Daniel, you may go ahead now.
Thank you very much. Hi, good afternoon, and good morning, everybody. Welcome to ArcelorMittal's Half Year 2019 Investor and Analyst Call. This is Daniel Fairclough from ArcelorMittal Investor Relations. I'd like to remind everybody, first of all, that as usual, this call is being recorded. Hopefully, everybody has had the chance to review our earnings statement, Q&A document, and the presentation with detailed speaker notes, which were all published on our website this morning. The idea then of this call is not to present those slides, but rather move directly to your questions. That way, the whole call should last about 45 minutes. To join the queue to ask a question, please do press star one on your telephone keypad, and we'll answer those questions in the order that we receive them. With that brief opening, I will hand over to Mr. Mittal.
Thank you. Good day, everyone, and can I add my welcome to this call? I am joined today by Aditya Mittal, President and CFO, Simon Wandke, CEO of Mining, Genuino Christino, Head of Finance, and Daniel, Head of IR. Before we move to Q&A, I would like to make some brief introductory remarks. As always, I will start by commenting on our health and safety performance. Excluding ArcelorMittal Italia, our lost time injury frequency rate for the first half of the year was 0.66 times, a small improvement on the rate achieved in 2018, which was a record low. Including ArcelorMittal Italia, the rate was 1.19 times. This highlights one of the challenges we have in Italy, although I would note that its rate has improved from over 20 times when we assumed control, to 12.35 times in the first half of the year.
We are focused on further improving its health and safety performance as quickly as possible and bringing it closer in line with our European average. Before I move to our financial performance, I would like to set some context in terms of the current market environment. The steel industry is inherently cyclical. Market conditions were buoyant for the majority of 2018. However, since October last year, we have seen a severe market downturn, the speed and extent of which has been surprising, and the usual correlation between Chinese and international steel spreads has broken down. While Chinese spreads remain within their usual historical range, spreads in our core markets today have fallen to very low levels and are well below historical norms. As a result, our first half EBITDA of $3.2 billion is lower than the corresponding period last year.
I would note, however, the performance of our mining business, which has contributed almost a billion-dollar EBITDA, highlighting the benefits of diversification. As you will recall, just over three years ago, we launched our Action 2020 strategic plan, the purpose of which was to ensure we delivered positive free cash flow in any market environment. It is therefore encouraging that despite the highly challenging market and the drag on our business from ArcelorMittal Italia, we still generated free cash flow of $900 million in the second quarter. This has enabled us to achieve further deleveraging progress and taken net debt down to our lowest ever level. Our focus on further debt reduction continues, and our full-year free cash flow performance will be supported by a material working capital release in the second half of the year.
However, given the extent of the market weakness, we have had to make adjustments to our business. In response to our European supply-demand imbalance, resulting from softening demand and record import levels, we have announced annualized flat steel capacity reduction of 4.2 million tons. More broadly, given the need to optimize our free cash flow performance, we are managing our CapEx very carefully while we continue to progress our high growth potential expansion projects in Mexico and Brazil. Looking to the second half of the year, there have been tentative signs of pricing improvements in the U.S. recently, which is encouraging, but conditions in Europe remain very challenging. Ensuring that there is a level playing field for European steel producers has an important role to play in restoring market equilibrium.
I therefore hope we will soon see the European Commission strengthen the EU safeguard measures so that they achieve the purpose for which they were intended. I am encouraged by the increasing support we are seeing for a green border adjustment, which is necessary to ensure all steel consumed in Europe is subject to the same carbon levies. Our focus on delivery against our Action 2020 initiative continues, as do our efforts to integrate recently acquired assets so they fulfill their full potential. We also continue to prioritize deleveraging and expect the business to achieve healthy free cash flow this year. Thank you. Now we are happy to take questions.
Thanks, Mr. Mittal. We'll take the first question, please, from Alain at Morgan Stanley.
Yes. Good afternoon, gentlemen. Two questions from my side. The first one is on the bridges between H1 and H2. You've highlighted on slide eight of the presentation that you have incurred losses at EBITDA level at both Ilva and the remedy assets. Do you mind quantifying or giving a range of the losses for the remedy assets as a standalone during the first half? You've also incurred some maintenance stoppages in Q2 in Ukraine, South Africa and Brazil. Are those supposed to be one-off or temporary factor that would reverse in the second half? That's the first part. The second part of the question is on the asset optimization that you've announced. Potentially, we could interpret that the sale of around EUR 2 billion of underperforming assets. Can you give us a bit more color on that at this stage? As much as you can say. Thank you.
Great. Let me start by answering your questions. In terms of the remedy assets, and Ilva profitability, we have not really broken it down, but I think it's fair to assume that the lion's share of the losses that we had in the first half of this year was related to Ilva. Clearly, Ilva, as you know, was a loss-making entity when we acquired it. Since then, the spreads in Europe have compressed by EUR 100 a ton. Clearly, the losses in Ilva have amplified. Having said that, we continue to make good progress in reducing its cost base. We have further accelerated our action plan.
Today we have six teams, which have been formed with experts from our central European sites, assisting the existing management team, and they have identified 52 projects which they're working on to dramatically improve the performance of Ilva in the second half and on a going-forward basis. Clearly, the improvement in Ilva, the idea of the action plan is to achieve break-even EBITDA with existing market conditions, but assuming no license to operate issues. In terms of Ukraine, South Africa and Brazil, I think in Brazil, the impact in second quarter was muted. It was much lower. In the third quarter, it will be greater because we have taken down the blast furnace, and it will be down the whole of third quarter. These are primarily marginal slab tons, so the impact is not so significant from a profitability perspective.
Actually, should help the business, because otherwise we'd be having negative contribution and higher fixed costs. It's a bit like the 4.2 million ton program that we have running in Europe. In terms of Ukraine and South Africa, these were scheduled maintenance events. I think in the second half, the production levels and shipment levels should be better. In terms of the $2 billion plan, these are not assets which are underperforming, so to say. I think you don't create value in that environment. These are assets which we think are attractive. By optimizing our portfolio and locking $2 billion of value, that's basically net debt reduction. I'm not suggesting that we'd be selling core assets, but predominantly we'll be maintaining our strategy and looking as to how we can monetize some of our non-core assets or sell some equity stakes in some of our core assets.
It's a combination of opportunities that we have. It's not that there's a $2 billion target and now we have to identify the assets. We have identified the assets. There's no immediate announcement either, but this is also not back-end loaded, so I'd expect us to receive the proceeds of the $2 billion asset optimization plan over the next two years. Other than that, I can't really provide you with more specific color on second half versus first half. We can talk about overall shipments for the group and mining performance if you're interested, but these are just some high-level comments.
Perfect. Thank you.
Thanks, Alain. We'll move to the next question, please, from Loannis M at Macquarie.
Thanks for taking my questions. Two questions on my side. The first, just to follow up on potential asset sales. Does today's announcement reflect your expectation on somewhat lower organic free cash flow beyond the short-term squeeze, i.e., for the years to come? Does it also set a soft deadline in hitting your $7 billion target by mid-2021? The second question, just some visibility on Q3 volumes, especially in Europe, would be helpful. Should we assume that the Ilva volumes offset the lost output from the divested assets and then we need to account for the production cuts you've announced? Are there more elements to take into account? Thank you.
Okay. In terms of the $2 billion value plan, not value plan value release from our portfolio, it's no different from what we've done in the past, right? We have had portfolio optimization plans, and we have raised cash as we have divested certain assets. Over the years, we have collected more than $5 billion in assets, and so it's very similar to that plan. What does it achieve? Clearly, it accelerates our de-leveraging, and that's a good thing. We've not provided a timescale on when we would achieve the $7 billion target, and that remains the case today. In terms of European volume, so Ilva was there the whole first half of this year, and so were the remedies. Right. The biggest impact when you look at our European shipments into the second half will be the remedies. The remedies are about 2 million tonnes.
You will see that change in our shipment number for Europe in the second half. The rest of the impact will be the seasonal slowdown in consumption in Europe. You can model as to what your forecast is, what is the seasonal slowdown in the second half versus the first half. Some of the production cuts will have some impact on that, but please recognize that the production cut is relative to our plan. A larger impact of the production cut is also going to be in our inventory as we destock into the second half of this year.
That's clear and helpful. Maybe just a quick follow-up on your comment around working capital. You've guided to $1.2 billion working capital release in the second half. Part of it, I guess, is the seasonal unwind. Could you perhaps quantify how much is left from the $1 billion structural release of the unplanned investment you did last year?
In the first half of this year, we have invested about $200 million in working capital. That will unwind in the second half. On top of it, we have a structural release of $1 billion of working capital. The combined cash generation in the second half on working capital should be $1.2 billion, assuming existing market conditions and prices. We looked at the working capital efficiency, based on this forecast of 1.2. We believe that on a day's basis, it's a good number relative to where we have been on historical average. To the extent that there's any change in the raw material complex, then clearly that number can increase. To the extent that there's no change, the $1.2 billion is a good number for the second half.
That's clear. Thank you.
Thanks, Yannis. We'll move to the next question, please, from Jason at Merrill Lynch.
Hi. I've got two questions. Can you just talk us through the process behind the write-down in the U.S. business? $600 million seems quite a large write-down to simply reflect a squeeze in spreads that's happened over the last 12 months in that business. Maybe you could just talk us through how we get to $600 million. The other question relates to your shipment trends in Europe in the first half. So far, there doesn't seem to be any evidence of your production cuts that you've announced in those numbers. When do we start to really see the potential benefits to the market of tons being removed and hopefully prices rising? Thank you.
Okay. Let's talk about the U.S. impairment. As you know, the U.S. impairment follows our regular annual impairment exercise. What we do is we compare the asset value to the present value of expected future cash flow. We check this on a quarterly basis for potential triggers for revision. In the U.S., given the weaker than anticipated operating environment, and this is lower than expected steel prices, lower apparent steel consumption, as well as higher raw material costs. The cash flow performance in the first half and our forecast for second half 2019 was below our original expectations. Primarily, this impairment deals with that deterioration in cash flow forecast. As such, a $600 million impairment on our ArcelorMittal USA fixed assets has been taken. Steel prices, when we run our impairment models, we use the realistic expectations on all factors.
Unfortunately, the impact on our cash flows relate to previous assumptions, and that was quite apparent in the second quarter, hence we took the impairment. The recent price changes, recent price announcements in terms of steel pricing in the U.S. is not baked into our second half 2019 free cash flow forecast. Moving to Europe, the 4.2 million ton production cut. It's designed to be in the second half, and as I said earlier, it's relative to our plan. A significant portion of that is a production cut, so it's impacting the levels of inventory, so it's a destock. There is some impact in the supply of tons into the second half of the market. Overall, I would expect our steel shipments to mirror the apparent steel consumption decline in the second half versus the first half.
Okay, thanks. Just a quick follow-up question on the U.S. Have you made any adjustments to steel price assumptions beyond 2019, or is the impairment simply related to lower profitability this year?
We have also made changes to first half 2020.
Okay. Thank you.
Thanks, Seda. We'll move to the next question from Luke at JPMorgan.
Yeah. Hi, guys. My first question is on met coal. Can you remind us what your internal sufficiency is and the split of the cost plus tonnes to each of the divisions? As a follow-up, just given the recent price declines, assuming they do stick, how long the inventory cycle is for that to be reflected in your P&L. Secondly, just on the EUR 500 million reduction in CapEx this year, how much of that is growth versus sustaining, and whether any of this is just a shift into 2020, and also just your thoughts on where you think your ongoing level of sustaining CapEx is over the midterm. Thanks.
Just firstly, Luke, on the coal, and we're talking met coal, coking coal. If you look at Q2, for example, 1.4 million tons of production. Of that, about 50-odd% is cost plus, which goes into the group. In terms of that total consumption, about 80% of that coal production is actually consumed in the group. It quite mirrors most of the year through each quarter.
Great. Thank you. In terms of CapEx, sustaining CapEx is about $3.1 billion, $3.2 billion, including Ilva. In terms of what we have cut, primarily these are growth projects across the board. This is not just a deferral. I think we do not want to create a balloon in 2020 in terms of the CapEx amount. What we have done is we have reviewed it and maintained what we think are the most important strategic growth projects. We're still going ahead with our Mexican hot strip mill project. We're still going ahead with what we plan to do in Brazil in terms of the Vega expansion, et cetera.
In terms of going forward, we have not provided specific guidance, but I would expect that our CapEx number would be around this level, i.e., there is no dramatic increase that we are forecasting in 2020, and we are preparing our five-year capital plans so that there's a combination of growth CapEx and build, but not exceeding approximately the levels that we are guiding to you in 2019.
Okay, thank you.
Thanks, Luke. We're going to take the next question, please, from Rochus at Kepler.
Yes. Hi, thanks for taking the question. First is on Europe. We have seen you making these production cut announcements in May, we haven't really seen that the market has got back to a balance. How do you look at the second half now? Do you think it is the seasonality who will bring the market in a better shape? What do you expect to happen on the import side ahead of any safeguard adjustment which might not become effective before the 1st of October? Related to that, can you give us a bit of an update what is going to happen with your production cuts in Poland, where obviously you have delayed a decision, and also in Italy, obviously, people have not been put on temporary leave after strikes. The second question is on your European spreads. How do you look at the spot spreads?
How would that might develop in the second half, and what would be your key arguments why those spreads are going to get better in the second half? The last question is on China. We have seen China steel spreads going up from late last year, but this trend has broken since the second quarter. How do you look at the demand and supply and discipline in China? Record production levels there are suggesting that the capacity hasn't gone down that much as we saw it last year or maybe has gone back up due to these replacement schemes. Any color on that would be very helpful.
Indirectly, you ask a lot of questions. I'm going to try and go through them in a logical order. Let's just start with China and the global demand-supply balance. We saw this high production number in China, the 10% growth. We think this is still some unofficial capacity becoming formalized. We don't see that much of growth domestically. We have updated our number for China. Fundamentally, we are seeing apparent steel consumption growth of 0.5%-1.5%. Therefore, we're not forecasting a dramatic increase in exports. This is really anomaly in the numbers. In terms of the demand situation in China, demand situation in China is still okay. Clearly, the construction sector or segment is much stronger than what we see in the automotive space.
Fundamentally, China is in positive territory, both on a real basis and on an apparent basis. In terms of Chinese pricing, you're right, Chinese prices moved up, moved down. The issue for us is not the base pricing in China. I think the issue that the steel industry in Europe and in North America is facing is that prices in Europe, for example, are lower than Chinese domestic pricing. Prices in the U.S. are lower than import parity pricing. There is a market price, which is built up on China. What we see in these core markets is that prices are lower than that. That I think is the number one issue right now. In terms of the U.S., there have been recent price increase announcements, and there's good evidence on them sticking.
In terms of Europe, I think there are two or three factors to think about. Number one is what you talked about, is an improvement in the Safeguard Measures, which is a September event. Number two, I think at these price levels, it's very difficult, at least you can see it in our numbers, for anyone to have a decent return, and therefore automatically, I would expect supply to reduce. Clearly, that implies an improvement in the demand-supply balance. We've seen that in the past, when European prices have achieved this level, I think there's a slide in our presentation on page six. It doesn't last for long. It's short-lived. That gives us confidence that there has to be normalization to what the global price of steel is, both in Europe and in North America.
In terms of our capacity or production cuts of 4.2 million tons, and your question on Poland, I think the key takeaway is that, look, we're focused on reducing our productive capacity by 4.2 million tons, and there could be small changes here and there, but that's fundamentally the plan. In terms of economic unemployment in Italy, our program is still continuing. We call it CIGO, and that program has not been postponed.
Okay. Thank you very much.
Thanks, Rochus. We'll move now to Myles at UBS.
Great. Thank you. A couple of questions. First, on Ilva. Could you just give us a quick update how the discussions with the government are progressing, and if you lose this protection from the 7th of September, is it likely you'll have to curtail/stop production there? A quick update on that situation. Maybe on carbon, the price of carbon in Europe has obviously gone to the moon. There are changes in the European ETS system. Do you think this is going to be a big driver for the steel industry in Europe, and force further restructuring over the next five years? Can you just remind us all the measures that you are taking, because you're a bit ahead of the pack in terms of addressing this issue. Thank you.
Okay, great. Let's talk about Ilva. Fundamentally, maybe I'm giving a little bit of background, but I think it's important to put the situation in context. The plant has not been in environmental compliance, and that's why the facility was nationalized and then re-privatized. To bring it into environmental compliance is not just about improving operational parameters, but it is also about spending CapEx, i.e., you cannot fix it in the short term. It requires three to five years. An environmental plan has been created to address exactly that. Under the share purchase agreement, we were offered certain protections, environmental immunity, and due to certain law changes in Italy, that was revoked. Technically, the immunity expires on September 6th, midnight, or September 7th.
We have been in discussions with the Italian government, who are working on providing us with legal safeguards, so that we are protected in this period. This is not just an ArcelorMittal issue. Any operator of that facility would face the same issue, because it's very difficult to operate a facility which is non-compliant if you do not have certain legal protection or legal safeguards. Based on our discussions, we believe that issue will get resolved, but obviously, no assurances can be given at this point in time. In terms of the price of carbon, you're right. The price of carbon has continued to increase. We have certain slides in our investor presentation towards end of the pack, which walks you through some of the ideas that we're thinking of. Fundamentally, we have three pathways to reduce our carbon footprint.
One is hydrogen, the other is to use Carbalyst, the other is to use Torero, et cetera. We believe that all of these technologies lead the industry, and the solutions that we have developed are unique and ahead of the curve. However, to properly deploy all of these technologies and to spend the CapEx, and to commit resources, you need a level playing field. I think in that regard, there's some good news, because the new president of the European Union has announced a Green Border Adjustment, which implies that any steel that is imported into the EU would have the same carbon costs. If the level playing field is created, I think ArcelorMittal is well-positioned, because as you know, we have a large R&D budget, we have a lot of talent in our organization. For example, when you look at the automotive business, we do inherently well.
We're number one in terms of technology globally, and here we have an opportunity to also outperform and find solutions so that we can have the lowest carbon footprint. That's just high level on the CO2 environment. If you have further questions, happy to answer them.
In that case, Myles, we'll move to the next question from Phil at KeyBanc.
Hey, thanks very much. Questions just on NAFTA. I know you had some operational issues in the first quarter in some of your U.S. operations and some downtime in Mexico, and I think with the volume pickup that you saw, we would have expected better cost performance and just better results. I know price was an impact. Anything going on there that's lingering in NAFTA in terms of operational issues? Also please discuss the tariff situation with Dofasco.
The operational disruption that we had with Q1 was basically Mexico. There was some also in Burns Harbor. All of those were not there in the second quarter. To the extent that you think the results are not as strong, from our standpoint, it is primarily market. We also do have this iron ore, which is linked to IODEX. When you look at our iron ore complex, it is much more expensive than perhaps some of the other players in the U.S. That's how we look at the results in our NAFTA business in the second quarter. No real operational disruption in 2Q. Your question on Canadian tariffs or Dofasco tariffs, what exactly do you want us to discuss?
Well, I know you had talked about $100 million a quarter of headwinds from that.
Yeah.
I think in mid-May, they had dropped the tariffs between the U.S. and Canada. I was just wondering if you saw any relief in the quarter or expect that more going forward?
Yeah, we did see some relief in the quarter, approximately $30 million. The remaining relief we'll expect to see in the third quarter. The $100 million number was good for Q1. Clearly, the price level is lower, so 25% on lower prices is not the same amount. To that degree, the 30 plus 50 is a good number going into Q3 relative to Q1.
Thank you.
Sure.
Thanks, Phil. We'll take the next question, please, from Sergey at SocGen.
Yes, thank you very much. I have a very small question on Section 232 tariffs. The elimination should presumably provide a boost to your profits in North America. Is it possible to estimate what would be the impact on EBITDA level at, say, second quarter prices? When do you think the full amount, the full benefit of this will be felt, in Q3 or in Q4?
The impact of 232 is not there, right, in the second quarter because prices in the U.S. are below import parity. When we look at import parity, we are classifying import parity post 232. You'd start seeing the benefits of 232 when prices in the U.S. were to move back to import parity.
Sorry. What I meant is that you incur costs due to shipping steel from Canada and Mexico into the U.S.
Yes. The tariff question, which we just went through, in the second quarter, we had a $30 million pickup relative to Q1, and then we'll have a $50 million pickup in Q3. That was the tariff that we're saving.
Okay, thank you very much.
Actually it's a wash, but that's a different discussion.
Okay. Thank you.
Great. Thank you.
Great. I think we will now move to our last question, which is from Bastian at Deutsche Bank.
Yes, good afternoon, gentlemen. I've got a couple of more questions on Ilva, and maybe you can walk us through each of the challenges you're facing. Firstly, on the constraints at your port logistics, when do you expect them to be lifted? If they were not to be lifted, what would be the annual volume run rate you would be kept at, given the lower raw material feed? That is my first question. Secondly, on the operating license, and as a follow-up to what Myles was asking earlier, you said that you can't run the plant without legal immunity, and there was some statements today that you may not actually receive the legal immunity by the Italian government. When do you expect clarity on the situation, whether it be before the 6th of November date, and is that your base assumption, that the situation will be resolved?
Secondly, if you don't receive the positive response, what would be the next steps? Is there a scenario where you would simply walk away from the lease and buy agreement given that Ilva is a liability and probably a $1 billion drag to your cash flow at this point of the cycle? Thank you.
Let me just provide a high-level update and then go into more detail on the license to operate issues. As I mentioned earlier, the immunity that we had has been lifted. The effective date on the lifting of that immunity is September 6th. Right? At that point in time, it is very difficult for us to operate the facility further. For that matter, I believe it would be very difficult for any other operator to operate that facility. We are working with the Italian government to institute legal safeguard measures, and our expectation is that those measures would be in place before the 6th of September. The deadline is the 6th of September. I think in all probability, you would have a resolution by then.
In terms of the other issues that we're facing, you've talked about Pier 4. There is a seizure on Pier 4. However, we are developing other alternatives while that pier remains under seizure, such as Pier 2. If we were to operate through Pier 2, we are losing about 10,000 tons of raw materials a day, which ballpark implies a one-third production cut to Ilva's productive capacity. If you're looking at a four and a half, 5 million ton number, you're looking more at 3.5 million on a going forward basis. We expect to resolve these issues. We don't expect the seizure to last indefinitely, and we're working with the authorities to find solutions. To the extent that we don't find solutions, clearly certain customer deliveries have been affected, and that's why we've issued a force majeure.
We hope that these issues are resolved in the near term as well. Does that provide you with enough color on your Ilva questions?
Yeah. Actually, I think I would like to follow up again on sort of Plan B. If you were not to get the positive response when it comes to the operating license at Ilva and this 6th of September deadline, what would be sort of your options? Could you basically just walk away from this? You're dragging EUR 1 billion in cash probably a year at the current run rate. You have the everyday loss, you're probably spending EUR 400 million-EUR 500 million in CapEx. You have the EUR 200 million rent. Setting that up is a large number. Could you basically just walk away? If so, what would be the cost of walking away? Do you have to pay essentially the full amount then, the full rent over the next 6-10 years up front? What would be sort of the various scenarios in such a case?
Okay. Look, the plan is what we're working on. I think we have good assurances from our discussions with the government that they recognize that there is a serious issue here and they're working to resolve it. In terms of planning, I walked all of you guys through it, but we have 16, 52 projects and we're working to minimize the cash losses of Ilva. To the extent that immunity is not granted, we have certain protections under the contract, but I think at this point in time, it's not appropriate to get into that, because all of us at ArcelorMittal are focused on plan A.
Okay. Perfect. Thanks a lot.
Thanks, Bastian. We do actually have one follow-up question from Phil at KeyBanc. Please go ahead, Phil.
Thanks very much. Just looking at NAFTA with the weakness we've seen in auto, particularly the light passenger side and then some weakness that we've seen more recently in the PMI data. I think Chicago PMI yesterday was below 50 solidly. Do you feel good that you have the right footprint right now? Any thoughts that you may have to take down some capacity similar to what US Steel has done in the United States? Thanks.
Yeah, we have not brought on capacity in the U.S., and we have no plans to take down capacity in the U.S.
Thank you.
There being no other question, thank you for all your questions and your interest. I think it's clear that we are making strategic progress, and the efforts we have made to reduce cost and strengthen the business in recent periods were reflected in the results over the first half. In particular, our healthy free cash flow performance, which I expect to continue. On the final note, I will bring this call to a close and wish everyone a safe and happy summer. Thank you very much.