Managing Director’s report
What we are seeing is a growing capacity to manage change and create momentum even in difficult conditions to better position our Company for future opportunities.
2007 was a year of good progress across the Group with increasing internal momentum. Last year our Annual Report discussed a range of internal strategic initiatives and this year we are pleased to be able to report that our run rate for total benefits by 2009 from strategic initiatives has improved and that our delivery in 2007 is ahead of our expectation last year. And this was all in a market where the negative headwinds have continued, making this progress all the more creditable, and critical.
We know that we cannot stay still, that we must continuously adapt as a company, and do so faster and more aggressively than our competition. We must provide our people with the tools they need to be successful in these difficult markets and we must continue to invest in the areas where we have strategic advantage. Likewise, we must improve our productivity to fund this investment and we must make the hard decisions where necessary to remove ourselves from uncompetitive situations.
On all these measures, 2007 was a successful year – not an easy year, but a year of good progress.
The PaperlinX net profit after tax for the 2007 financial year was $80 million, up 22 per cent on last year’s $65 million. Group operating earnings before interest and tax (EBIT) were $186 million. This is up 22 per cent on last year’s $152 million. This operating result reflects the strong focus on internal efficiencies, productivity improvements, cost management and real benefits from strategic initiatives supported by one-off gains from the sale of non-core assets, rather than any real benefit from external market conditions. The industry continues to face structural imbalances in global supply and demand, although we have seen the start of rationalisation in Europe. We have also seen a continuation of high input costs for our paper manufacturing business and a weakening in the US dollar impacting on paper selling prices in Australia and other non-US markets.
The key change in external conditions over the past year has been the continued fall in the US dollar. This is an important metric as the selling price of much of the world’s paper is based on a US dollar price. A downward movement in the US dollar puts downward pressure on paper selling prices when measured in other currencies. This has been clearly evident in Australia (where the Australian dollar was up 14 per cent against the US dollar over the year) and in New Zealand (up 27 per cent).
After removing the impact of one-off items from the reported EBIT, underlying EBIT was $198 million, up 26 per cent. While the overall result was an improvement over the prior year due to our internal activities, our Australian and New Zealand Paper Merchanting businesses and our Australian Paper Manufacturing business, particularly, faced significant external pressures which were exacerbated by the strength of the local currencies against the US dollar.
Earnings before interest, tax, depreciation and amortisation (EBITDA) was $287 million, up 11 per cent. Net operating cash inflow was $143 million. Working capital improved by $65 million, with year end working capital to sales of 15.5 per cent, lower than the prior year of 16.6 per cent. Average working capital to sales (currency and acquisition adjusted) for the year fell to 17.9 per cent versus 18.9 per cent last year; a good improvement.
If you have been a regular reader of our Annual Reports you will be aware of the number of activities that are underway across the PaperlinX Group, and again this year we will update you on their progress. One of the outcomes of this level of internal change is that there can be one-off financial impacts on our results. In any one year there can be both positive and negative one-off items, activities that are not part of the day-to-day operations of our company, but are reported in our results. While this is absolutely appropriate, we also like to ensure that we are transparent in explaining such impacts. This year the net impact of one-off items was $(12) million, and this number is the difference between our reported EBIT of $186 million and our underlying EBIT of $198 million. These impacts include the costs associated with investments such as our pulp mill upgrade in Australia, the Delivery Company logistics integration in the UK, or benefits from asset sales that we pursue to help fund these investments. One of our differentiators as a company is our ability to manage and deliver on our initiatives and the ‘above target’ $41 million of benefit from strategic initiatives embedded in this year’s result (off our 2005 base) is a key element in our ability to grow returns for our shareholders over time, even in challenging international markets. I believe our progress so far is a tribute to the idea transfer, commitment and change management skills of our people around the globe.
During March 2007, $285 million of hybrid securities in the form of Step-up Preference Securities (SPS) were successfully issued to Australian investors. This issue reduced debt, strengthened the Group’s balance sheet, provided increased financial flexibility and enhances PaperlinX’s financial platform to take advantage of future opportunities.
Reviewing our operating businesses individually:
We have two business streams. Paper Merchanting is a global network of paper merchants providing local customers with the products they need from a wide range of suppliers. Paper Manufacturing is an Australian business focused at the Australian office, printing and packaging markets. We report these two streams separately, and then regionally within Paper Merchanting.
Paper Merchanting achieved an EBIT of $205.2 million, up 9 per cent on the prior year. Operating earnings in North America were up 36 per cent in local currency boosted by the inclusion of Spicers Canada, while Europe was up 11 per cent in local currency. Australia, New Zealand and Asia was down 46 per cent, where the earnings remained under significant pressure from lower priced paper imports and currency impacts.
Merchanting businesses again improved return on average funds employed for the 4th year in a row, with clear potential for upside from any improvements in the current market conditions. Total Paper Merchanting return on average funds employed increased to 11.9 per cent from 11.4 per cent in 2006, and remains well above the cost of capital. Overall expenses rose 2.1 per cent (adjusting for acquisitions), while the year end working capital to sales ratio reduced to 13.5 per cent from 14.7 per cent. Average working capital for 2007 was in line with the prior year after adjusting for acquisitions.
Paper Manufacturing in Australia saw the benefit of internal initiatives, cost control and efficiency programmes. Operating earnings of $10.2 million included a net $(10.6) million charge due to implementation of strategic initiatives. Underlying operating earnings of $20.8 million was a sound improvement on the $10.2 million earned in 2006, especially considering the higher input costs and ongoing challenges in the marketplace. Earnings continue to be impacted by depressed paper selling prices as a combined result of the strong Australian dollar and oversupply in global paper markets, and by $26 million of input cost increases, such as pulp, fuel oil and chemicals that are not able to be passed on in the current price environment.
In last year’s Annual Report we first reported in detail on the strategic initiatives underway across the PaperlinX Group. Over the past couple of years we have invested capital and restructuring charges in these initiatives to improve competitiveness and strengthen our future platform. The 2008 fiscal year will see a continuation of this programme, with increasing net benefits emerging in 2009.
This year’s result gives further evidence of the benefits that PaperlinX has gained from its strategic initiatives with a net contribution of $41 million to EBIT (over our 2005 base). At the current run rate we have the potential to beat the announced incremental EBIT of $100 million from strategic initiatives in 2009 by a further $20 million. There is still much to be done to secure these benefits, but momentum is favourable. What we can do is to continue to deliver against this type of activity.
And as you can see we have made good progress against our own targets. The following highlights the current status of each key initiative:
Cascades Resources (now Spicers Canada) acquisition
Economies of scale and opportunities for synergies in Canadian merchanting platform.
PaperlinX Office consolidation
Combined different channels to Australian office products and stationery markets with improved service and clearer product offering.
Upgrade of the number 1 paper machine at
Enhanced product quality and competitive position.
Shoalhaven number 1 and 2 paper machines closure
Improved operating efficiency and product mix.
Exit of Portuguese, Swedish, Finnish and
Exiting sub-scale market positions.
Acquisition in Italy
Economies of scale and opportunities for synergies by growing Italian merchanting platform.
Upgrade to Maryvale kraft pulp capacity and
Improved product quality, lower costs, reduced exposure to imported pulp, improved environmental performance. Costs above original expectations, on track for targeted returns in fiscal 2009.
Maryvale wood yard
Reduced costs, improved efficiencies and improved consistency.
On track for start-up to match pulp upgrade.
The Delivery Co in the UK
Logistics integration to optimise customer service, maximise efficiency and minimise environmental impacts.
Seven sites operational as scheduled.
European IT systems
Improve working capital management, deliver additional synergy benefits and improve customer service.
Two implementations on track, one completed.
Improve alignment of channels to enhance customer service, deliver additional synergies and improve efficiency.
Driem integrated into Proost en Brandt, envelopes and packaging integrated.
Strategic sourcing alignments
Enhanced relationships with strategic suppliers.
Progressing as expected.
Global Customer Solutions
Unique position to meet global customers’ needs.
Paper Merchanting – Layers of Value
As PaperlinX is the first truly global paper merchant, some shareholders have asked how we create value from this platform as evidenced by four years of steady returns and growth.
When we buy a paper merchant, all the value we acquire is within that local merchant and its local customer relationships. One of our core tenets is to respect that local relationship as a basis of our merchant model. So how do we add value to that local business and what can we do to add value as a global merchant?
The first step in this journey happens before you acquire. You must have discipline. Discipline to understand the financials and pay the right price, and discipline to only buy good businesses with good people. We have done that well because of our adherence to clear acquisition criteria.
As we build in-market scale both organically and through bolt-on acquisitions, we develop a new group of opportunities. We tend to attract and retain the best people. We deal with the best customers, and we build relationships with the best suppliers. We develop opportunities for improved efficiencies that benefit our customers and suppliers, as well as delivering more efficient logistics along with back office synergies. We can then grow off of our base Paper Merchanting business into value-added activities such as Sign and Display, Industrial Packaging and Graphics. This builds on our existing platform, servicing many of the same customers with their changing needs in these fast growing segments.
Further global benefits come from best practice sharing in the areas of policy (safety, debtor management, working capital management, etc), operational excellence, branding and training. As we share ideas and build superior logistics capability we can enhance and build our supplier and customer relationships to a global level. This is an opportunity uniquely available to PaperlinX.
This is not just talk. Many of our strategic initiatives have been generated from this way of thinking and are already delivering benefits. Add to this our 10 per cent growth in proprietary branded volume in 2007, our 24 per cent compound annual growth in Sign and Display, Industrial Packaging and Graphics since 2004, and the year on year growth in returns for Paper Merchanting, and you can see why we are continuing to grow this business and look to the future with enthusiasm.
For PaperlinX to be successful we must have the right people and we must be prepared to invest in them. This is one of our core operating principles. Workplace safety is always a key priority for our people at PaperlinX. This is highlighted in our Sustainability Report. Our key measures of performance in this area are lost time injury frequency rate (LTIFR) and medically treated injury frequency rate (MTIFR). Our LTIFR of 5.8, while creditable on an industry wide basis, was down slightly on last year and not where we had targeted to be. In addition to our focus on safety, in 2007 we committed to a Group wide ‘health and wellness programme’ for all employees. Details are available in the Sustainability Report, but essentially this is about taking a more holistic view towards health and encouraging our employees to do the same.
2007 saw a continuation of our investment in our people through a range of training programmes specifically geared to our business. We have continued our senior management programme looking at leadership skills and economic profit and are planning the next series of courses for our senior leaders. Our strategic selling programme has been run through Australasia and North America and is currently being rolled out in Europe. At a local level in Australia, the LeaderlinX programme has helped build skills in our operating companies.
As we move through 2008 we will be rolling out a set of values across the PaperlinX Group that have been developed over the past year following a comprehensive consultation programme. These values are intended to act as a common thread though our organisation, building on our important local values, but encompassing an overall view of what it means for our people to be part of the PaperlinX family.
In this Concise Annual Report we do not spend time on the subject of sustainability. This is because we have committed an entire report to this key area. We know our business has impacts, be they economic benefits or the environmental impacts of our activities. Our goal is to be transparent in explaining our impacts and to look to continually improve our performance in all areas. Please look at our Sustainability Report (available in hard copy or on our website, www.paperlinx.com) where we detail our performance in the non-financial areas, and the work we are doing to underwrite our future performance.
2007 has further reinforced the progress we have made on our journey to grow returns for our shareholders. Our current returns are below our targets, but we are taking positive and aggressive actions at all levels of the company on what we can do. 2008 will be an important year with a number of key projects moving through critical periods towards their conclusions, to achieve the substantial targeted benefits in 2009 and beyond.
The impact of the weak US dollar on the PaperlinX results is substantial despite the real progress made on efficiencies, costs and expenses to mitigate the impact. Major exposures are on pricing, input cost recovery and export sales translation in our Paper Manufacturing business in Australia. Pricing in Europe, New Zealand and Canada is also indirectly affected. All of these factors will make 2008 a challenging year.
I would like to thank my fellow employees for the commitment and energy they have shown throughout the past year. It is exciting to see the growing momentum across the Company, with the sharing of ideas and best practice. We are uniquely positioned to take advantage of the opportunities ahead of us and I know that we have the team and are building on the skills and experience needed to be successful in the future.
Thomas P Park
Managing Director and
Chief Executive Officer