 2010. Severe weather conditions did impact the project timetable and a small cost overrun of up to 4% is now anticipated resulting in a capital cost of up to €545 million. This project will lower the Group’s cost base in Russia, increase energy production (with the benefit of selling surplus energy to the energy grid), improve internal efficiencies and increase integrated paper output.
- In late August 2009, the new machine-glazed paper machine at Ŝtêti in the Czech Republic was successfully commissioned on time and within budget, at a total cost of €47 million. It has an annual capacity of 45,000 tonnes and the grades produced on this machine are both cost-effective and technically advanced. This investment is part of our ongoing programme to modernise the Ŝtêti asset base.
The Group is coming towards the end of a significant, 10-year programme of modernising its asset base, with most large operations being overhauled. This underpins our long-term strategy, embarked on in the late 1990s and early 2000s, when the Group’s aggressive acquisition programme enabled it to acquire a substantial base in eastern Europe and Russia. Once secured, these assets, together with our South African operations, required significant modernisation, with just over €2 billion being spent on the major mills over 10 years on expansionary projects. Altogether, these assets today represent around 75% of our net operating assets.
Even if the economic recovery is slow and earnings do not improve sharply, the substantial investment made during the past years means that we are now entering into a period where shareholders should, on average, enjoy increased levels of free cash generation. While growth clearly remains an option, we will be disciplined with respect to acquisitions and expansionary capex, and will allocate increasing free cash flow to debt reduction and to improving the cash returns to our shareholders.
75% of net operating assets in emerging markets
Focusing on performance
Our relentless approach to cost saving is well established and received greater attention during this year of recession. Cost optimisation and the desire to be the lowest cost producer in our industry is entrenched within our culture at Mondi. Cost savings on the scale that we have achieved in the past year – in the order of 5% of operating cash costs – will be difficult to sustain. We will consistently target levels of more than 2% a year, which is still significant. Cost savings of some €251 million were achieved by year end, 31% of which addressed fixed costs, which, excluding depreciation, increased only marginally relative to revenue, from 25% in 2008 to 26% in 2009. This is a commendable achievement given the revenue pressures experienced as a result of the difficult economic conditions.
Stringent management of working capital has also delivered significant cash benefits, with inflows of some €372 million in working capital over the past three years – €248 million in 2009.
Mondi announced in the fourth quarter of 2008 that capital expenditure outside of the two major projects would be curtailed, with new capital expenditure approvals limited in the short term to 40% of depreciation. The benefits of this decision in terms of cash flows have been clearly evident. While we continue to operate in terms of this policy, as trading conditions improve we expect to return to more normal levels of ongoing capital expenditure.
Paying tribute to our people
In any year it would be remiss not to pay tribute to the people of Mondi, in this year it would be even more so. I have mentioned our cost optimisation culture and would like to acknowledge the way in which this has been embraced by our 31,000 employees around the globe – from those who work in the nurseries where our seedlings germinate and the forests that we tend, to those involved in our world-class production facilities and those sales people who get our products to our customers. I thank them all for their significant contribution to the Group. Our people take pride in being part of a successful business, one that is prepared to respond quickly and decisively to circumstances, and that knows how important it is to focus on the areas that we can control. Inevitably the numerous restructuring and cost-cutting actions taken during the year led to a 10% reduction in our total employee base. We pay tribute to those people who have unfortunately lost their jobs as a consequence. It has been a tough year for many people and we hope that 2010 brings new opportunities.
Ensuring our future
The Mondi Group sees safety and sustainability as critical to the future of our world and of our business. Our efforts to reduce the environmental impact of our products and to support communities, through corporate social investment, education and training, employment and small business development, among other things, reflect this. We publish a sustainability report, which is externally assured and further details about our sustainability performance are available on our website at www.mondigroup.com/sustainability.
Outlook
Looking ahead, it is clear that the Group’s performance will largely depend on the pace and extent of the global economic recovery. Furthermore, while there has been substantial industry capacity rationalisation over the past year, further supply side reductions may be required to ensure that supply and demand are balanced.
Encouragingly, however, we have seen a steady improvement in industry order volumes, with some recent price recovery in the European packaging grades. This improvement in our trading environment, together with the various restructuring actions taken over the course of 2009, positions Mondi well for the year ahead.
David Hathorn
Chief executive officer
