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Edited Transcript of SK3.I earnings conference call or presentation 31-Jul-19 8:00am GMT

Q2 2019 Smurfit Kappa Group PLC Earnings Call

London Aug 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Smurfit Kappa Group PLC earnings conference call or presentation Wednesday, July 31, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Anthony Paul J. Smurfit

Smurfit Kappa Group plc - Group CEO & Director

* Ken Bowles

Smurfit Kappa Group plc - Group CFO & Director

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Conference Call Participants

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* Alexander Berglund

BofA Merrill Lynch, Research Division - Analyst

* Clyde Alvin Dillon

Vertical Research Partners, LLC - Partner

* Cole Hathorn

Jefferies LLC, Research Division - Equity Associate

* David A. O'Brien

Goodbody Stockbrokers, Research Division - Investment Analyst

* Lars F. Kjellberg

Crédit Suisse AG, Research Division - Research Analyst

* Mikael Doepel

UBS Investment Bank, Research Division - Executive Director & Analyst

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Presentation

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [1]

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Good morning, ladies and gentlemen, and thanks to all of you joining us in the room and of course on the telephone. It's really great to see all of you, and I'd like to thank you for you attendance. As is custom, I will draw your attention this slide, Slide 2, and if you don't mind, I will take it as read.

12 months ago at the same period last year, we presented to all of you under the headline of leading, innovating and delivering. Today we're presenting on the same basis but have added a further heading, which is progression. Progression

builds on the story of transformation that we first presented to you in February 2018. The transformed business delivering transformed results with transformed long-term prospects. For the current period, we have delivered revenue growth of 4%, EDITDA growth of 17% with the margin of 18.3%, and return on capital employed of 18.7%, ahead of our through-the-cycle target of 17%.

ROCE is a key measure for the group and it reflects the most effective long-term measure of capital allocation. These results clearly demonstrate the continued progression of our company, and I'd now like to take you through a few factors that support this performance and will sustain future performance.

Turning to our theme of leading. At the outset, let me take a moment to summarize some of the factors that we believe defines Smurfit Kappa as a corrugated industry leader. For us and for you, it's about delivery, delivering on our medium-term plan. This plan, which Ken will develop later, was built on the conservative assumptions and provides a clear returns-focused framework for capital allocation. The medium-term plan is delivering and the plan itself is both flexible and agile depending on opportunity and market conditions.

You've consistently heard me talk about our culture and our values. We've a high-performance culture where we devolve production and marketing decisions with the box front managers, our paper mill managers, as they know the customers best. But we retain strong central controls on capital and reporting. Our business model, as an integrated packaging company with ever-expanding geographic reach, is evolving our relationship with our customers from supplier to a partner. Our innovation capability is truly transforming, accelerating that transformation.

We continue to build a better platform for long-term performance and success. In May of this year, we hosted over 350 customers from across the globe to our global Innovation Event in the Netherlands. The cornerstone of that event was our Better Planet Packaging initiative. We had twice the amount of customers compared to our previous event with global and local customers from all disciplines. From owners to marketeers, to product development specialists and purchasing managers. The level of interaction on the day made clear the increasing focus our customers have on the densifying sustainable packaging alternatives against their current solutions. We exhibited thousands of examples of solutions during this forum, demonstrating our leadership in sustainability and cost-effective and smart packaging solutions.

By our nature, our business is sustainable, our product is renewable, recyclable and biodegradable. And we continually challenge ourself to be ever more sustainable. Our leadership in sustainable activity continues with the release of our 12th sustainability report in May of this year. An ambitious new set of sustainability goals was unveiled having met or exceeded previous targets ahead of our 2020 deadline. Smurfit Kappa continues to have long-term commitment to making real and measurable progress against its 5 sustainability priorities of forests, climate change, water, waste and people. This report is evidence of our industry-leading transparency and demonstrates how Smurfit Kappa is making progress in supporting the UN's 2030 Sustainability Development Goals. We are delighted, truly delighted, to be recognized by many third-party bodies for good sustainable practices, and you'll see just a few of them listed on this slide.

We're all aware of the fantastic secular driver of eCommerce for our sector. Again, we are demonstrating our leadership in this space. At a recent large eCommerce event in Lisbon with 750 specific eCommerce business people attending, we were awarded 2 of only 5 awards, those being for cool vendor and sustainability. The other 3 being going to 2 robotics companies and a logistics company. No other packaging company won an award. The event was a huge success for Smurfit Kappa and generated a substantial volume of leads in this area for us to capitalize on.

Now turning to innovation, which is very much linked to what we've just covered. Smurfit Kappa continues to provide our customers with the most innovative and sustainable packaging solutions. We are the most future-orientated company in our industry, pioneering machine systems, performance packaging, ShelfSmart with IC technology, to name but a of our other industry innovations. We showcased many of those innovation case studies in regular investor communications. However, here you'll see independent validation of our leading innovative market offering. We won over 40 awards from across the globe in just the first half of 2019. All these awards highlight the breadth and depth of innovation in the company with awards from practically every country in which we operate.

We're of course all proud to work for the company we work for but we believe strongly we're -- and we believe strongly we're the best at what we do. But it's nice when you have other companies and industry bodies telling you the same. It also represents a step towards our vision of being a recognized and respected leader.

One of the many ways we can ensure innovation for our customers is hard data. The sheer scale and depth of data that we possess. You can see on this slide, we're truly applying science and technology to packaging innovation. To ensure we have packaging that gives our customers optimized lowest cost solutions, we have over 4 million data points. We've a library of 8,000 designs, which allows our designers to generate immediate ideas for our customers by harnessing the power of the global design team of almost 1,000 designers who are obviously all linked together. We can show at the click of a button how our customers' products look on the supermarket shelves across the world by using Shelf Viewer, where there is over 130,000 images. And from a cost perspective, SupplySmart enables us to identify cost-reduction opportunities for our customers, but critically one that will work in the marketplace supported by almost 80,000 supply chains analyzed.

Our global reach allows for continuous transfer of knowledge, best practice and innovation between our regions to the benefit of our customers. And handling and delivering our solutions are the network of 26 experience centers across the globe, from Dallas to São Paulo, from Moscow to Dublin. Tangible examples of the work we do with our customers to increase their sales and reduce their cost are obviously much more compelling than simply giving them the sales pitch. Proof that our methodologies work resulted in over 3,000 visitors to our global experience center network in the first 6 months of 2019 alone. And just to reflect to that, none of these even existed some 3 to 4 years ago.

Smurfit Kappa has an unrivaled offering but we ourselves are continually innovating and adapting these. Our applications rely on data sets that cannot be replicated, delivered from an asset base and geographic spread, which is second to none, and frankly, is unique and irreplaceable. The depth of the data, the real consumer insights and the experience of our people allows us to present applications, such as ShelfSmart and SupplySmart that facilitate real and significant increases to our -- in our customer sales on the shelf or analyzing the supply chains to provide credible cost takeout opportunities.

Smurfit Kappa is also the leading machine systems producer in the industry. With over 8,000 machine systems installed in our customers' operations to date, Smurfit Kappa's machine systems division has been helping our customers increase their productivity, reduce their costs and optimize their packaging design for over 50 years. This is a truly great way of building customer retention and loyalty. Trying being just delighted a little bit, I have just 2 of many, many thousands of examples to share. Smurfit Kappa is recognized time and again by our customers as the partner of choice. Here in the case of Kellogg's, our unique Pan America's offering coupled with our use of SupplySmart, delivered a 40% cost reduction to Kellogg's. As I say, this is just one example of the recognition we received.

Smurfit Kappa was awarded the Transforming Innovation award by Kellogg's for our innovative approach. And this of course has helped develop the global relationships between our 2 companies. Another small example is this time in Europe is how we use innovative work with our customers to help drive their sales. This involved a new innovative product supported by our smart applications that help stores of the U.K. increase their sales by 14%.

To highlight our recent actions on innovation and sustainability, we have consolidated the press releases we've made in the first 6 months of the year, and included them in this presentation and results released on our website. I'd encourage you to take time to review them.

We've referenced our Better Planet Packaging initiative with regard to sustainability a number of times but we're not taking a one-dimensional approach to addressing this issue. We have hosted or attended conferences across Europe and the world, building relationships, educating customers, developing partnerships, the net result of which is a very significant pipeline of new and potential business. The implications for volume growth are very difficult to quantify but the uptick in interest is very, very strong and producing meaningful opportunities for us as we go forward through the years. I'd like to now hand you over to Ken, who'll take you through our delivering piece.

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Ken Bowles, Smurfit Kappa Group plc - Group CFO & Director [2]

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Thanks, Tony, and good morning, everybody. Just reflecting on our results in a bit more detail. We're pleased to deliver a significant year-on-year improvement against almost all our key metrics and performance measures for the first half of 2019. We delivered revenue growth of 4% for the period to EUR 4.6 billion. EBITDA was up 17% to EUR 847 million, with earnings growth in both Europe and the Americas. I'll expand on the divisions bit in a moment, but at the group level, EBITDA was negatively impacted by currency and the Venezuelan deconsolidation, while net acquisitions were positive as was impacted by IFRS 16 releases. On an underlying basis, EBITDA for the year was 8% up on the first half of 2018. We also saw improvement in the EBITDA margin from 16.4% in the first half of 2018 to 18.3% in the first half of 2019, in lieu of 190 basis points. We saw improved margins in both Europe and the Americas, driven by our capital investment, volume growth, higher corrugated prices, the benefit of acquisitions, the impact of IFRS 16 and lower recovered fiber costs.

We delivered an improved return on capital employed of 18.7%. This is against a return on capital employed for 2018 of 18.1%, and well ahead of our stated target of 17%. And as a reminder, that target was set on the basis of the full implementation of our medium-term plan exiting 2021. Free cash flow for the first half was EUR 159 million, an 8% increase on the EUR 148 million delivered in the first half of '18, and while EBITDA was significantly up year-on-year for the 6 months, so too was capital expenditure and indeed working capital. The management of working capital remains a key focus for us and the working capital as a percent of sales at the half year is 9.8% but expected to come back to our normal range of 7% to 8% by the year-end.

Net debt to EBITDA at 2.2x was slightly up on the 2.1x reported this time last year and on the 2x reported at the end of 2018. The move in leverage really has to be seen in the context of, a, taking on the debt associated with IFRS 16, and indeed, the completion of the acquisitions in the first 6 months. And as noted in the press release, we wait the outcome of the Italian Competition Authority's work in relation 50 market participants, including one of ourselves, and we'll update you as appropriate.

And finally, reflecting the confidence the Board has in both the future and in the current prospects of the group has approved to 10% increase in the interim dividend to EUR 0.279 per share. Looking out to the European operations and their performance in the first half of 2019. EBITDA increased by 17% to EUR 688 million. EBITDA margin was 19.3%, up from the 17.3% reported in the first half of last year. And the reasons for this strong performance, I've already noted, is part of the overall group performance.

The European pricing for testliner and kraftliner has reduced by EUR 120 per tonne and EUR 140 per tonne, respectively, from the highs of October '18, but we have seen signs of stabilization in the recent months. And during the first half of 2019, we completed acquisitions in Serbia and Bulgaria, a further step in our South Eastern European strategy. And the integration of these assets into the group is progressing well and a strong examples of how we consider M&A in the context of integration.

Turning now to the Americas. And in the Americas for the first half, EBITDA increased by 14% to EUR 179 million. The EBITDA margin also improved from 15.2% in the first half to 17.1% in the first half of '19, driven, once again, by the performance drivers noted as part of the overall group performance. For the first half, 85% of the region's earnings was once again delivered by Colombia, Mexico and the U.S., with strong year-on-year performances in all 3 countries driven by increased volumes, lower recovered fiber costs and continued progression in our investment program.

In Colombia, volumes were 9% up for the year, driven by high growth in the FMCG sector along with the agriculture and flower markets. And in June, we announced a successful tender offer to acquire the minority shares in Cartón de Colombia S.A. The Consideration payable under the tender offer was about EUR 81 million and represents excellent value and further simplifies our corporate structure.

In Mexico, we saw continued improvements on both an EBITDA and EBITDA margin basis as well as continued volume growth. The growth of eCommerce, the increasing focus on sustainable packaging solutions, together with our ability to provide a unique Pan-American sales offering, have continued to drive demands in our Mexican business.

And in the U.S., our margins continue progressing year-on-year in the first half due principally to the strong mill performance and the benefit of lower recovered fiber costs.

Having looked briefly at the first half results, and before I touch on where we are in our investment plan, and we're counting it as part of the medium-term plan. I just want to recap on how we see capital allocation in its broader sense. Our return on capital target is 17% through the cycle. And as you can see from this graph, the returns profile of this business have been gradually improving and we're confident in our ability to deliver that 17% on completion of the plan. And to remind everyone, the plan was built on long-term average pricing and conservative volume assumptions.

We have always been a generator of significant free cash flow, and the continuous focus on the free cash flow gives the ability to balance our capital allocation priorities while ensuring the balance sheet remains strong. It's the balance sheet with considerable flexibility, well within the leverage range we outlined in February '18 of 1.75x to 2.5x. The dividend remains a key part of our allocation, and since its reintroduction in 2011, we've grown the dividend from the EUR 0.15 back then to EUR 0.976 in 2018 and a further 10% increase today.

Capital allocation to internal projects is key to the continued growth in performance of the business. Importantly, we take a returns-based approach to all our capital allocation decisions. We're disciplined when it comes to acquiring targets and we're disciplined when it comes to making internal investments.

Now looking at some of that discipline in action. We're about 18 months into the medium-term plan we outlined back in February of last year. And again, you may recall, the full implementation exiting 2021, where internal capital employed will be 17% through the cycle, open our previous 15% target. And to reiterate again, that plan was built on long-term average pricing and conservative volume assumptions. And that kind of really drives our ability to deliver on that target.

Earlier this year, we reminded you that the 2 key components of this plan were agility and flexibility when allocating capital either internally and/or externally. And a little over 18 months down the road, I can tell you now that we've approved over EUR 600 million of that medium-term related expense. And the results I think we present today are early indications of the success of our plan to date.

Over the next couple of slides, I just want to give you some granularity about some of the projects in the plan to date and the integration of our recent acquisitions. Ultimately, the goal is to ensure that from paper supply through the conversion, we have the most sufficient internal supply chain, delivering our customers the product they require, on time, in full and it's top end of the quality metrics.

Firstly, looking at the type of projects we've been carrying out in our European operations. In the Netherlands, we've invested to allow one of our flagship mills facilitate production of more lightweight containerboard grades. That's more tonnage of the product than market is demanding coming from the lowest cost, most sustainably focused mills in Europe. The investment of high-quality print and die cut machinery in Moscow will allow us to better serve our customers both local and European in that markets. And in terms of cost takeouts, the reduction in our reliance on third-party warehouses allows us to reduce cost and indeed eliminate risk. And importantly, our project deadlines here will deliver returns well ahead of the targets.

On the next slide we see some examples of the projects we're doing in the Americas. The drive to more sustainable packaging solutions is not exclusively European phenomenon, we're investing behind our Hexacomb product in the U.S. and Mexico to allow us to better serve the rapid growth in that product demand. The removal and replacement of polystyrene with a paper-based solution is an easy switch for our customers to make, providing logistical and cost savings, while addressing their sustainability need. Another trend that's developing more and more in the Americas is our desire for shelf-ready packaging. In Mexico, we've invested to allow our operations cater for this growing trend. It's another example of how the insights and expertise Smurfit Kappa has developed in its European operations is helping develop our Americas business.

And finally, we have another example of investments in our paper system, and this time in a Columbian mill. You'll be aware that we are short approximately 300,000 tonnes of container board in our Americas, so providing additional paper capacity at a low cost to eliminate reliance on third-party providers makes sense no matter where you are in the cycle. And again, as with Europe, all these projects will deliver well ahead of the target return.

The acquisition of the Reparenco mill in the Netherlands in 2018 is a clear example of how we are delivering on those commitments. Though not explicitly part of the medium-term plan, the acquisition speaks to the flexible and agile nature of the plan. If you recall, we said we would build or buy capacity paper in Europe when we unveiled the plans to you back in February 2018. We acquired a low-cost mill in our heartland, providing earnings day 1 and derisking a large element of the medium-term plan. And given the potential conversion of the second paper machine on the mill sites, the group has, to a degree, future proofed its containerboard requirements. Currently, Parenco produces 350,000 tonnes of lightweight containerboard being integrated into the largest corrugated system in Europe.

Paper from the Parenco mill is integrated in our system but also gives us flexibility when we looked at further expansion of the corrugated system. So the paper from Parenco is now going to the recent acquisitions we made in France in Papcarts and Caradec.

Alongside the medium-term plan, we have been continuing our expansion to a disciplined approach to M&A. The expansion in Southeastern Europe builds on the group's existing platform, adding both paper and corrugated assets and illustrates the approach we take to building integrated system through acquisition. Our acquisitions in Greece, Serbia, and most recently, Bulgaria, are operating at the regional integrated system. The paper from the mill in Serbia is going to the corrugated operations not only in Serbia but to Greece, Bulgaria, and in time, our Russian system. And as you can imagine, there are additional synergy savings to taking this approach for the wider group. But in simple terms, it means the mill can run full all the time. The longer producing multiple grades to cater for a vast array of customers but for a limited number of corrugated operations. And those corrugated operations, in turn, have the certainty of knowledge that they were exactly the spec of paper that they will receive from the mill, allowing them to deliver to their customers on quality in service. And it's that quality in service that our large FMCG customers value, and indeed, all our customers value when they come to Smurfit Kappa for their sustainable packaging needs. And it's that quality in service that allows us to continue to grow across our markets and geographies. I'll now hand you back to Tony for some concluding remarks.

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [3]

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Thank you, Ken. So turning to the summary and outlook. Arguably the best measure of effective long-term use of capital is of course, as I said at the outset, return on capital employed. This slide charts the increase in return on capital employed, which in turn, reflects the transformation of the Smurfit Kappa business. Our stated objective of 17% through-the-cycle ROCE, which was to be realized at the completion of our medium-term plan exiting 2021, has already been exceeded. So we set objectives, we met the objectives, we are delivering. The improvement in our operations is really meaningful and palpable. To illustrate the transformation of our business from an operational perspective, here are just 2 of so, so many examples.

Our Townsend Hook mill, which is in the south coast here, has gone from our (inaudible) mill producing 2 heavyweight containerboard machines on 2 machines to a single, state-of-the-art machine producing lightweight containerboard that is fit for purpose. This continuous improvement in our mill system is across all of the systems and has been and continues to be a key focus for us. The images you see here of Julich, a German corrugated site, clearly show how we transform this corrugated planet from a dated manual manufacturing site to a modern increasingly automated site. Just like our containerboard system, impractically all of our corrugated operations, we continue to make effective investments to continually increase the quality of the asset base in Smurfit Kappa.

A key differentiator of Smurfit Kappa is our geographic reach and our spread, something that we continue to develop with the recent entry, as Ken has mentioned, into Bulgaria, Greece and Serbia. The spread of our business gives us a diversity of earnings, and a lack of reliance on one -- any one individual country or region. Our geographic diversity is also important for our customers, and allows us to better serve their multinational needs. We have an ever more dynamic and efficient box system that is supported by our world-class integrated containerboard system, which is delivering a superior service and a product to approximately 65,000 customers.

Ken has summarized our medium-term plan very well, and remember what we said in February 2018, this plan is both agile and flexible, best shown in the example of how we acquired Reparenco rather than continuing on with an internal investment plan to build the mill. The plan will continue to equip our business to meet the requirements of today's very changing marketplace. Again, it's important to reiterate that this plan was built from the bottom up based on long-term average pricing and conservative volume assumptions. This is an experienced management team with a deep industry knowledge who have proven to be effective stewards of capital, and we will flex and allocate that capital to ensure it is put work in a way that we believe delivers optimal value and optimal returns for all stakeholders. We also recognize the importance of investing not only in our physical assets but in our people. Over 300 of our managers, senior managers, are completing a 3-week executive training course at INSEAD. Also, our significant improvement on safety is paramount to us, and our commitment to ensuring all of our staff go home to their families at the end of the day is vitally important for us.

And this management team, I believe, is committed to this and has shown by the loyalty by our staff and longevity of tenure that we are committed to this very important area.

By way of conclusion, I'd like to return to the opening concept of accelerated transformation of our business. We recognize that success is never a straight line and that there will be challenges and opportunities that present themselves. However, if you look at the strength of our business today and the increasing fundamental industry demand drivers, we believe there are significant opportunities for our business over the short, medium, and of course, long term. We have expressed our confidence in another year of progress and delivery. As our long-term performance indicator show, continuous investment in our people and in our business is delivering. Since our IPO to last year-end, our EBITDA has increased by over EUR 600 million, our EBITDA margin by 460 basis points, and our ROCE by over 1,000 basis points, and this has enabled us to sustain a progressive and effective dividend stream with a CAGR of over 30% since 2011.

Our journey of transformation will make us bigger, but more importantly, better. A quality business consistently delivering. A recognized and respected industry leader with what we believe to be superior returns, and of course, making our planet a better place with the performance culture that defines us and values within the company that bind us. So with that, ladies and gentlemen, thank you for your attention. And Ken and myself and Paul will take any questions that you have. We'll start in the room and then go to the phones.

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Questions and Answers

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Lars F. Kjellberg, Crédit Suisse AG, Research Division - Research Analyst [1]

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Lars Kjellberg, Crédit Suisse. The medium-term plan is obviously giving you some tangible benefits, which you called out, and should continue to do so. What I'm more interested to talk about is the other side of the innovation, the customer retention, et cetera. You called that it's difficult to talk about the volume benefits of that. Do you see any tangible benefits in terms of value, meaning where you called out containerboard prices immediately coming off? Do you see your -- any ability to stabilize box prices through these innovations, cost savings for your customers, et cetera? I just want to get your thoughts on that.

And Ken, if you can call out just some technical guidance on the -- what you expect from the medium-term plan for the full year, the M&A impact, the cadence of that? And also, if we look at the OCC benefit that you called out in H1 of EUR 32 million, if I recall, there's some indices that should've been a greater number. Is that a time lag, i.e., should we expect more to come in the second half of the year?

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [2]

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Just taking the customer piece, yes, I mean, we will be very silly if the investments in our business and the investment in innovation was not giving us tangible benefits, and I say that to our people, of course. If the investment in modern machines isn't allowing us to be more precise in our servicing to our customers to make sure that it runs effectively on their own modern machines, if that doesn't allow us an opportunity, then maybe we have to question that investment. I think if the whole innovation centers that we have around the world isn't bringing us advantage with regard to customer retention, customer margins, then we would be silly to do it because there's a cost to that. And clearly, the margins that you're seeing are a testament to the fact that not only are we saving our customers' money but we are actually making better margins ourselves. So in a sense, we don't -- you can see volumes going down because you're using less square meters for your customers, you're losing less paper because you've designed lighter packaging, and -- but at the same time, you're getting better margins for a period of time as that customer implements the new logistic supply chain. So there is a massive benefit from being innovative and staying away from the pure commodity area of the business. There's always going to be a part of the area of the business that is pure commodity, but if you're able to help your customers reduce their carbon footprint, if you're able to help their customers reduce their voids, if you're able to help their customers on the shelf sell more product, you are a winner. And we are proving that time and again with our customers that we're able to do that. And so there's no question that that's a big positive Smurfit Kappa, and it's how we compete against a lot of people who are prepared to not look at return on capital as it being the most paramount thing. So you have a lot of independence of just putting new capital and go for the lowest price, but they don't offer anything else. And that's what is really standing to Smurfit Kappa, and that's why we have 26 experience centers, that's why we have 3,000 customers in the first 6 months, that's why we have 350 customers come to the innovation event, that's why people say how are we going to get rid of polystyrene, how are we going to get rid of plastics. They come to us because we know what -- we know how to do it. And I would just emphasize, this is not a war on plastic. Plastic is a really important part of life. It's a war on waste and additional waste, and that includes in corrugated packaging because there is a lot of overpackaging that can be designed out, and that would mean less volume, but it will actually mean more contribution for us as we give those innovative designs.

Ken?

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Ken Bowles, Smurfit Kappa Group plc - Group CFO & Director [3]

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Yes. Lars, in terms of the broad drivers of the 3 topics, I suppose. In terms of medium-term plan for '19, probably about EUR 30 million, EUR 35 million in terms of incremental benefit. In terms of the acquisitions, we've taken Parenco, plus Serbia, Bulgaria and the 2 French ones, probably somewhere in the region of EUR 35 million to EUR 40 million. Remember, Parenco has obviously taken it slightly down because of a bit of a fall in recycled containerboard prices.

And in terms of OCC, no -- nothing to catch up on. I think Pixus is more direction of traveling than what's actually happening in the markets where we're buying in -- across all markets at all different prices than what we see as the 25 like in Europe and the 7 in the Americas. So Pixus is more direction traveled than actual pricing power.

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Unidentified Analyst, [4]

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(inaudible) So the things that you're doing in polystyrene into corrugated in protective packaging, can you comment at all on the margins on that side of business? Is that meaningfully different from the balance?

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [5]

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It really depends on the customer, it depends on the product design. I would say that it, generally speaking, would be higher margin than the -- certainly, higher margin than pure commodity, I would say. I mean, of course, when you're making a new design, your margins are generally higher at the beginning. What happens is that product life cycle to corrugated box, I mean, if you get a new design for your customer, you typically make full margin. And then when he or she is in that business in 2 to 3, 5 years, the price comes out of it. So -- or the margin comes out of it, and then you start again by redesigning. So that's the nature of our business.

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Alexander Berglund, BofA Merrill Lynch, Research Division - Analyst [6]

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Alexander Berglund, Bank of America. I have a follow-up on box prices. Just firstly, if you can, can I get a comment on what you're seeing while exiting Q2? And then also a bit of follow-up on large question about all the work you're doing on innovation and value-add solutions, how that potentially can make box prices a bit more robust in this containable downturn? Specifically, can you just kind of remind us or comment on what percentage of your box revenue is purely a function of indexation and at the mercy of what containerboard is doing? And then in what percentage you have the ability to potentially have a bit more robust pricing because of the innovation you're doing?

And then my second question is just on containerboard. If you can comment on how the inventory situation is right now? And also since like your -- a couple of your peers tried to increase prices, but we're seeing it doesn't seem like much of those are coming through, so just kind of general commentary on the pricing situation in containerboard. Those are my questions.

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [7]

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I don't know if you need...

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Ken Bowles, Smurfit Kappa Group plc - Group CFO & Director [8]

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No. I'll take some if you want.

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [9]

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Go ahead then.

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Ken Bowles, Smurfit Kappa Group plc - Group CFO & Director [10]

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I'll do the easy ones. Alex, in terms of the index/non-index, the index is about 41% of the business, and the free negotiated is about 59% with FMCG being kind of 65% to 70% of the total business, which is generating index versus non-index, 41% index, 59% free negotiations. So that should bring those...

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [11]

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And also remember, Alex, one of the points is that packaging is nonplastic. So about 25% -- somewhere between 25% and 30% of all packages change every year in some way, shape or form. So customers, they add new lines, they take up demand. So that 30% will have about -- a churn rate of about -- when we say 39%, 39% will have a churn rate of about 25%. So there's new packages coming in every year. So effectively, during the period of the contract with our customer of 3 to 4 years, you will have all of that packaging changing. Obviously, the simpler it is, the less changing there is, and the more optimized it is, the less change there is. But customers change, and so -- and there's a whole new chain of omnichannels that you got to deal with, the e-commerce world that you got to deal with, not just big distribution, you got to deal with smaller distribution chains. And so there's a whole lot of change going on in our customers' world. And that's, again, one of the reasons they come to a company like Smurfit Kappa because we're able to understand how to deal with that new omnichannel world.

And with regards to containerboard inventories, we -- I think they could be high all year but trending down. And June was a soggy month for us and for, we think, the industry. So inventories didn't draw down in June as we would've expected. The good news from our perspective is that we see July as being the strong month on the drawdown. It's a long month. It's 23 days in most jurisdictions or most territories. So we've had a very strong pull on containerboard. So our personal inventories are very low as we exit July. Now they'll go up again in August because August is a -- generally a slower month. But our own inventories have drawn down a lot during the month of July. And so that -- we don't have an industry figure yet, but that would be a good sign. And if August and September were stronger, then it points in the right direction for containerboard.

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Alexander Berglund, BofA Merrill Lynch, Research Division - Analyst [12]

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As a quick follow-up, on that 40% that is indexed, have you seen any decrease in prices so far on box prices?

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [13]

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It starts -- really effectively starts July onwards.

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Unidentified Analyst, [14]

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Tony, you mentioned earlier about overpackaging being designed out. I'm just wondering can you elaborate a little bit on that because, clearly, in U.S. year to date, we've seen U.S. box volumes down 1%, and part of that is certainly Amazon's Frustration-Free Packaging initiatives. So is that something we're seeing in Europe? Is that something that Smurfit Kappa is seeing?

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [15]

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I think just on -- the European packaging market is a very sophisticated packaging market. So there has always been a gravitation towards lighter-weight papers much quicker than U.S. market. Equally speaking, we -- the area of overpackaging would be much less in Europe. There is certainly overpackaging in Europe and that will be designed out in time. But the reality is if you're an e-commerce guy and you're starting off, you don't give really a lot of thought to the box beginning -- at the beginning. So -- and your growth is, generally speaking, very quick and very strong. So therefore, you follow your growth. And then as growth maybe slows a little bit, you then look at some of the costs, and which are -- can be boxes as well as other things. So that's where they come to us for expertise to say let's move down this big box to package a small thing, we need a small box to package a small thing. And so, obviously, we help them with that design. But in the beginning, there's a surge to just put the thing in a box, get it to the guy and then get it back as quickly as possible. And obviously, as they mature, they look at things, and so that's where we come in.

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Unidentified Analyst, [16]

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Just to follow up just slightly to what's been told. I know you took an extended shut in Piteå in May. Are there any other sort of extended maintenance/commercial downtime that you've taken across the system to get to a good increment position?

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [17]

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No. We took all of our shuts in Nettingsdorfer and Piteå in May. And actually, we had quite a difficult startup. It's affected us during the first half in Piteå. And -- but we should be finished with that as we go into the second half. But then at Christmas time, we take Facture, which is our large French mill, down for 45 days for a rebuild. And so the whole mill will be down for I think about 25 days, and then 1 machine will be down for 45.

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Unidentified Analyst, [18]

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And just once again, I appreciate you're unwilling to share with us sort of your own thoughts on containerboard -- sorry, corrugated price concessions, but can you just remind us of the sensitivity of the European business in terms of every 1% box price fall is how much of your EBITDA?

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Ken Bowles, Smurfit Kappa Group plc - Group CFO & Director [19]

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Generally, just 1% is about EUR 45 million EBITDA. 1% volume is EUR 15 million. So as always -- lastly, price over volume kind of a changed risk.

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [20]

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Okay. No more questions in the room. So going to see if there's any questions on the...

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Operator [21]

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(Operator Instructions) Okay. First question is from the line of David O'Brien from Goodbody.

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David A. O'Brien, Goodbody Stockbrokers, Research Division - Investment Analyst [22]

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Firstly, a very good slide on Slide 19 showing the European -- or sorry, Slide 18 showing the European EBITDA margins. I'm just wondering what will the direction of travel be of that margin into the second half given falling containerboards, medium-term plan kicking in, and then you've discussed the positive impacts of innovation and sustainability. So how should we think about European margins into the second half and how sustainable they are to current levels?

And secondly, can you just give us a little bit of a flavor on volume growth? What performance has been like on a regional basis across Europe and maybe a little bit in the Americas as well, but also just on the different end markets because you have fast food consumer goods or into industrial end markets?

And finally, just on Reparenco, of the EUR 30 million synergies, what will be realized in the current year?

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Ken Bowles, Smurfit Kappa Group plc - Group CFO & Director [23]

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I think on the first one we'll be slightly getting into a bit of forecasting and speculation. I think the trick here is just to keep doing what we're doing, and everything we spoke about this morning around innovation, differentiation and making sure the customer has what they want and has that margin resilience. I think it's an element of margin not only built on price, it's also built on cost takeouts and innovation around that. So the goal here is not necessarily to protect margins, make sure we protect them as much as we can going into the second half, but not only this year or last year, the next year as the gain goes. So can't predict margins in the future. All we can do is try and do our best to make sure that we either keep our holes or grow.

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [24]

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With regard to what we're seeing, I mean, clearly, the weakest market we currently see is the U.K. market. The rest of Europe can depend on the month, but basically, it's okay with particularly strong markets in Spain and within some of our Eastern European markets. Germany is not by any stretch of imagination doing well, but it's not doing as badly as you would read in the newspapers. Because basically, FMCG customers are fine, they're generally growing and progressing. But obviously, we're seeing a slowdown in a lot of the industrial customers that we have, and that would be some of the chemical makers and automakers that we supply the heavier-duty type of packages for. But if you were to say what's a particular market of weakness, I would say the U.K., albeit it was still doing still well here. And then if you go into the Americas, I would say that the first half has been heavily impacted negatively in Argentina, albeit that it's a small country for us with, regard to the hyperinflation situation in the country. Actually, in July in, it's the first month that we've seen volumes back to the same level as last year, which is very encouraging. But one swallow doesn't make a summer, so to speak. So we need to just keep an eye on that. Brazil is slightly improving in July after a difficult first half, and then Colombia is positively booming with good performances out of the United States and Mexico.

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Ken Bowles, Smurfit Kappa Group plc - Group CFO & Director [25]

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And then, Dave, in terms of Parenco, synergy target is fine. Most of it will come this year, maybe a little bit might drip into next year. In terms of Serbia and Bulgaria, probably more next year than this year. I think with Parenco, the only impact, if you like, on the run rate year-on-year is probably the impact of containerboard pricing coming out of the bill, but then you get the benefit of some of that in Papcart and Caradec in terms of integrated paper tonnes. So broadly, synergy target, absolutely in line. No issues there. Most of it will come this year.

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Operator [26]

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Next question is from Mikael Doepel from UBS.

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Mikael Doepel, UBS Investment Bank, Research Division - Executive Director & Analyst [27]

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Just a couple of questions on the cost side, firstly. So if you could just remind us of what you're seeing in terms of cost inflation for some of the key cost items that you have previously also guided on? And also, you said previously something about the OCC price. I couldn't really hear what that was, and if you just could repeat what you're seeing in terms of OCC going forward as well.

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Ken Bowles, Smurfit Kappa Group plc - Group CFO & Director [28]

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On OCC, we were saying that don't see any catch-up benefit from where we are into the second half. I think we tend to see Pixus as an indices of travel and direction rather than kind of a number that we kind of buy at because we're buying across all our territories at various prices at various depots. So the EUR 25 million benefit you see in Europe is very much the benefit we see in our system.

In terms of other cost lines, nothing has really changed since we outlined it in May time. So generally, distribution will be a headwind this year as it was last year, indeed. Labor will be offset entirely by our cost takeout program this year. Probably the one area where you might see it going back slowly than where we are is energy. So energy in the second half might be slightly lower than we would've guided at the full year. So generally -- but we're not seeing a lot of cost inflation, not seeing a lot of cost deflation either, yes. But most things, as we would've outlined at the first quarter call, would be only maybe small tailwinds, if you like, in relation of being energy of, call it, somewhere between EUR 5 million to EUR 10 million in total.

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Mikael Doepel, UBS Investment Bank, Research Division - Executive Director & Analyst [29]

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Okay. That's very, very clear. And just a final question in terms of the volumes growth. We talked about that already, but if you think about the full year, I think you mentioned in your previous trading update that for the full year, 2% plus is probably a reasonable assumption for volumes growth. Do you still stick to that? Or has something changed there?

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [30]

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No. Mikael, nothing has changed. I think if you listen to our European colleagues at our business reviews and you listen to our American colleagues, they would all be very much on that number. There's no -- obviously, what we say in the report is if there's a major issue with the Brexit, that can change things. But as we sit here today, we feel very strongly that that's a good number to go with. No reason to think otherwise.

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Operator [31]

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Next question is from Chip Dillon from Vertical Research Partners.

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Clyde Alvin Dillon, Vertical Research Partners, LLC - Partner [32]

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Just three kind of quick ones. Could you talk a little bit about why the tax rate guidance is down about 200 basis points from what you were looking for? Back in -- earlier in the year, I think you were looking for 27%, now it's at 25%.

And then secondly, I heard you mention the decline in European containerboard prices were between EUR 140 and EUR 160. I guess when it was testliner and when it was kraft, I'm not sure, but could you clarify that?

And then just thirdly, I mean, your debt situation looks great. I just didn't know with the incremental drop in interest rates, especially in Europe, if there's any way to further lower your interest costs through, I don't know, refinancing what you already have out there?

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [33]

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Well, Chip, they're all Ken's question. So...

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Ken Bowles, Smurfit Kappa Group plc - Group CFO & Director [34]

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Thanks, Chip.

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Clyde Alvin Dillon, Vertical Research Partners, LLC - Partner [35]

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Let me give you a break, Tony.

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Ken Bowles, Smurfit Kappa Group plc - Group CFO & Director [36]

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He doesn't need a break, Chip. In terms of tax rate, we -- essentially, the tax rate is built on how we feel the full year will fall out, that's what the standard requires. So the effective tax rate of 25% is the combination of our underlying earnings, but also you will get some extra depreciation streams coming through in terms of capital allowances from the investment plans. And indeed, look, we continue. When you look at a Group this size and the tax charge it has and the annual cash tax, we continue to plan around that and minimize taxes where we can. So if we sit at 27% at the start of the year, 25% now, it's really due to planning exercises and things like that.

In terms of containerboards, it's EUR 110 -- EUR 120 for recycled containerboard, Chip, and EUR 140 for kraftliner.

And then the last question on refis. Look -- and Paul signified me. We always look at the market that's there and see if there's anything to be done in terms of our cap structure. We've been very active in that. We did one already this year to refi the senior credit and indeed the bond we did, so 3.78%. So we're in good shape at the moment, but the market as we see, we have nothing to refi in the near term. But again, we continue to look at opportunities to do that. I think the thing we balance that against is the debt we have out there and the makeup and the cost of that versus new debt and the interest rate it might give us. So -- but we continue to look. But it's -- at the moment, no near-term needs, but we continue to kind of look at it.

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Clyde Alvin Dillon, Vertical Research Partners, LLC - Partner [37]

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Okay. That's very helpful. And just a quick follow-up. On the whole OCC situation, obviously, there's -- anything could change if China makes any major change. But considering it's continuing to dissuade imports of OCC, have you seen any impact of the collection systems in the regions you operate, particularly in Europe? I know here in the states, you're starting to hear about some of the collection systems actually going away and people landfilling OCC. I didn't know if you're seeing anything like that in Europe?

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [38]

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I think the only market that's comparable to United States, Chip, is the U.K. market, and you've certainly seen some loss of fiber in the U.K. either to landfill or to burning. But with regard to the rest of Europe, the collection systems are so well defined in the sense of their communities in which people operate and collect OCC that you're not seeing -- almost none of that going into landfill, or you're not allowed to put into landfill. And secondly, neither -- not very much of it has been burned either. So I don't think there's -- with the exception of the U.K. where you have merchs that are very similar to -- and you've got co-mingled waste which is no longer acceptable in the Chinese market, then you don't see any big changes outside of the U.K. And including the Latin America, it's basically status quo. But certainly, that is an issue for United States, and certainly, it is an issue for the U.K.

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Operator [39]

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Next question is from Cole Hathorn from Jefferies.

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Cole Hathorn, Jefferies LLC, Research Division - Equity Associate [40]

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Tony, I wonder if you could just give a little bit more color on your Better Planet Packaging. I mean going back to the event you held in May, there was innovation on replacing strawberry boxes, plastic boxes with papers as well as other developments. What do you think could be the potential containerboard demand for replacing plastics medium term? I know you're very reluctant to give a boost to growth rate each year but could you give us some form of quantum of where we could be going over the next kind of 5 to 10 years?

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [41]

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I wish I knew, Cole, because it would be easy for me to say it if I knew. But I wouldn't want to even hazard a guess because all I can tell you, and I think you were there, that you can see the level of interest whereby in many cases, we're turning people away when we run these Better Planet Packaging days at our experience centers. But -- and it actually is not just limited to the German market or the Dutch market, it's -- or the Swedish market, it's actually even in the Latin American markets we're seeing a very strong push towards the replacements of excessive plastic waste. And as you say, we just converted a large beer guy over into corrugated and litho-lamination from plastic and HiCo in Belgian markets and that will be launching in September. But the problem with this, Cole, is it just takes a long time because a lot of the times, you're dealing with customers that have their packaging lines done with plastic. And to change those packaging lines, even if they said yes, we want to do it, it might take them a year or 18 months to order -- to expect the packaging lines, order the packaging lines, get them installed and then move. So in many cases, it's -- they want to change and they're committed to changing, but it just takes a long period of time. So that's why it's very, very difficult for us to put a number on the opportunity. All we can tell you is that every customer we talk to is looking to move in that direction where they can.

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Cole Hathorn, Jefferies LLC, Research Division - Equity Associate [42]

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And then just following up on Chip's question on OCC. Have there been any debates you're having with safety or the industry bodies on kind of setting a level for OCC pricing across Europe? I mean prices have been coming down and you do want to incentivize the recycling to continue into the future.

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [43]

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No is the answer. We haven't had a debate about setting a floor. I don't think we'd be allowed to do that. But I think that there's a lot -- at the end of the day, we have to go back to the fundamental point that not a whole lot of new kraftliners are coming into the world. And the world, even if it's slower growth, is growing nonetheless, and most of the growth is in recycled containerboard. And Europe has seen a very big reduction in basis rates, which had masked the effect of OCC being collected. And so we would still see that -- longer term that OCC is a vital resource and will be at some point in short supply again. But clearly, the very dramatic move by China in a very short period of time has dislocated that trend. But I would say, still the long-term trend for recovered fiber is to go upwards at some point in the future. And obviously, that -- we are -- we got a foot in both camps. We have a very strong kraftliner system and we have a very strong recycled paper system. And so we'll continue to watch that. But longer term, I think, Cole, we would expect OCC to trend upwards and there will be a need for the fiber.

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Operator [44]

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And that was our final question, so I'll hand the call back to the speakers. Please go ahead.

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Anthony Paul J. Smurfit, Smurfit Kappa Group plc - Group CEO & Director [45]

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Well, thank you, everybody, for your time and your attention. We really appreciate the support that you give us and everything that you do for us. We thank you for your attendance here on the call and in the room and wish you a very good day. Thank you.