Good day, and welcome to the Norsk Hydro ASA Q2 presentation. 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, and welcome to Hydro's second quarter 2017 conference call. We will, as normal, start with a short introduction by President and CEO Svein Richard Brandtzæg, followed by a Q&A session, also joined by CFO Eivind Kallevik. With that, I'll leave the word to you, Svein Richard.
Thank you very much, and good afternoon. Let me start with a brief overview of the key developments in this quarter. Underlying EBIT for the second quarter of this year was NOK 2.9 billion, up from NOK 2.3 billion in the first quarter. The main explanation for the improved results is that we experienced higher realized aluminum prices in the quarter. This improvement was partly offset by lower realized alumina prices, higher raw material costs, in addition to continued disappointing results in Rolled Products. Following our recently announced acquisition of Orkla's shares in Sapa, I'm very happy to see that Sapa continues its improvements and are delivering record quarterly result in the second quarter.
I'm also pleased to say that our NOK 2.9 billion Better Ambition is progressing towards reaching the 2019 target with the clear measures across the business areas. We expect to reach the 2017 target of NOK 500 million. The Karmøy Technology Pilot is running as planned and is now 85% completed and is on schedule for the first metal in the fourth quarter this year. When it comes to the market side, we reiterate our estimate of largely balanced global market of 2017 with a global demand growth of output in the range of 4%-6%, in line with what we said in the first quarter. Let me then pick some key priorities going forward.
Safety is always number one, and good financial and operational performance do not stand alone. It has to go hand-in-hand with safety performance. As I mentioned for several years, I, as you will probably hear me mention for several years to come, our improvement ambitions remain very high on our agenda. This quarter, you have also heard, as mentioned, that we have a special focus on Rolled Products. I'm not happy with the performance in Rolled, and I want to underline that resolving these difficulties is high on both my and the rest of the Corporate Management Board's agenda, going forward, and we are taking several measures. We are prioritizing short- and medium-term performance in Rolled Products through targeted initiatives to lift production reliability and strengthening project organization.
We are confident, the operational challenges will be resolved shortly and that both the UBC line and the Automotive Line 3 will perform as intended after overcoming the initial challenges. Another priority of ours is to deliver on our main growth projects, the Karmøy Technology Pilot in Norway, the Automotive Line 3, and the UBC line in Germany. Given the announcement we had earlier in July on taking over, of course, 50% of Sapa, it is natural that we also prepare for the big and challenging task of integrating Sapa into Hydro. We will deliver on all of this while at the same time ensuring that we maintain the financial strength to be able to handle the volatility in our cyclical industry.
Thank you, Svein Richard. 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 your mute function is turned off to allow your signal to reach our equipment. Again, star one to ask a question, and we'll pause for just a moment to allow everyone an opportunity to signal. We will take our first question from Menno Sanderse from Morgan Stanley. Please go ahead.
Yeah, afternoon, everybody. Just two very brief ones. The first one is on new projects and on downstream. Clearly, the company's struggling a lot with new assets, UBC, automotive mill, et cetera. One of the most important new assets is coming on in the next six months. How can we be assured that this start is going to be better managed than what we've seen so far, especially given the spinoffs, positive spinoffs that have to come from this? What has changed in your project approach to this to make sure there's no repeat of the UBC and automotive mill issues?
Secondly, if I play devil's advocate, I would say that Norsk Hydro's skills are clearly not downstream based on the last three quarters of rolling results, but the company has just committed $12 billion of capital employed downstream. How can you give us some assurance that once the company takes full control of Sapa, you're not gonna encounter the same issues as we've seen in the last three quarters in rolling?
Thank you, Menno. With regard to the projects downstream compared to the big project at the west coast of Norway, the Karmøy Technology Pilot, I think there are some differences. Of course, we are absolutely not happy with the performance in the project in Germany. If you take the used beverage can recycling line, there has been an under-dimensioning of the furnace chamber that was, I would say, a project that should be delivered ready for full operation, and it took time before that was identified as the main problem. When we have identified that, I'm quite sure that we are going to also deliver on the volumes going forward.
Still, it will take some weeks and months before we reach full operation in that line. With regard to Automotive Line 3, I would say that we are 75% compared to the planned operational level as we are now. We have identified also there some weaknesses in the production line that we are now fixing and installing. Of course, both with regard to the UBC recycling line and the Automotive Line 3, these are very complex production lines which are highly sophisticated with regard to different technologies that are connected. I would say that there has not been built such lines before. Of course, we have used the expertise from the market which was not sufficient in this respect.
We are not happy with the progress there. If you go up to the Karmøy Technology Pilot, the difference there is that we are now installing a technology that has been developed by Hydro over several decades. We have experience in ramping up electrolysis cells. We have also experience on building electrolysis cells. I would say that what could fail there should then be a rectifier or the high voltage system because we know that the electrolysis cells are working because we have electrolysis cells that are in operations identically to what we are going to install at Karmøy. We have these running in the research center at Årdal, and we know the technology is working.
In fact, in that respect, we have done it before, but now we are going to do it in a bigger scale. When we got to rectify our high voltage systems, we are testing that before we start. I don't think we will get any surprises on that with respect to that. The same with if you think about the support system around the technology pilot at Karmøy. There are cranes which are delivered by a standard suppliers. I would say that the probability of having surprises there are far less than what we have done and experienced in Automotive Line 3 and also used beverage can line. With regard to the skills downstream, of course, I understand where you're coming from when you're asking a question.
I would say that we have quite good overview of our opportunities and also challenges. We are not underestimating that, but we also know there are a lot of opportunity also in this business. I would say that both Eivind and me has been responsible for that business in Hydro before. We were also responsible for establishing the joint venture, which we found the best way to develop this business. Of course, we have been following this very closely through the board of directors in Sapa. This is not something that is completely new for us. We are quite optimistic what we are going to achieve. We also know that this is a, it's a big task that we are not underestimating.
I think, with regard to the situation now in all quarters, as I said, it is very disappointing. I'm not happy about the situation. We have now strengthened the organization. We have even changed some management, a new plant manager in Hamburg. We have strengthened the project execution management in Germany. I think we have better resources in place now than what was the situation some months ago. At the same time, I cannot promise that this is going to be solved in the next couple of weeks because it's quite complex lines and we are also dependent on supplies from external suppliers. This is going to be, of course, first priority for us going forward.
Again, we see that gradually all products has solved the issues, but it has been very disappointing to see how these problems has been built up in the first and the second quarter.
Okay, thanks. A very, very brief follow-up on bauxite. How much extra reactive silica and less bauxite was there in this batch? Is this a particular part of the mine that the company went through? Is there more of this slightly lower quality bauxite and higher caustic soda consumption to come?
Menno, what we typically do is that we mine different areas of the mine and then blend it. What you saw in Q2 is that we mine mostly in let's call it the lower parts of the mine. It is only for Q2. As we get into Q3, we will be back to normal in terms of bauxite quality.
Okay. Thank you.
We will take our next question from Hjalmar Ahlberg with Kepler Cheuvreux.
Hi. First a question on, again, on the bauxite and the division. Could you say something about the overall cost per ton? I mean, you had a one-time issue with the lower quality bauxite, but then you will have higher raw material cost in Q3. Would you say that cost per ton would be up or down in Q3 versus Q2?
If you look into Q3, Hjalmar, what we will see is that caustic prices will increase with roughly 10%, which has an effect of probably around NOK 50 million, the way we see this. There will also be increased depreciation in Q3 as we start utilizing an additional dam heightening in the Paragominas mine. You have to remember, of course, that we had an obsolete asset write down in Q2 of roughly NOK 50 million. So there will be some price increase on the caustic side of around 50, and then depreciation goes against each other.
Okay, thanks. Just regarding sourcing of alumina, I mean, you have a long-term contract of 900,000 tons. But the other one, I think, I guess you source more on near-term pricing. Is that still a good business with a higher aluminum price? Or will you say lower sourcing volumes going forward in Bauxite & Alumina?
The way we see this is still a good business. As you do, we do need to split it in two. The sourcing out of the Worsley in Australia is still a very good business with today's aluminum prices. The other price that we source in the market is typically more related to spot prices, and that is more to do optimization between different geographic markets. There's still a good business case.
Okay. Then on rolled products, I think you mentioned that there's both partly a mix issue here, and there's also the production issue. Could you say how much is due to the product mix and how much is the production issues of the profitability? I mean, you were above $200 per ton before, now you're down to $150 or so. Could you say something about how much is mix and how much is production issues?
This quarter, we said in Q1 that we had roughly NOK 70-80 million in extra production costs. A large part of that is been fixed in Q2, so significantly less, so only a small fraction of that left. It's predominantly sales mix in this quarter where we produce then more can body than compared to the other higher margin businesses such as Lithography and Foil which dragged on the average margin this quarter.
Okay. Looking at 2018 and beyond, do you think you will be able to improve mix, again, or is it a tougher market for those products?
The target is of course to improve the product mix in all products going forward. We see that it is also coming up a better product mix. Saying that, we also know that there's, for example, one market segment that is under pressure, that is general engineering, where we see lower margins going forward. Of course, we are trying to reduce the low margin products and increase the high margin products. We say that it is still a hard work that has to be done to compensate fully for this development.
I can add just one comment, Hjalmar. Remember when we talked about 70, 80 in Q1 and less this quarter, that is of course the cost side. There is also of course a revenue impact by this when we have operational issues, meaning that we're able to produce less of the higher margin products that we anticipated originally. That of course will also come back when the production issues have been fully resolved. Then there will be a natural transition into higher margin products again.
Okay. Just last one, the Sapa acquisition, do you think? I mean, this will close in H2. When will you start reporting with Sapa fully consolidated? Could that be in Q3, or is it more in Q4?
That all depends on when we close the transaction. If for argument's sake that we will close early September, we will consolidate as of Q3. If it closes in Q4, it will be as of Q4. It's really up to when we get the final approvals from the competition authorities in the regions where we have applied for approval.
Okay. I see. Thank you.
As a reminder, it is star one to ask a question, and we will take our next question from Daniel Lurch with Exane. Please go ahead.
Hi, good afternoon. Thanks for taking my questions. Just 3 quick questions on my side. First one, also on Rolled Products. I understand the operational issues, and you're basically working on your setup there. Can you shed any light on any investments required for these improvements? Do you expect there might be increased CapEx in that business unit over the next 6-12 months? Second question is quickly a follow-up on the Bauxite & Alumina business. You already indicated the cost of performance here. Just a quick one on the ramp-up costs of the press filter in Alunorte. Is that a major component of the cost increase, or will that be a major component going forward, or is it relatively small?
The last one, just a background question on Brazil and your bauxite mining operations there. There seems to be talks on a new mining code in Brazil, which might be introduced and changes in royalty rates could come, but it's not yet confirmed. Is there anything you can share on this? Any thinking or any feedback from your local management there? Thank you.
Maybe I can start on the first and the last question, and Eivind can go more into the cost and ramp-up cost in Brazil. With regard to the operational issues and investments, we don't expect that there will be major investments that is needed. There are some equipment that is going to be put in place, but they are minor investments and adjustments, and not necessarily significant investments and necessary for bringing these lines up to full speed as we see it now. On Brazil, we know that there's been talks about the royalties, and we have people on the ground to follow this up.
The Brazilian Aluminum Association, ABAL, is following it up, and there's no signs that this is including bauxite. Of course, we are following this carefully.
In terms of the ramp-up cost for the press filters and running the drum filters at the same time, the total cost for this year is probably around $24 million, the way we look at this. Roughly half of that has been taken already in the second quarter. Around $12 million for the second half.
Great. Thank you.
We have no further questions at this time, but as a reminder, it is star one if you would like to ask a question.
Okay. As there seem to be no further questions, I think we can end this quarter's call. Thank you for joining us today, and if you have any follow-up questions, please do not hesitate to contact us. Thank you, and have a nice evening.
Ladies and gentlemen, again, this does conclude today's call. Thank you for your participation. You may now disconnect.