Good morning, ladies and gentlemen. It's just on 10:30. Welcome to Orica's 2017 half-year results. Today in the room in Melbourne, we have Alberto, who will be taking us through the results and the business initiatives. On the line from Denver, we have our CFO, Tom Schutte, who will be taking us through the financials. I do ask you to direct all questions to Alberto in the first instance in Q&A time, and then we'll manage the logistics to get them through to Tom accordingly. With that, I'll hand over to Alberto.
Thanks, Delphine. Good morning to all. Thank you for joining us here in the room and on the phone and on the webcast. You have the disclaimer on the presentation, so please be aware of it. We start, as always, with safety as a key priority for Orica. Nothing is more important than safety, and that is why it's so regrettable that we had in February a fatality in one of our customer sites, and some weeks ago we had a fatality in Sweden, in Gyttorp. Any accident that results in a fatality is obviously unacceptable. We should be able to ensure zero harm. We have a responsibility to our people to do everything we can to prevent these sort of fatalities or, let's say, serious injuries. In my experience, mining services companies have lagged the miners in many fronts.
For example, the miners were far quicker to reduce costs. We have followed, and we will talk more about it in our break-away project. Safety, unfortunately, is another area where services companies have traditionally lagged. This is particularly understanding that a low injury rate is no indication that critical risks are being identified and managed. You can't be in safety good or very good. You have to be for the things that matter, for those critical risks, you have to be perfect. You have to have the perfect control and ensure have the verifications in place that they're 100% effective 100% of the time. It is a different mentality than just the focus on lowering LTIs. This is not an excuse, though.
We have been focusing on our Major Hazards Initiative, identifying all our critical risks, ensuring this, that we have the right controls and manage these across 450 sites, and that everyone understands these. We are obviously reviewing the fatalities against the work we're doing in our Major Hazards Initiatives to ensure that any risks identified and controls put in place in the program of work would have been effective in preventing these terrible accidents. I will talk more on the next slide. From an environmental perspective, I'm pleased to say that we have had no significant issues, including the successful completion of the planned Kooragang Island maintenance shutdown, which involved the safe removal of additional asbestos identified on-site. The Major Hazards Initiative.
It is a company-wide program that will identify all critical risks at all of our sites and regularly verifies that the right controls are in place and are effective 100% of the time. The Major Hazard Initiative has deliberately targeted work streams. They identify for themselves the hazards that can lead to fatalities in the workplace. Unlike previous safety initiatives, it is not just top-down. The engagement has been aimed at employees owning the Major Hazards and identifying for themselves the controls that prevent fatalities. This will mean employees understand why the controls are critical rather than just being told they are critical. We are reinforcing this local ownership with a Leadership Interactions Program, where we are coaching all levels of leadership to get their boots on and engage with their employees with humility, inquiry, and empathy.
Fatalities are devastating for everyone concerned. Everyone in Orica senior leadership has responded with urgency to address our critical risks. I know that we're focused on the right areas. We just need to embed them swiftly and effectively through every part of our organization. This is the most challenging part because it requires deeply ingraining this as part of our normal culture and behaviors. During the six-month period, we started to see miners return to more normal mine plans and associated strip ratios. This was particularly on the East Coast of Australia and in Indonesia. Our group volumes are slightly up, still within the guidance range that we disclosed in the market in November of last year.
This gradual normalization of mine plans, combined with our Business Improvement Initiatives, offset the impacts from higher than expected headwinds, resulting mainly from increases in gas and ammonia prices in Australia and North America. As a result, underlying EBIT for this half was AUD 314 million, in line with previous year's EBIT, highlighting a stabilization of earnings after the volatility that had been apparent over recent years. In fact, this is the first time since 2013, in four years, that our first half EBIT has not fallen against the prior corresponding period. In November, I told you that we were expanding and accelerating our Business Improvements Initiatives in FY 2017, focusing on opportunities in the commercial space operations, our external spend, and through our supply chain. These initiatives would help offset the market headwinds.
I'm very pleased that we have delivered net benefits of AUD 53 million in this half, which has offset the headwinds that we flagged last year. Tom Schutte will talk more about this later on. I'm also very pleased on the work that has been done on the balance sheet, which has enabled us to increase the interim dividend by 15% to AUD 0.235. In summing up, these results demonstrate a returning predictability to our financial and operational results. While our turnaround will continue throughout FY 2017, our underlying EBIT reflects a stabilizing business performance. Let's now look at the performance of each individual business, starting by Australia Pacific & Asia. The API region contributes just under 50% towards the group EBIT and is the highest margin region.
We are very pleased with the 10% growth in volumes and 12% uplift in EBIT this half, as this has been driven by three key factors. Volume growth from existing customers due to the normalization of mine plans and associated strip ratios that I spoke earlier, volume growth from new customers through contract wins, and business improvement initiative benefits from global supply chain savings and lower overheads that offset the flow-on impact of price resets and the increase in our gas costs that we flagged with the market six months ago. North America. Overall explosive volumes were stable in this half, and EBIT was lower by 5%. The stronger Aussie dollar had a significant impact on EBIT of around AUD 6 million over the half. Without the FX, it would have been a slightly better EBIT uptick. Explosive sales were up in Canada and down in North America.
Sales into quarry and construction markets remained strong, with higher demand for aggregate driven by increased infrastructure spend. We flagged six months ago that there would be identified headwinds from contractual increases in input costs. These were partly mitigated by business improvement initiatives across procurement activities, efficiencies in logistics, and more advanced products and services. We were able to hold EBIT margin stable. Latin America. Overall volumes were flat. I want to focus on the change in EBIT of 20% from the last half. There were two contributing factors to that. Firstly, probably the most important, following the explosion of Antofagasta packaged explosives plant in Chile, we conducted a complete safety review of all plants in the region. This led to a decision to temporarily reduce the output from other plants to further improve safety standards.
This has placed increased pressure on sourcing costs as the region temporarily sources alternative products from these plants. Secondly, price resets in explosives and cyanide had a significant negative impact this half, reflective of pricing pressures in current markets. The business improvement initiatives across procurement activities and logistics have offset some of the headwinds. We expect, however, to close much of this gap in the second half of the year. Europe, Africa, and Asia. This multi-regional business region continues to be one of the higher opportunity regions, which is reflected in the 8% EBIT increase in this half. The continued recovery and growth in some European markets offset lower volumes in Africa. Demand from tunneling markets in Southeast Asia was down following the completion of major projects. Cyanide volumes across the region were up 10% with improved demand from customers in Africa.
The temporary oversupply has had an impact on pricing. Overall, a good result in EAA. Minova. Improved conditions across most regions have led to increased volumes in steel and resin and powders. Minova continues to be cash flow positive and, more importantly, EBIT positive. Included in this half EBIT is a divestment of an asset of around AUD 8 million. Also an additional AUD 6 million has been spent in building capacity that will ultimately deliver benefits. All in all, the EBIT performance has improved significantly in Minova, particularly in North America and Australia Pacific. I'm pleased with the progress made on the turnaround strategy, resulting in improvement in underlying EBIT. Importantly, the structure and foundation for improvement in the business performance has been put in place and is expected to deliver an improved performance going forward.
I will now hand over to Tom to go through the financial performance.
Thank you, Alberto, and good morning to all. For the first half, sales revenue was AUD 2.4 billion, which is 5% lower on a global basis than the previous corresponding period. While our volumes were up 4% from the previous period, sales revenue was impacted by three factors. The first one, lower input commodity indices during the first half impacted on the rise and fall arrangements that we contractually have with our customers. Second, as you are already aware, over the past 18 months, we've had price resets and contractual renewals, which have resulted in lower prices that flow through to the revenue line. Thirdly, quite importantly as well, currency movements impacted the revenue adversely as a result of the translation of foreign currency revenues into AUD.
If I move then to earnings for the half, both EBIT and EBITDA stabilized and were in line with the same time last year. EBIT this half of about AUD 314 million against the AUD 317 million of the previous period, and EBITDA of AUD 445 million against the previous half of AUD 450 million, which is roughly in line. As Alberto mentioned, this result highlights some stabilization of earnings after a volatile period that has been seen over the recent years. This was a slight improvement as well in NPAT from about AUD 190 million to AUD 195 million. The change in NPAT was post individual material item, relates largely to the Part IVA ATO tax case, which we disclosed to the market in December 2015, if you cast your memory back. Interest expense was lower in the first half of 2016 due to lower average net debt levels.
This has resulted in our interest cover increasing as well to 9.5 times, quite pleasingly, against the seven times for the period of the previous year. That means our cover remains very healthy, which is well above any of our banking requirements of two and our own internal target of five. The effective tax rate is also in line with expectation, and it will be in this range going forward, in line with what we had indicated before. As Alberto mentioned earlier, the board declared an interim dividend of AUD 0.235 per share. This represents around a 15% increase on the 2016 interim dividend and a half-year payout ratio of exactly 45%. In line with the new dividend payout ratio policy announced last year, it was in a range of 40%-70% for the year.
We will this year as well slant the payout ratio more towards the second half. I'll turn now to the waterfall on slide 14. Starting with our half year 2016 EBIT of AUD 317 million, we then remove the impact of FX and inflation on overheads. Inflation on our overhead costs had an adverse effect of around AUD 17 million, with the largest impact really being Latin America, which also has on average, the highest inflation rate, a combination of the countries in which we're present. The average Australian dollar exchange rate appreciated against most of the major currencies that Orica is exposed to. This had a further adverse impact of around AUD 11 million this half. The average Australian to US dollar for the six months to 31 March 2017, for us, was 75.4, compared with 72 in the prior period.
This predominantly impacted the North American business, driven by appreciation of the Australian dollar to U.S. dollar. The appreciation in the Australian dollar, as you all know, was driven by an improvement in commodity prices and a flight for safety to Australian dollars. At the 2016 full-year results, we highlighted as well that we were expecting contractual cost headwinds in 2017. At that time as well, we flagged that these would be in the range of around AUD 50 million-AUD 70 million negative impact, and these were relating to the commencement of a new gas agreement in Australia, as well as a step-up in material input costs on two supply agreements in North America. The impact of both these in this half was AUD 30 million.
We also flagged that there would be around AUD 60 million impact from price resets and contract renewals, partly from the annualized 2016 resets and in some new FY 2017 resets to the current market prices. For this half, this was around AUD 25 million, with the remaining portion being skewed towards the second half based on the timing of contract renewals. Importantly, whilst the impact of contract renewals remains within expectations, we have seen greater pressure on cyanide pricing as a result of a global oversupply in that product. We have also said that these headwinds that I've just been speaking about on the costs and the impact of pricing on contract renewals, that we will offset this with business improvement benefits. It's pleasing that the AUD 53 million in net business improvement benefits has offset that, and that's largely made up of three main components.
The one would be a roll-through of business initiative savings achieved in 2016. The second is gross business benefits from new business improvement initiatives, and that, of course, offset by the cost of implementation. We are actually just showing the net figure. As we stated in the 2016 year-end, we are aiming for these headwinds to be offset by business improvement initiatives. We've achieved this goal in this half, and we remain on track to offset the full-year impact of these headwinds. Turning now to changes in the market. As Alberto mentioned, we are beginning to see early signs of stabilization in the market, with some resumption of normalized mine plans and strip ratios at some of our customer sites. We are also seeing customers now trending more to value add and accretive discussions rather than just price, as we saw a couple of years ago.
That was mainly evident in increased volumes in the API region and a positive change to mix and margin in North and Latin America. These benefits more than offset the negative impact in Latin America due to the higher sourcing costs that Alberto spoke about earlier. Much of the AUD 8 million negative impact in cyanide were due to an increase in key manufacturing inputs, particularly gas, which has in turn decreased our cyanide margins. A combination of price and input. As Alberto mentioned, Min ova turnaround is progressing well and is now EBIT positive. The pipeline remains strong, and we expect the underlying business to continue to deliver a sound result. On the waterfall chart, the category Other is a positive AUD 9 million. It is made up of some non-repeat costs incurred in 2016.
All in all, a good result, with expected headwinds having been offset by the business improvement benefits. I will now turn to slide 15, which is the slide on capital expenditure. We continue to make good progress on the implementation of the capital management framework that I spoke about last year. I would like to reiterate that at all times, we will ensure that CapEx related to safety, environmental obligations, and ensuring that we meet our license to operate conditions is always maintained. In essence, capital allocations for these purposes will not be subject to any financial metrics. Sustaining capital was AUD 96 million, mainly related to the plant maintenance shutdown programs at Kooragang Island and Yarwun manufacturing sites, as well as some initial spend on our global IT program.
Contribution to the construction of the Burrup plant was AUD 11 million, compared with AUD 21 million in the first half of 2016. This plant is undergoing commissioning, and we are expecting the remaining capital to be spent this financial year. That is a remaining capital of circa AUD 40 million. The planned maintenance shutdown program at Carseland is scheduled for the end of this financial year. Alongside the completion of spend on Kooragang Island, we will see more sustaining CapEx being spent in the second half. Growth capital in this first half is low as a result of lower capital intensity of new contracts. This is expected to increase in the second half. We therefore expect that the 2017 capital expenditure will be between AUD 300 million-AUD 320 million, and that includes the scheduled maintenance turnaround of Carseland and KI, and also the remaining spend of Burrup.
This is no different to what we had indicated in the past. I will turn now to slide 16, which is about the debt. The group delivered a strong first-half net operating and investing cash flows of AUD 84 million. This reflects continued focus on working capital management, strict adherence to our capital investment framework that I spoke about before. Cash conversion is at 57% for the half. This reduction is simply due to a higher sustaining capital spend that I have already mentioned as scheduled on KI and Yarwun shutdowns, and then higher absorption into working capital as a result of these planned shutdowns, also highlighted to the market when we spoke last. We expect the full year to be in similar range as a result of the planned Carseland shutdown later on this financial year. As I mentioned, both of these were highlighted in 2016 final year results.
We recently announced the successful refinance of a new AUD 398 million or AUD 400 million issue of 10-year fixed rate senior unsecured notes in the U.S. private placement market, which has increased our debt maturity profile quite nicely to 6.3 years on average. The bond raising in the USPP market was well supported and resulting in us actually upsizing the transaction with participation across 30 or more investors. While we have done well over the last 12 months to reduce our debt level and manage working capital downwards, I would like to mention that the working capital increase over the year due to the scheduled turnarounds that I've mentioned. We expect our gearing to settle within a target range of 35%-45%.
Before I hand back to Alberto, I just want to mention, as previously communicated, we've made good progress on our business initiatives, which we said we would use to offset the expected headwinds. We expect to continue to do this over the remainder of the year, and our disciplined approach to capital expenditure will continue, thereby ensuring that our balance sheet remains strong. With that, I'll then hand back to Alberto to continue with his slides.
Thanks, Tom. Let's talk about business improvement initiatives now. The work we are doing today on business improvements taps into the enormous potential that exists in Orica and will ultimately deliver a more efficient and effective organization. This touches every part of our organization. We have involved more than 1,000 Orica people across the globe to review the whole business and consider all factors that create value so that we can buy better, produce more with less, add value for our customers, and deliver value to our shareholders. The programs have so far generated more than 1,300 ideas and initiatives. With individual initiatives benefits ranging from thousands of dollars to multi-millions over fiscal year 2017 and beyond. This will be a normal part of the way we do business, eventually creating a world-class organization well-positioned for all parts of the cycle.
On buying better. Buying better focuses on leveraging Orica's global network to lower unit costs. Let me take you through the process and deliverables for some of these initiatives. Take the first one, reducing ammonium nitrate for third-party purchase costs. The supply chain team identified that the cost of a key third-party supplier of AN were suboptimal relative to those available internally within Orica. So in their input costs, when they bought ammonia to produce their ammonium nitrate, they were buying ammonia at too high price. This followed a clean sheet exercise that highlighted the ammonia cost being above competitive market rates. We discussed an approach with the supplier, and with the agreement proceeded to negotiate reduced ammonia input cost leveraging our knowledge and experience.
A new contract is in place effective 1st of January 2017 with annual savings in excess of AUD 4 million. You would say, how is that sustainable if it's a commodity? What we negotiated was the margin on top of ammonia. It used to be ammonia plus 17, now it's ammonia plus 10. It's still variable, but there's a structural margin component, that's why it's sustainable. In the next example, focusing on volume leverage on competitive bidding. Through our global sales and operations planning process, a team qualified network benefit savings by consolidating AN shipments from Europe to multiple ports in Latin America. Our global team was able to utilize the consolidation of freight to consider alternative freight configuration, combined with competitive bidding to reduce shipping network costs. A new contract is in place effective 1st of April 2017 with annual savings in excess of AUD 2 million.
The next initiative focused on our booster network cost. These were reevaluated with a make versus buy analysis, identifying potential savings by increasing own production of boosters rather than sourcing third-party product. Increasing the production loading of our own booster plants enable improved efficiency of production, lowering unit production costs. Costs were further reduced through leverage of increased raw material spend, allowing more competitive pricing of inputs. These combined elements of increased make plus leverage sourcing are anticipated to save around AUD 2 million. These are only a few examples of the many hundreds of initiatives that have been delivered or are in the pipeline to be delivered. I think what these examples on the procurement side seeks to demonstrate is this is not about squeezing the small supplier on the last cent, because that is not sustainable in the end.
It is about finding ways to be more efficient, both our guys we buy from and ourselves to be more efficient and more productive. The other big focus is producing more with less. That's the one manufacturing approach. One manufacturing is more about a culture than it's about process. Our sites will move towards an owner's mentality where they are responsible for all the business outcomes for the sites and not just costs. We will use standardization to drive all sites to the benchmark then use continuous improvement to build on the benchmark. We will define what good looks like, what excellent looks like, then we have a gap and identify it, then we will seek to close it. We will drive for a consistent manufacturing look and feel to quickly assimilate good ideas across the network.
When SKUs are rationalized, our manufacturing approach will mean that we can standardize our plants and rationalize our network to maintain customer needs while leveraging our global footprint. Our products will be the same everywhere. Importantly, all of this is complementary to the work we are doing on our safety agenda. This initiative will be probably one of the longest lasting in all these business improvements. It may take us three years or more. Adding value to our customers. After several years refining a proprietary inductive communications technology that provides safe and remote detonation through dense rock layers, Orica has successfully introduced a wireless IS service with two commercial trials in Australia and North America. The system is an industry first as a fully wireless deployment.
We call it fully wireless because you may have a wireless on the top, but if you don't have a wireless that penetrates 800 meters of rock like we have, then you don't have a fully wireless deployment. We are the only ones in the industry to have this, and we're probably years away from anybody else in the industry. As is clearly illustrated, loading operations of blast holes are significantly complicated by the presence of wires. You see the two pictures that I draw your attention. This is how the traditional underground mining blasting would be. You can see why it is easy to have statistics that go from 15% to 25% of misfires, for example. You can see the issues on safety of having to put all of these wires from the roof, et cetera.
The second one is how it is right now, the trials that we have done. We have done already two trials. One of them, we shot 500 already and with zero misfires. The safety benefits are the productivity benefits. Changing the mine sequences will have what we believe are very significant value-adding for our customers. The impact on personal safety, mine planning, and operations was immediately realized with 100% success rate in both trials in challenging underground environments. Customer interest is significant, and we're currently working on the next generation of this game-changing technology across a broad range of blasting applications as a key enabler to automation. This is a reality. After years, probably, we hadn't really perfected a technology, but now this one.
There's been a lot of progress in the past two years, in particular, I think having proven it in real underground mines gives us a lot of confidence of what the future will provide for this. Another example of technology, we still believe that technology is the future, that's probably we have a quite different view than our competitors. In December, we introduced BlastIQ to our field operations. BlastIQ is an integrated field information system that improves blasting performance by linking modeling and design with the field operations and delivery. Our customers have realized the benefits of better predictability and control of blasting. For example, data collected across thousands of holes in the Pilbara has delivered a significant reduction in excess drilling. While controlling energy distribution in complex coal seams has created improved fragmentation for digging and plant productivity.
Other applications include supporting operations in sensitive environments by tailoring designs and the controlled use of explosives for controlled human noise. As a digital platform, BlastIQ will continue to rapidly evolve in response to the needs of our customers. The outlook. It's very short because basically it's unchanged. These results clearly show that we are doing what we said we were going to do. You will notice that we are not changing the outlook from what we said six months ago. Over the past six months, we have seen some normalization of mine plans, we believe that this will continue, but it will be gradual. The business improvement initiative benefits will offset headwinds. We expect an unfavorable AUD 15 million FX impact this year, this will be offset by improved volumes. That's really the only new part.
We will continue to focus on business improvement initiatives that improve profitability and drive shareholder value. Our differentiated strategy will enable us to create greater value for our customers and shareholders. To wrap up, we are pleased with what is a solid result in a time marked by significant external headwinds. Our result for the first half demonstrates a returning predictability to our financial and operational result and reflects a stabilizing business performance. With that, we can move to questions. Yes, Mark.
It's Mark Wilson from Deutsche Bank. Alberto, could you comment on the contract wins that you've mentioned in Australia in particular? Are there any other contract wins in any of the other regions?
I'll comment globally. We tracked of our existing ones, how much did we retain. The numbers are in the mid-90s, sort of like that. In Australia, it's higher than that. Then we also track greenfields and brownfields customer sites, and that number is also significant. In Australia, maybe 30% or 40% of the ones who participated, we've won. All in all, this takes time because they just come in, but I would say that when we track the whole volume of AUD, of AUD hundreds of millions of contracts, it's been good across the regions, particularly good in Australia, but North America has also been good, and all in all, we're ahead on all the four regions.
Can I just follow up with an additional question, just Latin America, could you give the rough split? You mentioned two major factors, the procurement costs-
What was the rough split there, and why are you so confident about recovering most of it in the second half?
The EBIT went down by about, was it AUD 8 million? Something like that. AUD 8 million. I would say half, roughly, a bit more than that is the additional cost that we have incurred on procurement, and roughly half was. 60/40, something like that. As we go into the next semester, we expect to have much less impact on the manufacturing, and we've had some commercial wins that we anticipate will close most of the gap, so that when you compare EBIT year-on-year, we hope to have closed at least most of that gap. Richard?
Thanks, Alberto. Richard Johnson from CLSA. A couple of things, if I might. Alberto, I was wondering if you could just talk a little bit about the WA market and what you're thinking about it. I'm particularly interested because although it's obviously been helpful for you that Burrup's been delayed this year, would it be right to say that as you roll forward into 2018, in fact, the opposite applies because of the contract cycle, it becomes important for you to show that the plant can operate on a consistent basis?
Yes. As you know, we currently have roughly about 50% of the plant, let's say contracts for 50% of plant. One thing probably that we said in the past is that we would need 70% to run. Once it's in operation, we can run at 50% by campaign, and it's quite manageable. That's the first thing. There are three large contracts that will be coming in the next years, they don't come. One of them is Roy Hill, BHP will come in some years and Rio Tinto, too. We are obviously focused on winning a sizable chunk of that one. With that, we think we can go to loading the plant. If you look at the next three or four years in Australia, we expect tons to be growing by about the size of Burrup.
If you look at the east right now, the east is already probably in deficit, much so that we are beginning to demothball Yarwun. Of course, when Burrup comes in, the west is in excess surplus. If you fast-forward those three, four years, Australia will be in equilibrium in around by the end of this decade. I think it is going to work all right.
I think one of the standouts over the last 12, 18 months has been the balance sheet remediation that you have delivered. Beyond the obvious things, I was wondering just if you could give us some ideas to your thoughts as to what the benefits of that are to the business, and particularly about your strategy going forward.
The benefits on what? I did not understand.
On the balance sheet remediation.
Oh, yeah.
With your gearing right down to the low end of the range. Because of the turn in the earnings cycle, presumably, the cash generation is going to follow that, and over time, you would just continue to de-gear otherwise.
We've talked about many times about the priorities that we have. We want to remain with our solid investment grade rating. We want to have money to invest in high RONAS, and so that is very important. As long as we satisfy that, we will go into the CapEx. We've talked about dividends between 40% and 70%. As you've seen, we've increased from 40% to 45%, but we would have obviously some room as the years go by to go back and increase that percentage. I would hope, again, that part of it will be in terms of payout ratio, and hopefully in some years we'll be at the top end of that. Yeah, I think we haven't changed those priorities. We're happy with the gearing at 34.7%.
I would just highlight, we were talking earlier that it's for any company to be able to go from 45% to 34% in difficult times just show you the flexibility of the balance sheet. Well, and a good CFO. Yeah, of course. I didn't have much to it, but it's Tom and Chris here. They do the hard work. Go to the phones?
Thank you. The first phone question comes from Ramoun Lazar from UBS. Please go ahead.
Good morning. I've got a couple of questions. Alberto, just one on pricing. Just keen to get a feeling of where you're seeing, I guess, spot and explosives pricing. I know you've outlined a further headwind to contracted pricing coming through the second half, just keen to get an idea of where you're seeing spot prices against contracted averages now.
Yes. Thanks, Ramoun. We haven't changed our guidance on price resets. We said it was going to be around 60, and we had 25, we expect therefore to have a bit of an uptick on the second half. I would divide between where is the prices now and what is the impact on our contracts, which are two different things. We sort of think we are at the bottom of the cycle of price declines. We've seen from both we're in the east, slightly below IPP, I would say, and we are at the limits probably also of even into negative EBIT territory for CSBP, for example. They're also fully loaded like now. We feel that at the east, sort of trend that started two years ago and that had such a big impact is towards the end.
It doesn't mean that we don't have rollover of contracts where we have to go from a high price to the new market price. That will still hit us. What I would probably say is that the price resets impact, for example, on 2018 are going to be lower than in 2017. The headwinds that we're seeing, very significant in 2017, would also be lower in 2018. They don't disappear, but I think that this would be the top end of the impact on Orica 2017.
Right. You expect a further price headwind in 2018? Is that what you're saying?
No. Further means not that the price will continue to go down, but there will be obviously contracts, three-year contracts, four-year contracts, that were set at a higher price, and then they have an impact, much less than what we're seeing this year, but I can't tell you it's zero.
Right. Okay. Thanks for that. Just in North America, obviously, the publicized contract loss there from the second half. Just keen to get an idea on, are the arrangements with your third-party supplier of AN there, are they on a take or pay basis? Or I guess another way is, if they are, have you managed to replace those lost tons with wins elsewhere?
We don't have a take or pay with CF. There are variable. Prices do sort of change below certain thresholds. We're obviously actively managing all of that. Let me just say something. A part of the loss in the tons were just that we used to sell them. We would buy them from CF and sell them to the Nelson Brothers with a very low pass-through margin, and now they're sourcing it directly. That would have no impact on the relationship with CF. It was the Peabody contract, that was a very low-margin contract that we lost this year. That had some impact, again, as I said, we don't have a take or pay, and we're actually mitigating with other sort of adjustments in terms of Well, as you see, the volumes are flat, we were able to compensate the volumes decline with wins.
the wins in North America were quite significant too, especially in Canada, we had a lot of wins.
Okay. Then just a couple for Tom. Just one, the business improvement implementation costs, what were they in the half to achieve the net AUD 53 million?
Hi, Ramoun. We haven't actually highlighted that. What we said is we're going to show these costs on a net basis only, the reason for it is you can't fully replicate these costs going forward. As you saw, just using some of the examples that Alberto mentioned of the type of projects that actually kick through these business initiatives, they vary a lot in terms of implementation costs. You can have one, and you can see they strip many initiatives, and some of them could have implementation costs, and others not. We don't specifically highlight that because all that's going to do is create another range of areas for us to manage. We said that on a net basis, we'll be offsetting all those headwinds, I think that's the number you should work on.
Okay.
If you look at the guidance, Ramon, we talked about
Yes
You would think that we would have an uptick on the net basis for the second semester because we had AUD 120 or something like that that we had flagged between old and new. We decided to talk about the impact on the fiscal year, which is, again, another level of, it's probably easier. We do expect some uptick on the net one. That's what we've guided to.
That's right. The guidance is the same, Alberto, as last year. It should be AUD 120, so you can work on that number going forward.
I would work with that one.
Tom, just on Burrup, just depreciation and roll-off of capitalized interest, when do you sort of anticipate that?
Well, the numbers are, I think we previously communicated, the depreciation's around AUD 2 million a month, and the interest is around AUD 3 million. That'll kick off as the Burrup plant gets commissioned, as Alberto said, probably within the next half year. As soon as that comes in, you make that adjustment. It's very simple, actually.
Okay.
Two entities.
I think you previously said end of May, that's sort of the anticipated time?
No, end of this calendar year. There is right now an issue with the environmental permission license because there was some environmental measuring air quality instruments that were not working as designed. Yara is sort of in conversations with the government, and we expect that to be solved sometime this year. That is a prerequisite to then begin working with the federal government to get the permission to go from commission to operations. Having said that, the plant is producing already. It is producing good quality AN, and it is also in the normal testing period. Even without that, you would still be in this phase of commissioning.
Okay. Sometime in the first half of 2018, then?
Sometime in calendar year, let us say, sometime in the second half of calendar year 2017.
Okay. Just one last one, just AUD 22 million of profit on asset sales in the period. I think Alberto said AUD 8 million of those two in Minova. Where are the rest, Tom?
The rest was Paycom and a couple of smaller asset sales. Now, just to mention that the comparative period, we also had numbers very similar to that. I think it was, from memory, and we can check the numbers, but from memory, it was around AUD 13 million, I think, the sale of PP in the comparative period. There's one or two small assets that we sold then.
On the mining side, it was the same numbers in last year and this year.
Yeah.
If you want on a net basis, it's the AUD 6 million or AUD 8 million on Minova is the new one. The issue obviously, if you start cherry-picking, you say, well, we have Forex of AUD 11 we didn't have last year, and et cetera. We just take it all in all. I think it's a good reflection of the numbers that the EBIT is flat. I think that stabilization still comes pretty solidly in our view.
Okay.
That's correct.
Thank you, Tom and Alberto.
My pleasure.
Thank you once again for the phone participants. To register a question, please press *1 on your phone. The next question comes from Grant Saligari from Credit Suisse. Please go ahead.
Good morning. Thank you. There's a comment on page 20 of the presentation about re-entering fertilizer production on the East Coast. I was wondering whether you could expand on what you've achieved there and what the intention might be.
This comes from an overall project in manufacturing of increasing utilization of assets. It is in this project that it's not that big, but it was clear that in the East of Australia, there is an opportunity to sell liquid fertilizers. In the West of Australia, that has been quite successful. Given that really it's about if you have the ammonia, you can easily do UAN, which I repeat, in the areas or in the regions of the world where you have available UAN, it is a very effective and efficient fertilizer. It's just about saying, okay, let's do this in the East and let's help obviously optimize our use of Yarwun. Basically, it's around that.
We do believe that if we extrapolate three, four years into the future between what we are seeing of the East mining tons and then agriculture, we can have, again, Yarwun running at full capacity in some years, and that's 600 or something like that. That's what underpins this. It's early days, but we see a very good opportunity to just have another nice contributor a little bit. It's not business determining, but it will have an interesting impact on the EBIT.
Interesting. Second question, could I just ask about the non-cash contributions to profit? Because we continue to see, I guess, in the cash flow reconciliation that there must be quite a large non-cash contribution to profit. It's around about AUD 50 million this half. Could you give some indication as to when you think cash and reported profit or accounting profit will start to converge?
Okay. I'll say something and then turn over to Tom. We had flagged that this was again temporary this year by the very sizable inventory buildup on the turnarounds of KI and the turnarounds of Carseland. As you know, they're about every five years we need to do those. They coincided this year. That basically is a temporary buildup that has lowered our cash conversion. That was pretty well flagged. Without that, our cash conversion would be more closer to historic of 90%. Tom.
That's correct, Alberto, and you answered the question correctly.
Tom, the non-cash items and foreign exchange, minus AUD 52 million in the cash flow reconciliation. I guess that's probably more what I was referring to rather than the trade working capital movement.
Okay. There was a revaluation on our pension. You may also be referring to the foreign currency. Is that right? Currency hedges?
Something like that.
Yes, I think it's largely foreign currency hedges with movement. That's all. There's nothing out of the ordinary.
Okay.
Yeah. You'll see actually, if you look at the non-cash foreign exchange movement there, the number last year was actually slightly larger from memory by something like AUD 30 million on a comparative period. I think this year the non-cash adjustment is it AUD 52 million, the number you're referring to?
Yep.
Yes, that's largely hedging contracts. We've got a very small hedging program, which is from history. We've got about 45 different currencies that we have. We largely leave them unhedged. There had been over the past period, some conversion of
Between Australian dollar, U.S. dollar on a top part of our debt book, and one or two other currencies. On average, we don't have a high hedging program. That's why I'm not concerned with it, not out of the ordinary.
Okay, thanks. Finally, if I could, if there's time, just on Kooragang Island gas costs that we haven't spoken, I guess, about this period, but obviously it got a lot of attention, I guess, earlier in the year. Is there anything that you could tell us about progress with securing long-term effective, cost-effective gas supply into KI?
Look, what I would say there, we have a contract until 2020. By how it was structured, it is reflecting sort of current, very close to current market prices. With that in mind, I think how I would see it is the most of the impact would have been felt this year. If you go to 2021, we would expect that the prices of gas in Australia would converge to LNG, and LNG net back Australia would be something around AUD 10 or AUD 11. We wouldn't expect any impact for the next decade. You can see we secluded some gas at sort of competitive price, but market prices in this year for Yarwun with Shell. As you know, there would be a lot of sort of exploration going on in two or three years.
This is assuming that we don't go anywhere with the Strike contract. They're still obviously investing money. They've had some issues. The gas is there, but with water management. It is not, again, even without Strike, that is not an area of, let's say, high concern for us even in 2020 or '21.
Okay, thank you. Appreciate the comments.
Thank you. The next question comes from Simon Thackray from Citi. Please go ahead.
Thanks very much, and good morning, Alberto. Good morning, Tom. I've just got two questions really. The commentary, Alberto, around some normalization of mine plans was reserved for the Asia Pac Indo market only. Can I first of all just talk about when that normalization was experienced in the half, and whether we get the potential for a full half run rate of that normalization in the second half? The second part of that question would be, given the commodity exposures in offshore markets, where you may be also seeing some normalization of mine plans in your offshore markets.
Okay. If we start with Australia, I would use as an example, they've flagged it many times, and it's obviously a large customer of ours, which is FMG. You can see how they've gone slow, now slightly going in the increasing their strip ratios and have a plan that will take four years, that will take their strip ratios from about 1.1 to an average of about 1.7, if I remember well. These normalization of mine plans take time, and that's why we insist on gradual. We keep back to going gradual because it will take, again, years to normalize the mine plans. We have seen it, however, when you look at the increase of 10% in Australia, about half of that increase, maybe a bit more, is from existing customers who are normalizing their mine plans. Which means their strip ratios are going up.
They are probably getting a bit more volume out, the ratio of waste to volume is going up again. That's where we have already seen it and experimented in Australia. We don't believe that the degree of high grading was as high in other regions of the world. Australia, I think, was really the one that probably was the champion in that regard, and it was very high on thermal coal, on iron ore, and on met coal. I think what we're seeing in other regions was, however, there was a hit to copper and gold, in particularly last year. If you look at Chile's production, this is more grade-related, Chile's physical production of copper went down. That did, again, affect us in some areas in North America. We're also affected by copper and gold.
In copper, what was interesting is I think that of the new mines that were going to come in in the next 10 years, about 70% came all in one year. That is Las Bambas or Toromocho and others. I still personally believe that there's going to be a copper will have again its day in the sun, but it will take some time.
Okay. Just so I'm clear, Alberto, just going back to the first part of the question, was that experience of the normalization, was that experienced across the whole first half, or was it more experienced towards the back of the first half? I'm trying to understand when the volumes really picked up in Asia.
It's month by month. It's nothing, again, we've just seen better months, it probably accelerated in the second half.
Okay. We should get a, all things being equal, we should have a better second half than Outcome around that normal-
I think we should continue. Let's say, I would probably say that it's going to be very similar. If we grew by 10%, we should grow roughly by something similar, I would think.
Okay. That's helpful. Thank you very much. Just a quick one for Tom. Just in terms of the net interest outlook, obviously, with the higher CapEx in the second half and with your private placement away now, what's the expectations for net interest for the second half? Just as a housekeeping question.
Okay. I think for you, if you can just do the calculation using our effective rate of, I would say roughly around 4.5% or something like that. Make the Burrup adjustment, which is AUD 3 million. The reason why it's lower is nothing to do with capitalization or anything because we've actually historically capitalized the Burrup number as well. It's really got to do with our lower net debt position. If you do your calculation just off that, which basically means our gearing is lower. Our total net debt at the moment is slightly lower. Our interest rate will probably remain lower than the comparative period, excluding the Burrup. I'll just highlight that we did say that the working capital will go down and come back up for the year-end, so we won't get a low average utilization rate.
The working capital will be funded out of debt.
That's helpful. Thank you, Tom. Just is there Given the commentary around the AUD 15 million FX impact, but the outlook remaining as is there an expectation in your outlook for, I guess for FX for the second half that you guys have baked into your expectations?
That's the number that we gave, which is the AUD 15 million. Of course, that could change depending on where currencies move to, because we haven't actually specifically hedged anything there.
Sorry, is that AUD 15 million as a mark to market?
As of current position, yes.
As of current position. Okay. Thank you very much.
Okay.
Thank you. The next question comes from John Purtell from Macquarie Group. Please go ahead.
Good morning. Morning, guys. Just had a couple of questions. Just following on from Simon's question there on gearing and net debt. Tom, I don't know if I heard you correctly, but you seem to be implying that gearing and net debt will increase in the second half versus the first. I mean, generally, we do see a seasonal reduction. Appreciate CapEx is going up and you've got Carseland and WebGen, generally, sort of runs contrary to the usual pattern.
You're right. If you look at the base cash generation. Essentially, please remember that we will be spending more CapEx in the second half to start off with.
Capital was AUD 114 million in the first half. We expect capital to be close to AUD 200. Let's say a little bit below, around AUD 300 for the year.
Correct. Around the AUD 320.
Just in terms of the working capital, you had the KI sort of shut in the first half, the effect of that. Really, the working capital piece is more around the Carseland shut in the second, is it?
Yes. They don't peak at the same time. KI shut, peaked, and then it started drawing down some inventory, and I think the Carseland one will hit us slap bang in the middle of August. Yeah, August, September. The number is not exactly the same. The real movement, there's a slightly bigger movement on working capital, potentially. There's definitely a bigger movement on capital, on CapEx, sorry.
Just in terms of the timing of the increase in costs as far as gas and sourcing in the U.S., to my understanding was that effective from sort of the 1st of January or?
Correct.
That would appear to imply that the effect should be bigger in the second half on first from those cost imposts.
That's correct. The first, as I said, started in January. As you look at it forward, in the future, there'll be one quarter additional, the annualization effect of that.
Okay. Just last one. Alberto, just in terms of your commentary from before, you mentioned sort of Yarwun in terms of potential restart. Just wanted to clarify that. Are you looking to sort of restart Yarwun some stage this year, or is this into the future?
Sometime this year. This calendar year, let's say.
Okay. Thank you.
Thank you. The next question comes from Brook Campbell-Crawford from JP Morgan. Please go ahead.
Good morning, Alberto, Tom, and Delphine. Brook here from JP. Just reflecting on the movement at EBIT and following divestment of the business in China, just keen to know if there's any other loss-making parts of that division or the division rather, that could be divested in the period ahead. Second point on Minova, just what the medium-term outlook for that business is. I think in recent periods you've talked about it being potentially non-core. How's the view on that change?
Minova is the turnaround is progressing. It is a difficult business, but we are probably quite happy how Australia and North America in particular, which was the last year was losing money, and now it's making some money, North America. That turnaround has progressed well. Europe has continued to decline. The underground coal market over there has continued to hit us. When I look at all is said and done in Minova, yes, there was this sale, but at the same time, we've put about AUD 6 million of additional cost on salespeople that we still have not seen the benefits. As I look forward, what would I expect? What are we seeing per month, roughly in Minova? We're currently seeing about AUD 1 million EBIT or something between 1 and 1.5.
I would expect that at some point in this calendar year, it should stabilize around 2. That is probably the month sort of things that I would expect. It is EBIT positive, which is important. We are winning contracts. The revenue is going up. Yeah, the turnaround is still in early days. As I said, we're happy at least that the EBIT is positive. The other thing that we're working on, we flagged it probably in the last result, is on tunneling. We're working together probably much closer in Asia between Minova, Orica, and a consultant called Nitro Consult that we own from Sweden that has about 50% or 60% of the market in Sweden of vibration and measurements on explosives. We think that that is an interesting new possibility. It's embryonic.
We have about 22 people now working in Hong Kong on that, you won't see anything significant in 12 months or something like that, but maybe in 2 years or 3 years, it may be something interesting.
Okay.
Thank you. At this time, we're showing no further questions. I'll hand back to Mr. Calderon for closing remarks.
Okay. Thank you. I think that's been a lot of questions. Very good. Thank you all for attending. Thank you for those in the room. They can come back to Delphine with any other questions. Of course, she'll surely answer them better than Tom or myself. Thank you very much.