Risk management

Risks

Our risk management philosophy

The Sappi group has an established culture of managing key risks. It has a significant number of embedded processes, resources and structures in place to address risk management requirements. These range from its internal audit systems, insurance, IT security, compliance and governance processes, quality management and a range of other line management interventions.

In the broadest sense, effective risk management ensures continuity of operations, service delivery, achievement of objectives (strategic and otherwise), and the protection of the interests of the group.

To achieve objectives, the risk management process is aligned with and compatible with Sappi's strategy, taking into account the recommendations set out in ISO 31000 standard (for guidance only) –'Risk management – Principles and guidelines', as well as King IV.

The Sappi Limited board of directors is responsible for the governance of risk. The Sappi Limited Audit and Risk Committee, in its capacity as a board committee, is tasked with assisting the board in carrying out its risk management responsibilities at the group level. Notwithstanding the above, the responsibility for the implementation of risk management processes rests with the line management in each region, business unit and operation.

Group Internal Audit provides independent assurance on the risk management process.

For an analysis of the principal financial risks to which Sappi is exposed, please see note 31 contained in the Group Annual Financial Statements on www.sappi.com/annual-reports.

For a detailed discussion of the group's risk factors, please see Risk Management Report on www.sappi.com/annual-reports.

Risk appetite and tolerance

Sappi has a board-approved framework for risk appetite and tolerance. Risk appetite is the total exposed amount that Sappi wishes to undertake on the basis of risk return trade-offs for one or more desired and expected outcomes. This is the quantum of risk that the board believes will provide an adequate margin of safety within the company's risk capacity while still enabling the achievement of the strategic objectives.

Risk tolerance is the amount of uncertainty Sappi is prepared to accept in total or, more narrowly, within a certain business unit. This is the maximum level of loss or reduced earnings that can be absorbed without compromising key objectives, eg return on investment.

Top 10 key risks (in no specific order)
Context
Mitigating actions
1. Employee safety

Injuries and fatalities
We operate a number of manufacturing facilities and forestry operations. The environment at these facilities is inherently dangerous. The health and safety of our own employees and contractors remain a top priority.

We minimise on-the-job injuries and fatalities by:

  • Performing root cause analyses of all major incidents and fatalities, which are reviewed at all levels of the business including the board
  • Group and industry-wide sharing of all incidents and associated mitigating steps, thereby helping to ensure continuous improvement in safety performance
  • Enforcing compliance with behaviour-based safety (BBS) principles
  • Providing continuing education and having a disciplined approach to all transgressions of our safety policies, inclusive of our contractors, and
  • Encouraging a reporting culture of near miss incidents.

An external recognised world leader in safety performance was commissioned to review and audit Sappi safety initiatives, processes and procedures focusing mainly on engagement and risk based issues. Detailed action plans and focus areas have been implemented being underpinned with the 'Own Safety, Share Safety' theme–getting into the hearts and minds of our people and ensuring safety becomes engrained into our business values.

For 2018, our performance criteria on the Management Incentive Scheme (MIS) has been reviewed and an increased score has been allocated to safety.

3Ps impact

Strategic and 2020Vision responses

  • Safety initiatives
2. Cyclical macro-economic context

We operate in a cyclical industry and as such, global economic conditions may cause substantial fluctuations in our results.

Our products are significantly affected by cyclical changes in industry capacity and output levels as well as by the impact on demand from changes in the world economy. Because of supply and demand imbalances in the industry, these markets historically have been cyclical with volatile prices. In addition, turmoil in the world economy has historically led to sharp reductions in volume and pressure on prices in many of our markets. We are continuously taking action to improve efficiencies and reduce costs in all aspects of our business.

We will continue to monitor the supply/demand balance, which might require us to impair operating assets and/or implement further capacity closures.

3Ps impact

Strategic and 2020Vision responses

  • Achieve cost advantages
  • Rationalise declining businesses
  • Accelerate growth in higher margin growth segments
3. Highly competitive industry

The markets for pulp and paper products are highly competitive, and some of our competitors have advantages that may adversely affect our ability to compete with them.

There is a trend towards consolidation in the pulp and paper industry creating larger, more focused companies.

We continue to drive good customer service, innovation and efficient manufacturing and logistics. We are focused on improving the performance and competitiveness of our businesses. We continue to drive down costs across all our businesses.

We recently announced our plan to invest ZAR5 billion (US$353 million) over the next five years through maintenance and upgrade projects to decrease production costs, introduce new technology and optimise processes at Saiccor Mill. These investments will secure the mill's future by increasing its global cost competitiveness and significantly reducing its environmental footprint.

During the fourth quarter we announced our commitment to capital investments at our Saiccor Mill in Umkomaas, south of Durban. The investments include a ZAR2.7 billion (US$191 million) dissolving wood pulp capacity expansion project.

3Ps impact

Strategic and 2020Vision responses

  • Achieve cost advantages
  • Accelerate growth in higher margin growth segments
  • Reduce our environmental footprint
4. Project implementation

In executing our strategy we carry out a number of capital expenditure projects. There is a risk that these projects may not be completed on time, do not deliver the expected quality or cost performance requirements or exceed the allocated capital spend. This would impact the project's financial return metrics, impact normal operations, delay the time to market or loss in market share. Reasons for this could be supplier and vendor performance, skill levels and ineffective project management and controls.

A comprehensive internal review of recently executed projects has been completed and engagement with key vendors continues to ensure lessons learnt, both positive and negative, are applied and included in future project management and controls globally.

Identified shortcomings between contractor and supplier interfaces, which together with the planning of local skilled resource availability, is to be addressed well in advance. This includes various contracting philosophies specific to the regions in which we operate in. Notwithstanding the above, a huge effort is placed on the use of modern tools available to improve the efficacy in the front-end engineering design, engineering standards, cost control and planning functions throughout the construction, erection and commissioning phases. We continue to develop strong relationships with the main suppliers to integrate project documentation seamlessly. A rigorous process is in place to select potential contractors that have the same Sappi commitment to quality and safety.

Where applicable, cross-functional global teams, additional internal expert resources and detailed oversight and review, including risk metrics, will be brought into the various phases of projects to ensure project execution. Operational and maintenance training also remains a key focus area.

3Ps impact

Strategic and 2020Vision responses

  • Achieve cost advantages
  • Rationalise declining businesses
  • Accelerate growth in higher margin growth segments
  • Provide greater opportunities for local communities
  • Reduce our environmental footprint
5. Evolving technologies and consumer preferences

New technologies or changes in consumer preferences may have a material adverse effect on our business.

Trends in advertising, electronic data transmission and storage, the internet and mobile devices continue to have adverse effects on traditional print media and other paper applications, including our products and those of our customers.

Digital alternatives to many traditional paper applications, including print publishing and advertising and the storage, duplication, transmission and consumption of written information more generally, are now readily available and have begun to adversely affect demand for certain paper products. For example, advertising expenditure has gradually shifted away from the more traditional forms of advertising, such as newspapers, magazines, radio and television, which tend to be more expensive, toward a greater use of electronic and digital forms of advertising on the internet, mobile phones and other electronic devices, which tend to be less expensive.

We have been and are implementing strategic initiatives to improve profitability, including restructuring and other cost-saving projects, measures to enhance productivity, as well as an expansion of our higher margin speciality paper businesses.

Our entrenched leading market share and low production cost, positions us well to take advantage of the growth in the dissolving wood pulp market and to continue generating good margins.

During the second quarter we acquired the speciality paper business of Cham Paper Group Holding AG for US$132 million. The transaction included all brands and know-how, the Carmignano and Condino Mills (Italy), as well as their digital imaging business and facility situated in Cham (Switzerland). The acquisition increases Sappi's relevance in specialities and packaging papers, opening up new customers and markets to Sappi's existing products and generating economies of scale and synergies. It will improve near-term profitability and serve as a platform for organic growth, further acquisitions and will add approximately €183 million (US$212 million) of annual sales and approximately €20 million (US$23 million) of annual EBITDA before taking into account synergies. The acquisition was financed from internal resources.

3Ps impact

Strategic and 2020Vision responses

  • Achieve cost advantages
  • Rationalise declining businesses
  • Accelerate growth in higher margin growth segments
  • Provide greater opportunities for local communities
  • Reduce our environmental footprint
6. Uncertain and evolving regulatory landscape

Regulatory limitations/requirements on business (including complying with environmental, health and safety laws) as well as international political uncertainty (including land reform policy uncertainty in South Africa) could translate into cost increases that directly impact Sappi's competitiveness and profitability.

Our worldwide operations are subject to various economic, fiscal, monetary, regulatory, operational and political conditions. We are therefore exposed to risks such as material changes in laws and regulations, political, financial and social changes and instabilities, exchange controls, risks related to relationships with local partners and potential inconsistencies between commercial practices, regulations and business models in different countries.

A legal compliance programme designed to increase awareness of, and enhance compliance with, applicable legislation is in place. The Group Compliance Officer reports twice per annum to the group Audit and Risk Committee.

Our aim is to minimise our impact on the environment. The principles of ISO 14000, Forest Stewardship Council® (FSC®), SFI®, PEFC™ and other recognised programmes are well entrenched across the group. We have also made significant investments in operational and maintenance activities related to reductions in air emissions, waste water discharges and
waste generation. (See Our key material issues.)

We closely monitor the potential for changes in pollution control laws, including GHG emission requirements, and take action with respect to our operations accordingly. We invest to maintain compliance with applicable laws and cooperate across regions to apply best practices in a sustainable manner.

3Ps impact

Strategic and 2020Vision responses

  • Achieve cost advantages
  • Provide greater opportunities for local communities
  • Reduce our environmental footprint
7. Foreign exchange volatility

Fluctuations in the value of currencies, particularly the Rand and the Euro in relation to the US Dollar, have in the past had, and could in the future have, a significant impact on our earnings in these currencies.

We are exposed to economic, transaction and translation currency risks. The objective of the group in managing transactional currency risks is to ensure that foreign exchange exposures are identified as early as possible and actively managed.

In managing transactional currency risks, the group first makes use of internal hedging techniques (hedging to the functional currency of the entity concerned) with external hedging being applied thereafter. External hedging techniques consist primarily of foreign exchange contracts and currency options. Foreign currency capital expenditure on projects is covered as soon as practical (subject to regulatory approval). See note 31 in Group Annual Financial Statements on www.sappi.com/annual-reports.

3Ps impact

Strategic and 2020Vision responses

  • Achieve cost advantages
  • Maintain a healthy balance sheet
8. Natural resource constraints

The inability to obtain energy, raw materials or water at reasonable prices, or at all, could adversely affect our operations.

We require substantial amounts of wood, chemicals, energy and water for our production activities. The prices for and availability of these items may be subject to change, curtailment or shortages.

To mitigate the risk, we are improving procurement methods, finding alternative lower-cost fuels and raw materials, minimising waste, improving manufacturing and logistics efficiencies and implementing energy reduction initiatives, such as increasing renewable energy, promoting cogeneration, investigating biofuel opportunities, promoting water-efficient production processes and infrastructure upgrades.

3Ps impact

Strategic and 2020Vision responses

  • Achieve cost advantages
  • Reduce our environmental footprint
9. Market share and customer concentration

A limited number of customers account for a significant amount of our sales. Therefore, should adverse changes in economic market conditions have a negative impact on them, it could materially adversely affect our results of operations and financial position.

We are, on a continuous basis, working to expand and diversify our customer base.

We sell a significant portion of our products to several significant customers. During 2018, however, no single customer individually represented more than 10% of our total sales. Any adverse development affecting our significant customers or our relationships with such customers could have an adverse effect on our credit risk profile, our business and results of operations.

3Ps impact

Strategic and 2020Vision responses

  • Accelerate growth in higher margin growth segments
  • Reduce our environmental footprint
10. Employee relations

A large percentage of our employees are unionised, and wage increases or work stoppages by our unionised employees may have a material adverse effect on our business.

A large percentage of our employees are represented by labour unions under collective bargaining agreements, which need to be renewed from time to time. In addition, we have in the past and may in the future seek, or be obligated to seek, agreements with our employees regarding workforce reductions, closures and other restructurings. We may become subject to material cost increases or additional work rules imposed by agreements with labour unions, which could increase expenses in absolute terms and/or as a percentage of net sales.

A concerted effort is being made across all our regions to interact and engage with our union representatives and organised labour on a frequent basis and to work on building constructive work relationships.

3Ps impact

Strategic and 2020Vision responses

  • Achieve cost advantages

Insurance

The group has an active programme of risk management in each of its geographical operating regions to address and reduce exposure to property damage and business interruption incidents. All production units are subject to regular risk assessments by external risk engineering consultants, the results of which receive the attention of senior management.

The risk mitigation programmes are coordinated at group level in order to achieve a standardisation of methods. Work on improved enterprise risk management is ongoing and aims to lower the risk of incurring losses from incidents. Asset insurance is renewed on a calendar year basis. The self-insured retention portion for any one property damage and business interruption occurrence is US$24 million (€20.5 million) with the annual aggregate set at US$38 million (€33 million). For property damage and business interruption insurance, cost-effective cover to full replacement value is not readily available.

A loss limit cover of US$871 million (€750 million) has been deemed to be adequate for the reasonable foreseeable loss for any single claim.