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 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 that did not see this morning's webcast of the results presentation, this is available on Hydro.com. With that, I leave the word to you, Svein Richard.
Good afternoon, and let me start with an overview of the key developments for this quarter. The underlying EBIT for the second quarter of 2016 was NOK 1.6 billion up from NOK 1.5 billion in the first quarter and down NOK 1 billion from the second quarter last year. We experienced higher realized alumina and all-in aluminum prices in the second quarter, which positively affected results in Primary Metal and Bauxite & Alumina . However, this was offset by the negative currency developments in the quarter. We also saw increased sales of alumina and aluminum affecting the quarter positively, while the bauxite and net spot sales in energy decreased.
Topline delivered another strong quarter, in fact, the strongest second quarter we have ever experienced since the closing of the Sapa joint venture back in 2013, driven by both stronger margins and higher volumes supported by seasonality. I am pleased to see the continued progress of our ambitious Better Improvement program, and I'm happy to see that we are back on track to reach the total improvement of NOK 2.9 billion in 2019. It is also encouraging to see that we are delivering approximately NOK 1 billion in positive cash flow, even in a quarter where we paid dividends for the full year of 2015.
Finally, we saw some positive developments on the market side and are now expecting to see a 45% growth of primary aluminum in 2016, adjusted upwards from our previous expectations of 3%-4%, much based on higher than expected demand growth in China. We still see a largely balanced market for primary aluminum this year. I would then like to end my introduction today by summarizing our key priorities going forward, which always, as always, our improvement ambitions remains high on our agenda, and today we are on track for our 2019 target of NOK 2.9 billion.
Our Better program is about taking control of all what we can influence ourselves by re-reducing cost and improving efficiency in our operations and equally about maintaining our technology lead and high-grading our product portfolio towards attractive high margin and high growth markets. Two good examples of the latter are the two main growth projects we are focusing on today, the Karmøy technology pilot in Norway and the Automotive Line 3 in Germany, which we will deliver on time and on budget. Testing the world's most climate and energy-efficient production technology is crucial to not only improve cost for the entire portfolio as we will do, but also to stay ahead of the game in the long run.
In the new tech automotive line, it will allow us to establish a long and 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 weather volatility in our cyclical industry. Our financial strength is key to provide a reliable 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 term.
Thank you, Svein Richard. Operator, we're now ready for questions.
Thank you. If you would like to ask a question, please press the star or asterisk key followed by one on your telephone. Please ensure that the mute function on your telephone is switched off to allow your signal to reach our equipment. Once again, please press star one if you wish to ask a question. We have a question from Jason Fairclough from ML. Please go ahead.
Yes. Good afternoon, gentlemen. Thanks for the opportunity to have a chat. Just a question on Sapa. It looks like the results are very strong from Sapa. To be frank, they're much better than I ever expected when you formed this JV. Could you talk to us a little bit about how you internally think about what to do next with Sapa? How do you frame the decision-making process on Sapa from here?
Yeah. Thank you, Jason. We are also happy with the development in Sapa, and results we see now is again the effect of restructuring and synergies and further improvements on product mix and again developing Sapa as the leading not only the biggest extrusion company in the world, but also the best one. We are following that carefully as both my CFO Eivind Kallevik sitting beside me and myself are in the board of directors of the Sapa company. You know that Orkla has stated previously that they are planning to leave.
We can join them together with an IPO if that is the preferred solution or the other alternative is that we could also take over their shares. Since we are not commenting on mergers and acquisitions, I cannot comment more on that today. We have the options, as we have said before, and we maintain these options also going forward.
Sure. Recognizing that you don't comment on M&A, what I was really interested in, Svein Richard, was, you know, how do you think about whether or not this makes sense for Hydro? Is it looking at the return on this versus the return on other investments that you might make? Or is it more, you know, what are we really in the business of?
I think we have the full value chain in the company with several options. For us, it is very much about value creation. If we are seeing that it's more value creation for us to lead together with Orkla, we will do that. If it is more value creation to take over the ownership of Sapa and develop Sapa further, that could be also an alternative. It is really a question of value creation for the shareholders.
Okay. All right, thank you then.
The next question comes from Menno Sanderse from Morgan Stanley. Please go ahead.
Yeah. Good afternoon, gentlemen. Just a couple of slightly dull ones. Just on the huge beverage can line, it's clearly not going very well to say the least. So why is that happening, and what does it mean for financials? Does it also mean we now need to worry about execution at Karmøy and Body in White, which are the two other projects that are ongoing?
Oh, thank you, Menno. Of course, we are following up these projects very carefully. With regard to the Karmøy technology pilot, I visited that myself just a couple of weeks ago, and I can confirm that this is also building according to plan, as we also see with Automotive Line 3 in Germany. With regard to the UBC line in Germany, we are a bit delayed on the ramp-up, which again is a ramp-up of a fully integrated recycling facility, which includes sorting of the metal. It includes delacquering of the metal and also smelting.
We have seen that there are some operational issues related to one step of this chain which is now on the way to be solved. I cannot tell you about the further progress before we have again the updates of the reports from what is now ongoing in the UBC line in Germany. We are quite optimistic. This is something that we are going to solve, and we will bring it up to speed. With regard to the capability of Hydro to run projects like this, I think I can confirm that we still are ahead of the issues. It was a surprise with UBC. We are not happy with that. With regard to the other projects, we are continuing as planned.
Just to make sure. You said you're quite optimistic that eventually you will make budget. It's just taking a bit longer to get there. Did I understand that correctly on UBC?
Of course, we are not happy to see that we are delayed, but this is quite advanced line with several new technology elements, which makes this line very competitive.
Mm-hmm.
I'm sure this competitive position that we are establishing with the UBC line will be delivered. As said, we are a bit delayed on the ramp-up.
Okay. Two slightly more mundane ones. On the automotive sector, clearly there are some signs that things are rolling over. What does Norsk Hydro see as an important supplier to that industry? In line with that, but separately, the company is quite exposed to end markets in Europe. Clearly it's very early to talk about Brexit, but maybe you can give us an understanding how you think about end demand in Europe and if you're taking any measures to be more flexible in the next six to nine months.
Yeah. With regard to automotive, we see definitely very positive development. We are of course heavily engaged in the entire general market for automotive, but the fastest growing market segment for automotive now is the Body in White. The growth rate last year was 75%, and we are not expecting that to continue. That was mainly influenced by the Ford F-150 introduction last year, which has been quite successful. We estimate that the growth further now will be at a 13% level for the coming years, which is still a quite good growth rate. Of course, we are happy that we have made the decision previously to invest in more Body in White capacity.
In the end of this year, when we start Automotive Line 3, we will ramp up that to a level where we will have about 200,000 tons capacity for Body in White for the automotive industry in Europe. We are supplying the most demanding customers in that segment in Europe, and we are working very closely with the automotive producers for also developing solutions for the next generation cars. Not only the cars that are running with petroleum and diesel engines, but also for the electric solutions going forward, where it's even more important to reduce weight due to the batteries that have an impact on the weight of the mass in these cars.
We are quite optimistic with regard to development of the automotive market, going forward, from a downstream perspective, but also from an upstream perspective, because that market segment will eat a lot of aluminum going forward.
Mm-hmm.
With regard to Brexit, I would say that there is no short-term impact on that. It depends very much on which kind of outcome you will get on the negotiations with the European Union and we all know that it will take a lot of time. For us, U.K. is not the major exposure for Hydro anyway because it's not the biggest market we are supplying to, and we have customers there, but it will have limited impact whatever happens. Of course, we are following carefully and will follow carefully the negotiation going forward between U.K. and the European Union.
Okay. Thank you very much.
The next question comes from Daniel Luz from Exane BNP Paribas. Please go ahead.
Hi, this is Daniel speaking. Thanks for taking my question. Just two quick questions. Could you provide a bit more color on the performance at Qatalum? Earnings have improved there considerably. What are the key drivers here? Is it primarily utilization, pricing, currency? Could you give us a split? Secondly, just a quick follow-up on capital allocation and your plans here. In terms of share of CapEx, you are allocating a lot of your CapEx in the upstream operation, of course, also in Body in White, right, downstream. However, downstream overall has showed quite a good momentum in the first half this year. Does this make you in any way reconsider capital allocation between the segments? Do you think downstream could increase that momentum over the next couple of quarters? Thanks so much.
Thank you, Daniel. Good questions. If you go to Qatar first and Qatalum, this smelter is running steadily above nameplate capacity. Of course, this smelter is in a country where we have not seen the same currency advantages as we have had in Norway and Brazil, for example. The operations in Qatar is very good. It's high production level compared to the nameplate capacity, and with regard to all production parameters, this is a good smelter. Running forward in Qatar is about continuing improvements, both with regard to production parameters and also of course on the cost side.
That is something that is ongoing, and Qatalum is a part of the joint venture program, the $180/ton program that will be finalized this year. This is a part of the NOK 2.9 billion Better program in Hydro that we have talked about. With regard to capital allocation, upstream versus downstream, I think this is a good example where we see that the profitability over time is moving along the value chain, and keeping along value chain also gives us a lot of strategic options. We see now that there are positive development in the downstream area, but we also see opportunities in other parts of the value chain.
We can just confirm that Hydro will continue as an integrated aluminum company with ore material production, with metal production. We will have recycling and also downstream production. We will utilize the capital where we see that we get the most value creation for the shareholders going forward, as we have done so far.
Great. Thanks so much.
We now have a question from Hjalmar Ahlberg from Kepler Cheuvreux. Please go ahead.
Hi. Thank you. Just a question first on your investment in CapEx for Karmøy. Can you say how much has been invested and how much is left? Also how you report the contribution from Enova? Is the Total CapEx only that, the one that is just you're putting in or is it adjusted for the what Enova is putting in as well?
Thanks, Hjalmar. On the CapEx side, we've spent roughly half a billion NOK on CapEx in this quarter, in the second quarter alone. In the cash flow, you will find that we've netted Enova funds or grants in that column as such. It's progressing very much according to plan, both on time as well as budget. In terms of the Enova fund refund that we got in second quarter, that is roughly NOK 100 million in each quarter.
Okay. Thanks. Karmøy metal division, you mentioned the ICMS tax, positive contribution of NOK 200 million. Is that like a one-time effect or will it be lower taxes going forward as well?
Well, it's NOK 75 million related to the reversal of the ICMS accrual. That has to do with potential ICMS tax on excess power sold in the past, where we made an accrual in previous periods, as well as in Q1. The way we see the legal situation today is that we believe it's more likely than not that we will not have to pay this tax, which is why we reversed it. Again, it's NOK 75 million.
75. On the bauxite and alumina, I mean, the current real estate again, and the cash costs have moved up quite a bit. Do you think you can get back to below $200 again with the cost-saving steps ongoing?
We will certainly try to compensate as much as we can with the improvement programs that we do have. Remember that what we saw in Q2 is that roughly a 10% movement strengthening of the BRL against the U.S. dollar gave an impact of roughly NOK 200 million in this quarter. That, of course, is a big number to cover in the short run at least, on the cost side.
Just lastly on China, I mean, aluminum price has been improving quite a lot. It's I mean, you haven't changed that much of the potential restock and addition. Do you see any major risks in this or major changes in the behavior in China on the producers?
Thank you, Hjalmar. When we go to China, we of course are following carefully the development. We see that there is a surplus capacity in China of about 1.5 million tons. We don't see more additions and now this quarter than what we saw last quarter. We estimated about 2.4 million tons new capacity coming on stream in the first quarter, and we see the same figure now. There are some restarts that has happened in the first and second quarter this year. You know, there is a delay on the effect of restarts, because you can take down a smelter, you could pay the smelter within a few days.
It takes some time, but to restart the smelter takes several months. The effect of this you will see now in the coming months in the second half of 2016. That is what we also have included in our estimation of the supply-demand balance. As you saw, we are in a deficit.
If you take a 12 months rolling average, in now as we see it in the second quarter, and if you take a full year perspective including restarts, new capacity, and demand both in China and outside China, we will end up with, again, deficit of 1-1.5 outside China and, surplus, 1-1.5 billion tons in China, and then ending up with a fairly good balance, in the end of this year. That is what we expect for the coming second half.
Okay. Thank you very much.
As a reminder, if you wish to ask a question, please press star one on your telephone keypads. We're now moving to James Gurry from Credit Suisse. Please go ahead.
Yeah. Thanks very much for taking my question. I've just got one question on Sapa and one on CapEx. Just in relation to Sapa, I remember when that joint venture was formed in 2013, there was a provision that if one of the partners wanted to IPO, the other could go to 34%. Can you explain sort of how it works to go from 50% to 34% or how it was envisaged then when you drew up that agreement, and if that agreement is still in place? And just in relation to CapEx, you're still guiding to, I think, NOK 5.7 billion for next year. Can you just say if there's any projects that are up for review or approval?
In relation to the rebate from the government for Karmøy, is that falling into this period or the next period? Is it a one-off payment or do you get, is it a series of payments?
When it comes to the Sapa agreement, James, it is correct that if one of the parties triggers the IPO, then the other party have to step down to 34% for benefit of shareholders. That's the whole thinking behind this is of course that, neither party would like to have a very dominant shareholder sitting holding 50%, basically controlling the company if it's listed. That's the thinking behind it. That agreement is still in place, and is still valid.
All right, thanks.
When it comes to the CapEx guidance for 2017, you know, we uphold the guidance that we've given so far. When it comes to the refund from Enova, it's basically a series of payment following the CapEx profile of the project, if you like. To make it simple, it's pretty much a 50-50 split in the Enova refund between 2016 and 2017.
Okay. That's helpful. Thanks a lot.
The next question comes from Anna Munthe-Holland from Deutsche Bank. Please go ahead.
Oh, hi. Good afternoon. I just had one question, please, on the request from the tax authorities to reexamine the case, obviously which you won earlier this year, giving you the rebate of NOK 700 million. What's the timeframe for that reexamination? What are the chances that it will have to be reopened?
We still believe that we have a very good chance of winning or a good chance of winning this case. Trying to get the tax authorities to agree on a very specific timeline is difficult. It's certainly going to be, we believe, not sooner than 2017. It could be in any quarter of at least the second half of 2017, we believe.
Do you have to keep the NOK 700 in escrow?
No. It's cash available for us to use if we see we need it.
Thank you.
As a final reminder, if you wish to ask a question, please press star one on your telephone keypads. We have a question from Eivind Eggen from DNB. Please go ahead.
Yes. Hi. Thank you for taking my question. Just a quick one on my behalf on Primary Metals. How much of the strong performance was actually related to the one-offs? How much was related to underlying improvement from the improvement program? How much was related to lower raw material costs? Thank you.
Eivind, it's on the one-offs what we said. It's about NOK 125 related to the one-offs. 75 of that relates to the ICMS reversal of the accrual, and about NOK 50 million relates to a insurance payment in relation to the Årdal power outage that we had in Q1. On the OpEx side, we saw roughly NOK 150 million down on the cost side. About NOK 100 million of that came out of the Karmøy costs coming down. That's sort of the major factors.
Okay. Thank you. Just a quick follow-up on the NOK 75 million ICMS. That was flagged in Q1, wasn't it?
We did an accrual for cost in Q1, somewhat less than the NOK 75 million. We have done also accruals in previous periods. NOK 75 was then reversed in this period.
Okay. Thank you.
There are no further questions at this time.
Okay. As there seems to be no further questions, we can end this quarter's call. From all of us here, I would like to thank you for participating today. If you have any follow-up questions, please do not hesitate to contact us. Thank you, and have a nice evening.
This concludes this conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.