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The specialised cellulose business performed very well, with excellent production volumes...
Letter to stakeholders from the Chairman and Chief Executive Officer

The last year was one of transition for Sappi as we successfully completed the two conversion projects in Southern Africa and North America to produce dissolving wood pulp.
Chief financial officer's report

This year was indeed a very important transitional year for Sappi. We successfully completed and commissioned the two major dissolving wood pulp projects, as well as the conversion of PM2 at our Alfeld Mill to speciality paper.

These projects were of significant strategic importance, accelerating our expansion in higher margin growth businesses.

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We also made good progress in repositioning the European graphic paper and Southern African paper businesses for improved and sustainable margins and strong cash flow. Further steps were taken to improve efficiencies and lower our costs.

In summary, we have successfully implemented the majority of the actions we intended for the year.

Our financial performance was disappointing, and not in line with our expectations. We always expected the performance to be negatively affected by the once-off impacts of the major projects, but the combination of high input costs, lower selling prices and lower demand in our European paper business resulted in an operational loss for that business that was not expected.

A number of our businesses, particularly specialised cellulose and the speciality paper businesses performed very well and provided important support in this transitional year.

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We have now successfully completed the two projects and these are running well.

Demand from our key customers and in general is good. estimates for annual growth range from 6 – 8% for the commodity grade of dissolving wood pulp, where the majority of our production is targeted. The market remains competitive with expected additional dissolving wood pulp capacity coming to market and a more competitive viscose staple fibre market.

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Our low cost base, modern facilities, quality product and decades of manufacturing and sales experience, gives us the confidence that we can continue to generate good returns, well above our cost of capital.

We aim to remain very competitive not only on cost, but importantly in quality and service levels. We have long-term contracts and valuable relationships with the leading customers in this market.

With regards to investments we certainly are looking at various growth opportunities as regards capacity and product range. In the near term we will focus on efficiency and quality improvements and do not plan any major investments in the next two years.

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We do not anticipate that the recently announced preliminary duties will impact our business results due to the nature of our current sales plans.

Duties have been imposed on manufacturers in three countries: the USA, Canada and Brazil. 75% of our dissolving wood pulp capacity is in Southern Africa, capable of supplying our customers in China.

We expect market conditions to remain challenging, with continued pressure on pricing and volumes. our strategy and actions to improve the performance of this business take this into account.

Our strategy is therefore to aggressively position our European business as the lowest cost producer within Europe over the next two years. To achieve this we will exit high cost capacity, improve efficiencies and invest to significantly lower the cost base of our world-class mills.

The result of this will be a smaller but more profitable European business which will provide reasonable margins and produce good cash returns on a sustainable basis.

Our stated target is a net debt to EBITDA ratio of 1.5 to 2 times. With the major capital projects now completed and behind us, the expected improvement in operating performance going forward and the strategic actions being implemented, I am confident that a net debt level of below US$2 billion by the end of the 2014 financial year-end is very much achievable.

We are, in addition, working on a number of projects which include the possible disposal of surplus softwood plantations in Southern Africa which, if successful, will result in a significant further reduction in net debt. We have adequate liquidity and headroom to execute our strategy, and our debt maturity profile is sound.

I believe that the single most important factor in terms of the sustainability of a business is its financial performance. This allows more flexibility and strength to deal with all the other relevant sustainability measures.

Sustainability is ingrained in everything we do at Sappi.

We are a long-term business with a wide footprint encompassing forests, mills, distribution centres and customers in more than 100 countries. We take our responsibility as regards the environment, employees and stakeholders very seriously and see these responsibilities as being totally aligned with our financial goals. In short, sustainability in all its facets remains a priority.

Yes, Sappi has an exciting and bright future. We have worked hard to implement our strategy to position Sappi for growth in higher margin businesses, to improve the returns of our graphic paper business, particularly in Europe and Southern Africa, and to sustain the performance of our other businesses. In this regard we have made very good progress and are well advanced down this road.

Secondly, we have committed enthusiastic and competent people across our business that are eager to be part of a successful and growing Sappi. We will return to profitability in 2014 and will make good progress in strengthening our balance sheet. I am of the opinion that we will gain further momentum beyond 2014 as well.

Dissolving Wood Pulp (DWP) is a term used for the product produced from the process of extracting cellulose (a natural organic polymer chain found in all plant materials) from wood. The wood from sustainable forest resources is processed and purified by applying specialised chemistry to extract the cellulose fibre chains which are then dissolved by our customers, regenerated and reformed to produce a host of natural products.

When converted to viscose staple fibre, it is a natural substitute in many applications for cotton and is also a blend partner for a number of other fibres, most notably polyester.

... VSF is used in the textile world for making clothes, in home furnishing applications, for wash and wipe toweling and for bed linen. In addition to its suitability for a host of fibre and textile applications, DWP can also be processed into products for eating and drinking, in health and hygiene products, wrapping and packaging and many more applications that touch our daily lives.Read More...
Due to the natural and sustainable attributes of VSF, it has characteristics which are not only complementary in blends with oil based synthetic fibres but which are often preferable to oil based synthetic fibres such as polyester.

The textile market demand is over 80 million tons of fibre with cellulosic fibres (VSF is the primary cellulosic fibre) being 6% of this demand.

... The demand for clothing and other household needs follows the global GDP and world population growth. The increasing need for more comfortable clothing, increasing urbanisation globally and the increasing standard of living in many parts of the world, especially in Asia, has increased the per capita consumption demand for most fibres including VSF.

The production of cotton (a major component of the textile fabric) is expected to stagnate over the next few years as arable land used for cotton planting will be converted to edible crops. Being a natural substitute in many areas for cotton, due to its ease of processing as well as the moisture management properties of this natural man-made fibre, the future for VSF remains extremely positive.

Growth in demand for VSF will be boosted in future as it fills the increasing gap in demand for a hydrophilic fibre created by expected limited cotton supplies, a phenomenon which has commonly become known as the ‘Cellulose Gap’.
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Real demand growth for dissolving pulp, including cotton linter pulps for all applications including acetate, Micro Crystalline Cellulose (MCC), ethers, cellophane, nitrocellulose, sponges and filaments has doubled over the past 10 years.

It is expected to continue growing around 6% or higher in the next five years. Sappi’s DWP capacity growth is aligned to that of our major customers where we enjoy strong and mature relationships as well as long-term commitments and agreements.

... Sappi’s extensive R&D capability, process knowledge, strong technical partnerships with customers, market leadership and expertise in its key target market segments, which is in particular focused on providing customer support and innovation, will enable the increased capacity to be absorbed into the marketplace. our other competitive advantages will also stand us in good stead.

These include our lower cost quartile position, proven track record, world-class manufacturing and R&D assets, consistent operational performance, three manufacturing sites on two continents offering supply and process flexibility, a global sales presence and low cost logistics capability, differentiated quality options and a sustainable and results driven business model focused on continuous value added improvements.

We are confident these competitive advantages will allow Sappi to grow its market share and leadership position in this competitive environment.
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We are in the process of optimisingconverted DWP mills at Ngodwana and Cloquet. Both these mills are already producing exceptional quality pulp and their products continue to gain customer acceptance.

Ramping up to full design rates and further de-bottlenecking will occupy our time in the immediate future.

All three Sappi mills currently fall within the lowest 10% of the competitor cost curves published by independent consultancies. This position is sustainable and can be attributed in large part to world-class operational excellence and manufacturing leadership.

The technical age of our modern assets and the process of continuous improvement and optimisation, as well as wood fibre yield improvements, increasing energy self-sufficiency, and supply chain optimisation are other contributors to this competitive cost position.

There are focus areas in the field of bio-refineries and speciality product development which will allow further diversification and growth opportunities in the near future.

Our key focus, however, remains building and supporting our position in the VSF and Lyocell segments while also pursuing growth and development in those speciality segments such as MCC, ethers and acetate where Sappi pulp qualifies

There is over-capacity in the supply of DWP in both the VSF and speciality markets.

Also, these are extremely competitive sectors, so we will continue to see pressure on prices and this may drive prices to the marginal costs of some competitive producers. Sappi plans to maintain full operating rates through the cycle due to its competitive cost position and by offering sustainable solutions to our customers.

... The global economic downturn has also impacted the textile industry and, combined with over-capacity in the VSF market, this has resulted in the current VSF pricing levels. Many VSF producer margins are under pressure. While VSF prices are currently low, volumes continue to move and VSF operating rates remain in the upper 80% with inventory levels remaining at about two weeks.

The China cotton reserve policy has allowed VSF to substitute for cotton in many areas, particularly in the very large Chinese fibre market. VSF expansion plans have also been announced in many Asian countries.

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Sappi is a global company focused on providing dissolving wood pulp, paper pulp and paper based solutions to its direct and indirect customer base across more than 100 countries...
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