UPM annual report 2014

UPM Annual Report 2014

CONTENTS

Financial targets

At the business area level, UPM targets top

relative performance in their respective markets

compared with key peers. UPM has also

defined long-term EBITDA margin and ROCE

targets for each of its business areas. In the case

of UPM Paper ENA, these long-term targets

are instead defined for cash flow margin and

cash flow return on capital employed.

In UPM Energy, where the asset base is

valued at fair value, the ROCE target is 6%.

In the less capital intensive converting industry,

UPM Raflatac, the ROCE target is 18%. Final-

ly, in the process industry businesses UPM

Biorefining, UPM Paper Asia and UPM Ply-

wood, the ROCE target is 10-12%, or cash

return in the case of UPM Paper ENA.

With the current business portfolio, achiev-

ing the business area targets simultaneously

would result in a UPM Group operating profit

margin of approximately 10%, and ROCE of

approximately 9%.

At the Group level, UPM’s financial targets

are based on return on equity and gearing. The

return on equity target is at least five percentage

points above the yield of a 10-year risk-free

investment such as the Finnish government’s

euro-denominated bonds. At the end of 2014,

the minimum target for return on equity, as

defined above, was 5.9%. The gearing ratio is

to be kept below 90%. For 2014, UPM’s return

on equity excluding special items was 8.3% and

gearing was 32% at the end of the year.

Earnings sensitivities

Changes in sales prices

The biggest factor affecting UPM’s financial

results is the sales price of paper. A change in the

volume delivered has less than half of the effect

of the same percentage change in sales prices.

EFFECT OF A 10% CHANGE IN PRICES

ON OPERATING PROFIT FOR THE YEAR

EURm

Papers in UPM Paper ENA

509

Fine and speciality papers in

UPM Paper Asia

Label materials

125

Plywood

Sawn timber

Chemical pulp (net effect)

FOREIGN CURRENCY NET CASH FLOW

EURm

USD

810

GBP

500

JPY

160

Others, total

170

COSTS, EXCLUDING DEPRECIATION

2014 2013

Delivery of own products

10 11

Wood and fibre

31 29

Energy

9 10

Fillers, coating and chemicals

11 12

Other variable costs

14 13

Personnel expenses

15 15

Other fixed costs

10 10

Total

100 100

Costs totalled EUR 8.7 billion in 2014

(2013: 9.1 billion)

Changing exchange rates can also have

indirect effects, such as change in relative

competitiveness between currency regions.

Cost structure

The company’s biggest cost items are the cost

of fibre raw material and personnel expenses.

Risk management

Risk description

Impact

Management

STRATEGIC

RISKS

Structural changes in paper usage

result in decline in paper demand which

leads to overcapacity

Continuously operating rates and weak

pricing power in the industry

Ensure cost efficiency of operations

Proactive product portfolio management

Delay in OL3 nuclear plant start-up and

consequent loss of profit and cost overruns

Material cost overrun

Ensure that contractual obligations are

met by both parties

Arbitration proceedings have been initiated

by both parties

Cost of an acquisition proves high and/

or targets for strategic fit and integration

of operations are not met

Return on investment does not meet targets

Disciplined acquisition preparation to ensure

the strategic fit, right valuation and effective

integration

Regulatory changes such as EU climate

policy and new requirements for CO

emissions

Subsidies for alternative uses of wood

raw material increase costs

Changes to relative competitiveness

of energy forms

Communicate the employment and value-

added creation impacts of such policies clearly

Invest in new, value-adding uses of biomass

Cost competitive operations

OPERATIONAL

RISKS

Availability and price of major

production inputs like chemicals, fillers

or roundwood

Increased cost of raw materials and potential

production interruptions would lower

profitability

Improving materials efficiency

Long-term sourcing contracts and relying

on alternative suppliers

Ownership of forest land and long-term

forest management contracts

Execution of investment projects

Material cost overrun, return on investment

does not meet targets

Disciplined planning, project management

and follow-up processes

Ability to retain and recruit skilled

personnel

Business planning and execution impaired,

affecting long-term profitability

Competence development

Incentive schemes

Availability of information systems

Interruptions in critical information services

cause a major interruption of UPM business

Technical, physical and process improvements

to mitigate availability risk

FINANCIAL

RISKS

Major trading currencies like USD

move significantly against euro

Changes in currencies change profitability

of exports and relative competitiveness of

currency areas

Hedging net currency exposure

on a continuous basis

Hedging the balance sheet

Payment default or customer bankruptcy

Loss of income

Active management of credit risks and

use of credit insurance

HAZARD

RISKS

Environmental risks;

A leak, spill or explosion

Damage to reputation, possible sanctions

Direct cost to clean up and to repair potential

damages to production unit, loss of production

Maintenance, internal controls and reports

Certified environmental management systems

(ISO 14001, EMAS)

Physical damage to the employees

or property

Harm to employees and damage to reputation

Damage to assets or loss of production

Occupational health and safety systems

Loss prevention activities and systems

Emergency and business continuity procedures

UPM’s business operations are subject to various risks which may have an adverse

effect on the company. The list below is not complete but it explains some of

the risks with their potential impacts and how UPM manages those risks today.

A more detailed description of risks and risk management is included

in the Report of the Board of Directors on page 70.

■

Operating profit excluding

special items, %

Operating profit excluding

special items

% of sales

■

ROE excluding special items, %

Minimum target

ROE compared with target

4,500

3,600

2,700

1,800

800

Net debt and gearing

EURm

Gearing %

■

Net debt

Gearing ratio

Gearing limit

Exchange rate risk

Changes in exchange rates over a prolonged

period have a marked impact on financial

results.

It is the company’s policy to hedge an aver-

age of 50% of its estimated net currency cash

flow for 12 months ahead.

At the end of 2014, UPM’s estimated net

currency flow for the coming 12 months was

EUR 1,640 million. The US dollar represented

the biggest exposure, at EUR 810 million.

Achievement of the long-term return targets in 2013–2014

ROCE %

)

ROCE %

CF/CE %

**)

ROCE %

2013 2014

UPM Energy

2013 2014

UPM Biorefining

2013 2014

UPM Paper Asia

2013 2014

UPM Paper ENA

2013 2014

UPM Plywood

2013 2014

UPM Raflatac

**)

cash flow after investments, changes in working capital and restructuring payments

shareholdings in UPM Energy valued at fair value

Target