Welcome to the Norsk Hydro Q4 Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Stian Hasle. Please go ahead, sir.
Thank you, operator. Good afternoon, everyone, and welcome to Hydro's fourth quarter 2016 conference call. We will start with a short introduction by President and CEO Svein Richard Brandtzæg, followed by a Q&A session, also joined by CFO Eivind Kallevik. For those of you that did not see this morning's webcast of the results presentation, it is available on hydro.com. With that, I'll leave the word to you, Svein Richard.
Good afternoon, let me start with a brief overview of the key developments in the fourth quarter. The underlying EBIT for the fourth quarter of 2016 was NOK 1.8 billion, up from NOK 1.5 billion in the third quarter. The main explanation for the improved result is that we experienced higher realized prices in the quarter, both for aluminum and alumina. This improvement was partly offset by reduced results in Roll, due to lower volumes and margins, in addition to increased costs. It is very positive to see that Alunorte and Paragominas are keeping up the strong operational performance with record high quarterly production in Paragominas, with more than 12 million tons of bauxite, and also Alunorte with the 6.5 million tons, as we saw in the previous quarter, both well above nameplate capacity.
I'm also pleased to say that our improvement efforts have shown significant results in 2016, delivering a total of NOK 1.4 billion in improvements. That we are also well on our way to reach our 2019 ambition of NOK 2.9 billion improvements. Our two large projects are running as planned. The Karmøy technology pilot is now 70% completed and is on schedule for first metal in the fourth quarter this year. At the automotive line number three, we have been running trial productions and will be ramping up during this year. The Board of directors proposed a dividend for 2016 of NOK 1.25 per share, demonstrating Hydro's commitment to provide predictable and competitive cash return to shareholders, while also taking into account the volatility in the aluminum industry.
I would also like to mention that the Sapa Board of Directors has proposed to pay a dividend of NOK 3 billion to the owners, which means, Hydro share is NOK 1.5 billion from Sapa. Finally, we are maintaining our expectation of 3%-5% global demand growth for primary aluminum in 2017, and expecting a largely balanced market in line with what we said at our Capital Markets Day in London in December. I would then like to end my introduction today by summarizing our key priorities going forward, which is always to improve and our improvement ambition towards 2019 remains high on our agenda. Our Better Program is about taking control of what we can influence ourselves by reducing costs and improving efficiency in our operations.
Exemplified lately, not at least by the strong operational performance in Brazil. The ambition is also about maintaining our technological lead, leadership and high grading our product portfolio towards attractive high margin and high growth markets. Another priority for us is to deliver our two main growth projects, the Karmøy technology pilot in Norway and the automotive line 3 in Germany, which is on schedule and on budget. The technology pilot is expected to deliver the first metal in the fourth quarter of 2017, and this pilot plant is crucial, not only to improve costs in itself for the entire portfolio, but also to stay ahead in the game in the long run.
The new automotive line, which will be ramping up during 2017, will allow us to establish a strong presence within the high growth automotive segment by becoming the second-largest body-in-white supplier in Europe. We will deliver on all this while at the same time ensuring that we maintain the financial strength to be able to handle the volatility in our cyclical industry. Our financial strength is key to provide predictable payout to our shareholders in the short- term, as well as to maintain flexibility necessary for creating the most value for our shareholders in the long run.
Thank you, Svein Richard Brandtzæg. Operator, we're now ready for 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 that your mute function is turned off to allow your signal to reach our equipment. Once again, that is Star one for questions. We'll go first to Jason Fairclough with Bank of America Merrill Lynch.
Good morning, Svein Richard , and thanks for taking the time to speak with us today. Just a couple quick questions from me. One is just on Sapa, and I'm sorry, we couldn't listen into your call this morning. How are you thinking about Sapa? We know that Orkla is a seller. The business seems to be going well. It's paying dividends. How do we think about the path from here to there? Because right now it's just something sitting there with a question mark over it. Secondly, just on bauxite and alumina, could you give us any feel for how much higher EBITDA would have been if you didn't have legacy contracts in that business?
Okay. Thank you, Jason, for good questions. With regard to Sapa, the situation is exactly the same today as it was in the Capital Markets Day, when we discussed it. It is an option for you, though. That was in a way the strategy behind this. First of all, to create a world leader in extrusion, which has been very successful. Sapa has delivered good results ahead of plan. Also with the synergies and improvements, NOK 800 million better than the previous year in 2016. We still see potentials, although we cannot promise the same speed of improvements in Sapa for the coming years, because now we have taken out a big part of the potentials. Still there are opportunities for us to improve the business in Sapa going forward.
I'm sure that you are thinking about the ownership and what we are going to do with the shares in Sapa, and that is very much again an option for us. We have three opportunities. One is to join Orkla with an IPO. Another opportunity for us is to partly do an exit through an IPO and have a minority share. Or we could also, when the time is right, to take over the Orkla share if that becomes more attractive. Again, this is still open and still an option for the company.
With regard to bauxite and development there, we say that I'm very happy for the performance in Brazil, and the fact that we produced 12.2 million tons of bauxite in the fourth quarter shows that the progress has been quite substantial. Again, this is a result of the Hydro performance system, the Hydro business system that we have introduced and that will still maintain and develop further. Maybe Eivind, you can comment further on the bauxite story.
Sure. On the alumina side, Jason, the average price that we realized in the fourth quarter was some $255 per ton, roughly 15% of LME. Spot price right now, say $335-$340. There's a gap of $85 per ton, right? In 2016 we had roughly 50% on the alumina index. Roughly 4 million tons times $85 per ton would be the improvement in B&A.
It's a pretty big number.
Yes, it is.
That's still to play for.
Yes. In 2017, 65% of the alumina will be sold on the index. Coming up from 50% last year.
Okay. Thank you very much.
Welcome next to James Gurry with Credit Suisse.
Thanks guys for my questions. You've been busy down in Brazil, obviously ramping up volumes in a good pricing environment, and getting to the end of your agreements with Vale. Just on the latter, can you explain what the situation is with the envisaged CAP project? Because I think previously you thought that you might have to build a project that's 2 million tons, and you'd have to expand the Paragominas mine at the same time. Also, being able to come to these agreements in Brazil, does it mean anything for the MRN mine that you were attempting to purchase last year?
Just in relation to the market in China, did you say this morning that you expect Beijing to implement those pollution easing policies potentially this time next year, next winter?
Thank you, James. With regard to the CAP project, we have decided to put the CAP project on ice and did the write-down of what has been done so far. It is still a very attractive alumina project, but the basis for this investment would be that the market really needs more alumina and there are enough alumina capacity in the world today. We don't foresee that this will be a project that will be executed for at least the next few years. It could still come up again as a good alternative in the future, but we have decided to put this on ice.
Then with regard to MRN, you probably know that we did not agree with Vale last year. The MRN shares of Vale is representing 40% of the ownership, and we have an evergreen agreement with Vale, so we are taking the bauxite anyway. We still feel that it could be of interest for us to take more operational responsibility in MRN. Also based on the experience we have now in Paragominas, where we, through the Hydro business Hydro production system, are able to lift performance to higher levels. That we also would like to see in MRN. It is not a critical situation for us as such. We are still open for discussions with Vale if they come back again.
Again, we are not in a situation where we again are going beyond our principles. We got the valuation of acquisitions. With regard to the questions on China, it remains to be seen, you have probably heard the same as we have done with regard to pollution and possible closures during the winter time next year. That will be the winter 2017-2018, which could have an impact on the volumes from at least three different provinces where there are a lot of aluminum capacity. I wouldn't speculate if this is going to happen or not. Again, China is representing 50% of the global aluminum market and more than 50% of the global capacity.
Any shutdowns in China will impact the global market. We are following carefully the development in China.
Okay, that's great. Can I just follow- up and just ask, what's the level of undrawn debt that you have at the moment?
Of undrawn debt? We have a revolver of NOK 2.7 billion, first, maturing in 2020, which is undrawn.
It's fully undrawn?
NOK 1.7 million fully undrawn, yes.
Okay. Thank you very much.
We'll go next to Menno Sanderse with Morgan Stanley.
Yeah, hi there, gentlemen. I just wanna dig into the not so well-performing business, unfortunately. Rolled Products, it was a bit of a disaster. Down NOK 180 million year-on-year in EBITDA, and NOK 200 million on EBIT. Can you please help us understand the bridge or the EBITDA and EBIT level split between the auto line, the UBC, the legal measures that you mentioned, the Neuss smelter, and the margin pressure so we get a better idea of how long this will last for?
Thank you, Menno. Of course, Rolled Products was a real disappointment in the quarter, and we are not happy with the performance in this business area. There are several reasons, and Eivind may go through it in more details. It's clear that this is a result of, among many factors also, pressure on margins, which is the reason why we are now investing in the automotive body-in-white market, which is more, of course, demanding. It requires more competence, but also where we get more value in the market.
Menno, I think it's almost easier if we look at this on a year-by-year comparison, if we compare 2015 to 2016.
Yep.
EBIT shortfall is roughly NOK 400 million between those two years. Roughly half of that relates to lower oil and metal prices at the Neuss smelter, in a way leaving you with NOK 200 million shortfall. A big part of that is margin decline overall average margins between 2015 and 2016.
Okay. On the depreciation charge you mentioned, how much is that in total?
Yeah, in the quarter as such, it's roughly NOK 16 million in Q4.
Okay.
Similar in Q3.
Okay.
On a yearly basis between NOK 60 million and NOK 70 million.
60 and 70. Okay, great. Okay, the follow-up question to this is, do you think this high-grading strategy is going to work? Because clearly you have to put a lot of capital in, takes a long time, and in the meantime, everything else is commoditizing at a pace that you can't keep up with. So, are we going to face a situation here in the next two years where the company's high-grading on the one hand, on the other hand, the rest is falling off a cliff so quickly that the overall result is very poor? Therefore, is this still an attractive business in your view?
Of course, we are quite optimistic with regard to automotive volumes because even with the capacity we are now building up, there are still demand for more.
Yep.
Of course, this is a trend based on the market development. Automotive industry is now moving from steel to aluminum. Also, because of the trend in the market demand, but also the requirement from authorities. You know, in Europe, the limitation will be 95 grams CO2 per kilometers in 2021, and it is not possible to reach that level without much more aluminum. Again, your question is related to what is going to happen with the rest of the business. Of course, we should expect that the margin pressure will still be there.
We will also probably see that Hydro is not the only company that will now use the capacity for hot rolling into other products than the low-margin products. When we see the growth in automotive, our customers are really concerned if there are enough capacity in the Rolled Products in general here because they need much more aluminum than the capacity is built up today. What we are doing is to cannibalize on the low-margin products and then taking optimal capacity, which is stable, from low-margin products towards high-margin products. Again, the strategy is to produce more complex, more advanced products and from that also get more value from it.
We will probably still see margin pressure in some of the commodity areas, but at the same time, we are working towards high-grading the whole product portfolio and the Rolled Products.
Okay. Final one on this particular topic. You don't see China moving downstream aggressively and therefore causing even more margin pressure than you already see today in the commoditized product, commoditized products?
The margin pressure of today in some of the we say commoditized product, Rolled Products, is not from China. It is from the competing industries in Europe.
Right. Understood. Thank you.
We'll go next to Daniel Lurch with Exane.
Hi, good afternoon. Thank you for taking my questions. Just two quick ones. The first one on alumina. Your costs have come down again in Q4. Can you remind us where you see cost inflation at the Brazilian operations for 2017? Can you explain how you will offset this inflationary pressure? How do you expect the cost to develop? The second question, just quickly on Sapa. You mentioned that there are a couple of options on the table which you can decide on. Could you remind us again whether there are any, or where you see synergies between your other downstream businesses like the Rolled Products business and the Sapa extrusion business? Are there some, and where would you find them? Thank you.
Oh, thank you, Daniel. With regard to the alumina situation and the cost inflation, I would say that we are mitigating that through the improvement programs that is in place. I would say that the Bauxite & Alumina organization did a good job in 2016, and we expect that they will continue to do good job and also in 2017, not only with volumes but also on the cost level, which is partly also correlated. Again, we have introduced, you know, business system or the Bauxite & Alumina production system, which is focusing very much on performance improvements. It's several areas where we are looking at improved operations. That will continue.
We also took a big share of the Better Program in Brazil during 2016. The improvements will continue. On Sapa, we have, I know we're talking about the biggest extrusion company in the world. There are some synergies between Rolled Products and Sapa in some areas like heat exchanger, automotive, where we have the same customers, similar challenges and opportunities. I would be careful to over-exaggerate how much synergies there are here because there are also several market segments that are very different between these businesses. Like a building and construction, for example, is much bigger in Sapa than in Rolled Products and goes to very different products.
There are some limitations with regard to synergies, but you could also say that in the areas where there are synergies, there are also good opportunities. This is in itself not an argument to say that we are going to take Sapa for any price. It is very much a value question for me and for Hydro. If it makes sense for value creation, then Sapa could be interesting. Again, it could also be the other alternative is it creates more value to do an IPO and then we will do that.
Okay, great. Thank you.
We'll go next to Fraser Jamieson with JP Morgan.
Hi, everyone. Thanks very much for taking the questions. Just two relatively quick ones, hopefully. Firstly, on the CapEx guidance for 2017, could you give us a rough breakdown there between on a divisional basis, please? And then secondly, just around the balance sheet, whichever metric we look at, whether it's your net debt to equity, FFO to adjusted net debt, the balance sheet looks incredibly comfortable. You've obviously boosted the dividend a bit today. What further kind of metrics, milestones are you looking to reach before you would consider even more enhanced payouts? Would you consider kind of one-off specials et cetera? If you could maybe make some comments around that, please.
In terms of the metrics, Fraser, as you will see, you know, we're quite comfortable within any metric that the rating agencies would put up in order to stay BBB flat. What we've said for a long period of time, and we will continue to say this, is that we will, you know, again, strive to keep what we define as financial strength. Of course, you can argue whether you need NOK 6 billion in the bank to have financial strength. This is a cyclical business. We want to have a strong enough balance sheet to ensure that we can cater to any situation that is thrown at us.
That being said, you know, clearly if we go through this year with the current pricing that we see both on alumina and aluminum, you know, this will very much be renewed discussion during the year and towards the end of the year. We'll have to come back to that at the relevant point in time. In terms of CapEx for 2017, I don't have the details split in front of me. Still remember that in those CapEx figures, there's still two large maintenance projects that needs to be completed in Brazil, in taking down the red mud, and certain other projects. A big part of the CapEx goes to Brazil.
We have the Karmøy technology pilot where we have NOK 1.1 billion still outstanding in addition to sustaining capital. That would be the second-largest capital expenditure in 2017.
Okay. Thank you.
We'll go next to Jatinder Goel with Citigroup.
Hi. Good afternoon. Two questions. First on NOK 500 million improvement target for 2017, are you able to give a split between three business areas as you did for 2016? Secondly, on the first quarter maintenance at Bauxite & Alumina, any indication of number of days or volumes that can be impacted by these shutdowns? Thank you.
Yeah. In terms of the improvement programs, probably north of 60% of this is gonna come out of primary metal. The remaining 40%, say about 25% is gonna come from rolled, and the remaining is gonna come out of B&A. I lost your last question, Jatinder. Can you repeat that?
Yes. On the first quarter 2017, maintenance shutdowns at Bauxite & Alumina division, any EBIT impact, volume impact, or number of days of shutdown you can provide?
Yeah. There will be some EBIT impact, and some maintenance cost impact. We expect the mine to be shut down for less than two weeks for this maintenance, and then there will be less impact in Alunorte.
Okay. Thank you.
Thanks.
As a reminder, it is star one for questions. We'll go next to Eivind Veddeng with DNB.
Hi. Good afternoon. Thank you for taking my questions. Just a follow-up on raw material costs guided higher in Q1 for bauxite and alumina. Can you give some color on which raw materials, and is it possible to quantify by how much you expect them to come up in Q1 and for the rest of the year, please?
We have a-
Second question on the dividend. Sorry, Eivind, go ahead.
We haven't quantified the cost, but what you will see is that there is an increased fuel oil cost in Brazil coming from an increase by Petrobras who wants now to float closer to market prices than what we've seen in the past. There will be an uptick on that. There will be a slight uptick also on caustic costs coming in Q1.
Okay, thank you. On the higher dividend, is it fair to assume that the hike was on the back of a better performance from your underlying business? Was it as a result of the proposed Sapa dividend?
This very much comes on the basis of the performance that we've had during the year, Eivind. The cash position that we have at the end of the year and the overall performance of all our businesses, not only Sapa. Obviously the fact that we can take out now NOK 3 billion of dividends from Sapa later on this year is a strength of the great performance that they have had and the turnaround that they have delivered in the last couple of years. It's based on the overall performance.
We'll take a follow-up from James Gurry with Credit Suisse.
Yeah. Just on the dividend again, have you adopted a progressive dividend policy for the years going forward? What's your thinking behind that, given that aluminum is typically or can be quite a volatile industry, as you would be well aware?
Well, I think we fully agree that this industry is very volatile, has been, and probably will continue to be. What we've done now and the way we see this is basically formulating the dividend policy, what we've been stating verbally at least for the last two years is that the Norwegian NOK 1 that we paid out in 2015, for instance, was to be considered as a floor, and that we intended to lift that when we had a sufficiently strong cash position and that we were sufficiently confident about the future for our industry. Now we lift that to NOK 1.25, again, indicating that we believe that that's a sustainable level over time. When we will lift that again is a big question mark for the future.
We will do that again when we have sufficient visibility and sufficient financial strength to uphold that for a period of time. Basically what we're doing is formulating in writing in the dividend policy what we've been saying verbally for the last two years.
Okay. That's quite clear. Thank you.
We have no further questions in the queue at this time. I would like to turn the conference back over to management for any additional or closing comments.
Thank you for the questions. That will conclude the call for today. From all of us here, I would like to thank you for joining us. If you have any follow-up questions at a later stage, please do not hesitate to contact us. Thank you, and have a nice evening.
That concludes today's conference. We thank you for your participation.