Jussi Pesonen, President and CEO, comments on the Q3 results:
“UPM reached all-time high quarterly results in Q3. The strength of our operating model was on full display as we simultaneously delivered record quarterly results in UPM Communication Papers, UPM Specialty Papers, UPM Raflatac, UPM Energy and UPM Biofuels. UPM Fibres and UPM Plywood achieved strong results, too. All in all, Q3 was a great success considering the highly uncertain and volatile business environment.
Good demand continued in most of our businesses, and sales prices more than offset the impact of continued increases in variable costs. Delivery volumes were back to normal after the exceptional H1 and operational efficiency was on a good level. No major downside risks materialised during the quarter.
Our sales grew by 36% to EUR 3,420 million (Q3 2021: 2,523 million), and comparable EBIT grew by 84% to EUR 779 million (424 million). As in the previous quarter, cash flows related to energy hedges affected operating cash flow significantly, resulting in an operating cash flow of EUR -201 million. Due to the nature of our hedging, this cash flow is expected to reverse in the future.
Our financial position remains strong, with cash funds and unused committed credit facilities totalling EUR 5.2 billion at the end of Q3. Net debt to EBITDA ratio was on a healthy level at 1.39. This gives us a solid base to navigate the unpredictable operating environment.
The quarter was clearly characterised by the energy crisis in Europe. Energy prices and volatility in the markets reached unprecedented levels. Market price signals are crucially important both for the energy system as a whole and for steering UPM’s energy production and consumption. We continuously optimise our electricity consumption towards hours when the prices and society’s energy needs are at their lowest, whereas we increase hydropower generation when energy needs are highest. Consequently, we help balance the electricity market, particularly in Finland. At the same time, all this is a significant source of value creation and competitive advantage both in our energy business and in our energy-consuming businesses.
UPM Energy achieved record earnings, benefiting from high market prices, optimised hydropower generation on the volatile markets, and the first notable generation volumes from the OL3 nuclear power plant unit.
UPM Fibres achieved an excellent quarterly result with continued solid demand and high prices for pulp. Our timber business, however, was affected by a visible slowdown in construction end-uses.
In UPM Communication Papers the excellent earnings level is a remarkable achievement. The business has faced a radical rise in input costs, particularly in energy and fibres, but they have been successfully offset by sales prices. The business has been very determined in adopting a more agile operating mode in the highly uncertain markets.
UPM Specialty Papers delivered all-time high quarterly results despite historically high-priced raw materials. The market for release liners and packaging papers remained strong. Asian fine paper markets continued to be challenging.
Favourable market conditions continued for UPM Raflatac. Customer demand for labels remained good, and the business performed extremely well. The acquisition of AMC AG in Germany was completed in September, accelerating growth and widening the product portfolio.
UPM Plywood had a good quarter despite slowing demand in construction end-uses. Sales prices increased for most products.
In Other operations, UPM Biofuels achieved record production and profitability in the strong markets for renewable biofuels. Our strategy based on proprietary technology and UPM’s integrated feedstocks, supplying highly sustainable renewable fuels is truly delivering results.
Our pulp mill in Paso de los Toros, Uruguay, is expected to begin commercial production in Q1 2023 growing our pulp business by more than 50%. A significant milestone in the project was reached when the new pulp terminal in the port of Montevideo was inaugurated in October. Direct connections from the new pulp mill to the global markets play a key role in the competitiveness of our pulp business.
The testing period for the OL3 nuclear power plant unit continues. Once in commercial production, it will grow our energy business by almost 50%, providing much-needed emission-free electricity to the markets.
Our biochemicals refinery project in Leuna, Germany, is proceeding as planned. We are opening a new growth business for UPM, providing more sustainable solutions to replace fossil-based materials in numerous end-uses. The keen customer interest in our innovative biochemicals products is inspiring. Basic engineering continues for the potential biofuels refinery in Rotterdam, the Netherlands.
During the quarter, UPM received its all-time high score from EcoVadis, the leading rating agency for supply chain sustainability, and was yet again recognised on Platinum level. Only one percent of the 90,000 companies assessed receive the Platinum score. Sustainability is at the heart of UPM’s Biofore strategy focused on providing the world with sustainable, renewable materials for various end-uses and competitive zero-carbon electricity.
Looking ahead, the uncertainties in the business environment continue to be numerous, but UPM is well prepared to face them with high-performing businesses, an agile operating model and a strong balance sheet. In addition, our growth projects are nearing their start up phases, adding significant new earnings in the future. This year, we expect our annual earnings to reach new record highs.”
Outlook for 2022
UPM’s comparable EBIT is expected to increase in 2022 from 2021. Following the record strong Q3 2022 results, UPM’s financial performance is expected to continue above last year’s level.
Significant uncertainties remain in the outlook, related to the war in Ukraine, the remaining effects of the pandemic, growth in the European and global economy, energy prices, availability and related regulation in Europe, the start-up of the OL3 power plant unit, and the tight raw material and logistics markets.
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, by optimising its product and market mix, through 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 pandemic 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. This has caused 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 advertising- driven 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 to 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 3,133 million at the end of Q3 2022. Net debt has been especially impacted by energy hedging derivative market value payments, which are driven by the increase in energy futures prices and volatility in the energy markets. Cash funds and unused committed credit facilities totalled EUR 5.2 billion at the end of Q3 2022. The total amount of committed credit facilities was EUR 5.7 billion of which EUR 160 million maturing in 2023, EUR 4.3 billion maturing in 2024, EUR 300 million maturing in 2025 and EUR 950 million maturing in 2027. EUR 4.3 billion of facilities were signed during Q3 2022. 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 more recently the oblasts of Zaporizhzhia and Kherson, 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. Further escalation of the conflict has involved Russia’s attempted illegal annexation of four partially occupied regions in Ukraine based on sham referenda, mobilisation of military reservists in Russia, issuance of open nuclear threats and explosions in Russia-to-Germany gas pipelines under the Baltic Sea, which have all increased the geopolitical tensions between Russia and several other countries and triggered further sanctions packages against Russia.
While the sanctions primarily target Russia’s ability to finance its military operations in Ukraine and cause economic and political costs on the people responsible for them, economic and geopolitical uncertainty and 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 export and import bans on several forest industry product categories, prohibitions on Russian transportation operators entering the EU and 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. The EU energy ministers also adopted a new temporary regulation (applicable from 1 December 2022 to 30 June 2023) on the reduction of electricity use, capping of revenues of electricity producers, and mandatory solidarity contributions from fossil fuel businesses. 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 Q3, the impairment was EUR 85 million and the credit loss provision was EUR 11 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, 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.