Thank you. Good afternoon, ladies and gentlemen, and welcome to Outokumpu's second quarter 2017 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.
Thank you, Tommi. As always, would like to start with our vision and just repeat it again. It is to be the best value creator in stainless steel by 2020 through customer orientation and efficiency. This is still, for us, the guiding principle. As you know, this is applied onto our three stakeholders, customers, shareholders, and employees. We remain committed to this vision, and are confident that we will fully reach the vision. Going to our Q2 results. We had a solid Q2, in spite of the issues that you all know about on the ferrochrome production, and I will get to that. Before, however, getting into those details, one thing is something that is very near to what I believe in, and it is that no result can be satisfactory if you do not have a spotless safety record.
Unfortunately, in the second quarter, we had a fatal accident with a contractor in our facility in Sweden, Degerfors. We have spent tremendous amounts of time and effort in improving our safety performance. Looking at the statistics, we have almost brought down our incident rate from 2015 to now by three quarters, and still, apparently it is not enough yet to safeguard everyone in our company who has to do with our company. So it is something that, in spite of the strong Q2, overshadows, in my opinion, significantly, the performance of the quarter. Moving to more of the numbers side. As I said, it was a solid result, EUR 199 million, bringing the first half of the year to an adjusted EBITDA of close to EUR 500 million. Of course, the market has helped us here.
We had a healthy market with higher ferrochrome prices and higher stainless steel base prices. However, our own productivity and efficiency improvements have contributed strongly as well. We have continued to bring down our SG&A, as you can see from the numbers. We have reached solid productivity numbers of 4.5% group wide. So we, in that sense, operationally are still well on track to bring the improvements that we have set off to do. One exception has been ferrochrome. Again, we have been talking about this now for a while. Our ferrochrome furnace number three kept on giving problems during the quarter.
Apart from not producing the amount that we actually wanted out of it, we have as well decided to take it down for longer towards the end of the quarter and into quarter three in order to fully mitigate and repair anything that is not alright with it. The low ferrochrome production was the other negative for the quarter. Then we had a negative timing impact due to the lower raw material prices. In spite of that, we achieved a very healthy cash flow of EUR 150 million, which allowed us to reduce our net debt to about EUR 1.24 billion. When you look at the markets, the European base prices have come under pressure towards the end of the quarter, specifically as nickel prices fell over the quarter and towards the end of the quarter as well, it became clear that ferrochrome prices will be falling.
We saw two effects. One was that there was a hesitation, especially in the distribution sector, to take volumes in expectation for lower alloy surcharges and lower transaction prices. That, in its turn, gave as well some downward pressure on pricing. If you look at the right hand of this slide, you see the import penetration that has actually grown. It is now up to 27%, so still on a slight upward trend from what it was earlier in 2016. This is specifically from the rest of Asia. Looking at the Americas, there the base prices have been stable. The effect of the destocking has been less noticeable, although destocking has happened there as well. At the same time, you can see that the import numbers still are pretty much in check now trending still downwards at about 22%, 23%.
With that overview, I would now like to hand over to Chris for some of the financials.
Thank you, Roeland. Good morning, good afternoon, ladies and gentlemen. If we turn our attention to slide number eight of the pack, we summarized here the key financials for the second quarter and set them in comparison to the second quarter of 2016. You can see that stainless steel deliveries in the second quarter relative to the comparable period last year were almost at the same level. We had increased deliveries in the Americas, but they were offset by somewhat decreased deliveries in both Europe and in Long Products. Look at the sales, they were clearly up. This was driven by higher prices. Looking at the adjusted EBITDA, you can see that it was very, very clearly up against the comparable period last year, 3x the level, and our net result was solidly positive in the second quarter.
The operating cash flow at EUR 150 million was robust, and our net debt has come down by over EUR 250 million versus the same period last year. It is now at the lowest level that it has been for many, many years. We continue to be very restrictive in our working capital expenditure, EUR 31 million of cash expenditure, although looking forward, we are expecting to finish the year at around EUR 180 million of cash out in terms of investing in key projects and maintenance of our assets. Our personnel numbers have also come down. We are about 400 people down versus the same period last year and about 350 people down versus the end of 2016, in line with our efforts to improve productivity, and particularly to reduce SG&A costs and the back office staff that we have.
Let us now turn to slide number nine, Europe in a little bit more detail, and you can see Europe continued its strong performance into the second quarter. Deliveries were about 3.6% down versus the same quarter last year. If you look at the market overall in Europe and the Eurofer reported market numbers, they were down 8%. Not only did we hold our market share, but we actually relative to the market increased a little bit. The adjusted EBITDA for the period was at EUR 178 million . That is over 130% up year-on-year, and it was driven partly by higher base prices for stainless steel, but as you know, ferrochrome prices in Q2 of this year were much higher than the same period last year as well.
It was also driven by product mix and of course by ongoing reductions in our variable costs per tonne and by the reductions in our SG&A costs. We continue to see in Europe strong underlying demand in Q2, and in all customer segments. We saw base prices increase not just quarter-on-quarter, but also significantly versus the same period last year by EUR 120 per tonne. Distributor inventories have now moved above average historic levels in Europe, so have moved up there. If we look at our ferrochrome operations, clearly the price was much higher this year than the same period last year. As Roeland already mentioned, we continued to have issues with our ferrochrome production throughout the quarter, so production volumes were low, 36% reduction year-on-year. This was also due to the postponed maintenance.
The production there struggled throughout the quarter, and due to the technical issues that we have talked about in previous calls. Turning to slide number 10, let us look a little bit more closely at the Americas performance. We can see that deliveries once again increased by 5.1% versus the same period last year and just about reached a new record level there. EBITDA compared to last year was up very significantly, and it reached almost the same level as in the first quarter, driven by higher deliveries and prices, but also by a reduction in variable cost per tonne and also SG&A costs in this area. We also are seeing the product mix in the Americas continue to improve. In the second quarter, demand was robust. We saw distributor demand somewhat negatively influenced by declining raw material prices, and inventories have decreased a little bit to below long-term average levels.
If we look at the quarterly base prices compared to the previous year's base prices, they were up by about $105 per tonne. The one comment we do have to make is that the result included a one of positive effect of EUR 6 million. Needless to say, you will be aware that the U.S. dollar also weakened a little bit during the second quarter, so that also had a little bit of an impact on the results. If you will now turn to page number 11 on the Long Products results, we can see that it was once again very solidly positive during the quarter. Second quarter results deliveries decreased a little bit because of lower internal slab deliveries to Europe. Long Products produces not just for the external market, but the melt shop in Sheffield also supplies Europe with slab and input for its own operations.
Looking at the adjusted EBIT improved mainly because of higher base prices, but also because of improved cost competitiveness and underlying demand during the quarter remained solid. We saw a decline in distributor demand towards the end of the quarter here, and higher base prices in Europe and the U.S. compared to the same period last year. The comparison to last year has to be made in the context of there being a significant loss last year due to the pound derivative we entered into last year. That was a EUR 5 million negative impact. While the increase looks very big at first sight, if we made that comparison, it was still higher, but not by quite as much. We also had a positive impact from raw material related inventories and metal derivatives in this result.
Turning to slide number 12, you can see that our cash position strengthened further. The net cash from operating activities was EUR 150 million in the second quarter, clearly much higher than during the second quarter of last year. We generated a net cash, so this is a few offset investments into assets minus receipts from disposals. It was EUR 9 million. If we deduct that, the cash flow before financing activities was EUR 141 million. Our cash and cash equivalents at hand increased significantly through the quarter and stood at EUR 289 million. There was an increase in net working capital during the quarter. Although we did reduce our inventory tonnes and our trade and other receivables, we did also reduce our payables by over EUR 126 million as we needed to support the reduction in inventories through lower purchases, and that reduced our payables.
The net impact of all of those was actually an increase of EUR 29 million. We did not get much support from lower prices overall during that quarter. If we look at the financing costs during the second quarter, there were EUR 31 million. Interest expenses of that were EUR 24 million. The rest went to derivatives and hedging instruments. Our overall liquidity reserves continued to be very strong. EUR 289 million of cash in the bank and very large standby facilities mean that we have a liquidity reserve of over EUR 1 billion. Our net debt decreased by EUR 137 million to a new low of [EUR 1.24 billion]. If we now turn to slide number 13, you can see on the left-hand side the development of our net debt. It has continued to come down.
It picked up a little bit in the first quarter because the working capital issues come down again in the second quarter. The leverage, of course, if you compare that against the LTM EBITDA, continues to fall dramatically. We are now solidly below 2x at a level of 1.8x. Our gearing is also continuing to decline. It has reached a new record low level of 48%. Debt maturity on our debt is also no longer an issue here. We have worked through all the longer term facilities 2017 and refinanced them. The facilities you can see here are short-term commercial paper, have little maturities coming up in 2018 with a big repayment wall, if you like, during 2019. That is a bond on the one hand and then revolving credit facilities that need to be renewed in the course of that year.
There is a couple of other things on the financing and balance sheet side that are relevant for the second quarter. We redeemed EUR 25 million of the EUR 250 million senior secured notes that are due in 2021. This was probably our highest piece of financing, and we negotiated as part of that financing the opportunity to refinance 10% in the first year and exercise that option because it was a big opportunity for putting some of our cash to work there. Moody's also upgraded us during the course of the quarter and moved our issuer corporate family rating from B3 to B2 and the probability default rating to B2- PD from previous B3- PD. Our senior secured notes, both those that are due in 2019 and those that are due in 2021, were upgraded to B1 from a previous rating of B2. The outlook on the ratings remains positive.
Let us go to slide number 14. Before we get into the outlook statement that Roeland will give, I would just like to say a few words on timing impact here. We have tried to demonstrate this in a couple of charts to try to make it clearer. The timing gains and losses when we talk about them occur from the difference between purchase price and invoice price of metal components. The purchase base is the period which determines the alloy purchase price for scrap or prime material supplies, while the invoice base is the period which determines alloy surcharge for stainless steel customers. Timing gains or losses between those arise from all alloys, but are usually significant only for nickel, chromium, molybdenum, and iron.
We have hedging in place to mitigate timing impacts related to nickel, but for ferrochrome molybdenum, and in this period, particularly for ferrochrome, it is very relevant, it is not possible to hedge those because there is no market. Just in terms of giving a sense of the size of timing impact, you will recall that we talked about timing and hedging positive impacts in the first quarter of around EUR 33 million, when ferrochrome moved up by $0.55 per pound. In the third quarter now, it has settled at $1.10 per pound. That is a decline of $0.44 per pound versus the level in Q2, and it gives perhaps some indication of the size of the timing impact that we are expecting in Q3. With that, I would like to hand back to Roeland to give you an outlook on the next quarter.
Yeah. Thank you, Chris. In summary, if you take all the things together we have been talking about, we see for Q3 the typical seasonal slowdown, which will lead to a slight decrease in volumes in Europe, and not so much, though, in the U.S., where we see stable volumes QoQ. We see some market pressure still continuing because of the de-stocking that started and because of the changes in the alloy surcharge. Then, we see indeed the effect from ferrochrome. As Chris was saying, we have seen a drop of $0.44 a pound that will significantly impact the profitability of our ferrochrome operation, which will not be significantly mitigated by volumes as the furnace has been under maintenance until the third week of July and has started to ramp up since then.
On top of that, we see the sizable negative impact from the raw material related inventory and metal derivative losses, as explained just in the previous slide. On the other side, underlying stainless steel demand is expected to remain healthy in both Europe and the U.S., and we experience that every day. Altogether, Outokumpu expects significantly lower Q3 adjusted EBITDA compared to the previous quarter.
Thank you, Roeland. Operator, we are now ready for the questions.
Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, ladies and gentlemen, star one to ask a question. We will take our first question from Mr. Michael Shillaker from Credit Suisse. Please go ahead.
Yeah, thanks very much for taking my questions. Three questions, if I may. Firstly, just on Section 232, Roeland, have you got any sense whether stainless is likely to be included in Section 232? Have you, if so, evaluated the potential on the business, A, from the U.S. operations, and B, any sense of what the Europeans will do to counter that? I think it's pretty clear that they'll end up countering with some kind of safeguard measures. The second, just on the [smelter ops]. Because I think several quarters in a row now, we've talked about the [smelter ops] being under control within the quarter, and we're still not quite there. So what's your confidence that by Q4, the smelter ops will be up and running fully?
Then third question, just on the guidance, and I think I probably know the answer, but I've got to ask anyway. There's quite a difference between somewhat used in Q3 and significant used in Q3 and somewhat used in Q2. I kind of know we went through the Oxford English Dictionary concept in the last quarter. But is it fair to say that somewhat probably became significant through the last quarter, i.e. it was quite a lot worse by the end of the quarter than you first thought, hence the pre-release?
Can you give us any help, and I know it's difficult, but any help in terms of the extent to which you expect Q3 weakness to be temporary, seasonal inventory write-downs and similar versus something that could be a little bit more permanent, which is the smelting operations, depending on how you work that through, and also base prices and similar. I mean, even if you can give us sort of a percentage split between how much you think is temporary or permanent or longer term, and therefore your confidence level that Q4 actually should be stronger than Q3. Thank you.
All right. Thanks, Michael. Let's start with Section 232. The easy part of the question. It's very unclear what is happening there. Theoretically, stainless steel will be included in Section 232, if that is going to materialize. The form is unclear. There have been various discussions, ranging from a flat fee, a flat remedy on all tonnes coming in, to a more likely scenario that has been proposed of having an import quota, depending on what was the historical average over a certain number of years, like 2014 to 2016, and then a tariff on top of any volume over the quota. We have, as a company, been looking at all these scenarios. We have been working them through. We've been seeing what it does to our operations, potentially. We have clear actions determined on how we would react if they happen.
Overall, we feel that we have enough work done that we can mitigate whatever the scenario is into possibly even our own advantage. The ferrochrome smelter. We intended to take it down in May for about a week's maintenance and then ramp it back up. We were delayed in that because of the availability or the delivery of some of the parts that we needed. So we have been limping through the quarter until we had all the materials in-house to execute the maintenance. We have, meanwhile, as well, gotten the input and help from two different sources, two different specialists in both ferrochrome smelting itself and just the technical side of the building of this type of furnaces.
With them, we decided to do a longer shutdown, literally scoop out the whole inside of the furnace, repair all sort of elements that we saw there, rebalance the volume of it. We have agreed to a very strict ramp-up curve that should avoid any repetition of the issues we had in the past, and as a result, would not lead to any imbalance as we have seen in the past. We restarted the furnace Sunday a week ago, by warming it up. We started charging material as from the end of last week. We have actually started to tap material yesterday evening for the first time, this morning again. We will do another tapping this afternoon. Power has been switched up to now about 40% of its full power, and everything is currently running according to schedule and without any hiccup.
With the help of the specialists we have called in and with the very rigorous program we have in restarting it and ramping up, we believe that the furnace will reach its designed capacity and will not have the instability repeated that we had in the past. That has somewhat become significant, yes. That somewhat became significant. That is, it was clearly as a result of the timing effects and this ferrochrome issue became a bigger drop than we had forecasted ourselves internally. How much is permanent and how much is temporary? Clearly, the timing is a temporary thing. It's like a python eating a deer. It takes time before it's being worked way through the snake. It's the same here. It takes time. But then, it's actually digested and gone. Same goes for the ferrochrome issue. I do believe that we will have the stability we need.
As we said, we see still markets as being underlying pretty healthy.
Okay. I think you alluded to it, but is it reasonable to assume that some of the base price fall has been in part driven by the transaction price fall on the back of ferrochrome, and therefore, you could argue that is to some extent temporary relative to underlying fundamentals?
It's anyone's guess. I only look at what do I see, and this is probably the best guidance. What do I see from our direct consuming customers, the automotive and appliance customers? There is absolutely no interruption in the strong demand that we have seen.
Okay. Very clear. Thanks a lot.
We will take our next question from Johannes Grasberger from Nordea. Please go ahead.
Yes. Hi, gentlemen. It's Johannes from Nordea. I've got a couple of questions here on my side as well. I'll try to ask them in one row. The first one would be on ferrochrome as well. I'm just wondering here, when you released the guidance downgrade for the second quarter the other week, what really was the main driver for this guidance change? Was it the fact that you would just not be able to use the less costlier ferrochrome output from your own smelter, and instead you had to buy as a net more ferrochrome from the market, and in a way you lost the quite wide, say spread to the market price relative to your own cash cost? That's the first. The second question on ferrochrome. Again, what are you seeing is happening in the spot market and in demand supply?
I've seen some price upgrades in the Chinese spot market quite recently. So what is your thinking? What is happening over there? The third question would be on working capital. The negative effect in the second quarter, was that kind of a timing issue? Should we still expect that the cash tied into balance sheet in the first quarter would eventually be released during the course of this year, as we see that the metal prices are quite a lot lower today than in the first quarter? The final question would be on any cost tailwinds coming in for the third quarter. You mentioned that in the second quarter there were some positive elements from variable costs and SG&A and that type of thing. Is there any kind of positive effects from these type of cost elements coming in for the third quarter?
That's the final question. Thank you.
Okay. Thank you, Johannes. I'll start off and then hand over to Chris. The main reason for the downgrade was, in principle, the inventory or raw material delay. The high cost inventory that started working through the system. Why was that? As we saw that demand was slowing down, and inventories went up, we decided to significantly reduce inventories by consuming the materials we had, and at some stage, even for a couple of weeks, stop our melting operations in order to make sure that we can evacuate the inventory. That changes the profile of the raw materials that you have in stock. In other words, you keep more high price materials in stock, and as a result, you have a bigger hit from that metal lag through your system.
As we saw that coming, we said, okay, this is now getting to a point that we want to go to the market and say that this is happening, on top of course, the ferrochrome issues that we discussed. To your second question, what is happening to the spot market in China? We see clearly an uptick in the stainless steel market in China. You see the melting rates going up, the demand for stainless steel is up, pricing is going up for stainless steel. Nickel is clearly underpinned by the activity and so is ferrochrome. The results of the past are no guarantee for the future. Same here in this market. If China keeps up, yes, then we would see positive support, but that is to be seen. Working capital, Chris?
Johannes, you recall that in the first quarter, obviously there was a significant build in working capital, and we put it down to three key factors. One was obviously, a reduction of balance sheet financing. That reduction remains in place. For the time being, it has not come out of working capital. The second piece was due to the higher level of pricing, particularly ferrochrome and chromite that was in the system, and the higher base prices and the higher business volume that we saw in Q1 due to Q4 of last year. While ferrochrome did come down a little bit in the second quarter, it wasn't very much. At the same time, base prices actually moved up a little bit. That pricing impact did not come out during the course of Q2.
Now, that seeing ferrochrome prices fall, and we've also seen base prices come down a little bit off their peak, we should see those effects coming out through the rest of the year. The final factor was working capital tied in due to high levels of receivable. We also started reducing those and also started drawing down some of our inventory levels. To do that, you need to sell more and buy less at the other end. When you buy less, when you sell more, then your receivables sort of go up. That's a counter effect to the overall level of receivable reduction we had. You need to buy less, which means that your payables go down as well. That's working its way through the system at the moment and will also come out therefore in the second half of 2017.
The last point on cost tailwinds. We, of course, continue with full focus and dedication with our cost programs. If you look at the cash conversion costs, we have now achieved in Europe, about a 3% improvement over last year. In the U.S., we are running at over 15% versus last year. That focus will not abate. This is for us, as we all said, this is the basic issue of fixing Outokumpu, is back to basics, making sure that we are the cost leader in our industry.
All right. Thanks. I have just got one more follow-up question here. Thinking about the fourth quarter, I understand that you are not guiding fourth quarter as such, but I am realizing that all right in Europe, there is going to be some maintenance breaks. I am thinking about the uptick in the Chinese market. Is there a risk that the stainless steel market in the Western part of the world could possibly overshoot in the fourth quarter? While inventories, I suppose, are not that high end of the day, and thus will have the very strong underlying demand trends, and if the Chinese prices are ticking upwards, it could be that the buying activity will be reversing quite quickly. The follow-up question of this follow-up question is that what kind of demand activity are you expecting for the third quarter?
I suppose there is no assumptions of any kind of reversal of the restocking or inventory activity or anything like that compared to the second quarter.
No. There is no doubt that inventory levels in the U.S. are quite a bit below the historical averages. In Europe, however, they are above historical averages. The scenario you paint is a possible one. I do not think that we would be negatively positioned if that happens. We have enough stainless steel inventory in our system to react to whatever is needed. We have enough contracts with our suppliers to make sure that we have sufficient raw materials to satisfy the market if that happens.
All right. Thank you. That is all from me.
Thanks.
Our next question comes from Seth Rosenfeld from Jefferies. Please go ahead.
Good afternoon. I have a couple of questions on the outlook for your realized prices the second half of the year. In the release, it looks like your Q2 results benefited from base prices actually slightly up quarter-over-quarter. But we have seen a pretty sizable reduction in spot prices from the Q2 peak, especially in Europe, and also meaningful discounting below benchmark based on what we are hearing from some industry contacts. I guess two questions. First, when should we expect recent base price pressure to hit your ASPs? Will this weigh on Q3 or actually not hit you until the fourth quarter, given your contract structure or lead times? Second, you note market pressure recently on base prices.
Can you confirm, does that comment reflect kind of a backward-looking issue throughout the second quarter, or is there actually a continuation or acceleration of that pricing pressure today going into late July? Thank you.
All right. Q2 base prices were indeed up over Q1. In Europe, about EUR 20. In the U.S., it was more or less flattish. We have seen as well the reports from CRU on the pressure on base prices in Q3. This is something that seems to be happening every third quarter when volumes get less or when raw materials prices fall. There is a spillover between the alloy surcharge and the base price, and a bit of a confusion there. Over time, the ship rights itself normally. As you know, we do not comment on, for what was it called? Competitive reasons, we cannot comment on future prices. I can only say that we still see this extremely healthy underlying market.
Can I rephrase that then? If base prices today flatline for the next six months, would your realized prices be lower or higher in the fourth quarter than in your third quarter?
Again, it's something that I'm afraid I'm not allowed to answer. Literally, competition authorities do not want any sort of price signaling going forward.
Okay. I'll try again. Can you give me a sense of where your lead times are currently in Europe and in the U.S.?
Yeah, t hat I can. We are in the U.S. about five to six weeks, and we are in Europe seven to eight weeks. We are starting to book into September in the U.S. We are finishing our book in September here in Europe.
Thank you very much. If I can just ask one final question on ferrochrome. As those volumes do come back, hopefully in the course of Q4, should we expect some improvement in your fixed cost leverage within that chrome processing business, such that higher volumes, even at a lower price, would aid your realized margins? Or is that not a fixed cost intensive business for you?
It's not that fixed cost intensive as the rest of the business is. Of course, you have your labor, but it is less cost intensive. It will have an effect, Seth, there's no doubt, but it's not as significant as you would have it if, for instance, the melting operation in your melt shop or your stainless operation.
Excellent. Thank you very much.
Our next question comes from the line of Olof Grenmark from ABG.
Yes. Good afternoon, Olof Grenmark, ABG Sundal Collier. I will limit myself to one question, please. That is that you talked a lot about your ferrochrome issues during Q2. Could you please help us out by stating what negative EBIT effect you had from those issues in the second quarter? That's all. Thanks.
Chris?
Yes. We do not want to particularly comment on the profitability separately of the ferrochrome business at this stage, but the negative EBIT effects from the volume were significant. They were significant enough to also cause us to make the early release of the results statement that we did last week.
I think that what you can see, Olof, is the production numbers that we report. You know that we have a potential production capacity of about 130,000 tonnes in the quarter. That shortfall, of course, is significant. I think you can probably get to the mark.
Okay, thanks.
Our next question comes from Carsten Riek from UBS.
Thank you very much. Most of my questions actually have been answered. One may be on the base prices again, because we still see a downward swing in surcharges at least until recently, and the transaction price differences between Asia and Europe, and Asia and America are still comparably high, especially compared to Europe. A similar question to Seth's question. How long will the base price pressure continue, in your opinion? Is it over in the third quarter, or is there a chance that actually it spills over in the fourth quarter?
You were referring to the spread to the Chinese prices?
Yeah, the transaction prices, e xactly.
If you look at how the alloy surcharge has come down now three months in a row with every month about over EUR 100. At the same time, you look at the swing up of about $200 per tonne in the Chinese prices, that gap has come down significantly.
Okay. So you believe it is over rather sooner than later?
I can only lead you to the water, that is all.
Okay. No, that is fair. The other question I have is, we recently got, again, this story about 3.8 million tonnes of new Chinese stainless steel capacity from Shandong Xinhai Technology, which apparently is supported by Baowu. Is that something which worries you going forward? It is more a strategic question. Or do you think the capacity cuts in China are sufficient in the stainless area in order to absorb these kind of incremental capacity of about 4 million tonnes?
It's very difficult to gauge that. There are closures of stainless, we have seen that. We have seen switches of stainless back to carbon. We have seen the opposite as well. You see that there's stainless capacity, especially on the nickel pig iron backing in Indonesia being built, all directed at China. I think for us, with our extremely strong footprint in the Americas and in Europe, the more important thing is that we are having significant protection for the next five to seven years. You have to look at this longer term view. I do believe that the Chinese government is very serious in closing down inefficient capacities, be it carbon or stainless. I do believe as well that the market there still is growing and will automatically absorb a big chunk of the overcapacity.
I do believe as well that at some stage, rational thinking will come into the whole capacity question in China as well. It's a long-term game. We, at this moment, do not see any short-term, and short-term I talk about 5+ year , significant impact.
Okay, perfect. Thank you very much. Cheers.
Thanks.
Our next question comes from the line of Luc Pez from Exane BNP Paribas.
Hi, gentlemen. A couple of questions, if I may. Could you be a bit more specific on the ferrochrome volume you would have in mind for Q3? I understand the risk associated with any ramp-up, but if I take your starting point during Q2 at [86,000] and the targeted run rate at let's say [130,000], [135,000], would give me something in the tune of [110,000]. Is it a figure you're comfortable with? That would be my first question. Second question, still related to ferrochrome. Could you maybe be a bit more specific as to what you see in terms of outlook and how market conditions are developing on the ferrochrome market, and how you would see Q4 trends? Last but not least, on the Americas, if I restate your EBITDA from the EUR 6 million one-off.
First, if you could explain how this is included in the adjusted EBITDA, I would appreciate. Secondly, it means that the profitability has only mildly improved versus Q1, whereas your utilization rate is at 86%. Consequently, my question is, when do you see your profitability getting, let's say, a proper level given the good utilization rate you're achieving there? What is needed to get to proper profitability? Thank you.
Okay. On the ferrochrome, in Q3, as I said, the first three weeks we were in maintenance, and then we were a week heating up. You can basically say that one third of the quarter is gone in terms of volumes. Then you ramp up, and as I said earlier, we don't want to make the mistake that we probably made last year in ramping up by doing it too fast, and then getting into an unstable operation. We have a clear but careful ramp-up schedule that we follow. The volumes will remain low. There will be no significant mitigation of the lower prices by volume.
The Americas profitability. First of all, we don't work, as I said earlier, with capacity utilization numbers. We sincerely believe that the nameplate capacities that is on these machines do not reflect the reality of what we can get out of them with the correct operational measures. Secondly, we have always maintained that it will take until 2018 for us to get into what we call commercial maturity as well. We still have in our mix, although we are improving and getting more continuous mill plate into cold rolled and more black band into continuous mill plate, we still have a significant part of our mix into black hot bands, and we still have an opportunity of moving more from the continuous mill plate into cold rolled.
I agree with you that the profitability is not where it should be, but at the same time, we are both commercially and operationally, moving continuously up the value-added ladder, and as I said, are confident that we will achieve that full maturity by 2018.
Could you maybe elaborate a bit more on the ferrochrome market outlook?
Oh, yeah, sorry. Very, very difficult. I will be extremely open there. We have seen this whiplashing up and down, and ultimately, the biggest sole driver is China. We saw it in Q2 of 2016 when in March, China stopped buying and ferrochrome prices tanked to $0.82 a pound, only for China to start remelting in April and May, and spot prices shooting up, leading to a $0.16 increase in the ferrochrome price the quarter after. We saw it as well from Q4 to Q1, and now again from Q2 to Q3. China is here the driver. Good news is the current demand and strength in the Chinese market reflecting in the spot prices in ferrochrome, but I would not dare to say anything about Q4.
Okay, thank you.
Our next question comes from Philip Ngotho from ABN AMRO. Please go ahead.
Hi. Good afternoon. Thanks for taking my questions. I have two remaining. The first one is just to try and get a better understanding of the order of magnitude for the Q3 earnings drop. You just discussed what the impact would be on ferrochrome. My question there as a follow-up, and it is also a bit related to the question about whether there is a high fixed cost base, is whether you can confirm the sensitivity that you gave a few quarters or a year ago, whether that still holds given the lower volume levels that you are pushing out. I believe it was EUR 15 million for every $10 per pound movement in the ferrochrome price. So that is my first question, if you can confirm if that sensitivity still holds. Then, my second question is related to the negative earnings impact of working through the more expensive raw materials.
I was wondering if, looking back now in hindsight, whether you think that you have been actually working with a too large inventory level, whether you were caught off guard, or do you see this really as something as just being part of the business and a bit out of your hands?
Yeah. So I will take the first one. The guidance that we gave still holds. We have actually always talked about EUR 15 million to EUR 20 million, and then I think we are more at the bottom end of the range here with the lower volumes. So you can use that as a benchmark, I think. Then, the negative earnings from the timing
I do not think we carry a particularly high level of inventory at the moment relative to historic levels. We are constantly trying to obviously reduce the level of inventory, but I think at the moment it is in reasonable shape. It is something we continue to chip away at on an ongoing basis, because the lower we can get it, obviously smaller those timing impacts will be, both on the positive but also on the negative side. It is the most effective way of mitigating those timing impacts.
Okay. Thank you.
Our next question comes from Cedar Ekblom from Bank of America.
Thanks very much. One question from me, gentlemen. If I read the release, it says that imports have gone back up quite strongly in Europe. It is now standing at 27% of consumption, which is close to where it was before we saw the initial moves to protect the European market against imports a few years ago. Can you comment about where you think there is going to be any increase in initiatives to try and bring more trade protection into Europe? Do you think that the supply that is coming into Europe now is more economically fair, if that is the right word to use? In other words, do you actually think the industry has the ability to argue for more trade protection or is high imports at nearly 30% of consumption something that we are just going to have to deal with going forward?
Yeah. I think the highest level we reached was something like 31% or 32% when China was pumping material into Europe. China alone represented more than 10% of the imports. It shows as well that in a healthy market that we have currently in Europe, there is room for imports because don't forget that the capacity we have in Europe does not only serve the European market. It serves to a large extent as well, the EMEA market and even the Asian market. We ourselves export a significant amount of material into Asia on the higher end of the spectrum. As a result, there will always be room for imports and actually need for imports. The main issue here is, are these imports at a decent price level? We believe that that is still the case.
The moment there would be any indication of unfair competition and dumping, of course, we as an industry will, together with Eurofer, make a case and try to eradicate any unfair trade practices. As long as it is fair competition, and if I look at the price levels in Q2 in Europe, I would say fair levels.
Okay. Just one follow-up question. Can you just comment on the origin of imports at the moment into Europe? The trade protection initiatives that we saw obviously targeted China to a large degree and Taiwan to a lesser degree. With the imports now ticking back up to close to peak levels, has there been a change in the mix in terms of where that's coming in from or is it rather about the same?
There's, of course, still the largest part comes out of Asia. Within Asia, I would say that the largest importer into Europe is actually Korea. What you have seen as well in Q2 is a significant increase of imports into Europe from the U.S. So those are the big moves. As said before, we don't see these import price levels as unfair and can easily live with them.
Okay, perfect. Thank you.
Our next question comes from Kevin Hellegard from Goldman Sachs.
Hi, guys. My only question left is if you can in any way quantify the impact of maintenance Q3 versus Q2 and maybe even into Q4 as well, the timing of maintenance in the second half of this year.
Again, these are normal patterns. In Q3, we would have, I would say, over Q2, a slightly increased maintenance in terms of value, for a simple reason, that you over July and into August, because of holidays, you have shutdowns and do maintenance. Then you have another, of course, heavy maintenance, seasonal, always the same every year in the late November and December part. That is no different this year from any other.
Okay, thanks.
Our next question comes from Bastian Synagowitz from Deutsche Bank.
Yes. Good afternoon, gentlemen. I have got two questions left. My first question is, again, on ferrochrome and how to think about the moving parts of the business. Essentially, I am trying to separate the elements in your numbers and guidance, which are driven by prices from the ones which are driven by the temporary issues. Besides the volume effects you have been talking about in length in the second quarter, were there any additional repair costs which have been charged through the P&L? Even if you do not give us the details on the absolute numbers, can you at least give us some rough sense for whether the net effect of both volume loss and possible repair costs will get sequentially worse or better in the third quarter?
I guess we are all pretty clear on how prices will impact, but it seems we are still very unclear on these temporary items. Any help would be much appreciated. My second question is just following up again on working capital, where I thought you did a good job, or precisely, cash flow overall. I understand that there is a lag in your business and how lower prices and volumes feed through in your cash flow. Given the lower transaction prices and particularly the lower chrome prices, would you rule out that the working capital you have been building up could be fully reversed in the course of the second half? Maybe you could give us at least a broad range here. Thank you.
I'll take the first thing on the ferrochrome. The maintenance cost is a very minor part. We're talking about EUR 1 million, which was the real cost of this maintenance. The larger cost comes from the fact that the furnace was out for three weeks while we were doing this and the ramp up afterwards. As reflected in the volume in Q2 with the [86,000] and the volume comments already made for what we expect in Q3. Maintenance is a very small part. Again, I believe that we will get the furnace now back into its normal stable operations and that this was a temporary thing. On the working capital, Chris, maybe you want to make some comments.
Sure. It's a good question, Bastian, and I think, just building on what I said before, it very much depends also on pricing levels at the end of this year. If we see ferrochrome, nickel, and base prices back at the same level that we saw at the end of 2016, then clearly the price impact of the increase in working capital will fully reverse out. But that's a big if, and at this stage, I don't think we can say where prices will end this year. That remains a question mark. As we also said before, we did reduce our off-balance-sheet factoring. What we've done there in the background is obviously take out facilities that were very high priced. We have a number of different facilities, some of them at higher prices and some of them at lower prices.
We also took out the higher price bonds. At this stage, overall, the off-balance-sheet factoring remains lower. If we can find ways to find lower cost facilities there, we may utilize them. But at the moment, we don't have any plans to do that. That would also be a permanent effect. The rest of it I think will reverse out mostly, I think, at least.
Okay. Thank you. Roeland, just one quick follow-up again on volumes, as I'm not entirely clear fully the volume guide. Obviously the ferrochrome furnace and essentially one out of the three, which is the largest, was not totally out in the second quarter, was just running at lower utilization rate. Now, if I understand it correctly, it was fully out for most of the first month of the third quarter, and now it's going to be roughly in a stable ramp-up process, brought back to operation. Is it fair to assume that the total production volume will be pretty much on the same level as in the second quarter, or will it be possibly lower than that?
No, it will be same level-ish. Yep.
Okay. Very clear. Thanks so much.
Our next question comes from Anssi Kiviniemi from SEB. Please go ahead.
Great. Thank you. Hi, it's Anssi from SEB. One question left from my side, and now I would like to get more clarification on the raw material timing effects for Q3 results. When we look back Q4 last year to Q1 and Q1 to Q2, you could assume just by looking at the ferrochrome price, that is probably the largest driver in raw material gains and losses, that the magnitude of the raw material adjustment, it's going to be somewhere between EUR 25 million -EUR 30 million on negative side. Is this a fair assumption and should we take into account other effects also? Or what is your view on that issue?
Yeah, I think in terms of timing effects, I don't think your math is too far out, Anssi.
Okay. That's pretty clear. Thank you.
Our next question comes from Krishan Agarwal from Citi.
Yeah, thanks a lot, guys. Most of my questions are already being answered. One question remaining is, the euro has moved a lot against the U.S. dollar, so is there anything significant impact you would like to flag on your operation given that in Americas you have a lot of U.S. dollar costs and the pricing is mostly in the U.S. dollar?
Yeah. The U.S. dollar, euro exchange rate impacts us in two significant ways. Clearly, it has an impact on the euro value of our American operations. Any result, adjusted EBITDA result that is generated in the U.S. will be worth less in euro terms if the dollar weakens and that has had a bit of an impact clearly in Q2 as well as the dollar has fallen. That is one part. The second part is actually on the ferrochrome side. Ferrochrome is priced in U.S. dollars or in U.S. dollars per pound. Therefore, if we see an ongoing weakness in the U.S. dollar, then the receipts from material that we sell into the market, in U.S. dollar terms will also be worth a little less in euros.
Is there any sensitivity number which you can provide for both these items to make it easier for us?
No, but I think you can probably do the sensitivity on the U.S. side pretty easily yourself because you know what the change in the dollar is, and you apply it to the Q3 and Q2 result, or Q2 result and Q1 result, and then you will be able to get to the difference. On ferrochrome, I think, again, you could probably do the maths by just applying the difference in exchange rate from Q1 to Q2 and full costs.
Most of the ferrochrome impact would come only for the ferrochrome deliveries you are doing outside and not for the material used inside?
No, inside it doesn't play a big role. It's mainly external. It's translation of the U.S. result into the euro that's important here because most of the U.S. operations happen in dollars. A lot of the Mexican business happens in dollars, and they transact in dollars between each other. It's what's left over that's relevant in terms of the conversion back into euros. There is a balance sheet effect as well, clearly, but that doesn't show up straight in the P&L, but a bit further down.
Yeah. Finally—
It's only the dollar.
Finally, you have $75 million of CapEx in first half in cash flow. Can you remind us for the full year guidance on this?
Sorry, EUR 75 million in cash flow, you say, in the first half?
In CapEx.
In CapEx. Okay. The guidance for the whole year is EUR 180 million.
Okay. Thanks a lot.
That 's euros, not dollars.
Our next question comes from Charlie Clark from Berenberg.
Hi there. Just two quick ones left, if that is okay. Firstly, is it possible to quantify the impact that nickel had on the raw material inventory losses? Also just a quick update on how ops are going at Calvert . Thanks.
Chris, can you comment on the nickel?
Yeah. In the second quarter, the big impact was really ferrochrome. Nickel did fall a little bit. It was small. We saw nickel during the quarter trend down about $1,000 per tonne, I think. It's a little bit of a negative impact. We also hedge a lot of that, so it wasn't that big. Do you want to comment on Calvert?
Yeah. Calvert is actually still going amazingly strong in the sense that you see the improvements quarter-on-quarter and you think, well, it should be plateauing. Then the next quarter, it's repeating the performance. So we see tremendously strong cost control. We see, especially on both fixed cost as well as variable cost, improvements quarter-on-quarter. Although Q2 and Q1 was probably less of a drop on the variable cost because again, there are limits to how far and how long you can go. It was a new record in terms of the variable cash conversion cost per tonne. So still going extremely well. All the facilities are doing well. So extremely pleased with the progress being made there.
Great. Thanks so much.
Our next question comes from Hjalmar Ahlberg from Kepler Cheuvreux.
Thank you. Just last question from me. You do not want to comment too much on base price, I understand, but you say that you see both pressure in U.S. and Europe. Could you say if there is any difference between the two markets? I know inventories and imports are high in Europe. Does that mean that the pressure is higher in Europe than U.S. or is it similar on base prices?
I have to refer to the [CRU] report, where [CRU] has reported about a $60 a tonne drop in Q3 versus about a EUR 30 to EUR 40 drop in Europe. I would go with those numbers.
Okay. Thank you.
Our next question comes from Johannes Grunselius from Handelsbanken.
Yeah. Hi, everyone. All my questions have been answered, but I also have a question on the Long Products, what you anticipate there for or what you see now. You helped us giving some insights in lead times, for instance, for Europe, U.S. What do you see in Long Products in terms of demand when you talk to your clients there?
Yeah. Long Products actually has turned out to be a very good market this year. We have seen interest from the oil and gas sector coming back, especially if you look at special bar in the U.S., has been going strong. Products that go into the production of flanges and valves, and all related to that same oil and gas market. Good. In Europe, on the automotive side, a very healthy market. So it is actually, as far as the external side is concerned, extremely positive. We do not see a change in that activity.
Is it fair that as big part as for your European business is distributed via distributors or is it more direct sales through our own channels here, or can you elaborate a bit on that, please?
Yeah. It is actually a lot of direct sales.
Yeah. Okay.
Because this is a high value. We are only on the high end of the product. The special bars, special rebar, all that is not as common. A lot comes through products, but a lot is direct customer business into automotive and into producers of equipment for the oil and gas industry.
Okay. Thank you.
Welcome.
It appears there are no further questions at this time. I'd like to turn the conference back to you for any additional or closing remarks.
All right. Thank you. Thanks for your attention to this call. In summary, a very strong Q2, and followed up by a Q3 that is impacted by a number of external factors. But the main message from my end is, as a company, we are delivering on our objectives internally, we are delivering on our operational targets, and we are well on our way to achieve our vision for 2020. Thank you very much for your attention.
Thank you, Roeland, and thank you everyone very much for your attention and active participation. Outokumpu's third quarter results will be published on October 26th. Until then, thank you and goodbye.