Good day, ladies and gentlemen, and welcome to the Outokumpu Annual Accounts 2016 conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Tommi Järvenpää, Head of Investor Relations. Please go ahead.
Thank you. Good afternoon, ladies and gentlemen, and welcome to Outokumpu's fourth quarter and full year 2016 earnings webcast. My name is Tommi Järvenpää. I am the Head of Outokumpu's Investor Relations. With me here today are also our CEO, Roeland Baan, and our CFO, Chris de la Camp. We will be referring to the presentation that can be found on our website. As always, please pay attention to the disclaimer on page three in the presentation as we will be making forward-looking statements. With these remarks, I am pleased to hand over to our CEO. Roeland, please go ahead.
Okay, Tommi, thank you very much. Welcome to you all on the line. Tommi already referred to the disclaimer. I will flash it by you quickly. Then to the first slide. I have promised that I will start every communication always with our vision, and this is no exception. Just to bring it back to the mind, our vision is to be the best value creator in stainless steel by 2020 through customer orientation and efficiency. Again, every word here counts. When we talk about best value creator, it is to our three main segments. It is our shareholders, our customers, and our employees. We have communicated to you from the financial community point of view, the measures of success for our 2020 vision, which is our EUR 500 million EBITDA, EBIT, sorry.
Our 12% return on capital employed as a minimum plus a maximum gearing of 35%. It is time-bound. There is a sense of urgency, as you probably have seen from what we have been doing during the past year and what the plans are. If we do not have that sense of urgency, then we will not make what we promised by 2020. Ultimately, if you look at how we are going to do this, customer orientation and efficiency is back to basics. I think you will find that back as well in the results that we are presenting. Next page. I think the initial message is a very positive one. For the first time since 2007, the company has returned to a positive EBIT of EUR 45 million after indeed eight years of consecutive losses.
The main reasons of this result were a significant reduction in costs, where we have been able to reduce specifically the variable cost, both in Europe as well as in the Americas. In Europe, we are talking about approximately a 15% drop in our variable cost per ton. In the U.S., we are talking about over 30% of cost improvements on variable cost per ton. A great contributor, of course, to the swing has been the Americas. Volumes have been going up significantly every quarter, and profitability has been improving quarter-over-quarter, as you will see later in the presentation. Our overall result in Q4 has been negatively impacted by a EUR 9 million charge of old invoicing that we needed to correct. So absolutely not pertaining to this quarter, but to prior periods. One of the big drivers we had, as you well know, is net working capital reduction.
We had a EUR 200 million target there. We have overachieved it and reached EUR 307 million overall reduction of net working capital. As a result of the profitability and the positive change in our working capital, we had a strong cash flow of around EUR 390 million. This has led to significant debt reduction, where we our schedule, and we ended the period with a net debt of EUR 1.24 billion. Last but not least, reflecting the strong improvements during 2016 and our outlook for 2017, the board of directors deemed it the right time to reinstate a dividend and has decided to pay a dividend of EUR 0.10 per share. Next. When we launched our vision, we have said as well that we will achieve this vision through self-help, and that our numbers are not based on market help.
If you look at 2016, and you look at what actually was the environment, this has been proven correct. In Europe, base prices have basically been flat. In the U.S., year-over-year, base prices were actually down significantly. We had a strongly lower nickel price during the year, and on average, we had a strongly lower ferrochrome price. In spite of that, we have moved from minus EUR 100 million to plus EUR 45 million. So in spite of a market that has actually been working against us, thanks to the significant improvement in our cost base, in our marketing, and our volumes, we have been able to achieve this turnaround. If you look a bit more granularly at prices, most of 2016, as said before, in Europe, the pricing has been pretty stable at a relatively low level, historically speaking.
Only towards the end, in the end of Q3 and Q4, have we seen a tick up of altogether probably about EUR 40. If we look forward, we can see this continuing into first quarter 2017, where we see a continuation of stronger pricing. On the import front, along one of the big issues, you can see that in terms of participation in the market, imports are still at around the 25%. So there is not a huge difference to the past. The big difference is that you can see the Chinese participation in imports has disappeared, and as a result, the unfairly priced imports have gone out of the market, which is supporting pricing in this market. Next.
In the U.S., you know this graph, when anti-dumping was put in place in Europe, the Chinese volumes redirected themselves into the U.S., which caused a very steep drop in pricing from over $1,400 to just over $1,200, so over $200 a ton drop. When the anti-dumping measures were announced, or let me say the investigation was announced, and later on, preliminary duties were announced, the Chinese imports, as you can see from the right-hand graph, disappeared from the American market as well. As a result, we have been able to significantly improve pricing. Still a far way off from where we were before the Chinese imports came in, but still significant improvement. Same that you saw in Europe, the import participation is still around 25%. So it is not so much that we have an issue with imports, we have an issue with unfair imports.
As soon as those are out, you can see that normal profitability returns. When you look at ferrochrome prices and nickel prices, nickel prices have been continuing down during 2016 and started recovering towards the end of 2016. We thought that we were ending up in a sort of a trading range between $10,500 and $11,500 when the Indonesian announcement came, which pushed prices back to the $9,500 level. Meanwhile, with the news coming out on what the ore export resumption, what that actually entails, as well as the results of the Philippine audits on the mining sector, the market has recovered, and we are back over $10,000 now. If you look at ferrochrome, there has been an interesting story.
It dropped to a historical low in the second quarter of 2016, only to work it back up towards the end of 2016 at, I don't know, it is not really a historical high, but one of the highest numbers it has been for a long time at 165. Going forward, currently, if you look at what is happening on the spot market, the spot market is trading probably about 10 to 15 cents below where we were when this 165 was established. To say as well that at the same time, not really a lot of business is being executed. In other words, the 15 cents lower is what the buyers are floating into the market, but they are not capable of selling or finding a lot of sellers at that level. So it seems to be relatively stable in that sense.
With that, I hand over to Chris for the financial part of the presentation.
Thank you, Roeland. Good morning and good afternoon, ladies and gentlemen. Moving on to slide number 10 now, which shows an overview of our key financials. On this table, I would like to pick out just a few of the key ones. Let us first of all take a look at the deliveries for 2016 versus 2015, and you can see that there was a very strong increase over the year. This was driven predominantly by higher deliveries in the Americas. If we move on to the sales, they were down in 2016 versus 2015, and this was as a result of lower sales prices that were achieved in both Europe and the U.S. Moving on to the underlying EBIT. I would like to highlight the fourth quarter result of EUR 38 million here against the third quarter result of EUR 32 million.
So an improvement, but particularly the improvement from 2015 to 2016 was very significant, as Roeland has already outlined. Conscious that there was also a change in the depreciation here, but nonetheless, the underlying profit also improved substantially because of the self-help measures we have taken. If we then move on to the net result, this is probably where the most significant change has happened in the fourth quarter with a very strong profit. This was driven by the booking of a deferred tax asset. I will come back to that point in a moment because it is very significant in our results, and obviously led to an overall net result that is positive for the year.
Our operating cash flow also in the fourth quarter, continued on the good track record of the previous three quarters, nearly EUR 319 million of cash generated during the year, with EUR 200 million, approximately of that in the fourth quarter. That was substantially driven by a further reduction in net working capital. I shall also return to that point. The gearing, and I will return to that too, very substantially down versus the third quarter and as was the net debt. Let's move on to slide number 11 and dwell for a moment on the tax booking that we made in the fourth quarter. You can see that there was approximately EUR 189 million of deferred tax income booked. This relates to previously unrecognized deferred tax assets from losses in Finland and Sweden.
We have from time to time talked about the very significant loss carry forwards from our history, and it was time to recognize some of those in Sweden and in Finland as we achieved positive results there. We are very confident in our forward view that we will continue to make a positive pre-tax result there. So there was a requirement to take those tax losses back on and credit the tax assets associated with that. There are still significant tax loss carry forwards in other tax groups of the company. They amount to over EUR 2.5 billion, mainly in Germany and very mainly in the U.S. As and when those entities make a yearly profit and are solidly back into profitable terrain, we will be able to recognize those deferred tax assets as well.
We hope to achieve that as soon as possible, and as soon as those entities turn positive. I'd like to move to slide number 12 now and start focusing on each of the three business areas individually, starting with Europe. The chart on the left shows the annual deliveries over the last three years. You can see that in 2016, we had a good increase of approximately 3% of our delivery performance in 2015. On the right-hand side, you see the improvement in the underlying EBIT, and of course, this is also a significant driver of our improved results for the year. It was driven on the one hand by the higher volumes, and on the other hand, significantly by decreased costs. We take a little bit of a look at how the year as a whole panned out.
In the first half, we still saw prices significantly under pressure, but as you know during the second half, they started to increase and certainly gave momentum to the improvement in the results in the second half of the year. The overall 2016 weighted average base price having deliveries decreased by EUR 30 a ton, so we did not get much help there year on year. Costs continue to be reduced very significantly and very successfully. We started the EMEA restructuring program with the closure of Bochum and Benrath prior to 2016, and the expected benefits started coming through strongly in 2016 now. SG&A costs in Europe in particular reduced by EUR 49 million and contributed strongly to the European result. Also to our overall target of EUR 100 million reduction by the end of this year.
We also saw, as Roeland has already mentioned, a very clear reduction in variable cost per ton in our European business. The ferrochrome production for the year was 469,000 tons. Of course, that was impacted somewhat negatively by the maintenance work that we carried out in the third quarter. Moving over to slide number 13 and the Americas business. We can take a look at this on an annual basis first, then delve a little bit more into the individual quarters. The chart on the left-hand side shows the movement in deliveries and the improvement in deliveries over the last three years. You can see that there's really been a step change in 2016 versus prior years in terms of the deliveries achieved.
We were almost 30% up due to very strong commercial development, and this wasn't just a good market environment, this was really self-help measures and a much greater focus on our commercial activities in the Americas. On the right-hand side, you can see the development of the EBIT over the last three years with a very strong improvement from 2015 to 2016, which was on the one hand, of course, driven by the higher deliveries, but also due to a 25% reduction in variable costs per ton. Generally, in the Americas, we saw significantly reduced import volumes from China as a result of preliminary anti-dumping duties that we've discussed in the past, and these reduced imports and a generally healthy underlying demand resulted in higher base prices through the year.
However, if we look at the full year and we compare it versus the previous year, then we still had an overall average sales price that was $10 per ton lower. I think if you look at the EBIT chart on this slide, it does not tell the whole picture for the Americas. I would like to turn to slide number 14 and just delve into that a little bit more fully. Let us take a look at the Americas performance on a quarterly basis for the year. You can see on the left-hand side that there was a very strong increase in deliveries from Q1 through to Q3. We did see a decline in Q4, as expected. This was due to seasonality, and is fairly normal in this business in the region there.
If you look on the chart on the right-hand side, you can see how EBIT has improved quarter-on-quarter through the first three quarters, although we did see a decline in the fourth quarter, which on the one hand was due to the lower volumes, but also because of the EUR 9 million charge that Roeland mentioned. We finally resolved a dispute with one of our suppliers over back invoicing issues and took a EUR 9 million charge there. That was an unusual charge and you might want to have to take that out in terms of showing the underlying trend for the year. I would then like to move to slide number 15, which shows the development of the long products business this year, and this business had a very difficult year.
It is, of course, somewhat dependent on the oil and gas sector, and you can see that played a role here. However, we did manage to increase our deliveries from 2015 to 2016. This was partly also driven by good internal demand. Here is where the melt facility in Sheffield plays a big role because it produces products not just for our long products business, but also for our European business. That contributed to the increase in volumes in the long products business. The underlying EBIT developed negatively. It was a small loss in 2016. Which was partly the result of lower prices. There were nonetheless in that very good cost reductions that the business did achieve. Again, if you look at quarterly results, it improved somewhat throughout the year. It has been a difficult business because of the pressure that we saw from import volumes.
We saw obviously, a drastically lower oil and gas demand as a result of the lower oil price earlier this year. We continue to work very hard on the cost base of this business, and to improve the profitability through that. We have also achieved the completion of an expansion project in our facility in the U.S. in Richburg. We are now focusing more of our production on rebar capabilities to become less dependent on the oil and gas business. Now let us move to slide number 16, where we show the cash flow improvements that we achieved in 2016. You can see that whereas we made operating cash losses in the previous two years, in 2016, it was a significant cash profit.
This was very substantially driven not only by our improving EBITDA, but also by a significant release in net working capital, which amounted to over EUR 307 million for the year. The cash inflow was obviously impacted or was offset partly by financing costs, a total of EUR 121 million of which interest expenses were EUR 105 million. As we've indicated in the past, we will put a very strong focus during 2017 to reduce that overall interest expense. CapEx came in at EUR 164 million. That was a little bit higher perhaps than the EUR 150 million we targeted. But it was due partly because of the investment in Hernani that we've already talked about previously. Our overall liquidity reserves were at EUR 1 billion, which is very adequate both from a covenant and a liquidity headroom point of view.
Overall, as I've explained, all of these activities and the significant cash generation led to significant reduction of net debt. We'll take a closer look at that on the next page. You can see here on the chart on the left-hand side, the development of our net debt over the last four years. It has come down very significantly, not just from 2013 through to 2015, but through the course of last year as well. We're now at EUR 1.24 billion, which leads to gearing ratio of 51% that we are well on our way to reaching the target of 35% that we set ourselves. Our net debt leverage is now down at 4.2. We still consider that to be high, but it is trending obviously in the right direction. On the right-hand side, you can see the overall debt maturity profile that we have for the company.
The 2017 number looks very high, but most of that dark bar there that you can see, the dark blue bar, is actually rolling commercial paper with some smaller unutilized facilities. Not so very long ago, we still had a very large debt maturity wall in February of this year, longer term debt maturity wall at the end of this month. I'm pleased to say that we've now entirely removed that wall so that we no longer have significant debt repayment challenges in 2017. Smaller ones in 2018, and the bigger wall is now out to 2019. So, that is also very good progress. Moving on then finally to slide number 18. I'd like to just briefly elaborate on a technical issue that we announced and communicated a couple of weeks ago.
We have decided that in the future we will use adjusted EBITDA as our main profit performance indicator. We've taken this decision because we believe that as a company, our focus in the foreseeable future needs to remain on cash generation and on net debt reduction, and that EBITDA is a better metric for this than EBITDA as it's actually the most relevant indicator for that. We'll start implementing this practice from the first quarter of this year. So this will be the last time that we will use EBIT or underlying EBIT as a key profit indicator. So from next quarter onwards, that will be the new way of reporting. Perhaps a couple of words around the differences. I'd like to restate those.
The underlying figures exclude raw material related inventory gains and losses and metal derivative gains and losses, while the adjusted figures do not exclude those raw material, more material related inventory gains and losses, and metal derivative gains and losses. That is the only key difference. If you look at the impact of that, in 2016, the impact would have been about EUR 10 million, and in the fourth quarter of 2016 it would have been negligible. This doesn't lead to a significant change in profit. But it does lead to, in our view, a more comparable and a better way of reporting our results. With that, I'd like to hand back to Roeland to discuss the outlook for the first quarter.
Thanks, Chris. Looking forward, as said, the stainless steel market is expected to be strong in Q1 with a healthy underlying demand both in the U.S. and in Europe. Our Q1 delivery volumes are expected to be higher in Europe and significantly higher in the Americas if you compare it to Q4. Cost saving initiatives are expected to continue according to plans and continue to build up on what we have initiated in 2016. The higher ferrochrome contract price, of course, will have a significant positive impact on the business area in Europe's profitability. If we go to the outlook as we have formulated here, there's one thing I want to say upfront, which is because we have moved from the underlying EBIT to adjusted EBITDA as our metric, we deemed it necessary to rebase the values for our outlook one time, and that is in Q1.
Although we normally guide on a qualitative basis, we have said that for Q1, because of the changes, we want to give a more direct quantitative guidance. What that guidance is that we expect our EBITDA, our adjusted EBITDA, to be over EUR 250 million for the quarter. Going forward, we will take that as the benchmark and go back to a qualitative expression of our guidance. Secondly, in our outlook, because of the progress made in 2016 and corrected for the fact that we are now going to pay a dividend, we still think that we will be able to improve on the end of year target that we have for net debt. We are looking to get to a target of below EUR 1.1 billion of net debt by the end of 2017. That concludes our presentation.
Thank you, Roeland. Operator, we are now ready for the questions.
Okay. Thank you. If you would like to ask a question at this time, please press the star or asterisk key followed by the digit 1 on your telephone. Please ensure that the mute function on your telephone is switched off to allow your signal to reach our equipment. If you find your question has already been answered, you may remove yourself from the queue by pressing star 2. Again, to ask a question, please press star 1. We will take our first question today from Seth Rosenfeld from Jefferies. Please go ahead.
Good afternoon and congrats on a very strong set of results. I have a couple of questions. First on guidance, then separately moving on to the Americas division. For the Q1 guidance, I was wondering if you can give us a bit more color or perhaps a bridge, perhaps quarter-over-quarter, looking at both the impact of the chrome price and also the underlying stainless profitability stripping out chrome. Can you give us a sense of what level of base price hikes we expect to see hit your P&L in the Q1, given the trailing impact in spot prices? Any sense of scale there would be very helpful. Then separately, on the Americas business, profitability has improved quite a bit, but clearly continues to disappoint and lag a peer, like Acerinox, for example. You are now running at very high utilization rates.
Can you walk us through what are the necessary steps to catch up on the margin front and on what sort of time horizon that might be an achievable target? Thank you.
On the first question, we do not guide specifically on parts of our business. We have given a guidance back in Q2 on what the potential impact is of a 10 cent move in chrome as a relative figure, which you have to correct as well for input prices. For instance, in Q2, coal prices were significantly lower than they are now. As a result, cost on producing ferrochrome have gone up, and the same goes for electricity, et cetera. So, an exact bridge we will not give. The impact is significant. If you get to the stainless market, we see significant increase in volume in the Americas, and we see a continuation of improved pricing in the first quarter in base price. The same we see happening in Europe, where we see an increased volume and better pricing.
Okay, thank you.
On the Americas?
Okay, thank you. On the Americas.
Yeah, on the Americas. Yes, we have been lagging for years the profitability of NAS. We are at the same time closing the gap, and that is something that is not overnight. The progress we have made specifically on the cost side is the big driver of profitability. That potential that we have in driving out further cost has not come to an end by far. So it is the continuation of our cost drive that will bring our margins ever closer to what you see from NAS. As we, by the way, do not have specific figures on the North American operations of Acerinox, I cannot really comment on it.
One last follow-up on the Americas. I know that you reported a small drop in your realized base prices during Q4. That seems to be somewhat different than the spot prices or the benchmark prices that we can see from various data providers. Was there an issue there with discounting or any other thing in the market that would have impacted you uniquely in Q4 in the Americas?
No. On the contrary. We have, in Q4, opted to not do any drop in pricing as you normally would see in Q4. Historically, you have always seen that as the distribution sector in the U.S. stops buying, the only way they would take volume is if you have steep discounts. This has been a practice for years. We have said that we absolutely will not participate in that practice and have opted to actually take advantage of some very lucrative export opportunities. Now, the one thing that always influences our specific pricing is our mix. If we get more black coil into Mexinox, for instance, then that influences immediately our average pricing. But our market pricing has been absolutely at the high end.
Great. Thank you very much.
Our next question comes from Philip Ngotho from ABN AMRO. Please go ahead.
Yes, good afternoon. It's Philip Ngotho from ABN AMRO. I have a few questions, if I may. First of all, on the tax loss carried forward. You indicate there's approximately EUR 2.6 billion left that is unutilized. That's of course, a different valuation from last year. I was just wondering if you could also indicate what portion of that will never expire. So which portion doesn't expire? My other question is on, we saw recently that you divested the quarto plate mill in the U.S. I was wondering if there are any other units within the portfolio that you might be looking at or what your view is on that. My last question is on your order book. I was wondering if you could give an indication of how well filled they are in Europe and in the U.S., what the lead time is at the moment.
Okay. I'll take the question on the tax losses. I don't think they are materially different from last year. Recall that the EUR 2.5 billion is after we have effectively put the tax loss carry forwards or the tax assets for Finland and Sweden back on the books. So the difference between the number you probably have in mind and the number that we're now declaring is the Finnish and the Swedish tax losses. So that gives you some sense of the size that we've put back on. The second question is, of those EUR 2.5 billion, a very large part, we don't number, but a very large part relates to U.S. tax losses, and those do not have an expiration period.
Okay. Thank you.
On the other two questions, Philip. The divestment of the quarto plate mill was an optimization of our portfolio. It was one of the mastering battles, as you might remember, in 2016. We always said there will be no large moves, either acquisitions or divestments. But this was typically one where it was within our portfolio, not core, or quarto plate is core, having a far-flung operation that is working in a very small niche, in a very large market without its own direct backup from melting, just didn't fit the portfolio. We do not see at this moment anything immediately on the horizon where we want to do something similar.
Okay.
On the order book, if you look at both EU and U.S., yes, they have been filling up nicely. Orders have been, I would say, accelerating in January in both territories. In Europe, we are booking into May now, and in the U.S., we are booking now into end of March, early April.
Okay. Thank you. Very clear.
Thank you. Our next question comes from Michael Shillaker. Please go ahead.
Hello? Hi, it's Mike Shillaker of Credit Suisse. A couple of questions, if I may. First question, can you just help us out a little bit, again on the ferrochrome situation in the Q1 guidance.
In terms of the timing of the surcharge actually hitting the P&L, because you benefit from the fact that you make ferrochrome, but you are raising the surcharge. I guess there is a degree of lag between you raising the surcharge, that actually being implemented, and then invoicing and actually hitting the P&L. Is it fair to say that did not fully hit the first quarter and some of that will lag into the second quarter, regardless of the second quarter contract? The second question is, I guess one we thought we would never ask a couple of years ago, but companies in this business tend to go from over-levered to under-levered quite quickly, and you could see a scenario within a year or two's time where you are actually looking under-levered.
Can you actually give us some thoughts on longer term capital allocation between CapEx, shareholder returns, M&A, and similar? Just finally on the ferrochrome market, it is very odd because it is not behaving at all like nickel, and I know you are talking about a sort of seller's strike apparently at 150 or so. But nickel still seems to be telling a very different story. So what really do you think has happened fundamentally between ferrochrome and nickel in the last quarter or so to see such a significant gap in fundamentals opening up? Thanks a lot.
All right. So on the surcharge question, the surcharge is nothing other than a pass-through of input cost to the customer. The profitability of our ferrochrome is the price we charge for the transfer from our operations into either our own facilities or into third-party markets. As I said, about 75% goes into our own system and the rest goes into the market. So it is a direct relationship. There is no lag. It is basically we produce ferrochrome, we sell it to either our own system or to the outside world, and it is an immediate realization. Under-levered, over-levered. I am an extremely conservative Dutchman, so I will give this question to Chris.
Well, it is a nice problem to think about, Michael. I think we said that at the end of December, we are at a leverage of 4.2. That is not extremely cautiously leveraged quite yet. So I would say let us get to the bridge and then cross it when we get there. We still have a long way to go before we are under-leveraged, I think, from the current base. We are a publicly listed company. There will be an expectation for dividends in the future. We will be conservative on CapEx, but we have some way to go before we are under-leveraged, I think.
Can we get to what is different in ferrochrome versus nickel? A lot is the answer. I will start with nickel. Nickel is one of the volume-wise largest, if not the largest traded metal. It is traded on the exchange, and it has a system of LME and as its stocks inventories where you can sell into. If you look at what happens on the nickel market, we have been growing inventory for years now because there has been overproduction of nickel. As a result, you have probably a combined 9 or 10 months of inventory sitting in LME and Sheffield warehouses. Currently, you could say that there is a shortage in the supply-demand balance of what is being produced and being consumed in nickel. But as said, you have this sort of natural cap of the inventories.
Then you have Nickel Pig Iron, probably with a price, a cost that will make it viable from about $13,000. That is another natural cap. As soon as you get to $13,000 or higher, you might see more Nickel Pig Iron come back. Although, again, the input costs are a big driver and with the current coke and coal prices, that is a moving target. But it is a very specific market. Ferrochrome is not being traded on an exchange. It does not have huge stockpiles. It is very much a product that is produced in three or four major territories, and you have basically one very large consumer. So it is a much more volatile, in that sense, market, but much more a real time market than nickel is.
Are you basically saying that the supply side as well in ferrochrome and the inventory situation is actually a lot lower and that is why the price is behaving like it is?
Well, the price is behaving like it is because, one, demand shot up with the increased melt rates in China. And two, because of the higher input costs, specifically coke.
Right. Okay. All right. Just sorry, back to the first question, Roeland. You're absolutely right in terms of the ferrochrome business itself, in that the price goes up and the ferrochrome business makes money straight away. But for Outokumpu, that only actually turns into EBITDA at the group level if the transaction price goes up. Otherwise, you're just going to squeeze your mills. You'll make it in ferrochrome and squeeze the mills. Therefore the question is the actual pass-through in terms of the transaction price and the surcharge, has that been in the first quarter absolutely instantaneous, or was there any lag?
Yes is the answer.
Yes, it was instantaneous?
Yes.
Okay. Thank you. Perfect.
Thank you. Our next question comes from Carsten Riek from UBS. Please go ahead.
Thank you very much. It's Carsten Riek from UBS. A few questions from my side. On the ferrochrome again, because for me it was a supply shortage in the middle of last year, where we're seeing four smelters going out in South Africa. All we see right now is supplies actually acting on the high ferrochrome prices. What is actually baked into your forecast going forward with regard to ferrochrome prices? Because if I look at your net debt target, it looks like you reduced net debt by around EUR 150 million, which would be more or less after the first or second quarter achieved. Are you a little bit more cautious on ferrochrome during the year? Second question I have is, if I look at your net working capital, which significantly contributed to the free cash flow, how much is left there?
With increasing ferrochrome prices and with also increasing volumes, what does it actually mean for your net working capital assumption next year? The other question you answered already, CapEx, I believe you're around EUR 150 million in 2017. That's it pretty much. Thank you.
Okay. Carsten, thanks for the questions. On ferrochrome, we give an outlook for the business quarter by quarter. We don't give any outlooks for specific parts of the business and definitely not for longer term. So I really can't help you there. Net working capital, I'll ask Chris to answer that. Your first thing when you talked in your first question about you must be less bullish on ferrochrome going forward because of the net debt not going down as fast. First of all, again, as I said, we have a dividend that we're going to pay. Secondly, we have decided, given the outlook, to increase our CapEx slightly to about EUR 184 million. We do that because we see significant opportunities to have cost saving, quick return investments in most of our facilities. The net working capital question will explain part of the cash as well.
Okay. Yeah. To address your first question, Carsten Riek, I think we squeezed the lemon fairly hard in 2016. I think there's not much juice left in that one. Underlying, I don't think there's much to go on net working capital reductions. But clearly given the guidance we've given, which is premised on higher ferrochrome prices, higher base prices, higher transaction prices therefore-
Higher volumes.
and higher volumes, you're going to see a significant increase in accounts receivables during the course of the first quarter. We're going to have a cash outflow due to net working capital increase, and that offsets to some extent in the first part of the year, the very strong EBITDA. Now we will see that come through as the EBITDA works its way through the cash conversion cycle and forms higher cash down the road, but it's not going to be by the end of the first quarter, as you suggested. I think that'll be more towards the second quarter.
Okay. Do we also see a reversal of the payables because they were considerably down in the fourth quarter?
A little bit perhaps, but not in a major way, I don't think. I think you'll see the impact hitting more on the AR side during the course of Q1.
Okay, perfect. Thank you very much.
Thank you. Our next question today comes from Bastian Synagowitz from Deutsche Bank. Please go ahead.
Yes, good afternoon, gentlemen. I've got three questions left. Firstly, just to clarify briefly on your guidance, can you just briefly confirm that your Q1 guidance is not including any one-off valuation effects from nickel or ferrochrome? Secondly, on base prices in Europe, it seems to me like European prices are still lagging the price dynamic which we've seen in China. On the other hand, we still have the reopened anti-dumping case against Taiwan. We've obviously seen some uptick in base prices, and you kind of hint that there is some more upside. But shouldn't this environment give us some more scope to see a much more significant base price dynamic? I guess as a market leader, you would obviously need to take the lead here. So quite curious to hear your views.
Lastly, could you please give us some color on how your P&L and cash tax rate would look like in the first quarter and maybe also if the first quarter result is sustainable, what is the tax rate we can assume going forward on this earnings level? Thanks so much.
Great. I'll take the first and the third one, Bastian. In terms of the guidance, we've not included any positive valuation effects of inventory and nickel in there. There's no assumptions around that. In terms of the tax, our cash taxes in the coming period will obviously be very small because we have these loss carry-forwards. Any taxes that come due on the profit will eat against the loss carry-forwards and therefore not be very cash relevant. There will be smaller amounts of cash taxes because we have to, again, go down to the very individual legal entity level. We do have some legal entities that did not have loss carry-forwards. In those we will have to pay and there are also some jurisdictions where you have minimum tax payments. It'll be very small, but some cash tax payments.
In terms of the cash tax rate, in terms of the actual P&L rate, I would expect it to be slanted a little bit more towards the 20% level than the 30% level because a lot of the profit will come obviously from the ferrochrome in the first quarter, and much of that profit is generated in Finland, and that has a lower tax rate than, say, the U.S. So, in the low 20s I would say.
Yeah. On pricing, China indeed the pricing has jumped significantly, and that is partially because of the high melt rates, but the largest effect on the Chinese pricing has been the cost. A lot of the melting comes through the integrated route in China, and again, back to coal and coke, that has a significant impact on the cost. As I said, we have still 25% of consumption in Europe comes from imports. It's not just China we're looking at. You have to look at all the exporting entities that look at this market. So you have to always weigh between what you prudently should be doing without actually opening the floodgates for imports coming in. It's not just China. On Taiwan, the anti-dumping case, there was an investigation to see whether there is any circumvention.
That is still going, and until there is an official announcement from the commission, there is nothing I can comment on.
Okay. Thank you.
Thank you. Our next question comes from Roger Bell from JP Morgan. Please go ahead.
Hi. Actually, it is Shepan Steindel from JP Morgan. I have two questions. The first one is on inventory levels at distributors. Are they above or below average levels given this part of the year? The second question is on the customer behavior given the increased volatility in nickel in the early part of this year. Thank you.
Yeah. Good question. So inventory levels in Europe are below historical levels for the time of the year. Not significantly, but they are below. In the U.S., they are slightly above. You would expect it as well, because towards the end of the year the end user consumption tails off. There is no big strain either way on either of the markets. The move that we saw of nickel suddenly dropping might have had an initial sort of pause, but as I said, our order books and order intake during the month of January have been very strong. So it looks that the underlying market is still strong enough, and inventory is not big enough so that people can sit back and see what actually is happening with nickel price.
Thank you very much.
Thank you. Our next question comes from Luc Pez from Exane BNP Paribas . Please go ahead.
Hi, gentlemen. One question, if I may, with regards to Mr. Trump and talks of border tax. Have you thought of the implication for your Mexinox subsidiary? Could you maybe quantify the share of final product that goes back into the U.S.? If any border tax is implemented, would you think of expanding the cold rolling operations in the U.S.?
First of all, it is still unclear what Mr. Trump actually is going to do. He has let up a lot of little helium balloons. Some of them will pop, some of them will stay. We will see. As far as the volumes that go, we bring black hot band from Calvert into Mexinox, so U.S. to Mexico, and we bring back probably about 80,000 to 90,000 tons from Mexinox into the U.S. If there will be a border tax, then there are a lot of questions. Is it a border tax just from Mexico into the U.S., or will Mexico put up their own retaliatory things? Will it be across the board or for supply chain parts that existed from before, will there be exemptions?
Whatever it is, we do have a plan B which is ready to go if it needs to be, that will absolutely minimize any negative effects. It will probably require small extra investments in Calvert, but in the order of EUR 10 million to EUR 15 million to take over some of the capabilities. But it is nothing major or alarming as far as we are concerned.
Thank you.
Thank you. Our next question comes from Johannes Grasberger from Nordea. Please go ahead.
Hi, gentlemen. Couple of questions on my side. First one is, I am sorry about this, but I have to come back to this deferred tax asset discussion. Am I understanding this right, you have sort of EUR 2.5 billion of unrecognized assets still kind of lying on the sidelines? Just trying to calculate this in my head, that would kind of imply sort of five years of zero tax payments for Germany and the U.S., while I guess Europe, the Finnish and the Swedish assets are already in pre-tax profit. So there, the tax payments are coming in advance. Is this the right way to look at it? That is the first question.
Well, the way you have to look at it is that we have. First of all, we have to subdivide our total loss carry-forwards into different tax entities, if you like. The five major ones are Finland, Sweden, Germany, the U.S. and the U.K., not necessarily in that order. The way we look at this is that we say, if we have a tax entity that is making a profit or that made a profit in 2016, and where we are very confident that it will continue to make a taxable profit going forward, then we have to take the tax element of those losses and put them back on our balance sheet, and that has a P&L impact. We have done that in the past. We indicated around about 3.7, 3.8 billion of tax loss carry-forwards. Now we are down to 2.5.
We have done that to the Finnish and Swedish ones, and the math suggests it is about EUR 1.3 billion, where we have now taken the tax credit back on. That means those loss carry-forwards are still there, but we have recognized the tax assets associated with them. Now, if you look at the rest, those entities did not, at a tax level, make a profit in 2016. We are not able at this stage to recognize the deferred tax assets associated with them. Once those do make a taxable profit, we will start recognizing the tax assets associated with them. The remaining 2.5 is predominantly Germany and the U.S., some in the U.K., and at this stage, we still have those tax assets associated with those losses to bring back on at some stage in the future. Was that clear or was that still confusing?
Yeah. Kind of follow up on that one. If I just take the Q4 equity level of EUR 2.4 billion and you reverse EUR 2.5 billion in deferred tax assets back to the balance sheet and then-
No, you have to take the tax. Those are the net loss carry forwards, and then you apply the tax rate in each jurisdiction to those 2.5 billion. Let us say as an average, the tax rate is 30%, then you would apply 30% of those 2.5 billion as loss carry forwards, so around about EUR 830 million as an asset onto the balance sheet. Not the 2.5 billion, but just the tax element of those.
Yeah, exactly. A very good point.
Yeah.
Now to the actual business questions. I am quite curious about the European stainless steel markets. Where are you actually seeing the demand coming from? Are you seeing any kind of restocking impact, or is the underlying demand really that strong, which is pushing up the volumes in Q1? Regarding that one, the discussion on base prices, do you think the base prices are at a fair level compared to the long history right now? Should the strength of the underlying market still allow higher prices given that the reduction in cheap Chinese imports has already happened?
Demand is very healthy, I would say, in everything that is consumer driven. Everything from white goods to automotive, as well in building construction, there is a lot of activity going on in the housing market. All those sectors are very strong. We still see the large industrial sector somewhat subdued. Although they are coming back, it is from the low of 2016. We are seeing some extra activity coming in the U.S., specifically on the oil and gas side. It is across the board. There are no real segments that are lagging behind that much. On base prices, if you look at historical numbers, we have been in Europe, at some stage at EUR 1,400 per tonne. We are currently at EUR 1,150, EUR 1,160. I think your banks are the first ones to say that performance of the past is no guarantee for the future. That goes for us as well.
There have been better pricing moments. We will, as a company, do what we can, of course, to optimize the way we price in the market, where we have to defend both our volumes as well as our profitability for pricing. We will make that call whenever we have the possibility.
Okay. The last question is really about Mexico as well. Have you had any indication from the market that you could have an inflationary environment for steel prices in case the tariffs are put between Mexico and the U.S.? Because as far as I understand, the U.S. stainless steel market is short of domestic capacity, so cutting anyone out of that market would, in theory, as far as I would look at it, raise the price. The second question is that you said that you have a plan B in place. Is it actually possible to just move the cold rolling equipment from Mexico to Calvert, which would, I suppose, reduce the cost? It didn't sound very expensive to do this plan B, if you were talking some EUR 10 million to EUR 15 million cost impact from that. That's the final question.
Let me start with that. Moving the cold rolling facility would not be EUR 10 million to EUR 15 million. That would be basically akin to building a full new plant of half a billion or whatever. That's not the plan B. Just a few points on the markets. The market in Mexico has been growing for the last decade very strongly for stainless steel. We are the only domestic producer. We are fully utilized in that facility, and actually could sell more into the Mexican market, if we would not have a strong supply commitments as well in the U.S. A plan B would be to redirect those streams that go now into the U.S. into the local market, which will displace a number of the importers, without, by the way, any loss of pricing as far as we can see.
The investments that we would do in Calvert are just in the small extra capabilities to be sure that we can replace that specific product and produce it locally in Calvert.
All right. Thank you. That is all for me.
Thank you. Our next question comes from Johannes Grunselius from Handelsbanken . Please go ahead.
Yes. Hello, everyone. Johannes Grunselius, Handelsbanken. Most of my questions have been answered, but I still have a few questions. First of all, there was apparently a sort of a non-recurring thing in the underlying EBIT in Americas, EUR 9 million you said in supplier invoicing correction. Could you give some color on what that is?
Yeah. We have a partner there who provides services for us. The last two years, in 2015 and 2016, they incorrectly invoiced us for some of their services. Then they came back in 2016 and said, "We believe that we mis-invoiced you for some of these services." Then we had a lengthy discussion with them through Q3 and Q4, and ultimately we agreed that they were correct, that they should have invoiced us more. That total amount over that period added up to about EUR 9 million. So we agreed with them that we would pay them for those services going backwards and made that booking in the fourth quarter.
Yeah. Okay. That's clear. But to me, it sounds like very much a non-recurring thing, but still you booked it as an underlying. That's good to get the color on it.
Yeah. It is an underlying because if you go back and you were to take it back over the last eight quarters, you could say if you divide it by eight, then each quarter we should perhaps have. Going forward, it will actually impact the cost base by EUR 1 to EUR 2 million as well. So we felt it was prudent and fair to book it as an underlying. You could make the argument, and we had the discussion whether it was underlying or not. In the end, we opted for the side of conservatism here.
Sure. Then another detailed question. If I look at your underlying EBITDA per division, for instance, you have a pretty big number now, which is the intragroup items and the other operations, minus 16. If I look at the full year, for instance, that number was 41, so it's about EUR 10 million per every quarter. Am I right that this number was pretty high, and we should expect the level for the forthcoming quarters to be slightly lower? Can you give me some help there, please?
Yeah. That number, part of it is services that would be just management service and other things we have in the company. But the main elimination area there is also for certain material to move around. For example, ferrochrome, as profits on those go up, then the elimination. The other piece is that also since 2016, in the end, ended up being a very strong year, perhaps a little stronger than we were expecting at the beginning of the year. It means that a lot of our employees become eligible for a bonus, and we also accrued that in the last quarter.
Okay. What is a reasonable number to think of for the coming quarters?
No, it's difficult to say. I think it was particularly high in the fourth quarter this year. I think that was perhaps a little bit of catch up on the bonus accrual as well.
Okay. On ferrochrome again. You gave us the volume for Q4, I think it was 109,000 tons. I think you have a production capacity of 530,000 per year. In other words, 132,000 tons per quarter. How should we think about volumes for 2017 and the quarters? Are you planning for any shutdowns during the year? Should I expect 130,000 plus to be the volumes to look at for the coming quarters?
We have guided for Q4 that we had in the ramp up during October, some issues with getting it to its normal capacity, and that's what you see in that 109,000 tons.
Okay.
We have as well guided for, as a general number, EUR 500,000 to EUR 520,000 as annual capacity. That's what we maintain, that's what we are pegging the coming year as well.
Okay. So no major impact from any shutdowns, would you argue, for this year as it looks now, or?
I think we have planned some maintenance for ferrochrome furnace one, which is a smaller furnace, but that will not be a major impact.
Okay. Thanks. My final question, the CapEx going forward was mentioned in one of the discussions here, I think earlier. Just to be clear, what kind of CapEx level should we look at for this year, 2017? How should we expect the CapEx for 2018-2019? Will that be a slight uplift in CapEx because of opportunities that you see right now?
I'll take that one. I think the range of EUR 150 million to EUR 200 million is a very solid assumption for this year. We expect that to be the same going forward. There may be smaller spikes as some of the bigger projects get implemented. Probably the biggest that's looming over the next five or six years is the Kemi mine. So, in 2019 or 2020, we may see a little bit of an uptick on that.
Okay. Thank you very much for helping me on my questions. Thanks.
Okay.
Thank you. Our final question today comes from Hjalmar Ahlberg from Kepler Cheuvreux. Please go ahead.
Thanks. I just wanted to check maybe if you could say something about the raw material cost push in the ferrochrome industry in general. Do you have any indication of how much the cash cost curve has moved in Q1 compared to Q4, maybe?
I have to admit, I don't. I know my cost curve. It's very difficult to see what it does in Kazakhstan, in South Africa, or in China. I think what you can say is that the cost curve in China has been most impacted by the underlying input cost changes.
Okay, thanks. On this new adjusted EBITDA, will you still specify raw material and inventory changes, or will you not mention them at all when you report?
I think we'll need to review that in Q1. I think our tendency at this stage is unless they are very large and significant, we will probably not report on them anymore in the future, or only as a side note.
Okay. Just a question on the savings. You said that you have realized around EUR 70 million or so in cost savings in SRNA in 2016. Will that mean that 2017 should have another EUR 30 million coming or so, or will it be a bigger impact since this was the run rate in end of the year?
It will be that order of magnitude. The run rate, what we said is that the run rate has to be at EUR 300 million or lower by the end of this year. There is more coming, but that is the target this stage. We are very confident that we will meet that, and we will work very hard to exceed it.
Right. On the other savings program, or the older savings program, you still have some around 1,000 people you want to reduce workforce with. Is that mostly going to impact Europe, or where do you see other cost savings coming?
As you know, the SRNA program that we started has a large headcount impact. We said 600 heads. We have part of that already realized in 2016, but part of that will be over the next year to 18 months take place. The same goes for the prior moves we have done with the closures. Not every head is out of our count yet, and that will happen over the next few periods.
Right. Lastly, you mentioned you have moved forward some of your debt and increased your maturities. Can you say anything about the financing cost? How will the net finance be impacted in the next two years?
It will go down. We have a clear target. As we said, we have a clear target to reduce our net debt. By the way, that will also include a reduction in the gross debt, and therefore we expect our overall financing to come down. As I said before, it is going to be a combination of refinancing at lower costs. We have some very high-cost debt repayment of certain facilities without refinancing them, and also looking at optimizing our overall liquidity level, for which having that availability also obviously costs money. There are also other ideas, but clearly, financing costs will come down in the next years.
All right, perfect. Thank you very much.
Okay, thank you. We actually have one further question now from Elena Epifantseva, from Rothschild Asset Management. Please go ahead.
Hi. Thank you for taking my call. It is just actually the same on financing. Do you plan to call the 2019 bond, the secured one that is callable from March, I think? If you are, I think just maybe want to give you a color, I think another convertible bond would be a good option. I think there would be investor appetite for that. Thank you.
At some stage, we will call that bond, because between now and when it matures, we will probably call it, but I can't give any indication at the moment of when exactly that will be.
Sure. Thanks.
If there are no further questions, I'll hand the conference back over to your host for any additional or closing remarks.
Thank you very much for your attention and active participation. Outokumpu first quarter 2017 results will be published on April 27th. Until then, thank you and goodbye.
You. That will conclude today's conference call. Thank you for your participation. You may now disconnect.