Earnings Call: Q2 2019

Jul 19, 2019

Welcome to Fortum's Webcasted News Conference on our Second Quarter Results here today, both those of you who are here with us in Espoo and those of you who are listening online. Please note that this event is being recorded and a replay will be available on the website after this presentation. My name is Ingela Ullleves, and with me here today is also Rauner Ammons from our IR team Our CEO, Pekka Lundmark and CFO, Markus Raurama, will present Fortum's 2nd quarter numbers and performance, after which we will open up for questions and answers. As a reminder, you are also able to ask questions on the web chat. I now welcome Pekka to start. Thank you very much, Ingell, and good morning, everybody, both here in Espoo and wherever you are. We are really pleased with this quarter. We had improved results in all business segments. We had strong cash flow, and I would say that the result improvement is fairly broad based. It's not tied to any particular single item as you will soon see. We achieved this result improvement despite the fact that Nordic spot prices in the Q2 were down 9% year over year. Our teams did a really strong result and good work in optimization, for example, of our hydro production. And as a result, we had an achieved power price, which was €35 per megawatt hour, up €1.90 from the year before. The reservoir levels are on now a higher level than they were a quarter ago, which, of course, is now contributing to the hydro volumes. As a result, our comparable EBITDA was up 32% compared to last year and comparable operating profit up 52%. In the share of profits of associates and joint ventures, SEK461 1,000,000, Now we have, for the first time, a significant contribution from Uniper. It was €384,000,000 And there, of course, we have to remember and note that €333,000,000 out of that is nonoperative adjustments, typically fair valuations of various instruments. This is very important to keep in mind also when you look at the earnings per share development in the quarter, which was, of course, extremely strong, €0.69 per share. There is, again, some items affecting comparability there that Markus will go through in more detail. But if you exclude the effects of these items and then if you take away the nonoperative adjustments from the Uniper contribution, we are still looking at very strong improvement in our EPS. We did have a very strong cash flow as well, 7 €40,000,000 Again, Markus will go through the details of the various components of the cash flow. And as a result of that cash flow, despite the fact that we, during the quarter, paid about €1,000,000,000 of dividend, our net debt to EBITDA has come down to 3.3x last 12 months EBITDA. And once again, here, we always have to remember that we are not consolidating anything from Uniper's EBITDA into our result. We have also finalized the Uniper purchase price allocation and also on this one, Markus will go through the details. When it comes to Uniper, we remain convinced that Fortum and Uniper together can take a leading role in the European energy transition. And working in close alignment, we would be stronger and better positioned to address the key challenges of the energy landscape in the future, affordability, sustainability and security of supply. The talks we held with Uniper during the spring only strengthened this conviction. Following the controversy that many of you have seen around the Uniper Annual General Meeting in May, we have now met with Uniper employee representatives. We have met with the new members of the Management Board. We have met with the Supervisory Board. And I'm pleased that we have now agreed that the discussions that were put on hold after the AGM will now continue. Now we need to see where these discussions take us. There has been a lot of confusion and also incorrect information in media recently. So it is now very important that we make quick progress in order to create clarity to all stakeholders as soon as possible. Then if I go back to our result and especially the water reservoirs, which is an important driver, The warm start into the Q2 initiated spring inflows earlier than normal, and that lifted the Nordic reservoirs above the long term average already in the beginning of the quarter. Then this was followed by warm April and rainy May June. So water reservoirs actually stayed above the average throughout the quarter as you see on this chart. The orange dotted line is the 2019 development and no, sorry, not the dotted line, but the orange line with white circles is 2019 and the gray dotted line is the reference level, the long term average. At the end of the Q2, the water reservoir levels were 6 terawatt hours above the long term average, while in the beginning of the quarter, they were about 2 terawatt hours below the average. So that shows how strong the development was during the quarter. Now the 1st couple of weeks of July have again been drier. So the very latest figure, which I believe is from yesterday or from the day before yesterday, is 2 terawatt hours above long term average. Commodities fuel price development, gas and coal are obviously the competing fuels in power generation in many parts of Europe, and that's why their prices are typically quite intertwined. Coal has been actually more affected by the darkening global macroeconomic environment and particularly Chinese weakness as roughly half of the global coal demand is in China. And just as one example of the development, coal for power demand growth in China has essentially paused. There is currently no growth at all. When it comes to gas, the prices have been more driven by the strong supply growth in LNG that the East Asian buyers have not been able to absorb, And that has meant that Europe has been the market balancer. The storage is pretty high, about 80% at the moment. And one very interesting detail is that this gas price collapse that you see on this screen has contributed to a roughly 20% year over year decrease in coal for power demand in EU 28 in the Q2 of 2018. Another player and a significant driver obviously on the power market is the CO2 price development. And the EUA price has held up very well despite what you just saw on the coal and gas prices. And this is because of the tightening CO2 market, mainly through the market stability reserve, which has created or to put the market in deficit. 2019 is the 1st year of operation for the market stability reserve. And according to the current decisions, the instrument will continue to keep the market tight at least until end 2023. There is an agreed checkpoint in the system in 2021 when it will be discussed whether the 24 percent intake rate will potentially continue even after 2023. But currently, there are no decisions on that. This is a very important driver. And just as one interesting detail, I already mentioned that this, together with the coal and gas prices, is currently driving coal to gas switching. But there were even temporary situations in Germany where even the clean brown spread, CBS was negative, I. E, making gas go above lignite in merit order. That was a temporary thing, but it was interesting to note that, that really happened as well. Nordic spot price has been on the weak side lately. The improving hydrology is, of course, the main reason for the decline during 2019. In addition, as I mentioned, declining gas price created softness in German spot price, which also had an impact on the Nordic spot price market. But then when we look at the forwards, we can see on this chart the lower right hand corner that despite the weakness in spot price, both the Nordic and German forwards for the 2020 contract have held up quite well. So the forward market is expecting a recovery in prices. When it comes to the spread between the Nordic and German prices, in realization in spot price, the quarter was pretty much on the same level in both regions. But actually, the spread for 2020 has increased to €15 per megawatt hour. And one key driver behind this is the CO2 price, which is, of course, supporting prices both in Germany and in the Nordic region, but in relative terms, slightly more in Germany than in the Nordics. Here you have in graphical format the price development achieved price, as I said, up from 33.10 to 35 at the same time when the spot price was down 9%. On the Russian side, pretty good development. Spot price up 15% in rubles. And our achieved price, which also takes into account the capacity payments and then translates this everything into euros was now 11% higher. And actually, this is now the 4th consecutive quarter, as you can see here, where we had an improved achieved price in euro terms in Russia. Then before Markus continues, quick comments on each of the segments. Generation first, of course, the achieved power price is a strong driver here. But also in addition to this, the volumes had now good development. We had 5.3 terawatt hours of hydro production versus 5.1 a year ago. And then the nuclear development and nuclear availability was also in a very good level, 5.9 terawatt hours compared to 5.6 a year ago. Another driver behind the result, which is not to be forgotten, is the Swedish tax decisions that were made a couple of years ago, and that is supporting the generation segment's result with approximately €20,000,000 this year compared to 2018. City Solutions had also better result than last year, of course, seasonally weak, but EBITDA €31,000,000 compared to €23,000,000 last year. This was again warmer than normal, but not as extreme as last year. So that supported the result a little bit. Another positive thing was the improved result in waste and recycling business, which is obviously based on the old EcoChem acquisition. Of course, the return on assets in this business is not yet on a satisfactory level, 5.7%, Rona, whereas in the generation business, which I actually forgot to mention on the previous slide, we had pretty good 11.8% return on net assets for the last 12 months. The fleet in City Solutions is fairly new, which, of course, affects the run up. But I just want to say that we are not happy with this 5.7 percent level. Our goal is clearly that this would also, in the future, climb gradually towards our target of 10%. Consumer Solutions had another good quarter in a row. Comparable EBITDA from SEK 26,000,000 to SEK 34,000,000 and corresponding development in operating profit as well. We had higher product margins as a result of introduction of certain new products. The competition remains very tough. Churn continues to be an issue. But despite of high churn, we were able to mainly through the introduction of these new products and other efficient operational execution, we were able to improve the result. And then, of course, both in City Solutions and Consumer Solutions, we repeat the Hafslund synergy guidance. In City Solutions, €5,000,000 to €10,000,000 to be achieved by the end of 2020 and in Consumer Solutions, roughly €10,000,000 to be achieved by the end of 2020. I mentioned already after the good Q1 in Consumer Solutions that part of this improvement cannot be automatically extrapolated to the second half of the year. Now I repeat what I said earlier. This is just a word of caution. We are optimistic about the prospects of result development, but please don't assume that it would continue quite this strong. Some of this is temporary. And then on top of that, there are uncertainties regarding the development in Poland when they are still when it is still a little bit unclear to us how the proposed price regulation in consumer prices will be implemented and how that would be potentially compensated to suppliers. That creates certain uncertainty for the second half of the year. And then finally, Russia, an excellent quarter. EBITDA from €73,000,000 to €107,000,000 and operating profit from €37,000,000 to €69,000,000 Several factors behind this higher power margin spread, higher CSA payments and on top of that, clearly lower bad debt provisions compared to last year. All this contributed to a pretty good result and last 12 month return on net assets, 11.7%, which obviously starts to be on a pretty good level. So now I will ask Markus to continue. And then after that, we are ready for questions. Markus? Thank you, Pekka. So I will start by first summarizing the 2nd quarter performance. Very strong performance, comparable operating profit from SEK153,000,000 to SEK232,000,000. This was driven by better volumes in both hydro and nuclear as well as better prices in generation. Russia improved on the lower bad debt provisions, higher power margins and CSA payments. Also, City Solutions and Consumer Solutions improved year on year. Segment Other was impacted by the increased spend in Business Technology, including the internal and external ventures. Other corporate function costs were flat year on year. For the first second half, we can see the same development. Generation up, driven with prices and volumes, Russia improving on the back of higher margins and CSA payments and lower bad debt provisions. Recycling and Waste Solutions and Norway improved City Solution results, and sales margins were higher in Consumer Solutions. All this resulting to that comparable operating profit went up from SEK558,000,000 to SEK640,000,000. Then I move over to more of the technical parts and first start with Uniper purchase price allocation. We finalized the purchase price allocation during Q2 of this year. Uniper's balance sheet as of 30th June 2018 has been used as the starting point for this purchase price allocation. First, we take Fortum's share of the goodwill on Uniper's balance sheet, SEK 930,000,000 and derecognize that as it is not an identifiable asset according to IFRS. Potential future impairments of goodwill that existed on the 30th June 2018 in Europo's balance sheet, booked by Uniper, will thereby be reversed to Fortum's share of profits of associates and joint ventures. Then a fairly adjustment of CHF 613,000,000 was made for the acquired assets and liabilities. This is relating mainly to political and regulatory risks that are reflected in the fair value of certain generation and production assets. The fair value adjustment will be reversed to share of profits of associates and joint ventures over a period of 20 years, €30,000,000 on annual basis. Fortum's 2nd quarter share of profits from Uniper include a positive impact of €15,000,000 from the reversal of the fair value adjustment for the first half of this year. If Uniper would report negative impacts relating to these generation and production assets, then Fortum will assess potential need to use this fair value adjustment to reverse these negative impacts. In addition to this, there is comprehensive disclosure in our 2nd quarter report in Notes 6 and 11 regarding the PPA and the value. Then I move over to the key financials. To start from the top, sales, EBITDA and comparable operating profit are up in all periods in Q2, in the first half and LTM versus last year. When we go down on the table, operating profit is impacted by sales gains, nuclear fund adjustments and fair value changes, and I will open these up on the coming slides. Uniper result had a big impact on the share of profits from associates, and I will also come back to this line in the coming slides. So finally, profit before tax, EPS and cash flow improved significantly also in all periods, in Q2, in first half and last 12 months. When we go deeper into the income statement, I start from the comparable operating profit line. That was up. Then we have movements in the items affecting comparability, and this included impact from the regular nuclear technical update that is done periodically. Maybe the key thing to start with is that the underlying cost of the spent nuclear waste handling has reduced substantially. And this means that the nuclear provision goes down. But as we are overfunded, as you can find in our notes, that means that we can also recognize less of the Fund assets, and this results in a negative €54,000,000 impact in items affecting comparability. And on the other hand, because of the discounting and interest effect, we have a positive item in the net financials of SEK 40,000,000. Net impact from all of the changes in nuclear accounting and the underlying factors is not material. The underlying cost is coming down. So overall, situation is very good. And the impact, as I said, is not material. There is more comprehensive disclosure on this item as well in Note 14 of our quarterly report. One thing to note also is that in Q2 'eighteen, we had a positive impact from the sale of 10% stake in Hafslund Products soon, which resulted in a SEK 77,000,000 sales gain. Then if we go down, also in Q2, we had a very strong contribution from the share of profits from associates, SEK 461,000,000. Uniper out of that was a total of SEK 399,000,000 and that is already including then the SEK 15,000,000 impact from the fair value adjustment that we will then record periodically. Then moving over to the cash flow statement. Cash flow was very strong, strengthened by the dividends received and working capital. If we look at Q2 of this year, we received dividends of SEK 165,000,000 from Uniper, but also dividends from Stockholm Exergi and TSC, Torun Sjogren Energia. In this quarter, we had positive working capital change of CHF 233,000,000 The same item was very strong in the first half of the year, driven also by the change in settlements for futures. So total in working capital change in the first half was SEK502,000,000. And as we know, this can be a very volatile item due to the changes in the settlements. All in all, this resulted in very strong net cash flow from operating activities. And then if we continue down on the table, the first thing I would note there is on the last 12 months numbers, we have CapEx of SEK 696,000,000. This is including the communicated regular maintenance CapEx. Some growth, not very much. And then the big part on top of this is the solar and wind investments, as we have said, that also have potential to be recycled as we have done before. Then a key item, if we go down, is the acquisition of shares in the Q2 of 2018. Uniper, this is also reflected in the full year 2018 numbers. Going further down, divestment of shares. Last year, Hafthorn Production had a big impact. And then the collateral arrangement that we did in Q1 was releasing cash. This is visible in the first half numbers. So all in all, all this is resulting into very strong cash flow before financing activities, SEK 527,000,000 in Q1, SEK 1,400,000,000 for the first half year and in last 12 months, SEK 1,200,000,000. Then I move over to the balance sheet and funding key indicators. And here, we are focusing on optimizing our cash flow to delever our balance sheet towards our target 2.5x. This is also to maintain our financial strength and flexibility. If we compare the numbers to 2018 full year, EBITDA up to SEK1.62 billion and net debt, because of the drivers that I went through and Pekka mentioned, net debt actually went down to SEK 5,400,000,000 And this means that the comparable net debt EBITDA has come down from the level of SEK 3.6 billion to SEK 3.3 billion. Our liquidity is strong. We have SEK 1,300,000,000 of cash and cash equivalents, undrawn committed credit lines of SEK 1,800,000,000. Average interest is coming down now at 2.2%. And on the maturity profile, we have no maturities in 2020. Then finally, to the outlook. We continue to expect that demand growth for electricity in the Nordics is 0.5%. Our hedging levels have increased to 80% for the rest of the year 2019 at €33 and for 2020, up from 55% to 60% with the same hedging price level €31 We continue to guide the CapEx to be between €600,000,000 €650,000,000 excluding acquisitions. The targeted cost synergies are well on track. We are expecting €15,000,000 to €20,000,000 materializing in City Solutions and Consumer Solutions gradually this year and next year. The effective tax rate for the group remains at 19% to 21%, more likely on the higher side. And we continue to get a positive impact still by the Swedish tax reductions that will then end in 2020. With this, we can move to Q and A. Thank you. Thank you, Markus, and thank you, Pekka. So we are now ready for the Q and A session. We will start with potential questions here in Espoo and then continue to the teleconference participants. Any questions here in Espoo? Okay. Thank you. Operator, we are then ready for the questions from the teleconference. Please go ahead. We have a first question from Vincent Ayral from JPMorgan. So a couple of questions. 1, you said that you want to move as soon as possible to get more clarity for stakeholders. What did you mean here? A bit more color on your intent would be very useful. 2nd, we see that the bad debt in Russia since you have materially improved, but we don't have really necessarily the numbers. Could you give us like the amount of provisions you did in H1 or Q1, Q2 last year versus what you've done this year so we can basically put the number on that? That would be useful. Another one on the achieved pulp price and the spot. So you showed that the spot is basically at a lower level. I wanted to understand a bit how you managed to avoid a bit for getting too much impacted by that. So what are the specifics on exactly your areas and just getting some color? And finally, on City Solutions, you say that part of improvement is temporary. You started to touch on that. Could you give us exactly the nature of this improvement and why part of it is temporary? That would be extremely useful for all of us. All right. Thank you. If I start from the Uniper and the clarity question. Unfortunately, after the AGM, there has been a lot of confusing media reports, including, as I said, a lot of also misleading or directly incorrect statements about various stakeholders' views and intentions and so forth. And that's why it is really important that we now, not through media, but through constructive discussions with company's management and also, very importantly, with the personnel representatives, discuss that how we look at the future of this company. We continue to believe that working in close alignment, these two companies could create tremendous value and play an important role in the European Energy transition. I have a lot of sympathy for the personnel's concerns at the moment because they have seen all these confusing statements in media. And it is very clear now that we sit down constructively with the company and talk about the future. We have said very clearly that what type of different routes forward we see. This is what we want to discuss with the company. But very importantly, we have agreed with them that now when the discussions continue, that they are confidential discussions. And we intend to keep our part of that promise. And that's why, unfortunately, I will not go into any more details about what specifically we would and will discuss. Okay. I can take the bad debt provision. So we don't disclose exactly what numbers they are. But as it is in the waterfall and also on a text mentioned as one of the important factors, so I would just describe it as being one of the top factors in the Q2 delta. And we mentioned the others as well, the CSA payments and electricity margins. And then we have to remember that we also recovered some of the part of this is recovering the receivable that we had from the guaranteed supplier that we eventually bought into the joint venture. Then for the achieved power price, even when spot is lower, good question. So the result is result of hedging and the physical optimization. And the physical optimization, we had a really good result now in 2nd quarter and June. Then for the actually, the temporary improvement was in Consumer Solutions. And the driver there is that mostly and largely, we hedge our the consumer electricity sales back to back. So what we sell, we have hedged. But some of the products, a minor share, have pricing that is valid for the time being. So there is no set schedule when we would have price changes. So when the procurement price from the market goes down and if the for the time being price stays longer than the price is going down, we may get a temporary spread improvement. So this is basically the statement is assuming that if nothing else happens, then we're not going to get this kind of benefit. But of course, going forward, whether the market prices go up or down, that then drives what happens in the coming quarters. I hope this opened up a little bit. Thank you. Next question comes from Jose Chumacher from SocGen. Sir, please go ahead. Okay. It's Lule Schumacher here. SocGen, I assume that it's that was my name, that was called there. Two questions on my side. One is straightforward on the accounting side. Why don't you include the Uniper non operating result in the items affecting comparability because they well, they do the comparability. So it would perhaps be useful to strip them out to allow comparability. The second one is straightforward really and relating to the various press articles we had. You said you don't want to comment on it, but they are discussing investment restrictions in Russia with President Putin, the recent article in the FAZ. So straightforward, is your aim, sooner or later, to get a majority stake in Uniper? Okay. I can take the accounting question. So you are correct that we record our net our share of Uniper's net profit in our share of associate and joint venture income. One reason is that, that's where we, according to our policies, book the results. The other one is that we would not have full visibility in what are the items affecting comparability when we record the numbers. So it would be also difficult for us. So this is a more straightforward way. And then there is also good disclosure from Uniper. So how they break up the numbers, that is best to discuss then with Uniper. Then when it comes to the Russian situation and our shareholding, we have said from the beginning that we do not speculate on whether or not we would have an interest to buy more shares in the future. There's a lot of value creation that can be done even with the current shareholding, but we do not feel that the 50% restriction that there is in Russia or because of the drinking water supply operation in Russia is really in the interest of shareholders. It is of a technical nature. We have in our own operations outsourced similar activity to a Russian partner. This is in no way core to Uniper's operations. And what the way we see the situation is that it limits, 1st of all, our optionality, but it also limits other shareholders' optionality in case there would be shareholders that would like to sell their shares to us. So we do not believe that it is in the interest of shareholders to have the restriction there. And that's why we have been working since it was put on us, we have been working actively with our partners in Russia with the authorities to find ways how to deal with the situation, and that work obviously continues. But then the second part of your question, once again, about our plans to potentially buy more shares. Currently, our hands are tied. If the restriction is to be removed in the future, that is then a new situation, but that is the question that we are not speculating on what we would do or would not do in the future. Next question comes from Claus Max Wagner from SRZ. Sir, please go ahead. Good morning and thank you for taking my question, gentlemen. I would like to repeat the SocGen gentlemen's question and take up your answer on that. If restrictions in Russia were to be listed, do you then intend to acquire a majority stake in Uniper, Mr. Lundmark? Yes or no? I did not my answer was that I do not want to speculate on that question. That restriction limits the optionality when it comes to our possibility to buy more shares. It also restricts other shareholders' optionality in case they would like to sell shares to us. But I do not speculate on the probability of, number 1, that restriction to be lifted and in the theoretical case that it would be lifted, what we would do in that situation. Thank you. Next question comes from James Brand from Deutsche Bank. Sir, please go ahead. Good morning. Just a couple of questions on your nuclear associates, please. Firstly, on Okolutu III, I saw that the target commission date had been pushed back to the mid-twenty 20. And you also highlighted in the statement you had this agreement with Areeva where TVO could receive up to €400,000,000 of compensation. Can you just remind us how the compensation works there? And if there are further overruns cost overruns for that project, Is Ariba still on the hook for those? Or could TBO be required to commit some funds to complete the project if there were further cost overruns? And then secondly, just on your new kit associate contribution for H1, it was up pretty strongly to about €40,000,000 from pretty close to 0. What's driving that? Because I could see that you highlighted some one off negatives that you had last year, but normally those nuclear associates don't really contribute any profits. So I was just wondering whether that EUR 40,000,000 or so was one off in nature or whether that was coming from something that might repeat in the future? Yes. Okay, I can take that one. So correct, the plant supplier came with the revised timetable, basically pushing the PTO date half a year forward. And it has been communicated as part of the global settlement agreement with regards to settling the arbitration that there is a compensation mechanism whereby the plant supplier, Arrivos Siemens, will then pay compensation. But the exact details of the compensation haven't been given. So I cannot comment that further as such. Then for the Nuclear Associates and their result impact, the basic setup is exactly as you indicated. So from our nuclear associates, we get power at cost, and the result of the associates should normally be close to 0. So the major part of the positive impact is now coming actually from the technical updates at this time. So from time to time, there can be changes in the nuclear provisioning, spent nuclear fuel cost and so on. And this may get reflected then in the results, but over time, should be 0. There are no further questions at this time. Please go ahead, teachers. Thank you, operator. Thank you for all the questions, and thank you for participating. If there are no further questions in the audience either, I want to thank you all for participating here today. And on behalf of Fortum, wishing you a very nice upcoming weekend. Thank you so much.