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Hello, and welcome to the DS Smith Q3 Trading Update. My name is Rosy, and I'll be your coordinator for today's event. Please note, this call is being recorded. [Operator Instructions] I will now hand you over to Miles Roberts to begin today's conference. Thank you.
Well, good morning, everybody, and thank you for joining us today. I'm Miles Roberts, the CEO of DS Smith; and I'm joined by Adrian Marsh, our Finance Director. I should say our statement today covers the trading period since the 1st of November 2020. Well, first of all, obviously, we all hope everybody on the call is safe and well. And throughout these really very strange times, I continue to be immensely grateful to everybody who works in DS Smith for their commitment that has allowed every one of our plants to remain open and fully operational. They, together with our scale, footprint and our leading positions in recycling and packaging, have enabled us to deliver for our customers throughout the entire period of this pandemic. And trading continues to progress well. The trends described in our half 1 results in December continued into H2. We are seeing particularly strong box volume growth, driven by a differentiated offering. And whilst input costs have increased, overall trading remains fully in line with our expectations.Like-for-like box volume growth has accelerated compared to Q2 of this financial year. And the expected e-commerce and FMCG strength over Christmas has indeed continued into 2021, together with some early but very encouraging signs of recovery in the industrial sector. Very pleasingly, our North American business continues to deliver strongly improving results as a consequence of good domestic growth with corresponding reduced exports of paper but also with increased pricing.Input costs, including OCC, have increased in the period, which, together with high demand, continues to drive paper prices higher. We've already started to recover these additional costs through higher packaging prices. And our expectation is, with a customary lag, that we fully expect to recover these increases which, again, will really underpin our momentum into 2022. Working capital and cash generation remain key areas of focus, and we anticipate a continued strong free cash flow performance in the year with cash conversion of over 100%. But as you all know, we're the leader in sustainability, and we operate a circular business where we collect more packaging, we recycle more packaging than we produced. And we are purely focused on fiber-based products, supporting and benefit from the plastic replacement trends. And I'm also delighted more widely, we've been upgraded by a number of ESG rating agencies in the period. But carbon reduction, whilst our carbon reduction program is progressing very well and we expect to achieve another year of excellent progress, it is not enough to only be low carbon. It is also the product that you make. That is why we are purely faced on fiber-based packaging, working with our customers to replace plastics at every opportunity and that doesn't conflict with other parts of our business. So in summary, we're seeing excellent demand from FMCG and e-commerce customers. And we continue to invest for growth in these areas, such as our new plants that we announced in December. COVID-19 continues to accelerate a number of the structural growth drivers. And our leading positions in recycling and fiber-based packaging, together with our growing, really very exciting digital platforms, position us well to capitalize on this in the future and drive further market share gains. Whilst the economic environment remains uncertain, we experienced good momentum across the business. And we're confident of delivering results in line with our expectations for the year and showing further good progress and momentum as we move into the next financial year. Thank you very much. I now open with Adrian to answer any questions people may have.
[Operator Instructions] And our first question comes from the line of Sam Bland from JPMorgan.
I have 2 questions, if I can, please. The first one is on -- so e-commerce is helping to drive pretty strong volumes at the moment. Any thoughts on that or what you're hearing from customers around how permanent and sticky that sort of e-commerce volume could prove to be as obviously shops reopen at some point in the future? And the second question is on exceptional items, particularly cash exceptionals. Just any comments on, I think there's about GBP 50 million expected in the current year, where that could go to in the year to April '22 as the integration comes to a close?
Thank you, Sam. I'll take the first question and then Adrian will come on the second. E-commerce has been very strong overall in the volumes. I think what's very interesting, though, throughout the pandemic, we really saw, I'd just say, some of the really big e-tailers really accelerating their position. And that has and remains very strong. But during this pandemic, we've seen a number of other customers who haven't had their own platform starting to develop their own e-commerce platform so that in the future, if the High Street doesn't have the footfall that it's had in the past, they will be able to have their own offering going direct to the consumer.Now this is a really interesting area for us because the packaging is not just about the delivery and keeping a product safe, it's also about a different relationship, enhancing the relationship between the supplier, the producer and the final consumer. So in this area, we're seeing good growth. But the quality and the type of packaging is developing really very rapidly, more personalization, more product presentation within the box. And I think this is the trend that's been -- we're just very pleased to see coming through. And when we look going forward, even though the shops will reopen, I think these platforms that people have built will continue to be a major focus for them because maybe, I mean, who knows what to happen next winter? I think having a strong e-commerce platform is going to be strong for them. But what's also interesting is the way that customers want to transact with us. They want to communicate. They want to develop and design. That has changed as well. And as you know, we've built some fantastic digital platforms. We talked about some of them at the last -- at the half year with things like ePack where anybody can go online and order packaging. The response to this has been absolutely electrifying, it really has. We're rolling them out across Europe. But the other digital platforms we've created, how people continue to design and create their packaging even when we're not meeting physically together, that's been a very strong trend with us. So it's been a very interesting time, but I think there's an awful lot of mileage still left in the whole e-commerce development area.
Just on the second question, Sam. I mean, obviously, I'll give proper guidance at the usual time when we announce our full year results. However, you're absolutely right, I mean, the integration of recent M&A concludes this year. So absent anything that I don't know as of today, you can assume there'll be a significant reduction in cash exceptionals next year, in fact.
Our next question comes from the line of Cole Hathorn from Jefferies.
Miles and Adrian, encouraging 3Q trading update. But looking out into FY '22, I hope you can just help us understand the driving blocks of what should be a, hopefully, a positive growth in profit here for FY '22. What's going to be the drivers? Is it higher box volumes, pricing, North America recovery? What builds that bridge to kind of over GBP 600 million EBITDA level?
No, look, it's a very good question because we're finalizing. But you're absolutely right, it's about the volume going forward and, again, our segmentation in particular product groups, types of packaging, customers and regions. We've done fantastically well with some -- with our large customers, as you know, where -- who are the large FMCG companies right across Europe. Our service and quality and innovation has been excellent, and we're seeing continued, very strong momentum there. I mean it's been very good. It's been very good. They've been very appreciative of our -- all of our service and quality throughout the whole period. But these digital platforms we're creating is also giving us some very encouraging opportunities in smaller customers. We are seeing some -- in terms of sectors, I think FMCG is going to be -- remain strong, particularly on the -- with the on-trade business. We are seeing a slight return on industrial, and we do expect that to continue. So we see a good volume trajectory into the coming year. In terms of pricing, we've seen some significant increase in the price of paper. Interesting, paper still isn't back to the price it was just over 2 years ago. We're very well experienced in how to recover this. We're already out. I have to say the progress we've made to date has actually been very encouraging. It's been very strong demand at the same time, but as I said, the fundamentals, the service and quality and innovation they want.So I think we'll be getting these increases back in our customary. I mean, on average, it takes us between 3 and 4 months on average. And sitting here at the end of February, looking at the increases that came in towards the end of last year, we are fully consistent with that on pricing. You're right about North America, that's coming back strongly, very pleased to see that. You've seen the profits that we've made in that division previously. We know the reason the profits fell because the paper was exported. So we're now building the volumes in North America, domestic volumes, domestic packaging volumes, got a new plant opening, has opened. That's coming along very nicely, and that has quite a significant effect. And then, of course, we've got our new investments that we've spoken about. We have continued to invest in new capacity and new sustainable solutions to replace plastics. We've got the 2 new sites, should be on-stream towards the end of our new financial year. I mean, to be honest, we can't wait for them to come online. We're feeling there's a very strong pipeline of opportunity there. But both in Italy and in Poland, though, yes, they'll be online at the end of next year.
You've also got, Cole, don't forget, we took a reasonably significant hit in our first half COVID-specific costs that we said we'd gradually process reengineer away. That is happening. We're operating much more efficiently as every month goes through. And we'll have the benefits of other capital that we've invested in efficiencies carrying on, as we always do. As you know, we always focus hard on efficiency programs. But we won't be repeating the one-off costs that we have for COVID in the first half, assuming that the world recovers as we expect.
Our next question comes from the line of Mikael Doepel from UBS.
Just a quick question here. I was wondering about the industrial end use. You're mentioning that part of the business is showing some signs of recovery. So basically 2 questions there. One, how big is that exposure to you? And then secondly, where in particular do you see this recovery there?
Before, the industrial sector is about, typically, over the previous year, is about 16%, 17% of our business. And we saw that at the start of the pandemic because a lot of our customers in those sectors weren't essential businesses. They effectively closed. We have seen a recovery. And instead of being down circa sort of 10%, pretty much in line with the economies last year, we expect that to return to growth. All the signs are that, that is happening. Our customers obviously dusting down their plants, how they -- a lot of them have restarted production. And the -- and there's some encouraging signs coming out of them. It's still early days, but there are some quite encouraging signs. Clearly, governments looking to boost economies with investment. You can all see these -- they use green fund or substantial funds, obviously, looking to boost the economies, plus national governments as well. Infrastructure spend, et cetera, is being talked about. And the industrial sector is responding. So we do expect it to be back in growth. That does make the difference. That certainly does make quite a difference to us. And the second question was? I don't know. I can't read my writing. Just a sec.
I do think it was industrial. Our focus, obviously, we're trying to continue to grow our exposure to FMCG. The 2 new greenfields are very much around FMCG growth. So I think, again, over time, we're -- that exposure to the more cyclical industrial sector will decline.
The next question comes from the line of David O'Brien from Goodbody.
Firstly, just on OCC. If we mark-to-market here, what is the headwind for FY '21 as we stand? Secondly, look, it's encouraging to hear that box prices look to be turning already. Can you just give us a sense of the feedback from customers on the ground as you implement increases across your business?And finally, there's, it looks like, even other testliner price increase out in the market. Any feedback you can give on that as well?
No, thank you. Thank you, David. I mean OCC is -- it's proving to be -- the headline numbers are -- there's quite a bit of volatility there. And the volatility is coming from, obviously, high demand, but also the availability, broadly. A lot of this OCC seems to be in people's carriages rather than in the normal sort of High Street stores. And then, of course, we've had some poor weather as well, which has just restricted some of the supply. So it's come down from about probably about 8- or 9-days stock. It's currently around about 7 days. And obviously, people start and think about the Easter shut. So at the moment, we have seen -- if we look at deliveries into March, they have -- the cost has gone up quite a bit from February. But I think there's just still -- I think there's just a number of very unusual factors there. The recent spike, I think, will come off. But the prices are higher. I mean it's -- if we look in the final quarter, I mean, it's difficult to know because of volatility. But it could be circa 20 a tonne, something like that, on the price of OCC on average, the final quarter compared to the previous quarter.
Agreed. I think it's harder to mark-to-market simply because it's now going through into paper prices, which is sort of your last question, David, and paper prices are going through to packaging. So we called out at our full year results an impact of the spike when the OCC rose significantly, but that wasn't accompanied at the time with a rise in the price of paper. And therefore, yes, it caught us particularly hard.But yes, I mean, going into Q4, we've got that headwind as that fall through to paper price rises, which fall into packaging, which are then recovered, as Miles described, with our usual lag. So there's a little bit of left pocket, right pocket between Q4 this year and Q1 next year. You're absolutely right.
And on the pricing, the -- we have been out already recovering the increases that came through in October, November. And look, I mean, hope you want to see, nobody likes a price increase. But demand is very strong. And people want the quality and they want the service, and it does come off -- it does come on the back of actually some reductions. So we are -- nobody likes to increase, but they are going through, and they are being accepted.I have to say, just generally, I know there's sort of different sort of reports, but I wouldn't be surprised if there was generally just a bit more inflation coming through. We've definitely strengthened our position during the pandemic, our market shares, et cetera. I've talked about our service and quality. So those price increases are going through. And on the testliner price increase, your first question on the OCC, these testliner prices, they are not small. It's not sort of 10 and 20. These are 50s going through. And that really does mirror the strength of demand, and those price increases are being -- are going through. So in fact, we saw another one yesterday. Yes, so -- and we weren't surprised by that at all. We've made various announcements.And with OCC where it is, I wouldn't be surprised if there are some more as well. But it's still not back to the price it was just over 2 years ago. So we feel pretty confident that this will be accepted by the market, and that's in Europe and in the U.S. as well, there's another one coming through.
Yes. If we look back on that scenario 3 years ago, when prices rose materially, we saw the whole market recovering it because it has to be because there's no other option. So in certain respects, it's a lot more sensitive to big -- to large price rises than it is to small price rises on input costs.
We have no further questions coming through. So Miles, I will hand back to you for any concluding remarks.
Firstly, thank you. Again, thank you, everybody, for your time today. Just to say that we're pleased to see the trends that we saw in the first half really continue. Volumes are good. Pricing is going up, and we're really looking forward to further progress into full year '22. Thank you for your time.
Thank you.
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