Please go ahead.
Hello, everyone. It's Yulia Chekunova speaking, Director for Capital Markets. On behalf of UC RUSAL, I would like to welcome you to our second quarter 2017 results call. Let me introduce UC RUSAL management team presenting today is Vladislav Soloviev, our Chief Executive Officer, Oleg Mukhamedshin, Deputy Chief Executive Officer. We have Alexandra Bouriko, Chief Financial Officer, and Steve Hodgson, Director for Sales and Marketing, as well as Denis Nushtaev, Head of Research. With this, I would like to pass over the word to Vladislav to kick off our today's presentation for the second quarter results with key highlights. Vladislav, over to you.
Thank you, Yulia, and good day, everyone, and thank you for attending our call today. This is the second quarter 2017 results for RUSAL, and we traditionally, as usual, start with the key numbers overview. In terms of operating results, RUSAL continues to deliver strong and stable performance. Our smelting capacity utilization rate remains high, nearly 100%, 95%, to be exactly correct. Aluminum production in second quarter 2017 totaled 920,000 tons. Aluminum sales increased 1.7% quarter-to-quarter to 1 million tons, and I am proud to announce that we have a very positive development in value-added sales. Value-added product sales, which solidly increased by 13% quarter-on-quarter and now amount close to 50% of our sales average for the first half of the year. Realized aluminum price increased 6.8% quarter-on-quarter to $2,081 per ton, largely driven by LME component growth.
Now turning to financial performance, we demonstrate another quarter of sequential improvement, mainly on the back of high aluminum price and sales volume, RUSAL revenue reached $2.5 billion or 7.4% quarter-on-quarter. At the same time, EBITDA increased 7.4% quarter-on-quarter to $510 million, and we maintain one of the highest margin in the industry at 20.7% in second quarter 2017. I'm delighted to report what we have stated before, our proactive approach with debt management resulted in our significant debt optimization. Since the last reported results, we completed the UP export facility and renegotiated terms on our bilateral facilities, including VTB. Now we extend maturity profile to 2024 and significantly reduce the cost of funding as well as increase the share of unsecured debt in our portfolio to 17%.
Amid the solid financial performance, our achievements on debt portfolio optimization and constructive outlook for the rest of the year, our board approved the proposal to pay interim dividends of U.S. dollar $0.0197 cents per share, which is equivalent to almost $300 million total. We expect to distribute it in October, post closure of third quarter 2017. All in all, it is a very solid quarter for our company. Now let us move on to slide number five, our usual slide, health and safety. Traditionally, we would like to give an update on our company's performance in the health and safety area. That continues to be one of the strategic priorities for us.
In overall lost time accident frequency rate of RUSAL, what is shown on the chart, remains one of the lowest in the aluminum industry as we continue demonstrating improvement on health and safety area across all divisions of our company. In 2017, we will continue to improve the programs to reduce the health and safety risks. The program Safe Mind, 100% unification of workplace, safety culture and production will be further integrated on all production sites. All that would allow preserving our leading position as a responsible employer with safe working environment, which is a key element of our sustainable business development and platform. Now let us move forward to the slide number six and our environmental achievements.
Okay, on this slide, we would like to draw your attention to our strong commitment to the leading role we have taken in the fight to reduce greenhouse gas emissions in whole aluminum industry. One of our strategic goals, as we mentioned before to this end, is to reduce direct specific greenhouse emission by 16% as compared to the level of in 2014 at all our aluminum smelters. As you can see on the chart on this slide, we are making very good progress to achieve this target already, and we have reduced emissions year-on-year in 2016 and through the first half of 2017, we continue delivering on emission reduction. I would further note that we increased the share of renewable hydropower used in the primary aluminum production by 2% to 98.5%.
Well, now let us move into the review of our operational and financial results. I would kindly like to pass the word to Steve Hodgson, who is going to open this section with sales dynamical overview. Steve.
Thank you, Vladislav, and welcome everyone. I'm on slide eight. Let me just start this part of the operating results with an overview of sales and price performance. As Vladislav has already mentioned, RUSAL's total aluminum sales in the second quarter moderately increased by around 1.7% quarter-on-quarter to just over 1 million tons. This has largely been through supply chain efficiencies following traditional winter seasons, if you will, in the northern ports. We continue to increase the sales of value-added products, which is a key pillar of our company strategy, reaching new markets and end consumers in line with our target segments of automotive, building and construction, as well as leveraging our carbon footprint, as Vladislav mentioned on the previous slide. This is reflected in our second quarter VAP results, which increased strongly by 13% to 493,000 tons.
And this is creating around about 49% of our total product portfolio for Q2 as value-added product. As I mentioned, this is in line with our strategy, in line with very targeted sales plans within the key growth segments, but most importantly, of course, delivered through continuous upgrades in relevant capacities in our smelters. Looking specifically at price, the Q2 average realized price increased to $2,081, which is a 7% increase, more or less, quarter-on-quarter, with the LME components reaching $1,907. As you'll see later, some very constructive market conditions, both around demand and developments in China, which have been very supportive of price. The commodity grade aluminum premium increased to $88 a ton, with very good results coming through from Asia and the CIS countries. That's above the $71 a ton of the previous quarter.
The average upcharge per ton of value-added sales was $175 a ton in the second quarter. Our regional sales mix remained largely unchanged. Our focus is to supply the key deficit markets globally. Of course, Europe, North America, and the Asian markets comprise those. And of course, the rest of the sales supported our very strong position in Russia and CIS countries, which is growing year-on-year. With that positive picture on price and the sales structure, I'll pass the word back to Alexandra Bouriko, who will comment on the company's financials.
Thank you, Steve, and good day, everyone. We're now on slide number nine, where we will briefly touch our revenue mix and dynamics. RUSAL total revenue, as my colleagues have already mentioned, in the second quarter increased by 7.4% to $2.5 billion. The largest contributor, as usual, was revenue from aluminum sales, which increased by 8.6% quarter-on-quarter to $2.09 billion, and that was largely driven by a favorable pricing environment as well as some increase in sales volumes quarter-on-quarter. The rest revenues totaled $376 million. Revenue from alumina sales to third parties decreased slightly to $175 million, largely due to slightly lower realized prices in the second quarter of 2017. Revenue from sales of foil and other aluminum products totaled $82 million amid higher sales volumes. And revenue from other sales remained largely comparable to the previous quarter level, totaling $125 million.
Let's look at our costs now on slide 10. You can see that in the second quarter, production cash cost of aluminum increased slightly quarter-on-quarter to $1,497 per ton. We saw some increase in carbon raw material costs. You can see it on the right-hand side breakdown, as well as a rise of transportation tariffs and the continuous appreciation of Russian ruble by 2.9% as compared to the previous quarter. All of that, of course, impacted our overall costs and particularly ruble costs were on the rise in dollar terms. However, due to typical seasonal factors, the energy costs for us actually reduced quarter-on-quarter as we saw some reduction in level of market prices in the second quarter.
Just a brief reminder on this slide, in the beginning of 2017, we have changed the presentation of our aluminum segment's cash cost to separate performance of our own operations from sales to third-party products. We are now reporting our aluminum cash costs excluding the impact of any aluminum resales. With that, let's move to slide 11, where we can see energy cost dynamics. In the second quarter 2017, the average energy purchase price for UC RUSAL stood at $0.0309 per kilowatt hour. We have seen a combination of factors that contributed to such a level of price. The largest negative contributor was the exchange rate. As I mentioned, the ruble has strengthened, quarter-on-quarter. However, weakening of day-ahead market tariff, which is seasonal in warmer months of the year, helped us to bring the overall tariff down.
Let's move to slide 12 now, where we can see the bridge for our EBITDA. As you may see from the top chart, the LME component growth in aluminum price, quarter-on-quarter, on the back of favorable aluminum market momentum, was more than offsetting aluminum cash cost increase in the same quarter. Those two factors were largely behind our second quarter EBITDA increase by 7.4% to $510 million for the second quarter. Our EBITDA margin remains stable quarter-on-quarter at 21%, which is one of the highest in the industry. In terms of segment impact, aluminum segment, of course, remains the largest contributor to our group EBITDA. As a guidance for investors, we provided a brief note to each of the segments on the bottom chart explaining what components the segments consist of. Hope this will be helpful for your review.
Additional details on that are presented in the appendix to this presentation. Let's move to slide 13, where we presented the details for our free cash flow. In the first half of 2017, RUSAL continued to generate positive free cash flow, and the total amount was $179 million. The working capital-related cash movements were negative $375 million, including $179 million of inventories increase due to increase in the overall cost base in comparison with prior year increase in trade and other receivables of $47 million. That was largely explained by increase in prices and our continued switch, I would say, from traders to our end users and consumers, and additional credit terms granted to our customers. Total investing flow was + $8 million.
The amount includes dividends received from Norilsk Nickel of $312 million and does not include dividends received from Norilsk Nickel in early July after the reporting date of $310 million. The financing cash outflow was $398 million. The largest portion was related to financing costs and $101 million of derivative settlements represented by the outflow and commodity-linked instruments, and foreign exchange hedging over Norilsk Nickel dividend flow. Let's see now slide 14, where we present the details of our capital expenditures. On this slide, we provided an overview of our existing capital projects. In the second quarter, our total CapEx was $192 million, including maintenance of approximately $128 million. Our focus in terms of the projects remains unchanged since the first quarter results update. Thus, there are four major areas we are investing into: bauxite self-sufficiency, alumina capacities expansion, carbon material self-sufficiency, and growth of value-added products.
More recently, as the project development plan announced in July, August 2017, we were delighted to report about the launch of a new calciner at the Irkutsk Aluminium Smelter, which was part of our self-sufficiency in calcined coke, which will increase to 71% as a result of this project. We have also launched the complex of furnaces for hardening of wire rods at the Kandalaksha Aluminium Smelter, which will positively impact the premium upcharges we receive for wire rod products we sell from our Kandalaksha Smelter. It is also worth noting that new large diameter billets at Krasnoyarsk and the foundry alloys property line at Khakas Smelter both entered in the final stages of construction works recently. We would like to reiterate that the capital expenditures for UC RUSAL remains stable, and as such, we maintain our guidance of around $650 million for the overall capital expenditure budget.
Which is somewhat higher this year as compared to our previous couple of years due to a large number of strategic projects in our pipeline and stronger ruble, which impacts a certain portion of our capital expenditures. On slide 15, we would like to present some overview of our key growth projects. On this slide, you can find a brief description of our strategic growth projects, including BEMO and Taishet. The key parameters of this project remain the same as we have previously disclosed to you. First, let's look at BEMO project, which is a joint venture with RusHydro. Currently, along with RusHydro, we completed the first half of the first stage, which has capacity of approximately 150,000 tons per annum, and now are in the process of completing the second half of the first stage with another 150,000 tons per annum of aluminum production.
Important aspect to mention here is the value-added product will account for 120,000 tons of the first stage, and the financing of the project is provided by VEB.RF on the project financing basis, so without recourse to the investors. Secondly, speaking about Taishet, you have to remember that this project, which we started construction works back in 2006, was suspended in 2009. As said last time, we have taken a decision in principle to resume some preparation works for a construction site so that we do not miss the construction window in summer in Siberia next year. The historical capital expenditures on this project amounted to $878 million, excluding value-added tax, and we preliminary estimated that the CapEx to complete the first line is around $711 million, including value-added tax. You can see a summary of key parameters from our preliminary evaluations presented on the right-hand side of this slide.
The financing for the first stage of Taishet is likely to be provided under project financing scheme. The same approach is currently applied for BEMO project. With this, I would like to pass the word to Oleg Mukhamedshin, who will cover debt condition change in the following slides.
Thank you, Alexandra. Welcome, everyone. We are currently on page number 17. This is our traditional slide where you can see on the presented charts. You can see the dynamics in our gross debt and net debt, which declined to $8.3 billion in the first half of this year, which was mainly due to firm operating cash flow. We have placed few market instruments through the first half and as a result, the share of unsecured debt grew to 17% and the share of public debt to 16%. I would like to flag that we stick to our strategy reducing debt levels and cost of funding and practically engage with our core financing partners where we have to report on several milestones delivered as of today. On next page, slide 18. We continued actively managing our debt portfolio with a few of further improvements.
We already reported about the successful debut Eurobond issue in February. Another successful issuance of Eurobonds in May. We raised $500 million with a six years maturity and a coupon of 5.3%. As well as we are the only Russian corporate and among very few international companies to tap into the Chinese market with our debut Panda bond issue again in May. We just conducted an huge syndicated PXF platform finance facility of $1.7 billion which was quite successful. First we fully refinanced the previous PXF facility $1.3 billion with a much cheaper margin which is down by nearly 1.6% in total. And obviously we repaid other more expensive debt including those facilities due in third quarter of this year. Second achievement, the new PXF provides much smoother repayment profile in both 2018 and 2019. It is actually $1.3 billion and $1.4 billion respectively.
Sorry, it is actually only $0.3 billion in 2018 and $0.7 billion in 2019. It used to be $1.3 billion and $1.4 billion before the refinancing. And finally we terminated the cash sweep mechanism and agreed a new package of financial covenants. Leverage ratio is now calculated as net debt reduced by Sberbank loans secured by Norilsk Nickel shares, which is $4.7 billion. Moreover, as Vladislav told you, we are delighted to inform you that the company has agreed with Sberbank to extend final maturity on the loans secured by Norilsk Nickel shares to 2024. We decreased the interest margin from 4.75% by 1% to 3.75%. And also we adjusted the covenants under this facility generally in line with the new PXF. As a result of debt structure optimization, we get total savings of interest expense in amount of more than $50 million on annual basis.
We achieved more flexibility from operational perspectives and as I told you much smoother and less risk maturity profile. We will continue this work further and will update markets when further achievements will be made. Key targets remain as I told you already to decrease total debt and focus on reducing our cost of financing. All of that may allow us to deliver more regular returns to equity holders. Obviously subject to overall performance of the group. As said, we will update you on our progress later. Next slide 19. On this one, we would like to remind you regarding our top priorities for the use of cash flow we generate. Priority number one stays continuous de-leveraging in terms of absolute debt reduction, targeting absolute debt reduction below $7 billion.
Priority number two, we will continue to use capital to release necessary capacity upgrades and maintenance, as well as our strategic projects. Priority number three is delivering adequate remuneration to our shareholders as per our improved dividend policy, which is 15% of common EBITDA. Importantly, given the changes in our debt profile, as I told you before, and the changes to our covenant structure, the board of directors yesterday approved the option on our dividend policy to distribute dividends on a quarterly basis. This is subject to financial performance and certain applicable restrictions. If after this capital allocation, we are left with excess cash, we will look for ways to further optimize balance sheet and by repayments of loans. We will evaluate our organic growth options and opportunistically may look into potential M&A projects. Next page, number 20.
On this slide, we outline the details for the decision made by the board to approve dividends distribution. We performed a comprehensive evaluation of our company performance to date, our current financial position, the repayment schedule for our loans until the year-end. Some of the key events in July, August, for example, we received a portion of dividends from Norilsk, and we have confidence in further constructive developments in aluminum. On those grounds, our board considered it quite appropriate to approve distribution of nearly $300 million as interim dividends. We are going to pay this money after the end of third quarter, around 10th of October. The table that this slide provides for to date, please refer for further details in relevant disclosure by our company on the Hong Kong Stock Exchange.
Given this timeline and our ability to pay up to 15% of common EBITDA, we think realistically we can move on to quarterly dividend distribution starting from second quarter of next year. This is basically all about the capital management, and let me go through traditional slides dedicated to our investment in Norilsk. Page 21. We are committed to our investment in Norilsk Nickel, which continues to generate quite solid dividend flows. It allows to diversify exposure to base metals, at the same time yield lucrative and sustainable cash returns. Dividends from Norilsk cover all of RUSAL's interest payments and contribute to accelerated de-leveraging. This year, we received $315 million in January, and then additional $310 million in July. As you already know, to date, the board of directors of Norilsk recommended the interim dividends for six months of 2017 in the total amount of approximately $600 million.
We estimate net proceeds to RUSAL around $160 million. Lastly, I would reiterate our confidence in the financial position of Norilsk Nickel despite the observed volatility on base metals market. But recently we all observed quite a good rally in nickel price. Also we see strong demand fundamentals for not only nickel, but also palladium driven by stainless steel and the automotive sectors. Supply side discipline is secured by nickel ore supply constraints and the abundance of palladium compared to other projects. That's pretty much it on Norilsk. I would like to pass the word to Steve for the start of the market discussion. Thank you.
Thanks very much, Oleg. Let me just very quickly run through the key markets and how we see the
The demand profile. I'm on slide 23. Kicking off with Europe, I think the important thing here to say is that Europe is out of the doldrums, and we're finally seeing, particularly in the second quarter, some tremendously good industrial activity flowing into demand growth. Given that Europe was a bit of a laggard in the last few years, this is really starting to pull in additional aluminum into production in finished products. You can see the manufacturing PMI on the chart here. It's risen to its highest level since April 2011. We do include Turkey in the statistics, and Turkey growth in terms of automotive, in particular, was incredible. That's 18.3% year-on-year.
European construction sector represented very solid growth, and we've seen that translating mostly into non-residential construction and investment into plants and equipment, which bodes well for future growth in manufacturing, given that this investment is largely in fixed assets. Demand for primary aluminum in Europe has grown very firmly by 2.8% in the first half of 2017. Flat-rolled products 3.7%, extrusions 1.9%. We're seeing very good across-the-board growth. Wire rod was relatively flat, but we are aware of quite a number of major energy projects which are due to commence in the second half of the year, in particular, the interconnector through the Channel Tunnel and various connections to offshore wind farms across Europe. On the back of this manufacturing activity, just as a reference, if I include CIS countries, we've seen our value-added sales growth, first half this year compared to last year, of around about 9%.
Looking at North America, a slightly different picture. Although the demand drivers are still relatively strong, we have seen some kind of pluses and minuses, I would say. Very strong manufacturing activity, 57.8 in June, that bodes well for further industrial production. On the other hand, we might say that the automotive market has eased back a little bit by around 0.8% in terms of vehicle production in the first half of the year. That is mostly U.S.-driven, as we have seen quite a good increase in Mexico. Intensity of use of extrusion rolled products, generally speaking, has been very solid, and we have seen recent improvements in housing starts in North America, which also bodes well for aluminum demand. Overall, we are looking at a 2% growth in aluminum demand year-on-year. A slight weakening in the can stock area, but a very good growth in auto body sheet.
I should mention that whilst we do see a slightly softer vehicle production environment, it is more than offset by an increase in aluminum intensity of use in automotive. As I have mentioned, the auto body sheet shipments in particular have ramped up considerably in the first half of this year. Then maybe just finishing here on Asia, but excluding China. Oleg will discuss China in more detail shortly. I was in Japan last week and had a very clear picture to some of the great things that are happening in the country at the moment, the impact of Abenomics, slightly weaker yen, and a very positive manufacturing and industrial environment. We are looking at some very good manufacturing indices, typically in Korea, Japan, Taiwan, and Thailand, which are the main drivers of growth in the region.
Housing starts in Japan are looking good with an increase of 2.1% year-on-year. We are starting to see the industry, the construction industry, ramp up ahead of the Tokyo Olympics and Paralympics in a few years' time. I think the most impressive area has been the automotive production growth in Japan, increasing 8% year-on-year. If you add to that also improvement in aluminum intensity of use, it presents a very solid picture for the future. Flat roll products and extrusions both benefiting from that. Overall, across Asia, vehicle output grew by about 2.9%. I should also say that a good part of that growth came from South Korea, where you might remember a year ago, you and I were embroiled in a bitter labor dispute, which caused a small contraction last year in auto output.
Generally speaking, a very firm manufacturing environment, broad-based, global, and flowing very nicely into our book. Value-added growth as a reference for you in the Asia region is 18% in our book year-on-year. So we are certainly maximizing the opportunities as we have invested in these products and now managing to bring that to market. With that, I will hand back to Oleg, who will just walk us through the global supply-demand balance and with the focus very particularly on China. Over to you, Oleg.
Thank you, Steve. I would like actually to pass the word to Denis Nushtaev, who contributed a lot to this part of the presentation, and Denis will tell us about recent developments on Chinese aluminum market and efforts of the government to reduce negative environment issues. Denis?
Thank you, Oleg. Good day, everyone. Thank you for joining this call. Yes, aluminum prices increased by 22% year-to-date to $2,100 per ton. The key driver behind the price surge was solid demand growth. We are projecting 6% growth this year. This is up from 5.5% last year. As Steve mentioned, we see a real strong demand growth across key regions and in China. We also see very strong demand growth, up to 7.5% this year, and definitely expecting good growth numbers from 6%-7% going forward over the next years. Another key driver was improving tremendously supply discipline in China. In our view, this was as a part of a real life supply side reform. In case of this, I would just switch to slide 27.
China proposes to cut aluminum and alumina production, an important part of China's authorities' initiatives related to the production capacities that was built illegally or without the necessary approvals or permissions. The government has identified 5.1 million tons of illegal capacity, out of which 4 million tons has been already suspended as of mid-August 2017. This is 13.2% of overall operating capacities in improved provinces. If you look at the hours on the chart, overall, we believe that the government will close up to 6.2 million tons this year. This actually gets back the overall operating Chinese capacity to 2015 levels is about 32.4 million tons, which is significantly eliminates oversupplied capacity in China.
This already turned into declining production in July, and we are expecting production to decline further due to also cuts in illegal capacity as well as in addition to this very tight environmental initiative for 2+26 winter cuts policy, which was issued by Ministry of Environmental Protection and which is applying for special keep producing areas located close to Beijing. As a result of these winter cuts, which will be implemented from, as we think, from October to April overall, will definitely lead to a capacity loss of around 1.2 million tons in aluminum and more capacity losses in alumina and carbon products as well. This will definitely be some additional positive factors for imbalancing in China.
On slide 28, I just want to outline that this supply side reform in aluminum is the next step of all previous steps which were made in coal and the steel industries, where we see real supply elimination and better situation with margins today. Overall, we definitely believe that the Chinese government will continue implement these very strict measures in our supplied industries, and this was also recently confirmed by very high authorities as well. On slide 29, definitely additional factor is raising cost of production on aluminum in China. On this slide, we can see on one chart that the key cost inputs for aluminum production in China increased significantly over 2016 and up to date.
As also for carbon products, for power, for coal, and also we're seeing that the trend for alumina, which is returning to growth pressure due to additional cuts in bauxite mining in certain provinces. It's very interesting to see that even in bauxite mining, there are some illegal capacities exist in China. It is really significant for key bauxite mining areas like Shanxi, which is almost 20%-30% may be considered as illegal. This will definitely, coupling with upcoming winter cuts, will be severely putting up pressure on alumina pricing, and we believe that alumina price will definitely go up in the next couple months. Additionally, given good possibilities for keeping aluminum prices uplifting. Overall, on the next slide, definitely we're expecting the Chinese balance is on a current consumption basis, will turn into deficit in 2018 and some slight deficit going forward.
As a consequences of this, we definitely will see a significant reduction in semis export in China, which we believe some arbitrage metal will be less exported because arbitrage is negative even today. We definitely seen that semis export will be much less, and we also don't exclude that China may import some on road metal to supply gap. Overall, we're definitely expecting global stocks in China and outside of China to continue declining going forward. By this, I would like to conclude the market section and pass over to Vladislav for concluding remarks and outlook page.
Thank you very much, and team, thank you very much as well. Now let me turn on the final slide, number 31, where you can see the highlights for our outlook for the whole second half of 2017. Once again, there are some highlights. First of all, volume-wise, we expect stable operations at achieving close to 1.9 million tons of output, with more than 50% share of value added products in our total production mix. Secondly, we recognize that some of the micro factors indicate further cost inflation, yet we feel confident that in this environment of aluminum prices are predominantly with opening of RUB fix rate, we will be able to maintain our industry leading margins. On the CapEx side, as Alexandra mentioned already, we stick to our strict discipline and we target to keep it under control. On core operations, we estimate CapEx at $650 million.
Some uptake is possible due to expedited project works. Lastly, we feel confident that in our environment, our strategy on continuous deleveraging is highlighted by Oleg, could bring absolute level of debt maybe 5% down year-on-year. Thank you very much once again for your attention, and now we are open for your questions. Please.
Thank you, sir. Ladies and gentlemen.
Yeah, thank you. Operator, can you please remind the participants of the call how to ask the question, and then we are happy to go further to the Q&A?
Thank you. Ladies and gentlemen, if you would like to ask a question at this time over the phone, please press the star or asterisk key followed by the digit one 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 that your question has already been answered, you may remove yourself from the queue by pressing star two. Again, please press star one to ask a question. We will pause just for a moment to allow everyone the opportunity to signal. Thank you. Now we will take our first person from the queue. Daniel Major from UBS, please go ahead. Your line is now open.
Thanks so much. A few questions. First on the dividend, the shift towards paying a quarterly dividend, can you remind us exactly what That is 15% of covenant EBITDA on a quarterly basis from the second quarter of 2018. Is that the correct interpretation of what we should be thinking about going forward? The $300 million you have announced for the interim dividend this year, am I correct that that is exactly 15% of covenant EBITDA for the first half of the year? That was the first question. The second question, the negative cash flow impact of derivative financial instruments was $97 million in the first quarter and dropped close to zero in the second quarter. What can we expect from this line item going forward? Has there been any changes to your guidance or expectations on the negative impact of derivative financial instruments?
The third question on working capital build and your working capital this quarter. What is your expectation through the rest of 2017, assuming current prices and defense?
Thank you, Daniel. This is Oleg. Maybe I take your first question, and Alexandra will address the second and the third one. Your interpretation is a bit incorrect. When we are talking about 15% of covenant EBITDA, we are talking about annual figure. We have made, as you remember, two interim dividend payments in 2015 and 2016. Once we removed the quite restrictive financial covenants limiting our ability to pay dividends, now we do not have any limitations. We made the decision to make our dividend policy more concrete. Basically, we stick to the previous policy. We continue to distribute not more than 15% of covenant EBITDA per year, but we are planning to make quarterly payments. Basically, starting from the second quarter of 2018, we will distribute this 15% of covenant EBITDA by four quarterly payments. Is it clear now?
Yeah, that's clear. Just to reiterate, you'll calculate the dividend with respect to 2017 at 15% of covenant EBITDA, and it will be paid in four installments, Q1, Q2, Q3, Q4, right?
No. 2017, we're going to make an interim payment in October, $300 million, which is actually a bit less, 15% of covenant EBITDA forecast. Starting from 2018, we'll make quarterly payments, but in total, again, not more than 15% of annual covenant EBITDA. Alexandra maybe you want to address the second question.
Yes. Thank you, Oleg. Let's move to the second question, which I think was on financial instruments revaluation. As we said previously, we don't have any significant financial instruments outstanding, but we do have some embedded derivatives in our long-term contracts for our key raw materials, and we do some hedging from time to time on the aluminum and foreign exchange front. With the sharp increase in LME prices that we've seen in the first half of the year, indeed, there was some negative revaluation of our hedging instruments. However, we do not expect this to be significant on the go-forward basis. The third question was on the working capital level. Again, working capital increase that we're seeing during the first half of 2017 is driven largely by increase in commodity prices.
It touched everything from our accounts receivable to, most importantly, our stocks, where also the value of our stocks has increased. However, we expect that with the current levels of prices and foreign exchange, our working capital will remain stable in the second half of the year. We will be able to realize the full potential of our increased EBITDA in our free cash flow in the second half of the year. Okay?
Great. Thank you very much.
Next question? Mm-hmm.
Thank you. Now we'll take our next person from the queue. Jason Fairclough from Bank of America. Please go ahead. Your line is now open.
Yep. Good afternoon, everyone. Thanks for the call. Just two quick ones from me. First, any thoughts on the indications from Norilsk Nickel on their dividend? It does look like that's going to come under pressure a little bit, and arguably it was unsustainably high. Do you have to run your business differently if that dividend goes down? Then just secondly, on the VAP, the value-add products, to what extent are they dependent on local domestic demand, or are these actually products that you can export for profit? Thank you.
So maybe
I will be happy to take the second question, Oleg, Jason. Just in terms of the
We address the first one.
Okay. There you go, Oleg.
Talking about Norilsk, I think, as I mentioned during the presentation, we believe that Norilsk still demonstrates quite a solid financial performance, and we do not have doubts about Norilsk Nickel ability to pay dividends as per the dividend policy. It should not reflect our financing activity. Steve, maybe you can address the second question.
Sure. Just in terms of our VAP target markets, we consume or we supply about 30% of our VAP sales to Russian and CIS markets, and around 70% of our produced VAPs are exported. We are the largest cross-border supplier of sheet ingot globally, and the same for wire rod. We are number two in casting alloys and number two in extrusion billets. We are quite a key player in international markets.
Okay, thanks. That is very helpful. Oleg, could I come back on the Norilsk dividend? To be clear, it is being paid according to the policy, but we are getting to that point in the policy where it looks like we start to slide along that sliding scale away from 60% of EBITDA down towards 30%, 35% of EBITDA. Is that a concern for RUSAL, or it is not?
It is not.
Jason, it's not. I can mention that we have a quite solid EBITDA of ourselves. We saw from our aluminum operation. It's why we're not in a position to worry a lot about the fluctuation Norilsk Nickel dividends. But again, I agree with Oleg, we do not.
Okay. Thanks very much, guys. Very helpful.
Thank you. Now we'll take our next person from the queue. Sergey Donskoy from Societe Generale. Please go ahead. Your line is now open.
Yes. Thank you very much. I have two quick ones. Firstly, just maybe to round up on dividends. Do I understand correctly that the dividends that you have announced today, this $300 million payout, it's basically estimated based on what you expect to earn for nine months of the year? So it's not effectively dividends in respect of the first half of the year, but more so in respect of the first nine months of this year? My first question. Second question, your interest payments, they have not yet, I think, responded to improved loan terms that you have agreed with the banks. When do you expect to see any material decrease in interest payments? Should we expect to see this before end of this year or more likely in 2018? Thank you.
Oleg, would you like to take the follow-up question on dividends? Let me do that. The $300 million that we have announced today will be similar to the distributions that we have done in previous years, which basically is a dividend in respect of the entire year of 2017, unless we see some additional positive changes in performance towards the end of the year. Basically, we will make the distribution in October, and then unless there are some unusual positive factors, the next distribution will come after we release our annual results and towards the release of our first quarter results in the second Q of 2018. That's on dividends. Regarding the interest rate payments, in terms of cash flow, when you compare with the first half of 2016, indeed, you don't see any reduction. There are two key factors in that.
First is increase in LIBOR that we've seen year-on-year, and secondly, in the first half of 2016, there was significant payment in kind component on one of our largest facilities with Sberbank. While we incurred expenses, those did not directly impact our cash flow. If you look at our interest expense line, you actually already see the reduction in the first half of 2017 in comparison with the previous year. Yes, in the second half, it already will be very noticeable both in expense line and in our cash flows.
I just would like to reiterate that our estimate is around $50 million savings per year due to the reduction margins as of today.
Mm-hmm. Thank you. Just one thing regarding the dividends. Do I understand it correctly that it's just in respect of this year that you are going to pay all dividends before the end of the calendar year? Because normally, I think people would expect you to pay your final dividend somewhere in the first quarter of the following year.
Well, that is exactly the plan. So basically, we are planning to start dividend payments in the second quarter.
The last payment for 2018 will be in the first quarter of 2019.
Understood. Thank you very much.
Thank you. Now we take our next person from the queue. Alex Collins from Barclays, please go ahead, your line is now open.
Hi. Thank you very much for a very thorough presentation. I have one very short question. Given the ongoing debt management and managing the debt profile, do you plan to issue additional Eurobonds this year? You were very successful issuing two in the first half. Just looking at comments perhaps on Bloomberg from a few months ago. That is my question. Thanks.
Well, maybe Oleg Mukhamedshin again. As of today, we do not have any particular plans. We have done the refinancing of all the loans we planned so far. We merely made all the necessary prepayments for this year, so we substantially extended our maturity profile. Frankly speaking, we are facing some difficulties in making further prepayments to the lenders because they do not want to give the money back. It does not mean that we are not looking at the market. If there is a good opportunity and we can raise effectively cheaper financing, which we can use for repayment of some more expensive loans, of course, we can do that.
Okay, that is very clear. Thanks.
Thank you. Now we will take our next person from the queue. Anastasia Tikhonova from Renaissance Capital, please go ahead, your line is now open.
Good afternoon. Thank you for the opportunity to ask questions. Actually, I have two questions. First one, could you please provide possibly some sort of long-term guidance for CapEx, given the projects that you are expecting? Also probably you could share with us your views about the price premiums in the second half of 2017 as well as 2018. Thank you.
Let me start on CapEx. Then, Steve, if you can take the second part. On CapEx, as we mentioned, our priority is a disciplined approach to capital expenditures. This year we are forecasting $650 million-$700 million, depending on how you look at the expenditures that we are incurring in relation to Taishet project. We expect that in the next couple of years, we will see similar levels of CapEx, including all our key priority projects that we have previously mentioned, anode factories, Dian-Dian mine and value-added projects. Okay. Steve, on premiums, if you can
Yes, on premiums that we just commented, I think premium is very much affected by regional demand, which of course we see as being very strong at the moment. Also affected by the ability to continue to finance metals already in the supply chain. As you know, those that look at the forward curve, there have been regular periods of backwardation, which have had some impact on the ability to finance metal and therefore cause some premium softness through financial factors. Underlying demand in the net deficit markets of the U.S., Europe, and the Asian region, is fundamentally strong. We forecast a significant growth in the deficit position in all of those markets. We do not forecast significant supply growth into those markets. So ultimately, premiums remain very well supported at current levels.
Indeed, we would expect as the forward curve returns to contango, we would expect that premiums will be reflecting the willingness of metal financiers to let go of that metal. So we certainly would see some upside in all regions.
Thank you very much. Just a short follow-up question regarding the CapEx. So, what long-term maintenance level of CapEx, and since when do you expect? Okay, we get it that in the short term, due to these projects that you have in your plans, it will be elevated. But generally, just to get the sense of what could that be in the long term. Thank you.
I think that we've disclosed all we can disclose at the moment.
Okay. Thank you. I get it. Thank you.
Thank you. Now we'll take our next person from the queue. Alex Collins from Barclays for follow-up. Please go ahead, your line is now open.
Yeah, just a follow-up question from me. If we are looking at the change in net debt in Q2. If you look at the presentation, if you add the two numbers together, you get over $100 million of other factors, which caused an increase in net debt between Q1 and Q2. These are factors that are not on the cash flow statement. I am just wondering if you could give a rough breakdown of what these are. I imagine these may be partly FX or some sort of revaluation, but any detail on that would be fantastic. Thanks.
Alexandra, would you like to comment?
Yeah, sure. Net debt was affected by several factors in Q2. One was amortization of previously unamortized fees and commissions that were paid in previous years upon PXF and other refinancings, and were amortized slowly over the life of basically of the line. However, upon refinancing, the remaining balance was written off. That was one factor. Another factor was that some of our trade finance facilities that were previously classified within working capital were reclassified in the second quarter into net debt.
Okay, that is much clearer now. Thanks.
[inaudible].
Thank you. As a reminder, ladies and gentlemen, please press star one to ask a question. We may take our next person from the queue. Kwan Su from True Ocean, please go ahead, your line is now open.
Hello. My question is about the outlook for second half EBIT margin. Given the LME aluminum price already raised a lot from July, you forecast the EBIT margin for the second half is stable. Does that mean your costs were always the same level as the aluminum price? Do you have some layers to control the cost? Thanks.
Thank you for your question. Of course, we are enjoying the current increase in aluminum prices that we are seeing. In outlook, I guess the assumption was that the prices would be on par with the levels that we have seen in the first half of the year. Of course, if the prices remain at the current levels, we will see greater EBITDA and higher EBITDA margins. I think that we previously disclosed our sensitivities, and a $100 increase in aluminum price gives us approximately $350 million in EBITDA annualized. Of course, the reason aluminum price alone does not negatively impact our costs.
Okay. Do you have any guidance about the cost for the second half? Do you think how many percentages the costs were raised or down or stable?
At this time, we do not have any expectations that the cost will come under further pressure in the second half of the year.
Okay, thanks.
Thank you. We take our next question from Nikolay Sosnovsky from Prosperity. Please go ahead, your line is now open.
Yes. Hello. Thanks a lot for the presentation. Got a couple of questions. Sorry, I just wanted to extend on dividends a bit as a first question. Am I right that there will be only one payment for 2017? There will be no full year payments? If yes, if this understanding is correct, then I just wanted to reconcile a bit this $300 million you've announced. In terms of your own EBITDA, that's roughly a little bit less than one billion. First half, we can assume more or less the same sort of EBITDA or generally the same sort for the second half. In terms of Norilsk dividends, you received interim dividends from Norilsk last year dividends 2016 and first part of 2017. Then in July, company paid full year, then it will pay, as we discussed, $160 million of interim first half 2017.
So all in all, these three dividend installments from Norilsk equal total $800 million and roughly $2 billion EBITDA, maybe a bit less. In this case, 15% of the total amount would be more than $400 million. Am I right in these calculations? If there is a difference between 15% of covenant EBITDA for the factual numbers, what would happen to the difference in terms of payments?
Okay. Let's start with the details for your calculation, maybe. The key point is that Norilsk Nickel dividends, when we calculate covenant EBITDA, are prorated forward for the period to the number of months that they relate to. So if we receive dividends in July 2017, the full amount does not fall into 2017 when we calculate covenant EBITDA. So that is one matter to consider. The other point is that 15% of covenant EBITDA is the upper limit that the company puts for itself. It does not mean that we will distribute exactly that amount every year. For now, we are making an interim distribution of $300 million. What will happen at the end of the year and what the results will be may warrant or may not warrant some additional distribution as a final distribution.
At this point, I don't think that it's appropriate to comment exactly what will happen after we have our full year results.
Okay. Super. That's clear. That was the missing part, this prolonging of dividends extension from Norilsk Nickel. Sorry if I missed that, I got disconnected couple of times. On working capital, do you expect any meaningful releases in the second half of the year after the $300 million build up in the first half?
Yeah. On working capital, what we have said is that we expect that working capital has stabilized. We do not necessarily expect any significant releases, but we do not believe that there will be any further increase in working capital. The growth in working capital was relating to increase in our cost of sales and in value of our inventories. As long as prices stay at the levels that we have seen in the first half of the year and that we are seeing currently, there will not be releases, but we have kind of secured the current levels of working capital.
Mm-hmm. Thank you. My last question is to Denis and Oleg on China and these illegal capacities. We are talking about these capacities in terms of illegal banned capacities and the market will lose these volumes. But in reality, these are physically existing things. They can be revealed, they can be reapproved somehow, they can be relocated, and so on and so forth. Do you have any sense, maybe from the local ground in China, is there any work ongoing on how to legalize this capacity and how quickly these physical capacities can return in any form of production going forward? Because it is really hard to assume that current owners will just abandon them physically and then they will disappear completely and for all.
Well, I think, first of all, it is a matter of fact that certain capacity has already stopped. A few companies announced quite significant numbers, like Hongqiao, for example. They told the market that they already shut down more than 2 million tons of capacity. Your question is what is going to happen next? I think the key is that those private companies in China are not going to build any additional capacity. We have a relationship with every major Chinese aluminum company, including private companies. In our conversations, they are telling us that now it becomes very risky to expand capacity further. Of course they will try to utilize this shutdown capacity. We do not know how much of capacity will come back to the market. Again, the key point is that they are not going to expand as they have done before starting from 2011, 2012.
Just to add one point, this is Denis. It is just to legalize this capacity, you can do it in two ways. First, you should find quota for capacity which used to be legal but was closed, like in Henan and other provinces. It is a very small chance to find the sufficient tons of such a kind of capacity. Second is, Oleg is right that in the future, if the Chinese market will fall into very heavy deficit situation and they will face very high prices pressure, they definitely, higher authorities may be considering for release of some capacity and legalize some part of this capacity. Again, they will definitely be strictly absorb and how to not allow this capacity to be oversupplied. That is a key point that the government definitely and be observing and controlling current and future capacity in the market.
This is also-
Sorry.
This is Oleg. This 26 + 2 program also quite an important factor because, in reality, you cannot shut down 30% of your capacity for five months, then restart it and then shut down again. Basically, we believe that if they shut 30% and they have to, 30% of capacity in this 26 + 2 cities, there is a little chance this capacity will come back because it is too expensive to restart and shut down every five months.
Mm-hmm. In this situation, can they really work with reduced capacities, reduced production at the same capacity level just to comply with some output limitations, but at the same time producing with higher costs at this reduced capacity, or it is not the case? They will just shut down some particular plants as you mentioned.
Denis, can you comment?
Yes, definitely they first, they closed off some previously operated capacity, and there is some newly built capacity which can be operational. They still hold on with this, and they will put this into operation after winter comes. But they first they closed all the operating or some operating capacity they are not afraid to lose or they can. All newly built capacity definitely be holding into operation.
Mm-hmm. Okay. Thank you. That is clear.
Thank you. Now we take our next person from the queue. George Buzhenitsa from Deutsche Bank. Please go ahead. Your line is now open.
Good afternoon. Thank you very much for the presentation. I have two questions, please. First of all, I just wanted to clarify, when you say CapEx of $650 million-$700 million beyond 2017 as a sustainable level, does that include the growth projects that you currently have in the pipeline? I am referring to BEMO and Taishet primarily. This is the first question. The second question, given the recent run in aluminum prices and given your balance sheet situation, would you think that hedging a part of your revenue could be an appropriate strategy? Thank you.
Thanks for your question. With regards to CapEx, of course, in 2017, when we are doing some construction works on Taishet, those expenses are included in our estimates. in 2018 and go forward, we expect to construct Taishet as a joint venture in manner similar to BEMO. As you know, BEMO CapEx centers and we expect that Taishet CapEx centers are not included in our own CapEx as they are project financed. That is on the growth project. In terms of hedging, of course, we are constantly looking at various opportunities, but at this time, we have not made any decision to make any significant strategic hedges at the current level of prices.
Thank you.
Thank you. Now we take our next person from the queue. Alexander Naumov from VTB Asset Management. Please go ahead. Your line is now open.
Okay, guys. Thank you for your results. I would like to ask a question about selling general and administrative expenses. Why we will see such growth in the second quarter, and is it sustainable growth? Thank you.
Thanks for your question. In fact, in the second quarter, our administrative expenses were $147 million, and in the first they were $145 million, so they were pretty flat quarter-on-quarter. In fact, there was some increase if you look in the first half of 2017 in comparison to the first half of 2016, but that was largely driven by ruble appreciation in 2017 as compared to levels we've seen in 2016. There was some growth in distribution expenses in the second quarter as we saw some sharp increases in rail tariffs, the rates that you pay for rail cars on transportation. On average, we expect that to remain broadly the same as we go forward.
Okay, thank you.
Thank you. As there are no further person in the queue, I would like to hand the call back for closing remarks to Yulia Chekunova.
Well, thank you everyone for dialing in and for your vivid interest in the results of UC RUSAL and the outlook. We appreciate all the questions. If you have any further, please do not hesitate to contact us. We are very available for the follow-ups if required. With that, we conclude our call. Thank you everyone for dialing in. Bye-bye.