Stora Enso Interim Review January-September 2011

STORA ENSO OYJ INTERIM REVIEW 21 October 2011 at 13.00 EET

• EUR 204 million quarterly operating profit excluding NRI and fair valuations, EUR 51 million lower year-on-year due to cost inflation and unfavourable exchange rates, partially offset by clearly higher sales prices.
• Profit before tax negatively impacted by EUR 128 million NRI related to NewPage.
• Strong quarterly cash flow after capital expenditure at EUR 282 million due to working capital management, liquidity improved at EUR 1 181 million.
• Production curtailments to control inventory levels increased in Q3 and will continue in Q4.
• Q4 operating profit excluding NRI and fair valuations forecast to be somewhat lower year on year.
• Completed Inpac acquisition, Montes del Plata project and containerboard investment in Poland progressing as planned.
• Strong financial and cash position gives a solid platform to pursue selected growth.

Summary of Third Quarter Results

Fair valuations include equity incentive schemes, synthetic options net of realised and open hedges, CO2 emission rights and valuations of biological assets related to forest assets in equity accounted investments.
NRI = Non-recurring items. These are exceptional transactions that are not related to normal business operations. The most common non-recurring items are capital gains, additional write-downs, or reversals of write-downs, provisions for planned restructuring and penalties. Non-recurring items are normally specified individually if they exceed one cent per share.

Markets
Compared with Q3/2010

Industry inventories were slightly lower for magazine paper, lower for coated fine paper, unchanged for newsprint and wood products, and significantly higher for uncoated fine paper.

Compared with Q2/2011

Industry inventories were significantly lower for coated fine paper, lower for uncoated magazine paper and wood products, unchanged for coated magazine paper, slightly higher for uncoated fine paper and significantly higher for newsprint.

Stora Enso Deliveries and Production

Breakdown of Sales Change Q3/2010 to Q3/2011

*Wood, energy, RCP, by-products etc.
**Asset closures, major investments, divestments and acquisitions

Key Figures

NRI = Non-recurring items. These are exceptional transactions that are not related to normal business operations. The most common non-recurring items are capital gains, additional write-downs or reversals of write-downs, provisions for planned restructuring and penalties. Non-recurring items are normally specified individually if they exceed one cent per share.
Fair valuations include equity incentive schemes, synthetic options net of realised and open hedges, CO2 emission rights, and valuations of biological assets related to forest assets in equity accounted investments.
 

Reconciliation of Operating Profit

Q3/2011 Results (compared with Q3/2010)
Operating profit at EUR 204 million excluding non-recurring items and fair valuations was EUR 51 million lower than a year ago. This represents an operating margin of 7.5% (9.7%).

Price increases in local currencies and a favourable product mix increased operating profit by EUR 142 million, but lower volumes reduced operating profit by EUR 31 million. Paper and board production was curtailed by 9% (8%) and sawnwood production by 8% (5%) of capacity.

The costs of chemicals, fibre, transportation and other variable raw materials were higher than a year ago, but productivity improvements and cost savings partly compensated for the cost increases. The overall net impact of the increase in variable costs in local currencies was a negative EUR 92 million. The net impact of market pulp remained strong and similar to a year ago.

Fixed costs were similar to the third quarter of 2010. Increased depreciation had a negative impact of EUR 11 million due to impairment reversals recorded in the fourth quarter of 2010.

Exchange rates had negative impacts on sales and on costs totalling EUR 29 million, after hedges. In addition, exchange rates had a negative impact of EUR 12 million on equity accounted investments mainly due to valuation of Veracel loans denominated in US dollars.

The share of the operational results of equity accounted investments amounted to EUR 3 (EUR 22) million.

The Group recorded a provision of EUR 128 (USD 180) million as a negative financial non-recurring item in arriving at profit before tax in the third quarter of 2011 due to NewPage Corporation’s Chapter 11 filing in the USA as announced on 7 September 2011.

Net financial items were EUR -193 (EUR -51) million. Net interest expenses increased from EUR 24 million to EUR 36 million. Net foreign exchange losses amounted to EUR 11 (EUR 18) million and the net loss from other financial items totalled EUR 146 (EUR 9) million, including a negative EUR 128 million provision due to the NewPage lease guarantee as described above. The remaining loss of EUR 18 million was mainly related to the fair valuation of interest rate derivatives.

Group capital employed was EUR 8 665 million on 30 September 2011, a net increase of EUR 439 million mainly due to an increase of EUR 250 million in operative working capital, EUR 240 million of impairment reversal in the fourth quarter of 2010, increased value in equity accounted investments of EUR 120 million mainly due to equity injection into the Montes del Plata pulp mill project, EUR 70 million for the Inpac acquisition and an increase of EUR 50 million in the PVO valuation. The increase was partly offset by EUR 230 million due to low capital expenditure compared with depreciation and by EUR 90 million due to weakening of the Brazilian real, Swedish krona and Polish zloty.


January–September 2011 Results (compared with January–September 2010)
Sales increased by EUR 672 million year-on-year to EUR 8 283 million. Operating profit excluding non-recurring items and fair valuations increased by EUR 93 million to EUR 681 million. Significantly higher sales prices in local currencies and a favourable product mix more than compensated for higher variable costs and unfavourable exchange rate trends.

Q3/2011 Results (compared with Q2/2011)
Sales were EUR 78 million down on the previous quarter at EUR 2 739 million. Operating profit excluding non-recurring items and fair valuations was EUR 24 million lower than in the previous quarter at EUR 204 million. Reductions in fixed costs could not compensate for significantly higher production curtailments to manage inventory.

Capital Structure

Financing Q3/2011 (compared with Q2/2011)
Cash flow from operations was strong at EUR 362 (EUR 207) million due to working capital management. Cash flow after investing activities was EUR 282 (EUR 122) million. Interest-bearing net liabilities of the Group increased by EUR 87 million to EUR 2 648 million due to the NewPage lease guarantee provision and the Inpac acquisition.

Total unutilised committed credit facilities were unchanged at EUR 700 million, and cash and cash equivalents net of overdrafts remained strong at EUR 1 181 million, which is EUR 185 million more than for the previous quarter. In addition, Stora Enso has access to various long-term sources of funding up to EUR 550 million.

In September 2011 Stora Enso raised a long-term loan of EUR 30 million from IKB Deutsche Industriebank to finance the newsprint machine investment at Sachsen Mill in Germany announced in December 2010.

The debt/equity ratio at 30 September 2011 was 0.45 (0.41) following the NewPage lease guarantee provision of EUR 128 million posted during the third quarter and presented as a financial liability, the negative EUR 96 million currency effect on owners’ equity net of the hedging of equity translation risks and the EUR 86 million decrease in the PVO valuation. 


Cash Flow

Capital Expenditure for January–September 2011
Capital expenditure for the first three quarters of 2011 totalled EUR 223 million, which is 51% of depreciation in the same period. The capital expenditure forecast for the Group for the full year 2011 has changed from the second quarter 2011 estimate of EUR 500 million to approximately EUR 450 million with no impact on strategic project timings. Annual depreciation in 2011 will be about EUR 560 million. The equity injection into Montes del Plata, a joint venture in Uruguay, will be approximately EUR 120 million. Close to 80% of capital expenditure including equity injections is allocated for the strategic high-return growth areas in 2011.

The main projects during the first three quarters of 2011 were power plants, the Ostrołęka containerboard machine and the Skoghall woodyard investment.

Near-term Outlook
Demand (compared with Q4/2010)
Demand for consumer board is forecast to be weaker than a year ago, as well as seasonally weaker than in the previous quarter. Demand is forecast to be slightly weaker for industrial packaging. Demand in Europe is expected to be significantly weaker for newsprint and coated magazine paper, and weaker for uncoated magazine paper. Demand is forecast to be stable for coated fine paper and slightly weaker for uncoated fine paper. Weaker demand for wood products is anticipated.

Prices (compared with Q3/2011)
Prices are expected to be stable for consumer board and lower for industrial packaging. In Europe prices are forecast to be stable for newsprint, magazine paper and coated fine paper, slightly lower for uncoated fine paper and lower for wood products.

In Consumer Board proactive reduction of customer and own inventories is expected to lead to significantly lower operating profit excluding NRI and fair valuations year-on-year.

The Group expects its cost inflation excluding internal actions to remain unchanged at approximately 4% for the full year 2011. Actions continue to mitigate cost inflation. Production curtailments to control inventory levels increased in the third quarter and will continue in the fourth quarter of 2011. In the fourth quarter of 2011, as in the third quarter, foreign exchange rates are expected to have a negative impact on the results.

In the fourth quarter of 2011 year-on-year higher pricing is forecast to be more than offset by diminishing cost inflation and significant production curtailments, and the Group’s operating profit excluding NRI and fair valuations is forecast to be somewhat lower than in the fourth quarter of 2010.
Segments Q3/11 compared with Q3/10

Consumer Board
Consumer Board manufactures all major types of consumer board, such as liquid packaging board, food service board, graphical board and cartonboard for packaging food, cigarettes, pharmaceuticals, cosmetics and luxury products.
 

* Excluding non-recurring items and fair valuations ** ROOC = 100% x Operating profit/Operating capital
*** Excluding pulp
 

• The Skoghall Mill in Sweden investment project is proceeding according to plan.
• There will be an annual maintenance stoppage at Skoghall Mill during the fourth quarter of 2011.

Consumer board sales were EUR 626 million, up 6% on the third quarter of 2010. Operating profit was EUR 64 million, down EUR 13 million on the third quarter of 2010. Higher variable and fixed costs, higher depreciation and lower board volumes caused by inventory management were not fully compensated by higher sales prices and higher market pulp volumes.

Markets

Industrial Packaging
Industrial Packaging manufactures corrugated packaging and containerboard, cores and coreboard, and also paper sacks, and sack and kraft paper.
 

* Excluding non-recurring items and fair valuations ** ROOC = 100% x Operating profit/Operating capital
 

·         Stora Enso completed the acquisition of 51% of the Chinese packaging company Inpac International in July 2011. The integration is proceeding well and additional business is anticipated.
 

Industrial packaging sales were EUR 254 million, up 13% on the third quarter of 2010. Operating profit was EUR 20 million, up 8% on the previous year as higher sales prices in local currencies more than offset raw material cost increases.

Markets

Newsprint and Book Paper
Newsprint and Book Paper manufactures a wide range of standard and improved newsprint, and book and directory paper grades.
 

* Excluding non-recurring items and fair valuations ** ROOC = 100% x Operating profit/Operating capital
 

·         Industry inventories were similar to the third quarter of 2010 but significantly higher than in the previous quarter.
 

Newsprint and book paper sales were EUR 331 million, up 2% on the third quarter of 2010. Operating profit was EUR 34 million, up EUR 34 million on the previous year as higher sales prices in local currencies and lower fixed costs more than offset variable cost increases, mainly in RCP. Volumes were lower than a year earlier as the permanent shutdown of the newsprint machines at Varkaus Mill in Finland at the end of the third quarter of 2010 and the newsprint machine at Maxau Mill in Germany at the end of November 2010 reduced production volumes.

Markets

Magazine Paper
Magazine Paper manufactures uncoated magazine paper mainly for periodicals and advertising, and coated matt, silk and glossy magazine paper for specialist and general interest magazines, supplements, home shopping catalogues and magazine covers.
 

* Excluding non-recurring items and fair valuations ** ROOC = 100% x Operating profit/Operating capital
*** Excluding pulp

• Kvarnsveden Mill in Sweden has launched a new uncoated magazine paper grade with a combination of high brightness and superior gloss.
• Industry inventories were slightly lower than a year ago, and similar to the previous quarter for coated magazine paper and lower than in the previous quarter for uncoated magazine paper.
• The annual maintenance stoppage at Sunila Pulp Mill in Finland is scheduled during the fourth quarter of 2011.

The Magazine Paper segment’s sales were EUR 562 million, up 4% on the third quarter of 2010. Operating profit was EUR 48 million, up EUR 3 million on a year ago as higher sales prices in local currencies more than offset increases in variable costs and unfavourable exchange rate trends.

Markets

Fine Paper
Fine Paper manufactures high quality graphic and office paper for printers and publishers, merchants, envelope converters, office equipment manufacturers and office suppliers.
 

* Excluding non-recurring items and fair valuations ** ROOC = 100% x Operating profit/Operating capital
*** Excluding pulp

• Product swaps between coated fine paper mills have resulted in improved flexibility in capacity utilisation. Uetersen Mill in Germany will increase speciality paper production and at the same time Stora Enso will reduce standard woodfree coated fine paper production capacity by approximately 140 000 tonnes annually.
• Cost-efficiency improvements are ongoing at various mills.
• Industry inventories for coated fine paper were lower than a year ago and significantly lower than in the previous quarter.
• Industry inventories for uncoated fine paper were significantly higher than a year ago and slightly higher than in the previous quarter.
• The annual maintenance stoppage at Veitsiluoto Mill in Finland will be in the fourth quarter of 2011.
• Production curtailments are anticipated in the fourth quarter to secure cash flow and balance inventories.

Fine paper sales were EUR 530 million, down 6% on the third quarter of 2010. Operating profit was EUR 38 million, down EUR 33 million on the previous year as higher sales prices in local currencies could not fully compensate for higher variable costs, mainly for chemicals, unfavourable exchange rate trends, lower volumes and early production curtailments to manage inventories. Annual maintenance stoppages at Suzhou Mill in China, and Varkaus and Oulu mills in Finland were completed during the third quarter 2011.

Markets

Wood Products
Wood Products manufactures wood-based products for construction and interior decoration, and solid biofuels for the energy sector. Its recyclable products are made from high quality renewable European pine or spruce.
 

* Excluding non-recurring items and fair valuations ** ROOC = 100% x Operating profit/Operating capital

• Wood Products is taking several actions to mitigate margin deterioration:

o  The permanent closure of Kopparfors Sawmill in Sweden has been brought forward to October, instead of the end of 2011 as previously announced, but the pellet mill will remain in operation until the end of 2011.

o  It is planned to restructure part of the further processing operations at Honkalahti Sawmill in Finland during the fourth quarter of 2011.

o  There is pressure for further curtailments at several sites in Europe subject to product and raw material development. All authorisations for temporary lay-offs are already in place in Finland and shift reductions have been implemented in Austria.

• Industry inventories were similar to a year ago and lower than in the previous quarter.
• Stora Enso will build a new combined heat and power (CHP) plant at Zdírec Sawmill in the Czech Republic. The EUR 21 million investment will optimise energy production and usage at the mill by boosting its heat supply.
• Major cross-laminated timber (CLT) projects are ongoing in London and Vienna. In September Stora Enso announced that Wood Products will participate in construction of the Finnish Nature Centre Haltia in Espoo, which will be the first public building constructed of CLT in Finland.
• Stora Enso plans to undertake a unique wooden construction project in Helsinki called Wood City in collaboration with the construction company SRV.

Wood Products sales were EUR 414 million, down 2% on the third quarter of 2010. Operating profit was EUR 10 million, down EUR 15 million on a year earlier mainly due to lower volumes.

Markets

Short-term Risks and Uncertainties
The main short-term risks and uncertainties are related to continuing economic uncertainty and its potential impact on demand for the Group’s products.

Energy sensitivity analysis for 2011: the direct effect on 2011 operating profit of a 10% increase in electricity, heat, oil and other fossil fuel market prices would be about negative EUR 22 million annual impact, after the effect of hedges.

Wood sensitivity analysis for 2011: the direct effect on 2011 operating profit of a 10% increase in wood prices would be about negative EUR 230 million annual impact.

Pulp sensitivity analysis for 2011: the direct effect on 2011 operating profit of a 10% increase in yearly average pulp prices would be about positive EUR 54 million annual impact.

A decrease of energy, wood or pulp prices would have the opposite impact.

Foreign exchange rates sensitivity analysis for the next twelve months: the direct effect on operating profit of a 10% strengthening in the value of the US dollar, Swedish krona and British pound against the euro would be approximately positive EUR 104 million, negative EUR 79 million and positive EUR 57 million annual impact, respectively. Weakening of the currencies would have the opposite impact. These numbers are before the effect of hedges and assuming no changes occur other than a single currency exchange rate movement.

Third Quarter Events
On 30 September 2011 Stora Enso announced that the Montes del Plata pulp mill project, a joint venture with Arauco, was proceeding and the external financing for the project had been finalised. Montes del Plata has signed the loan agreements and as part of the financing arrangements, Stora Enso has signed an agreement to guarantee 50% of USD 1 354 million of loans raised by Montes del Plata. Stora Enso’s 50% share of the total guarantee will be a maximum of USD 677 million (EUR 498 million).

Veracel
On 11 July 2008 Stora Enso announced that a federal judge in Brazil had issued a decision claiming that the permits issued by the State of Bahia for the operations of Stora Enso’s equity accounted investment Veracel were not valid. The judge also ordered Veracel to take certain actions, including reforestation with native trees on part of Veracel’s plantations and a possible BRL 20 million (EUR 9 million) fine. Veracel disputes the decision and has filed an appeal against it. Veracel operates in full compliance with all Brazilian laws and has obtained all the necessary environmental and operating licences for its industrial and forestry activities from the competent authorities. In November 2008 a Federal Court suspended the effects of the decision. Veracel has not recorded any provision for the reforestation or the possible fine.

On 30 September 2009 a judge in the State of Bahia issued an interim decision ordering the State Government of Bahia not to grant Veracel further plantation licences in the municipality of Eunápolis in response to claims by a state prosecutor that Veracel’s plantations exceeded the legal limits, which Veracel disputes. Veracel’s position is supported by documentation issued by the State environmental authority.

Class Action Lawsuits in USA
In the context of magazine paper sales in the USA in 2002 and 2003, Stora Enso was sued in a number of class action (and other civil) lawsuits filed in the USA by various magazine paper purchasers that claimed damages for alleged antitrust violations. On 14 December 2010 a US federal court granted a motion for summary judgement that Stora Enso had filed seeking dismissal of the direct purchaser class action claims. The ruling, which the plaintiffs have appealed, means that the court has ruled in favour of Stora Enso and found the direct purchaser class action claims to be without legal foundation. Further, most of the indirect purchaser actions have been dismissed by a consent judgement, subject, however, to being reinstated if the plaintiffs’ appeal in the direct cases is successful. The ruling, if it stands on appeal, will also provide a strong legal basis for final dismissal of all remaining civil cases. No provisions have been made in Stora Enso’s accounts for these lawsuits.

Legal Proceeding in Finland
On 3 December 2009 the Finnish Market Court fined Stora Enso for competition law infringements in the market for roundwood in Finland from 1997 to 2004. Stora Enso did not appeal against the ruling.

On 31 March 2011 Metsähallitus of Finland initiated legal proceedings against Stora Enso, UPM and Metsäliitto claiming compensation for damages allegedly suffered due to the competition law infringements amounting altogether to EUR 283 million. In addition some Finnish municipalities have recently, and after the period, initiated similar legal proceedings.

Stora Enso denies that Metsähallitus, and other plaintiffs, suffered any damages whatsoever and will forcefully defend itself. No provisions have been made in Stora Enso’s accounts for this lawsuit.

Share Capital
During the quarter no A shares were converted into R shares.

On 30 September 2011 Stora Enso had 177 149 022 A shares and 612 389 477 R shares in issue of which the Company held no A shares and 918 512 R shares with a nominal value of EUR 1.6 million. The holding represents 0.12% of the Company’s share capital and 0.04% of the voting rights.


This report is unaudited.

Helsinki, 21 October 2011
Stora Enso Oyj
Board of Directors

Financials

Basis of Preparation
Except as described below, this unaudited interim financial report has been prepared in accordance with the accounting policies set out in International Accounting Standard 34 on Interim Financial Reporting and in the Group’s Annual Report for 2010.

The following amendments to standards and interpretations were adopted from 1 January 2011 but had no impact on the Group financial statements:
 

• IAS 24 Related Party Disclosure – Revised definition of related parties
• IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments requires the extinguishment of a financial liability by the issue of equity instruments to be measured at fair value with the difference between the fair value of the instrument issued and the carrying value of the liability extinguished being recognised in profit or loss.
• Amendments to IFRS – Through the annual improvements process, the minor and non-urgent changes are collected into one ensemble and implemented at the beginning of the year. In addition, the IASB has published a few other small amendments which have also been implemented at the beginning of the year. These changes and amendments effective from 1 January 2011 relate to nine standards and interpretations. They did not have a significant effect on the Group financial statements.

Inpac acquisition
Stora Enso acquired 51% of Inpac International on 28 July 2011. Inpac is a Chinese packaging company with production operations in China and India, and service operations in Korea. The company specialises in manufacturing consumer packaging, especially for global manufacturers of mobile phones and other consumer goods.

The preliminary consideration amounted to EUR 42 million. The acquisition has been financed from the Stora Enso Group’s own cash assets. The initial acquisition accounting of the integration of the company has been only provisionally determined at the end of third quarter of 2011. The necessary fair valuations and other calculations have not been finalised and they are based on management’s best estimate.

Condensed Consolidated Income Statement

Consolidated Statement of Comprehensive Income

Condensed Consolidated Statement of Cash Flows

Property, Plant and Equipment, Intangible Assets and Goodwill

Borrowings

Condensed Consolidated Statement of Financial Position

Items designated with “O” comprise Operating Capital
Items designated with “I” comprise Interest-bearing Net Liabilities
Items designated with “T” comprise Net Tax Liabilities

Statement of Changes in Equity

CTA = Cumulative Translation Adjustment
OCI = Other Comprehensive Income

Commitments and Contingencies

Purchase Agreement Commitments

Fair Values of Derivative Financial Instruments

Nominal Values of Derivative Financial Instruments

Sales by Segment

Operating Profit/Loss by Segment excluding NRI and Fair Valuations

* Fair valuations include equity incentive schemes, synthetic options net of realised and open hedges, CO2 emission rights, and valuations of biological assets related to forest assets in equity accounted investments.

NRI by Segment