Notes to the condensed group results

1. Basis of preparation

The condensed consolidated interim financial statements for the quarter and nine months ended June 2019 are prepared in accordance with the International Financial Reporting Standards, IAS 34 Interim Financial Reporting, the SAICA Financial Reporting Guides as issued by the Accounting Practices Committee and Financial Pronouncements as issued by Financial Reporting Standards Council and the requirements of the Companies Act of South Africa. The accounting policies applied in the preparation of these interim financial statements are in terms of International Financial Reporting Standards as issued by the IASB and are consistent with those applied in the previous annual financial statements except those new standards adopted and set out below under “Adoption of accounting standards in the current year”.

The preparation of these condensed consolidated interim financial statements was supervised by the Chief Financial Officer, G T Pearce, CA(SA) and were authorised for issue on 1 August 2019.

The results are unaudited.

Adoption of accounting standards in the current year

The group has adopted the following standards and amendments to standards during the current year, all of which had no material impact on the groups reported results or financial position:

IFRS 9 Financial Instruments

IFRS 9 set out a new classification and measurement approach for financial assets that reflects the business model in which the assets are managed and their cash flow characteristics. The three principal classification categories for financial assets are: measured at amortised cost, fair value through profit or loss and fair value through other comprehensive income. The new classification did not have a significant impact compared to the previous accounting for financial assets under IAS 39. IFRS 9 replaced the ‘incurred loss’ model in IAS 39 with a forward-looking ‘expected credit loss’ (ECL) model. The group applied the practical expedient in IFRS 9 to calculate the ECL on trade receivables using a provision matrix. The application of the ECL model did not result in a material impact compared to the previous accounting under IAS 39. With respect to hedging, a new non-distributable equity reserve was created called cost of hedging reserve. This reserve is used to separate all time value of money and forward point valuations on hedged instruments, as required per IFRS 9. This resulted in an increase to retained earnings and a decrease to this ‘cost of hedging reserve’ of US$4 million on adoption of IFRS 9.

IFRS 15 Revenue from Contracts with Customers

Revenue is derived principally from the sale of goods to customers and is measured at the fair value of the amount received or receivable after the deduction of trade and settlement discounts, rebates and customer returns. For the majority of local and regional sales, transfer occurs at the point of offloading the shipment into the customer’s warehouse whereas for the majority of export sales, transfer occurs when the goods have been loaded onto the relevant carrier unless the contract of sale specifies different terms.

The adoption of IFRS 15 resulted in the group recognising revenue from delivery activities as a separate performance obligation when control of the goods pass to customers at the point when the goods have been loaded onto the relevant carrier for export sales. Given that the group is acting as an agent in these activities, revenue is recognised when the delivery is arranged which is considered to be at the point of loading of the goods resulting in no significant timing differences compared to revenue recognition under IAS 18. The related delivery costs have been set off against this revenue based on agent accounting principles whereas these were previously included in cost of sales. Refer to note 2 for the quantitative impact of this adjustment. The group elected to adopt IFRS 15 on a cumulative effect method.

2. Segment information

    Quarter ended    Nine months ended   
Metric tons (000’s) Jun 2019        Jun 2018    Jun 2019        Jun 2018   
Sales volume                     
North America 320     318   991     1,008   
Europe 789     833   2,440     2,502   
Southern Africa – Pulp and paper 375     383   1,189     1,179  
                                 Forestry 369     380   992     882  
Total 1,853     1,914   5,612     5,571  
Which consists of:                    
   Dissolving wood pulp 285     277   932     866  
   Packaging and specialities papers   295       289     820       718  
   Printing and writing papers 904     968   2,868     3,105  
   Forestry 369     380   992     882  
    Quarter ended    Nine months ended   
US$ million Jun 2019         Jun 2018     Jun 2019         Jun 2018    
Sales                     
North America  343        339     1,072        1,044     
Europe  715        759     2,214        2,188     
Southern Africa – Pulp and paper  307        325     991        983    
                                 Forestry  21        22     58        56    
Delivery costs revenue adjustment(2)    (15)         –       (43)         –    
Total  1,371        1,445     4,292        4,271    
Which consists of:                               
   Dissolving wood pulp  244        245     815        765    
   Packaging and specialities papers  326        327     920        777    
   Printing and writing papers  795        851     2,542        2,673    
   Forestry  21        22     58        56    
   Delivery costs revenue adjustment(2)    (15)         –       (43)         –    
(2) Relates to delivery costs netted off against revenue. Refer to note 1, IFRS 15 adoption.
    Quarter ended    Nine months ended   
US$ million Jun 2019         Jun 2018     Jun 2019         Jun 2018    
Operating profit (loss) excluding special items                     
North America  (9)          10        18     
Europe  20        37     81        119     
Southern Africa  34        44     199        192    
   Unallocated and eliminations(1)                   
Total  48        85     293        332    
Which consists of:                               
   Dissolving wood pulp  35        46     189        177    
   Packaging and specialities  papers        18     26        59    
   Printing and writing papers        18     75        93    
      Unallocated and eliminations(1)                   
Special items – (gains) losses                               
North America  –           13          
Europe  (3)       (2)          (1)   
Southern Africa        (6)    (16)       (35)   
   Unallocated and eliminations(1)                 11    
Total                 (22)   
Segment operating profit (loss)                              
North America  (9)       –     (3)       15    
Europe  23        39     79        120    
Southern Africa  33        50     215        227    
   Unallocated and eliminations(1)  (1)       (5)    (5)       (8)   
Total  46        84     286        354    
EBITDA excluding special items                               
North America  11        20     71        75    
Europe  52        71     176        218    
Southern Africa  52        59     251        240    
   Unallocated and eliminations(1)                   
Total  118        155     502        538    
Which consists of:                               
   Dissolving wood pulp  49        60     232        218    
   Packaging and specialities papers  22        33     81        98    
   Printing and writing papers  44        57     185        217    
     Unallocated and eliminations(1)                   
(1) Includes the group's treasury operations and our insurance captive.

Reconciliation of EBITDA excluding special items and operating profit excluding special items to segment operating profit and profit for the period

Special items cover those items which management believe are material by nature or amount to the operating results and require separate disclosure.

    Quarter ended    Nine months ended   
US$ million Jun 2019         Jun 2018     Jun 2019         Jun 2018    
EBITDA excluding special items  118        155     502        538     
Depreciation and amortisation  (70)       (70)    (209)       (206)    
Operating profit excluding special items  48        85     293        332     
Special items – gains (losses) (2)       (1)    (7)       22    
   Plantation price fair value adjustment           14        30    
   Acquisition costs  –        –     –        (2)   
   Net restructuring provisions  –        –     –          
   Profit (loss) on disposal and written off assets  (1)       (1)    (4)         
   Asset impairments  –        –     (11)       –    
   Asset impairment reversals  –                   
   Black Economic Empowerment charge  –        –     –        (1)   
   Fire, flood, storm and other events  (2)       (11)    (14)       (18)   
Segment operating profit  46        84     286        354    
Net finance costs  (28)       (18)    (65)       (54)   
Profit before taxation  18        66     221        300    
Taxation  (10)       (15)    (60)       (84)   
Profit for the period        51     161        216    
    Nine months ended   
US$ million Jun 2019        Jun 2018   
Segment assets           
North America 1,177     1,141   
Europe 1,609     1,556   
Southern Africa 1,583     1,380  
   Unallocated and eliminations(1) 25     4  
Total 4,394     4,081  
Reconciliation of segment assets to total assets          
Segment assets 4,394     4,081  
Deferred tax assets 104     92  
Cash and cash equivalents 226     317  
Trade and other payables 838     916  
Provisions 6     4  
Derivative financial instruments 4     11  
Taxation payable 42     46  
Total assets 5,614     5,467  
(1) Includes the group's treasury operations and our insurance captive.

3. Operating profit

    Quarter ended       Nine months ended     
US$ million   Jun 2019          Jun 2018       Jun 2019           Jun 2018      
Included in operating profit are the following items:                                          
Depreciation and amortisation   70          70       209           206      
Fair value adjustment on plantations (included in cost of sales)                                        
Changes in volume                                          
   Fellings   19          17       54           49      
   Growth   (19)         (17)     (55)         (52)    
               –       (1)         (3)    
Plantation price fair value adjustment   (1)         (8)     (14)         (30)    
    (1)         (8)     (15)         (33)    
Net restructuring provisions             –                  (2)    
(Profit) loss on disposal and written off assets   1          1       4           (8)    
Asset impairment reversals             (3)     (8)         (3)    
Asset impairments             –       11           –      

4. Earnings per share

   Quarter ended     Nine months ended    
US$ million Jun 2019        Jun 2018     Jun 2019        Jun 2018    
Basic earnings per share (US cents) 1           30        40    
Headline earnings per share (US cents) 2           31        38    
EPS excluding special items(US cents) 4        10     33        41    
Weighted average number of shares in issue (millions) 542.7        538.9     541.7        537.8    
Diluted earnings per share (US cents) 1           29        39    
Diluted headline earnings per share (US cents) 2           30        38    
Weighted average number of shares on fully diluted basis (millions) 546.4        550.0     547.9        549.5    
Calculation of headline earnings                               
Profit for the period  8        51     161        216    
(Profit) loss on disposal and written off assets  1           4        (8)   
Asset impairment reversals          (3)    (8)       (3)   
Asset impairments          –     11        –    
Tax effect of above items  1        (1)    (1)         
Headline earnings  10        48     167        207    
Calculation of earnings excluding special items                               
Profit for the period  8        51     161        216    
Special items after tax  5           10        (15)   
   Special items  2           7        (22)   
   Tax effect  3        –     3          
Refinancing costs  9        –     9        –    
Tax special items          –             19    
Earnings excluding special items  22        52     180        220    

5. Plantations

Plantations are stated at fair value less cost to sell at the harvesting stage. In arriving at plantation fair values, the key assumptions are estimated prices less cost of delivery, discount rates, volume and growth estimations.

Mature timber that is expected to be felled within 12 months from the end of the reporting period is valued using unadjusted current market prices. Mature timber that is to be felled in more than 12 months from the reporting date is valued using a 12-quarter rolling historical average price. Immature timber is valued using a discounted cash flow method taking into account the growth cycle of a plantation.

The fair value of plantations is a Level 3 measure in terms of the fair value measurement hierarchy as established by IFRS 13 Fair Value Measurement.

US$ million  Jun  2019        Reviewed 
Sept 2018 
  
Fair value of plantations at beginning of year  466        458    
Additions  2        –    
Gains arising from growth  55        69    
In-field inventory  (3)         
Gain arising from fair value price changes  14        27    
Harvesting – agriculture produce (fellings) (54)       (66)   
Translation difference  2        (23)   
Fair value of plantations at end of period  482        466    

6. Financial instruments

The group's financial instruments that are measured at fair value on a recurring basis consist of derivative financial instruments, available-for-sale financial assets and a contingent consideration liability. These have been categorised in terms of the fair value measurement hierarchy as established by IFRS 13 Fair Value Measurement per the table below.

      Fair value(1)  
US$ million Fair value
hierarchy
  Jun 2019     Reviewed
Sept 2018
 
Investment funds(2) Level 1   7     7  
Derivative financial assets Level 2   13     21  
Derivative financial liabilities Level 2   6     6  
Contingent consideration liability(3) Level 3   5     7  
(1) The fair value of the financial instruments is equal to their carrying value.
(2) Included in other non-current assets.
(3) Included in other non-current liabilities and trade and other payables.

There have been no transfers of financial assets or financial liabilities between the categories of the fair value hierarchy.

The fair value of all external over-the-counter derivatives is calculated based on the discount rate adjustment technique. The discount rate used is derived from observable rates of return for comparable assets or liabilities traded in the market. The credit risk of the external counterparty is incorporated into the calculation of fair values of financial assets and own credit risk is incorporated in the measurement of financial liabilities. The change in fair value is therefore impacted by the movement of the interest rate curves, by the volatility of the applied credit spreads, and by any changes to the credit profile of the involved parties.

The contingent consideration is based on a multiple of targeted future earnings, of which a weighted average outcome has been considered.

There are no financial assets and liabilities that have been remeasured to fair value on a non-recurring basis.

The carrying amounts of other financial instruments which include cash and cash equivalents, accounts receivable, certain investments, accounts payable, bank overdrafts and current interest-bearing borrowings approximate their fair values.

7. Capital commitments

  Jun 2019     Reviewed
Sept 2018
 
Contracted 264     293  
Approved but not contracted 268     381  
  532     674  

8. Material balance sheet movements

Cash and interest-bearing borrowings

On 26 March 2019 the group raised an aggregate principal amount of €450 million (US$505 million) in new senior unsecured notes due 2026 at a coupon of 3.125% per annum. The proceeds from these notes were used to redeem the full amount of the group's €450 million senior (US$505 million) unsecured notes due 2022 on 10 April as the group exercised its option to early redeem these notes. The coupon on the notes redeemed was 3.375%.

On 17 May 2019 Sappi Southern Africa Limited entered into a new R1.5 billion (US$107 million), five-year floating rate bilateral loan with Nedbank Limited. The loan was swapped from a floating rate to fixed rate via an interest rate swap. The loan matures on 16 May 2024 and will be repaid in a bullet payment.

Inventories and trade and other receivables and trade and other payables

The increase in inventories and decrease in trade and other receivables and trade and other payables is largely attributable to seasonal working capital movements.

9. Related parties

There has been no material change, by nature or amount, in transactions with related parties since the 2018 financial year-end except for The Boldt Company which is no longer considered a related party.

10. Accounting standards, interpretations and amendments to existing standards that are not yet effective

There has been no significant change to managements estimates in respect of new accounting standards, amendments and interpretations to existing standards that have been published which are not yet effective and which have not yet been adopted by the group. Management is in the process of completing their assessment of IFRS 16 Leases.

11. Events after the balance sheet date

On 31 July 2019, Sappi signed an agreement to acquire, subject to conditions precedent including the prerequisite approvals of certain anti-trust authorities, the 270,000 ton Matane high yield hardwood pulp mill, in Quebec, Canada, from Rayonier Advanced Materials Inc for US$175 million. The acquisition will increase Sappi's pulp integration for both its North American and European packaging businesses and lower Sappi's costs of pulp, reduce its volatility of earnings throughout the pulp cycle and provide certainty of supply. The acquisition will be financed from internal resources and is expected to be concluded in the fourth calendar quarter of 2019.