Smurfit Kappa Group Plc (OTCPK:SMFTF) Q2 2022 Earnings Conference Call July 27, 2022 4:00 AM ET
Company Participants
Anthony Smurfit – Group Chief Executive Officer
Ken Bowles – Group Chief Financial Officer
Conference Call Participants
Lars Kjellberg – Credit Suisse
David O’Brien – Goodbody
Justin Jordan – BNP Exane
Cole Hathorn – Jefferies
James Twyman – Prescient
Kevin Fogarty – Numis
Operator
Ladies and gentlemen, hello and welcome to the Smurfit Kappa 2022 Half Year Results Call. Throughout the call, all participants will be in listen-only mode and afterwards there’ll be a question-and-answer session. Just to remind you, that this conference call is being recorded.
Today, I’m pleased to present Mr. Tony Smurfit, Group CEO. Please go ahead with your meeting.
Anthony Smurfit
Thank you, Sharon, and good morning, ladies and gentlemen, and thank you for joining us today on our half year results. I’m delighted that Ken Bowles, our CFO joins me today on this call. And before we get started, I refer to the disclaimer concerning future expectations listed on the slide above.
As you will have seen today, our results — we’ll go through them shortly, but I would like to remind you all of our vision, which we have been evolving over the last number of years. This vision guides our approach to our business and our culture. And I think we’ve demonstrated to you all that we are truly living this vision in Smurfit Kappa.
Turning the page, as you’ll have seen from this morning’s release, we have delivered a very strong performance against all measures. We’ve talked to you before about the transformation of our business with quality at the center of that journey. I believe our reported performance very much reflects that. Moreover, some years back, we set ourselves an objective to deliver the type of performance that we are now delivering, earnings growth of some 50% and EBITDA margin of 18.4% and a return on capital employed of over 19%. All the while continuing to invest significantly behind customer growth and the many internal growth efficiency and sustainability opportunities presented throughout our business.
Ken will take you through the detailed performance, but for me the core message is that the steps that we have taken and of course continue to take over the last number of years are driving financial and operational outperformance. Those steps include building on our established competitive strength as outlined on this Slide five. We are an acknowledged leader in sustainability in our sector. Our integrated business model has proven to be effective through the decades. Smurfit Kappa typically has a number one or number two market position in each of the markets in which we operate. We have a proven to be a disciplined and effective capital allocator, which is part of the DNA of the company. And we continue to deploy significant capital to support our customers and to optimize our system.
In Smurfit Kappa, we’ve built an unparalleled knowledge-based suite of applications to ensure our customers have the most effective packaging solutions. It is these strengths, I believe, that has allowed us to both live and to deliver our vision. A vision that you all know is shared throughout Smurfit Kappa Group.
Turning to the next Slide, I continue to talk about the quality and importance of our people. I will not apologize for this. Our people are exceptional with loyalty, integrity and respect as the core values that drive the Smurfit Kappa team. Our culture is performance led, but it also has as its core ownership and autonomy. We and Smurfit Kappa are investing heavily over many years in our people and their developments. This investment is a cornerstone of the continued success of the company both in the past and into the future.
On to the next Slide, you’ve often heard us talk about our integrated model. This model, as I said, works for decades for Smurfit Kappa and its stakeholders, including customers and shareholders. Integration inherently means reduced volatility with consistency and quality as the power of innovation is harnessed by our box business and the efficiency of our mill system is maximized. The integrated model is good for customers in all markets as it ensures security of supply delivery in a world of sustainability and ease of chain of custody.
While I’ve always said that success is never a straight line, our focus is and continues to be on building a quality business to deliver and to support long-term growth and to ensure we meet our customers’ expectations. Over the last 18-months, we have approved some EUR2 billion of capital to improve our operating efficiency and to support customers’ growth. We continue to see significant and growing opportunities across our markets. Corrugated remains the most environmentally, friendly, transport and merchandising medium in the marketplace.
A huge differentiating factor for Smurfit Kappa is our business applications. No other company in our sector can offer the solutions that Smurfit Kappa provides through these applications. We anticipate and we solve our customers’ pain, whatever that may be, whether there is supply chain issues, design, sustainability or merchandising. The corrugated box business has changed remarkably over the years and our use of our extensive geographic network, our 29 global experience centers are over 1,000 designers allows the continuous transfer of best practice and innovation capabilities for the benefit of all of our customers. Our results clearly demonstrate these benefits also for SKG.
We continue to make significant progress on achieving our sustainability targets as outlined in our 15th sustainability development report. Compared to the baseline in 2005, the Group has reduced its submissions intensity by 41% by the end of 2021, which is another significant step towards the Group’s net zero target. Other highlights from 2021 SDR include the reduction in water consumption of over 6% year-on-year and a reduction in waste to landfill intensity of 7% year-on-year.
I’m delighted that in February of this year that SKG was recognized as a top ESG performer by Sustainalytics. By committing to our sustainability targets, the Group’s Better Planet Packaging portfolio of sustainable products, will continue to help our customers deliver on their own sustainability goal. Every day in Smurfit Kappa, we are working on helping our customers use more sustainable packaging, helping them with the changing demands of consumers, helping them to market their products to sell more and to help them take advantage of the e-commerce developments.
The next few slides provides just a few simple illustrations out of the many 1,000s we have developed of how our packaging is helping our customers. Above, we’ve helped a large customer move out of non-branded, difficult to clean and unsustainable plastic trays into a branded renewable and recyclable corrugated alternative. Another example is with a large sanitary wear company where the removal of EPS by fully paper-based corrugated alternative eliminated both waste and unsustainable packaging, which EPS certainly is. This area of opportunity is especially pronounced for our Hexacomb business, which has been growing strongly.
The importance of brand perception has led to an evolution in the way our customers are viewed by the consumer. There is a need for our customers pushed by the consumer and indeed legislation to become more green and more innovative in providing paper-based packaging solutions. As mentioned, our innovation capabilities solve that problem. Just a couple of examples are our safe and closed detergent boxes or our green portfolio for fruit and vegetables. We’re actively working with many of our customers on development of paper-based punnet boxes, which are required to be moved away from plastic through legislation across Europe. This is occurring across all the regions in which we operate.
Today corrugated is a market in medium for our customers. The days of the counting products and supermarkets have passed due to labor costs and shortages of labor. And as such, our product is in many ways and in many instances the primary display for customers. With advancements in technology and digital print where we continue to invest and with continued development in print quality, and of course, through our knowledge in development centers, demand from our customers for solutions like this can be fulfilled. These examples show an award winning display for a chocolate producer in Sweden, a corrugated solution for our homeware producer and similarly, a corrugated solution for a crisp manufacturer in the U.K. Our solutions obviously promote our customers’ products in a very impactful manner. Again, corrugated has worn out.
This is a further illustration of why our investments towards graphics and big data is winning for our customers and of course for Smurfit Kappa. A lot has been said about e-commerce and the potential to slowdown. In the first half of the year, though in Smurfit Kappa, we’ve seen significant growth in many of our countries. This has been done through innovation and the continuing need for customers to move online in practically all territories in which we operate.
The above examples are just minor illustrations of the need of many of our customers’ needs. As recently in Colombia, where the major flower grower commented as he is moving more and more directly to the consumer that we and Smurfit Kappa sell happiness. I do not think — I do think that might be a slight stretch, but at least I do know that we are making this growing online customer happy and therefore his customers happy.
And with that, I will hand you over to Ken, who will take you through the financials.
Ken Bowles
Thank you, Tony. And good morning, everyone, and thank you for taking the time to join us. As Tony has outlined, and I think you can see anyway, the performance is yet another illustration of the dedication and commitment of everyone in Smurfit Kappa. We are pleased to deliver significant year-on-year improvement against all — almost all key performance measures for the first half of 2022. And as Tony also mentioned, this performance is a result of the many actions we have taken over the years. It illustrates the benefits of the Group’s integrated and resilient business model, our geographic diversity, our performance at culture, and our continued investments with long-term customer growth.
It is also important to remember that these results have been delivered against the backdrop of a global pandemic that continues to disrupt their daily lives, significant supply chain problems that are now abated and the ongoing conflicts in Ukraine. The performance has also been delivered in the pace of rising input costs, principally, but not limited to energy. And we continue to overcome these hurdles as evidenced in the results today.
Let’s look at the past performance in a little more detail. Looking to the Group results on Slide 17 our net delivery. Group revenue was approximately EUR6.4 billion for the first half of 2022, up 36% in the first half of ’21 or 32% on an underlying basis. With the rise reflecting box price recovery and volume growth that was in line with our expectations.
Group EBITDA was up 50% to EUR1,174 million. The group EBITDA margin improved by 1.7 percentage points from 16.7% in the first half of 2021 to 18.4%. The result reflects the resilience of the Group’s integrated model, box price recovery and the benefits of our capital spend program, partially offset by much higher year-on-year energy, recovered fiber and labor distribution and other raw material costs. EPS is up 85% in the first half of 2022 to EUR2.219 per share and the Group’s return on capital employed increased from 14.8% for the first six months of ’21 and 19.3% for the first six months of 2022.
Free cash flow for the first half of the net outflow of EUR28 million, compared to a net inflow of EUR117 million in the first half of 2021. And although EBITDA was up significantly year-on-year for the first six months so too with cash expenditure and working capital. The management’s working capital as ever remains a key focus for us and working capital as a percentage of sales of 9.7% at June 2022 is expected to fall within our guidance 7% to 8% range by the end of the year. As noted in the press release, on the 1st of April, the Group announced its decision to exit the Russian market in an orderly manner. And while this process is ongoing, we hope to conclude this by the end of the year.
Finally, reflecting confidence both we and the Board have in the group and indeed strength and resilience of the cash flows and our future prospects. We are pleased to announce an 8% increase in the interim dividend to EUR0.316 per share.
And turning now to our European operations on Slide 18 and their performance. EBITDA increased by 57% to EUR926 million, primarily as a result of box price recovery. EBITDA margin was 18.7%, up from 16.2% from the same period in 2021, delivered against the backdrop of supply chain disruption and significant cost inflation. Corrugated demand was up approximately 1% in the first half of 2022, against very strong comparators and corrugated pricing has continued to improve in line with our expectations with continued progression into the second half.
Finally, our European business continued to build on a strong operating platform in the first half with a number of projects across our paper and corrugated division. In our paper division, we announced the completion of a large scale sustainability project at our Zulpich mill in Germany that will reduce CO2 annually by 55,000 tons, a 2% reduction for the Group. We have also approved projects in our Facture, Wrexen and Verzuolo mills that will reduce cost, increase efficiency and improve the Group’s sustainability footprint.
In our corrugated division, we approved projects across a number of our core European markets and the Group also announced an investment in its first Moroccan facility and the acquisition of a corrugated business in the U.K.
And now turning to the Americas on Slide 19. In the Americas, EBITDA increased by 29% in the first half of 2021 to EUR271 million. EBITDA margin was 18.8% in the first half of 2022 versus 20.4% in the first half of ‘21. Columbia, Mexico and the U.S. accounted for 80% of the region’s earnings with strong performances in all three countries. Box demand for the first half was up 8% year-on-year or 5% on an underlying basis. In April, the Group announced the acquisition of Argencraft, a corrugated business in Argentina and we’ve also recently approved expansion and sustainability focused projects in our paper, corrugated and stacked businesses in North, Central and South America.
Our Better Planet Packaging initiative, our unique Pan American sales offering, together with our experience center network and coupled with the benefits derived from our investments in the region recent years, continue to deliver growth of both SKG and our customers in the region.
Turning now to Slide 20, and you’ll see a number of ways that Smurfit Kappa is positioned to continue to overcome the unprecedented energy cost inflation I mentioned earlier. Notwithstanding the fact that box pricing has needed to reflect rising energy prices, SKG’s unique position in the market ensures that we continue to successfully navigate through these cost pressures. And you can see that in the performance I outlined earlier.
For those of you on the call today here may be less familiar with our business, it may be a surprise to learn that almost half of our fuel consumption across all operations comes from biofuels and not fossil fuels. And while the topic generally centers around supply in German production, it’s important to remember that we have a network of recycled paper mills that not only in Germany, which accounts for maybe less than — slightly less than 20% of our total production that might be affected. And of which 10% could be switched to alternative fuels. But we also have a mill system in the Czech Republic, France, Italy, the Netherlands, Spain, Serbia and the U.K. territories, which will be largely unaffected into buy terms. This is alongside our kraftliner production in Austria, France, and Sweden.
As you know, we’re the number one kraftliner producer in Europe producing over 1.6 million tons of containerboard each year from a mill system that is largely energy self sufficient. Our integrated models and centralized logistics systems means that we cannot only maintain security supply of this premium paper grade, well we can effectively carousel the paper around the network to ensure that our box fence stays supplied.
Another important factor has been our geographic diversity. Not only do we operate in 23 countries across Europe, one quarter of our business is spread across 13 countries in the Americas, a region that has been largely insulated from the energy cost inflation we see here in Europe. The Group has also invested over EUR900 million since 2005 directly in energy efficiency improvements. This means that we have accelerated our transition to renewables and have ensured that we maintain a world-class asset base with our plant and machinery at the lower end of the cost carbonate sector, giving us a real competitive advantage at a time, but high energy prices are putting tape makers on the pressure.
At Smurfit Kappa, we’ve also operated a prudent and conservative hedging policy for a number of years. This policy has continued to protect the Group from exposure to the exceptional energy price increases that we’ve witnessed to-date. At the end of June, we have hedged over 80% of our energy needs for 2022 with partial hedge cover in line with our policy also in place for ’23 and ‘24.
And lastly, an important reminder from COVID, Smurfit Kappa was classified globally as a provider of an essential service. Paper-based packaging is essential for global supply chains, which are already under enormous pressure. It’s also vital for our 65,000 customers. The majority of whom are in essential sectors such as FMCG, pharmaceutical and healthcare, that was directly linked to the end consumer.
Slide 21, gives you an overview on capital allocation. The performance both Tony and I have spoken about today has been built on the foundations of the capital allocation framework that is integral to our success. And given the uncertainty and volatility of the world around it, we thought it might be worthwhile taking a moment and reminding you of key features of each of our capital allocation priorities. As you know, our aim is to provide a fair and balanced allocation of capital across all our stakeholder Groups. It’s return focused allocation, which as you can see continues to be a key underpin to our success.
We believe capital allocated to internal projects is key to the continued growth and performance of the business. We continue to see multiple opportunities around us as the world re-opened and our customers begin to focus on their priorities around areas such as sustainable packaging. As you know, our current plan was Smurfit Kappa, invest circa EUR1 billion per annum for the next couple of years. And that capital we deploy internally has a number of goals, providing capacity to support our customers growth, providing capacity to meet the needs for sustainable packaging products and investing in optimization and cost takeouts to continue to manage our cost base.
You should also remember that when we build our funds to make them flexible and agile, with the ability to react quickly as the market does. This can be seen in our current performance as we were able to accelerate investments during the last couple of years of high growth. And this will remain the case as we deploy our capital on our current investment plan.
And turning to Slide 23 in M&A. But before we take a bit — talk about M&A specifically, let’s remember that SKG is already a group with significant global scale and reach. We are a global player something which is again a point of differentiation for our customers. We have spent in excess of EUR2 billion since 2012 on acquisitions, which have included our return to the U.S. and our subsequent expansion. The building of our Balkan region with acquisitions in Greece, Serbia and Bulgaria, expansion in Central America. Box expands across numerous geographies such as Argentina, France, U.K., Mexico, Spain and our first entry into Brazil, Peru and Morocco. And the purchase of the world-class Parenco and Verzuolo paper mills, which together have strengthened both integration and security of supply.
Our expansion has enabled us to support our customers’ growth and we’ll continue to do so. Equally, we will remain disciplined when it comes to M&A. It is always benchmarked against any other alternatives buy versus build, for example. And as always, we have a number of projects in the pipeline focused on building at our strong geographic network or further enhancing our product portfolio.
The dividend is a key pillar of our thinking around capital allocation and Slide 24 is very much an illustration of that. The curious example of this was in 2020 where we were one of the few to recognize the importance of the dividend for shareholders and paid in full. We’ve said it before, but I will reiterate this. The dividend is an input to our capital allocation framework rather than an output. Our policy is progressive and aims to ensure that the allocation of cash flows to the dividend is proportionate to other forms of allocated capital over the long-term. SKG is a highly cash generative business and with the integrated model results in less volatility in those cash flows. And as a sign of confidence in both those cash flows and our future prospects, we are announcing an 8% increase in the interim dividend to EUR0.316 per share.
Finally, our balance sheet, which has significant financial flexibility and firepower. And again, Slide 25 is a perfect illustration of the work we’ve done here. And if you think about all the capital allocation to internal investments, M&A and dividends, we’ve also managed to reduce our leverage. We have no near-term maturities at an average coupon of 2.86%, we also had the lowest cost funding in our sector with the 50 basis points each year and 1% 12-year green bonds we issued last September, a clear example of not only the strength of the credit of SKG, but the strength of our circular business model.
With a net debt-to-EBITDA of 1.6 times, the strength of the Group’s balance sheet continues to secure long-term strategic flexibility and the Group remains strongly positioned within its BBB minus, BBB minus, Baa3 investment grade credit rating.
Thank you all of your time, and I’ll now hand you back to Tony for some concluding remarks.
Anthony Smurfit
Thank you, Ken. The continuing development of our business, our people, our culture and our vision is an immense source of pride for me. Over the last number of years, we have capitalized on customer growth opportunities and have and will continue to invest significantly behind those opportunities. Equally, the many acquisitions across our platform have and will continue to considerably strengthen our customer offering. I’m delighted with how those businesses have been integrated within our system delivering in many instances exceeding expected returns.
A key point to understand Smurfit Kappa’s competitive strength is our geographic business. With businesses in 36 countries and leading market positions primarily orientated to FMCG and the strong secular drivers of sustainable packaging and e-commerce. Geographic balance provides us with multiple opportunities across different markets at different times and is a meaningful contributor to both today’s performance and tomorrow’s prospects. And while of course, there are current global uncertainties that we have not seen in recent history, we remain and are very confident about our future prospects. I have no doubt that our first half performance has set a strong foundation for the remainder of 2022 and beyond.
As I mentioned earlier and was led by one of our largest customers in Colombia last week, we do bring happiness in Smurfit Kappa. That said, although we are happy, we are never ever satisfied. My concluding comments very much reflect the points made at the outset. The steps that we have taken and continue to take are delivering financial and operational outperformance. At the heart of this is our disciplined and effective capital allocation decision making process. As significant shareholders in the business, which all the management team are, we treat capital as our own with some EUR7.3 billion deployed since 2012. That process has contributed to a 460 basis point increase in EBITDA margin and a 730 basis point increase in return on capital employed.
Leverage multiple of 1.6 times today and an investment grade balance sheet provides us with significant financial and strategic flexibility and our dividends have grown substantially as I believe Ken has shown you just a few minutes ago. Whether expressed in terms of performance and prospects, the Smurfit Kappa business today is unrecognizable from years past. Quite simply, it is a better, stronger and higher quality business.
I thank you all for your attention for both Ken and myself. And now we are very happy to take your questions about our results. Thank you, all.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] And we will take our first question, please standby. Your first question today comes from the Lars Kjellberg from Credit Suisse. Please go ahead. Your line is open.
Lars Kjellberg
Good morning and congrats on a very strong results. I have three questions, if I may. Starting with just volumes, can you share with us the second quarter volumes in the two geographies? And also when you’re talking about, kind of, going into second half, how do you see these volumes moving forward? Theh — you’re also talking about the opportunities for growth in your outlook statement, talking about sustainable and innovation, innovative packaging. Can you share with us what that really means? How do you see this driving your volume versus market?
And a final point, Ken, if you can clarify a bit on the energy side, you called, of course, your hedge levels, et cetera. But how should we think about energy costs, assuming we’re steady where we are today in terms of market prices, whatever that is, but looking into ’23, so we could get some sort of sense of the underlying cost inflation going into that year? That’d be really helpful. Thank you.
Anthony Smurfit
Okay. Lars, I’ll take your first question and let Ken take your second one and third. Basically, if you take volume, one of the things that we are seeing is continued volume growth in the Americas, we have about 8% and without acquisition is about 5% in the second quarter and that continues to be strong against very high comparisons about 7% growth last year. And so we see good growth in the Americas, against a massive increase of 14.5% in Q2 last year. We see basically flat growth in the second quarter and that’s really a mix of different countries. Some countries are suffering with volume, I would say specifically and I think I called it out in the first quarter, call that the U.K. has had a very slow first half of the year, our first quarter and now second quarter. And that is, of course, related to things that you’ll be well aware of, such as Brexit and such as supply chain disruption.
What we have seen is we have seen some slowdown in our German market, which again will be affected by energy, consumer confidence and also the supply chain issues during the second quarter. Equally, we see pickups in other markets such as the Spanish market, the French market is continuing to do well, the Italian market is continuing to do well. So it’s a bit like the curate’s egg in many respects. There are good points and bad points, but clearly the U.K. and Germany, which are big markets for us, will drag us down a little bit on the volume side, as well as we’re still reporting Russia, because we still own it. And clearly, there’s been some very significant volume drops in that region, so that does have an influence.
But overall, one of the interesting things that our U.K. manager said to me a couple of days ago was, in fact, that’s he has a bit of capacity now. He has actually the time to work on many of the sustainability projects, which we frankly couldn’t work on for the last couple of years, because we had no capacity. So there’s a silver lining to everything, and if you take last year when we grew at 14.5%, we were working Saturdays and Sundays. And yes, we put it a bit of capacity, but if we had grown very significantly this year again, we would not have been able to meet capacity needs. So there’s always — so we’re actually more efficient this year than we were last year. And that in some way contributes to the results that we have.
What we’re seeing right now, this is your second question, is we’ve seen basically a continuation of that trend. There’s nothing dramatic at the moment, but it is still — we would — I think the third quarter, we put 7.5% in Europe and similarly in the Americas. And we’re seeing a similar, sort of, trend as we go into the second — into the third quarter that we saw in the second quarter with some of the bigger industrial economy still suffering, but as I say, it’s still a little early for that. And the other economies, which we would expect such as Spain, Italy, France where there’s more tourism benefiting from that.
Ken if you want to add anything to that, Ken?
Ken Bowles
I suppose, Lars, maybe we spoke about it a few quarters where you have asked — posed the same question. We said, look, we have that space in time to get on those, kind of, projects, and I think Tony’s exampls of U.K. is the clear example, you know, maybe one of the, kind of, upside to volumes going back, a little bit to more normalized levels is that people can begin to focus on those kind of projects. Clearly regulations playing the part, particularly around things like green finance. So there is that ever increasing shift towards where people need to start making clearer decisions and where [Technical Difficulty].
And remember, when you think about our customers, their biggest impact from the scope and mission perspective is scope 3 rather than say scope 1 or 2, which is more us. And in reality, when they look back into the supply chain, we will be one of the ones who can give them the biggest benefit around that kind of scope 3 reduction emission target, which a lot will happen out tio 2030 and beyond. So that deadline isn’t moving for anybody and there clearly is a need and the willingness for them to move towards it also.
So I think that momentum we still see very much coming. And look, all through COVID, all through 2021 now, we’re very engaged and our customers feel very engaged on us, as well you look back to the EU green event as well and the participation we have from customers at that. So there clearly is appetite to find solutions for their supply chain problems around emissions.
On energy, I suppsoe, Lars, I’ll get this by saying, if you ask me in 10 minutes, I’ll probably give you a different answer the way the markets are moving at the moment. I think we would have guided at the first quarter, we would have said energy for ’22 was probably EUR500 million, EUR600 million headwind on last year, that’s probably about EUR650 million to EUR700 million as we sit here today. What’s clearly the work we’ve done around box pricing and everything else over the six months has put us in a great position to be able to [Technical Difficulty] as you look forward to ’23 clearly, you know, it’s very difficult to kind of pin a number on where you might get to. Will there to be a headwind? You’d have to say yes as we sit here today. Is that in the order of maybe somewhere between EUR250 million and EUR300 million probably. But the reality is if that’s the space where we are [Technical Difficulty] to-date is that in the order of maybe somewhere between EUR250 million and EUR300 million, probably. But the reality is if that’s the space where we are, everybody’s either in, at least that space are incrementally worse given that we already have hedging going into ’23 and ’24.
So the reality is if I think it’s fair to say that if energy prices continue at these, kind of, levels, we’ll be in a sense nor either for downtime, because [Technical Difficulty] economic [Technical Difficulty] operate at these levels or further price increase to offset the energy cost. So the — it’s not a Smurfit Kappa issue, I think it’s a total industrial production issue, let alone a peper industry issue.
Anthony Smurfit
Thanks, Lars
Lars Kjellberg
Got it. Thank you.
Operator
Thank you. We will now take our next question, please standby. Your next question comes from David O’Brien from Goodbody. Please go ahead. Your line is open.
David O’Brien
Good morning. Thanks guys for taking my questions. Three from me please, firstly, box pricing momentum exceptionally strong again during the period. Just wondering, if you could give us any color if there’s any variance in the experience between the index stuff is going straight through. But any change in behaviors that’s free [indiscernible] is still very tight, just another pushback, just how the experience have gone on that front? Sorry to bring it back to energy again, but I guess if we look at the level of hedging you have in, what do you estimate and I understand [indiscernible] what do you estimate that saved you or will save you in 2022 in terms of cost, if we were to assume the current price at spot persists? And could you give us some color on the level of hedging in place for 2023?
And just touching on the points you brought up Ken in terms of people taking commercial downtime, if they don’t get pricing through as one of the largest buyers in — of testliner in Europe. Are you guys already seeing some of the independents pushing from material increases? And do you think inventory levels are sufficiently low for them to speak in the market?
Anthony Smurfit
I’ll take one and three and then ken will take energy. He’s become an expert on the energy, he knows all things about energy over the last six months. With regard to box pricing momentum, as we said in the latter part of last year that we would be pushing through price increases as normal. Clearly, everybody else less than most, I would say, but everybody got caught out by the momentum of inflation. But we have adjusted obviously all of our contracts to now to — as they come due to reflect inflation pressures out there. So we have been very active in pushing box prices through the first half of the year and to basically recover inflation and costs and of course paper price.
And what stands to Smurfit Kappa is the areas that I talked about David, which is our innovation, our ability to work with customers to reduce their costs and to give them security of supply and so there has been no real change in the customers that we have for — in behavior, because they frankly still see the same issues that are out there that we see, which is very difficult supply chains and very difficult situation for them to make sure that they have their products to market. So I think there’s no real changes there, I think that we still will have momentum of box price increases into the second half as some of the contracts that we have with customers come due during July, August, September, October. So I think there’s still some momentum in box prices.
With regard to customers’ paper, we’re not really actually one of the biggest buyers anymore because Verzuolo, in many respects, has taken care of that. But we still do buy boxes and we still do get — sorry paper and we still do get letters from customers. And as recently as one hour ago, we got a letter from one of our big suppliers to say that basically they are taking downtime in August due to the cost. We are also taking downtime due in August, due to cost and we understand from practically all participants that downtime has been taken and this was due to costs that were a week ago and now with costs considerably higher in the last three or four days. I would imagine that many independents are contemplating more downtime in order to not produce paper that is basically sending money with every roll of paper to their customers. So there will be more downtime and if prices of energy persists there will be price increases to offset that irrespective of anything.
Ken Bowles
Good morning, Dave. And supposed to kind of frame it a bit in terms of your question. So as I said, we’re about 80% hedged for 2022 as we stand here today, and that breaks down into for the remainder of the year, a little over 60% for quarter three and kind of mid-50% for quarter four. And that’s very much in line with our policies, a lot of our hedging come in as 2022 was done way before 2022. So I think — and again, similar to what I said to Lars, if you ring me in 10 minutes, I’ll probably give you a different answer the way energy prices have gone at the moment. But I’d estimate that the hedging we’ve put in place for 2022 has probably saved us something in the order of anywhere between EUR450 million to EUR500 million as we sit here today.
It’s important to point out that we don’t base any of our pricing models around it that the hedge price or the net price we base on the work we see around us. So it doesn’t — which is why I think you see some of the outperformance. And then as we look forward to ‘23, ’24, well, where we’d be very much in line with our policy as we begin that is about 20%-odd for ’23 and 20%-odd for ’24. That would — and again, some of those hedges, most of which we’ve put in way before ‘22. So — but at these levels, I mean, I think it’s fair to say that you’d be very difficult to find a hedge party that kind of — if you woke up this morning at EUR200 million, so I think it’s where we’d like to be in transfer policies we sit here. And then what we do is we have a very with a steering committee on energy, who’ve done an incredible job, as you can see, over the last year to 18-months and continues to do so in tough market, help us navigate through that particular, kind, of cost bookings.
David O’Brien
That’s great. Thanks very much guys.
Operator
Thank you. We will now take our next question, please stand by. Your next question comes from Justin Jordan from BNP Exane. Please go ahead. Your line is open.
Justin Jordan
Thank you. Good morning, everyone. I’ve got two quick questions, firstly I guess, can we be both [indiscernible] can we just talk about price versus cost spread? Because when I look at your Q1 EBITDA margin at the group level 17.0%, that actually improved to 19.6% in Q2 2022. So can you just help us understand just the positive price increases that you’ve had in excess of cost inflation in Q2 over Q1? It’s clearly demonstrating to the higher end margins? And then I suppose just following on that, Ken, in your prepared remarks, you talked about continued progression in corrugated box prices in H2. I just want to sort of delve into that a bit deeper, particularly given we’ve seen some softness in German containerboard prices recently?
And then secondly, just following up, I’m sorry, I know energy is in top of [indiscernible], but can you help us understand back in Q2 2020 at the peak of COVID lockdowns clearly, some of the capital seems to be pretty much an essential service and mandated by various governments to continue producing packaging, particularly for food and beverages. Does that give you potential prioritization in a situation of gas rationing, if we see that in 2022 in the second half of this year? Thank you.
Ken Bowles
On margin, I suppose, it’s difficult to kind of give you the excess pulp price achieved over cost basis, because what we do is as you know, the teams particularly close and trying to achieve as much as they can possibly do in the context of whatever relationship they’re in. Look, I think it’s really simple if you think about it, we’ve raised box prices from the low to the — to where we’re at the end of June by close to 40%, 10% Q2 over Q1. So no matter how you kind of look at the phenomenal performance, but the team is — the various team in Europe and indeed Laurent teams in the Americas. So and that’s why, but also it’s not just that though, it’s also that kind of constant focus on the cost base, the investments we make to take any cost out. So it’s — you know what we don’t — it’s not about looking just as a top line what you can achieve on price is what you can take in the cost plan and make sure you manage that too because that’s the bit that can actually get out of control in times of growth and we just didn’t allow that to it. I think some of the investments has allowed, as we’ve spoken before, to be structurally better anyway in terms of the cost base, I think you’ve seen some of that investment also feature the margin and the margin resilient. So I think it’s an element of, yes, pushing hard on the box price. As Tony said, we’re pushing hard early on the box price, I mean, from a year ago now. But also being conscious that trying to get ahead of the problem as we see it, but also managing the cost base because that is fundamentally what you have to do, and you can’t get back at [indiscernible].
In terms of [indiscernible] Tony, you’re kind of tough on the ball between the zero and kind of pricing into the second half of the year, but there clearly is a bit to go, because as we sit here as cost continuing the rise, you really can’t allow that to kind of get away from you. So clearly [indiscernible] will trigger whenever they trigger and depending on where prices go, but [indiscernible], if it’s necessary, we’ll go again. But we start to see a little bit more to go on box pricing as we begin in the second half.
Anthony Smurfit
Yes. And with regard to — Justin, with regard to sssential service, I mean, yes, you’re entirely right, that corrugated packaging was during the pandemic team did an essential service and I think Ken mentioned that in his speech earlier on. I think that we would expect to be prioritized, but I don’t think that we’re not — in the event of gas rationing, I think that we the industry would be rationales as well. I think it is obviously a massive unknown situation as to what will happen in the event that there’s lack of gas, will we be allowed to burn brown coal again in our Zulpich mill, which is about 9% of our production in Germany. I suspect that we will if we can get a brown coal supplier, because most of those guys have stopped to dig in. But are will we bring coal from Colombia? We don’t know, I mean, there’s a lot of unknowns at the moment.
But I would suspect that we will be seeing as an essential service, practically all of our box fence can continue to run, because they can shift over to oil if necessary. And as Ken mentioned, about 11% of our paper production is fully exposed towards gas in Germany, where we can’t actually switch over at this moment in time. But aside from that, that’s what would be affected. But clearly, that would have a very dramatic effect on the general marketplace, because the largest paper producing nation in Europe is Germany. And if there was paper to be stopped, well we would be happy enough that we can continue to supply our box plants and our customers and that’s what customers are actually asking us for. Right now, we would say that there will be some shortages of paper in Europe in that event that gas is stopped supply to Germany.
Okay. Thank you very much Justin.
Operator
Thank you. We’ll now take our next question, please stand by. Your next question comes from Cole Hathorn from Jefferies. Please go ahead. Your line is open.
Cole Hathorn
Good morning. Thanks very much for taking my question. Just to focus on the box pricing environment, you’ve continued to push that through. I mean, as the European number one in boxes. How are you positioned here? I mean, if paper prices are being supported, should your box price business must still relatively be doing very well and all your customers that they don’t really have an item to push back on from a cost perspective. So you should be holding on to this higher box pricing environment even if volumes are a little bit softer, because you’ve got that cost support, which means a better profitability for your box business. Just trying to understand, how should box pricing develop this cycle even if 2023 is softened from a macro environment?
Anthony Smurfit
Well, as I said — thanks, Cole for the question. I mean, at the end of the day, what we’ve said is we still have momentum in box price increases in July, August and September. We would suggest that security supply is still the largest issue for our customers right now. Remember the box unfortunately is not the highest cost elements of most of our customers’ issues and having security supply is very important for them and the most expensive box they can have is the one they don’t have. So therefore, we are a great provider of services to our customers. We’re a great provider of innovation. We’re a great provider of sustainable packaging and that’s not going to change. And I think our customers depreciate what we do for them and we are winning business. We continue to be very comfortable in our — in where we sit with practically all of our customers. And while we don’t win every bit of business, we continue to win business as I see it.
So I don’t see the box pricing environment changing in the short-term. I think obviously if paper again moves up, because of energy, we will have to go back to the market again. Equally, we may have to go for box price increases irrespective, because if inflation is going to be stronger than anticipated for next year for labor costs, for starch, for transport, for everything else, then there might need to be box price increases even outside of the cost of paper. But it’s a very, very, very fluid situation and I don’t — as we mentioned in the press release, we haven’t seen times as volatile as this in practically all of our lifetimes. I mean, I’m sure it was like that in the early 70s. when inflation was taken off. So I think we just need to ourselves just continue to watch it and manage it as we’ve done in the past. And I think we’ve proven that we are able to manage whatever’s thrown at us.
Cole Hathorn
And then is the right way to think about Smurfit Kappa’s paper mill asset base. I mean, can you yourself have brought out a few comments around EUR900 million invested in energy projects? 50% biomass fuel mix and being in the lower end of the cost curve plus your hedges. Should we be thinking that relative to a fragmented market, I mean, if the market is taking commercial downtime, you should just be relatively better positioned. So will be the net winner versus some of the smaller players no matter where energy effects?
Anthony Smurfit
I could give you a very long answer to that, but the simple answer is yes.
Cole Hathorn
And then final, a quick one for Ken. I just missed that you called out the percentage energy hedges in the second half and into 2023. Apologies, I just missed this.
Ken Bowles
Sorry, Cole. Good morning. So for the second half, we’re about 60, little over 60% hedged for Q3 and kind of 54%, 55% for Q4 and then call it 20% for ’23 and ’24 as we sit here today.
Cole Hathorn
Thank you.
Anthony Smurfit
Thanks, Cole.
Operator
Thank you. We’ll take our next question, and your next question comes from the line of James Twyman from Prescient. Please go ahead. Your line is open.
James Twyman
Yes. Thank you very much. I’ve got two questions. Firstly, are you seeing destocking going on in the European containerboard system at the moment? And if not, is that something that you would expect to see given the level of stocks in the system?
And then secondly, you mentioned that you’re going to be taking downtime. Could you just give us some idea of the sort of scale of what you’re planning in the next couple of months? Thank you very much.
Anthony Smurfit
Thanks, James. We’re going to take somewhere around 30,000 to 50,000 tons, we’re not sure yet. I mean, it’s a bit of a moving piece, because of the price of energy. We don’t want to build up stocks in August typically, our business builds up stocks in August, because August is a basically paper mills run 31 days and box plants shut for holidays and typically we build up stocks during the month of August. So that when business starts to come back in September through the rest of the year, we have enough stock in our warehouses.
At this moment in time, stocks are already high enough so therefore, with the current price of energy there is absolutely no sense whatsoever to make stock when you can actually take some downtime. And in fact, it helps our hedges a little bit. We have heard of many instances where people are taking downtime and selling their hedges for profitability, but that’s not what we’re necessarily doing. We’re just making sure that we don’t have too much stock as we come into August and making paper with 200 plus energy, which doesn’t make a whole lot of sense to us. So we’re going to continue to adjust really on a daily basis, because we don’t want to — if I was speaking to you a week ago, James, we would have been saying we’re not going to take that — we would have taken around 30,000 tons, but today at 220, we might take 50,000 tons, because just doesn’t make any sense to make paper.
And we’re seeing that announcement, as I said, just as early as this morning from a totally independent guy that we buy from rorating the 15% of his production out in August that wasn’t expected yesterday. So I think you’re going to see a lot more of that, because it’s just uneconomic for us and uneconomic for industry to produce that energy prices of 200 plus.
With regard to destocking, there will be destocking going on as people take downtime and as demand is normal in September, but I wouldn’t say you’re pretty much destocking in July and August, because just as I say that there was already sufficient stock in the system, but there won’t be any build — further build up in stock, I don’t think.
James Twyman
Great. Thank you very much. Thank you.
Anthony Smurfit
Thanks, James.
Operator
Thank you. We’ll now take the next question, please stand by. Your next question comes from Kevin Fogarty from Numis. Please go ahead. Your line open.
Kevin Fogarty
Hi, good morning, guys. Thanks for taking the questions, I’ve got two please. Number one, just given the balance of the sort of demand outlook and what you said in terms of industry downtime. I just wanted to what extent do you think sort of this year follows somewhat kind of normal seasonality for you guys? As much as you can tell at this point, again given the sort of strong H1 that you’ve just delivered?
And just secondly, in terms of cash generation, clearly, a lot of working cap investment in H1. And just sort of against that, just sort of confidence on a lot of that, sort of, unwinding, should I unwind it normally in the second half of the year? And just the CapEx plans remain unchanged given despite sort of I guess, it kind of softer demand environment. I just wondered what level of flexibility you might have in terms of that CapEx for the second half of the year, i. e. kind of projects that may not have started at this point. Just any color you can give on those would be great?
Anthony Smurfit
Yes, I’ll take the first one, I’ll let Ken take the second one. I mnea, I suppose in some sense that Kevin and we did say this last year, consistently through the year that we didn’t expect the kind of demand levels that we saw last year to continue. I mean 14.5% in Q2 and 9.5% and 7.5% in Q3 was really exceptional. And the fact that we’re even line ball with those I think is a good performance in many respects. I think that the normal seasonality is that in August, we do have a slower month, because people take holidays and there is no COVID — sorry, there is COVID, there’s lots of it, but nobody cares about it anymore. So there is a normal seasonal pattern that August is a slower month for corrugated consumption. And so we would expect to see that again and then we would expect to see from September onwards ramp up as we have always done, unless your view is very bearish on the world and we think there’s going to be a very severe recession, then I don’t suspect that we’re going to see anything different.
But clearly, we have positioned ourselves well to make sure that we are able to adapt to any situation that happens, and that’s why we are taking the 30,000 to 50,000 tons of downtime to make sure we don’t have excess stock as we go through the year. Ken, do you want to take the second question.
Ken Bowles
Good morning, Kevin. And short answer is yes, I mean, the second half year tends to be more cash generative than the first half. So by the end of the year, I kind of said, we definitely see working cap as a percentage going back within the 7% to 8% range. And definitely returning to kind of positive free cash flow. But I suppose a function of the success on box pricing is that kind of EUR0.5 billion investment in working capital for the first six months, function, kind of, to 10% quarter-over-quarter. So as that kind of box price moderates, to kind of lower levels in the quarter 10% increases, you’ll definitely see that moderation in spite of unlocking and indeed the cash return.
On CapEx, I suppose the projects that are coming in this year and they paid for kind of ordered a year or so 18-months ago and we were paying out those. We don’t have any large big ticket projects that we have to make any kind of big decisions on as we sit here today. Again, as I kind of said, we kind of build all these plans on being flexible and agile, and as we go back to what Tony just said there, we had 14.5% growth in the second quarter last year followed by 7.5% growth. So we really needed some of this machinery just to come in to provide capacity. As we also said last year, if we continue to see these levels of growth and actually wouldn’t be able to not just us, but the industry couldn’t possibly service that level of growth. So a lot of us coming in as necessary capacity just to get us back to kind of normal operating levels where we’re not having to work weekends or extra shift just to kind of get the customers satisfied.
So but there’s nothing in there in our plans as we go forward. That isn’t flexible that we can’t change [indiscernible], but most we continue to — we just continue to go on as we are because it’s for growth to come that we will see.
Kevin Fogarty
Okay. You know, that’s helpful. Thanks a lot. Thank you. Thanks.
Operator
Thank you. We will now take our final question, please stand by. And your final question today comes from the line of Lars Kjellberg from Credit Suisse. Please go ahead. Your line is open.
Lars Kjellberg
Yes, thank you. Just a quick follow-up on box prices. Clearly, you managed to accelerate that box price realization relative to some sort of three to six months that we’ve got accustomed to in the past? How should we think about you and we have responded to this in a way, because it’s not necessarily tied to paper prices, I suppose. But have you taken anything that normally would have fallen into Q3, Q4 upfront now. So we — in terms of the way to think about the model that we should temper our price expectations for — in the H2 versus, kind of, the normal trajectory? Or is that not relevant to think about given the various cost pressures you’re talking about?
Anthony Smurfit
I think we’ve demonstrated that we have been pushing our increases through to ensure that we covered in our inflationary costs. And last year, we ate a lot of costs, because we didn’t have enough clauses in our contracts for inflation along with the rest of the world, I think. And so you should expect that if inflation continues to be strong that we will deliver further increases to make sure we offset that inflation throughout our system. And that’s just an absolute necessity for us. And I think we’ve demonstrated that we are able to do it and we will continue to do it if necessary. But clearly, our performance has shown that we have been successful in doing it and I suspect that we will continue to do it.
Lars Kjellberg
Very well. Thank you. Very clear.
Anthony Smurfit
Thank you, Lars.
Operator
Thank you. I will now hand the call back to you sir, for any closing remarks.
Anthony Smurfit
Yes, thank you, operator. And again, I want to thank you for taking the time to be on this call with Ken and myself. And we look forward to a fantastic future in Smurfit Kappa notwithstanding the fact that there are of course outside forces that are always going to challenges from time-to-time, but we have continually said that the success is never a straight line. And our whole ethos has been to develop our business with our customers, to make sure that our customers are supplied, to make sure that we give great value to our customers and to make sure that our customers see Smurfit Kappa as the supplier of choice in the corrugated packaging sector across the world.
I think one must should never forget that Smurfit Kappa has an irreplaceable footprint that we are all very proud to build on and develop whether that’s through acquisition or through investments. We continue to see significant opportunities across many of our product — our countries in which we operate and many of the factories in which we operate. And hence, that’s the reason why we look forward to the future with such confidence. We have the best people in the business, we have the best assets in the business, we have the best market positioning in the business. And we are the best company in the business.
So I want to thank you all for your support. I want to thank you for your continued attention to Smurfit Kappa. And we look forward to seeing you both personally and going forward into the future. Thank you all.
Operator
Thank you. This concludes today’s conference call [Technical Difficulty] participating. You may now disconnect. Speakers, please standby.
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