Jussi Pesonen, President and CEO, comments on the Q2 results:
“UPM delivered record Q2 earnings driven by successful margin management in exceptionally tight markets for our products. All our businesses reported strong earnings amidst a volatile environment of rapid inflation in input costs and challenging supply and logistics chains. In addition, customer deliveries from our Finnish mills started smoothly after the end of the strike in late April. As a result, our quarterly sales increased by 7% to EUR 2,562 million, and comparable EBIT increased by 26% to EUR 387 million. This was a great achievement taking into account that during the first half we only had one month of normal full production. For the full year, we expect to reach a new record of annual earnings.
Operating cash flow was EUR -879 million and our net debt at the end of the quarter was EUR 2,688 million. Cash flow was significantly impacted by the timing of cash flows from our energy hedges during an unprecedented rise in energy futures prices. Due to the nature of our hedging activity, this cash flow is expected to reverse in the future, meaning that a significant part of the increase in net debt is temporary. Our financial position remains strong, with cash funds and unused committed credit facilities totalling EUR 1.5 billion at the end of Q2. We further improved our liquidity in July, with two new credit facilities totalling EUR 500 million. This gives us a solid base to push on with ongoing transformative growth investments and face the unpredictability of the operating environment.
Market fundamentals for UPM Fibres were strong in Q2, for both pulp and timber. Production at the Finnish pulp mills started well after the business specific collective labour agreements were signed in April and two major maintenance shutdowns were completed.
UPM Communication Papers had a strong quarter. Demand for graphic papers was good and price increases exceeded the rise in input costs, with the cost of energy posing a particular challenge. During the quarter we announced the sale of UPM Steyrermühl, in Austria. This is another step in securing competitiveness of the Communication Papers business, adjusting our newsprint production to the long-term market development. Newsprint production at the mill will stop at the end of next year.
UPM Specialty Papers’ results showed an improvement from the first quarter. Demand and prices of release liner and packaging papers continued to be good, while the Asian fine paper markets were softer, impacted by the lockdowns in China. Sales prices increased, but input costs were still on the rise, and exchange rates did not develop in our favour.
UPM Raflatac’s quarterly result continued at record level despite sales volumes being limited by raw material availability and sales to Russian markets being discontinued. Demand was healthy, and margins were well managed in the environment of high-cost inflation. UPM Raflatac announced the acquisition of AMC AG in Germany, to accelerate growth and expand its product offering. The necessary regulatory approvals for closing the acquisition are expected to be granted in Q3.
UPM Energy reported strong quarterly results as energy markets were very volatile and prices high, providing value creation opportunities for our hydropower generation. In June, prices of energy futures saw an unprecedented rise, resulting in extraordinarily high cash outflow of our energy hedges, totalling EUR -1,032 million in Q2. As our energy hedges are only for hedging our existing electricity generation portfolio, this cash outflow will later be offset by a similar cash inflow from hedges or production.
All in all, there is exceptional uncertainty and tightness in the energy markets. This indicates strong earnings potential of UPM Energy. Furthermore, the OL3 nuclear power plant unit will increase UPM Energy’s carbon free electricity generation by nearly 50% at an opportune time.
UPM Plywood’s earnings stayed at near-record levels. Plywood markets were tight in all end-use categories. As the world’s first plywood manufacturer, UPM launched the lignin-based bonding technology throughout its entire range of products. WISA® BioBond helps customers meet their own sustainability targets.
In other operations, the markets for UPM Biofuels’ advanced renewable fuels are favourable, and strong earnings are to be expected once the business can report a full quarter of production again.
Our Paso de los Toros pulp mill project, in Uruguay, has proceeded smoothly and the commissioning phase is now underway. The commissioning plan was granted approval by the Uruguayan environmental authorities in late June. Testing of pulp production equipment at the mill has begun, and other commissioning tasks and the respective adjustment of production equipment will be carried out until the start-up of the mill in Q1 2023.
Construction at the biorefinery-site in Leuna, Germany, has progressed well and commercial activities in various product and application areas have continued to advance. The environmental benefits of the biorefinery and the UPM Biochemicals portfolio have been publicly acknowledged with several nominations. The detailed commercial and basic engineering study for a possible next generation biofuels refinery in Rotterdam, Netherlands, has continued.
Rarely have there been so many uncertainties in the world and in the global economy as there are today. We are well prepared to face this uncertainty as our businesses are competitive and performing well, and our financial position is strong. This year, we are expecting our annual earnings to reach new record highs. Some of the uncertainties in the medium-term outlook are mitigated by our growth projects, which will add significant new earnings, ramping up as early as next year. Over the longer term, I am confident that UPM’s Biofore strategy is well-calibrated to provide what the world will need in the future: competitive zero-carbon electricity and sustainable and renewable materials with countless possible end-uses."
Outlook for 2022
UPM’s comparable EBIT is expected to increase in 2022 from 2021, and in H2 2022 from H2 2021.
Significant uncertainties remain in the outlook for 2022, related to the war in Ukraine, the ongoing pandemic, growth in the European and global economy, the energy prices and availability in Europe, the start-up of the OL3 power plant unit, and the tight raw material and logistics markets.
In the first half of the year, production was significantly affected by the strike at the Finnish units of UPM Pulp, UPM Biofuels, UPM Raflatac, UPM Specialty Papers and UPM Communication Papers. This no longer limits production and as a result, UPM’s delivery volumes are expected to increase in H2 2022 from H1 2022. In the full-year 2022 result, the estimated impact of the strike is not material.
Sales prices and variable costs are expected to be higher in H2 2022 than in H1 2022 in most of UPM businesses. UPM will continue to manage margins with product pricing, optimising its product and market mix, efficient use of assets as well as by taking measures to improve variable and fixed cost efficiency.
Impact of COVID-19 pandemic
The COVID-19 pandemic, the related containment measures around the world and the rapid changes in the global economy continue to represent significant uncertainty.
The COVID-19 pandemic and the related containment measures resulted in a sharp decline in the global economy in 2020. In 2021, the global economy started to recover, but it is uncertain how long lasting the recovery will be. Despite progress with vaccinations, additional waves of the epidemic in different parts of the world remain possible.
The recovery of the global economy from the deep downturn in 2020, combined with the ongoing pandemic has created tightness and disruptions globally in many supply chains, including logistics and energy, causing rising costs and uncertainty on the price and availability of many raw materials and energy.
Safety and business continuity
UPM has implemented extensive precautions to protect the health and safety of its employees and to ensure business continuity and the progression of its strategic projects during the pandemic. Despite these efforts, the operation of one or more units or the supply chain and logistics could be temporarily disrupted during the pandemic, the related lockdown measures, or the following economic recovery. In these circumstances some units may need to limit operations or be temporarily shut down. So far UPM has been able to protect its business continuity well.
Demand for UPM products
Many of UPM's products serve essential everyday needs and have therefore seen resilient demand during the crisis. These products include pulp, specialty papers and self-adhesive label materials. However, even in these businesses, demand is influenced by general economic activity.
Demand for graphic papers is more prone to be impacted by the lockdowns and economic cycles. Lockdowns limit a wide range of consumer-driven services and retail, as well as work at the office. This has had a negative impact on printed advertising and graphic paper demand during the pandemic.
Lockdowns and the level of economic activity may also influence demand for electricity, plywood and sawn timber.
In 2020, graphic paper demand in Europe decreased by 18% compared to the previous year, particularly as advertisingdriven paper consumption and office paper demand was impacted by the lockdowns across Europe. In 2021, as economies in Europe started to gradually open, graphic paper demand increased by 4% compared the previous year.
Pulp demand has held up relatively well, supported by good demand for tissue and hygiene products as well as for some packaging and specialty paper products. Pulp consumption in graphic paper production decreased in 2020 but improved in 2021.
Demand for self-adhesive label materials and specialty papers has grown during the pandemic, as consumers have shifted some of their spending from away-from-home categories to packaged daily consumer goods. E-commerce has continued to grow, supporting some labelling and specialty paper applications.
Adjusting to different scenarios
The potential impacts on UPM are likely to differ by business and phase and waves of the pandemic, lockdown measures, changes in consumer behaviour, and the recession and recovery thereof. UPM has used shift arrangements, temporary lay-offs, or reduced working hours as required to adjust its operations in different scenarios.
Projects and maintenance shutdowns
The pandemic and the required health and safety measures add challenges to large investment projects and maintenance shutdowns. UPM's transformative pulp project in Uruguay and biochemicals project in Germany are proceeding with strict health and safety controls. Despite these efforts, some changes to the detailed timeline and costs of the projects are possible during the pandemic, the related containment measures, or due to tight global logistics and supply chains.
UPM rescheduled the maintenance shutdown at the UPM Kymi pulp mill from Q2 2021 to Q4 2021 due to the pandemic.
Timing of significant maintenance shutdowns in 2022
UPM’s financial position is strong. UPM's net debt was EUR 2,688 million at the end of Q2 2022. Net debt has been especially impacted by energy hedging derivative market value payments, which are driven by the increase in energy future prices and volatility in the energy markets. Cash funds and unused committed credit facilities totalled EUR 1.5 billion at the end of Q2 2022. This includes EUR 400 million under the sustainability-linked EUR 750 million committed syndicated revolving credit facility maturing in 2027 and a EUR 160 million equivalent rolling overdraft facility. In Q2 2022, UPM successfully issued its third Green Bond under its EMTN (Euro Medium Term Note), at EUR 500 million. In addition, UPM has signed two new bilateral credit facilities in July, totalling EUR 500 million. The facilities mature in 2024. The facilities and UPM's outstanding debt have no financial covenants.
Impact of the Russia's war in Ukraine
In response to Russia´s attack on Ukraine, the European Union as well as the United States, the United Kingdom, and other countries have imposed extensive sanctions on Russia, the breakaway regions Donetsk and Luhansk, and Belarus. Since 21 February 2022, these measures include for example asset freezes and travel restrictions on individuals and entities, economic sanctions targeting sectors of the Russian and Belarusian economies, and diplomatic restrictions. Russia has also implemented several countermeasures affecting especially foreign companies’ operations within Russia and with Russian counterparties.
While the sanctions primarily target Russia’s ability to finance its military operations in Ukraine and cause economic and political costs on people responsible for them, economic and geopolitical uncertainty as well as inflation may accelerate around the world. Import bans concerning various goods categories will restrict the availability of raw materials and drive cost increases in many supply chains that have been under increasing pressure during the COVID-19 pandemic. Export bans will impact industries dependent on Russian markets and shift delivery volumes and services to other markets. Fuel prices are exposed to geopolitical uncertainties. Because of Russia’s attack on Ukraine, the sanctions imposed on the Russian energy sector and Russia’s countermeasures on gas and electricity deliveries, energy price levels and volatility may increase, especially in Europe if the scope of EU sanctions expands to further fossil fuels such as natural gas.
Impact on UPM businesses
The EU has imposed bans on wood product exports and imports, prohibitions of Russian transportation operators entering EU as well as sanctioned several Russian banks. Disruptions in international sales, purchases and payment flows involving Russian counterparties are inevitable. The EU has also imposed restrictions on Russian seaborne crude oil, certain petroleum products and oil transportation services. Russia has also restricted or suspended the flow of natural gas or electricity from Russia. These restrictions have impacted several European countries where UPM has production locations and caused increases in the price of power and gas. The unprecedented increase in energy futures prices has impacted cash flows from energy hedges, temporarily tying liquidity. Major forest certification organisations (i.e. FSCTM and PEFC) have also excluded Russian and Belarusian wood from their certification systems. UPM businesses have suspended deliveries to Russia as well as wood sourcing in and from Russia. UPM also decided to suspend the UPM Chudovo plywood mill operations. Due to the significant uncertainties related to operations in Russia and Ukraine, UPM recognised a write off of all assets and receivables locating or relating to operations in these countries in Q1 2022. Impairment of fixed assets, inventories and other receivables amounting to EUR 95 million was reported as items affecting comparability. In addition, in Q1 the group increased the general provision for expected credit losses on trade receivables by EUR 17 million, which is impacting comparable EBIT. At the end of the Q2 credit loss provision was EUR 14 million. UPM’s sales to Russia and Ukraine combined was approximately 2% of UPM’s total sales in 2021. Assets in Russia were less than 1% of the group total. In 2021, less than 10% of UPM’s wood sourcing to Finland originated from Russia.
Adjusting to different scenarios
The full impact of the current and possible new sanctions, counter-sanctions and market development will be known only as the situation evolves. UPM has implemented mitigation plans to contain and reduce negative consequences for its employees, customers, vendors, and other stakeholders as well as operations affected by the sanctions and the war in Ukraine in general. The potential further impacts to UPM are likely to differ by business and by the pace, scope and duration of sanctions, market price reactions, development of supply chains’ footprint, and the length of the war in Ukraine. UPM is monitoring the situation closely and preparing plans to adjust
its operations in different scenarios accordingly.