day and welcome to the Norsk Hydro ASA third quarter conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Pål Kildemo. Please go ahead, sir.
Thank you. Good afternoon, and welcome to Hydro's third quarter 2015 conference call. We will start today with a short introduction by President and CEO, Svein Richard Brandtzæg, followed by a Q&A session where also CFO Eivind Kallevik will join. 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.
Thank you, Paul, and good afternoon, everybody. Underlying EBIT for the third quarter of this year was NOK 2.2 billion, which is down NOK 500 million from second quarter and up 0.7 billion from the third quarter last year. If we start with the bauxite and alumina, I'm happy to report a historical low implied alumina cost of $217 per ton on the back of weaker BRL, as well as increased alumina production at Alunorte, and record high production of bauxite at Paragominas, which is now at the level of 10.9 million tons annualized. This effect was somewhat offset by lower realized alumina prices. In primary metal, the falling all-in prices continue to influence earnings negatively, but also here the weakening NOK and BRL against the US dollar benefit us.
Last quarter, we talked about the record downstream results. The third quarter is seasonally weaker in the downstream segments. Results actually increased in the rolled products area, which is a strong development. In energy, we saw an increase in results due to high production as the delayed snow melt came in full effect in the third quarter. This was partly offset by lower energy prices. I'm also pleased to announce that we have signed a letter of intent with Vale for their 40% stake in the first quarter MRN bauxite mine. We will now undertake due diligence to see if we will follow through with a transaction.
When it comes to the market, then the increasing supply in China and weakening demand growth in and outside China continues, resulting in us taking down our 2015 global primary output from around 5% to around 4%, an increasing expected oversupply to around 1 million tons this year. The Chinese oversupply continues increasing while the undersupply outside China remains stable. Chinese exports of semis have declined significantly and are now at levels 10% below the levels we saw last year, partly reflecting the reduced arbitrage opportunities for exporting semis for remelting purposes. As we undertake the final quarter of this year, our improvement focus remains high on the agenda.
Through the third quarter, we have demonstrated that we are in control of the enablers, like for example, bauxite production, which is running at close to 11 million tons in annualized speed at Paragominas. As we said last quarter, we have managed to lift production at Alunorte, but with 5.9 million tons, we still have some left to get to the nameplate. However, we are stabilizing and continuing to lift production. At the same time, we are delivering operational and commercial improvements. We also are releasing operating capital, another item we placed high on the agenda the last two quarters after the buildup in the first quarter. A release of NOK 2.1 billion is of course largely relating to falling prices, but also some inventory release.
We are continuing to deliver some very interesting downstream growth projects, including the automotive body-in-white line in Grevenbroich, as well as the UBC recycling facility at Rheinwerk, which will be delivered on time and on budget. At the same time, we announced the divestment of a non-core lower margin operation in Italy, and the combination of these efforts contributes towards the high grading of portfolio in the current markets, which can be described as challenging.
Thank you, Svein Richard Brandtzæg. Operator, we are now ready for questions.
Thank you. If you would like to ask a question at this time, please press star one on your telephone keypad. 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, that's star one if you would like to ask a question, and we will pause for just a moment to allow everyone to signal. We will now take our first question from Dominic O'Kane from JP Morgan. Please go ahead. Your line is open.
Hello, all. Two questions from me. Just firstly on CapEx. The CapEx reduction that we've seen so far in 2015, could you maybe give a bit more details on where and what those optimizations are? Should we expect a deferral of that NOK 1 billion into next year, or will some of that come out of the, o r will simply some of that not be spent? My second question is on again, just on the sort of timing of the LME versus index alumina contracts, could you maybe just help us with our modeling for the next, say, four quarters?
Okay, Dominic. On CapEx, of course, NOK 1 billion is split in two. Roughly NOK 200 million, driven by currency changes, where we are helped by the BRL dollar for the Brazilian investments. That's partly offset by the Euro development, impacting the investments that we do in Germany. Of the NOK 800 million, which we then named CapEx optimization and postponements, a big part of that comes from the Brazilian operations, and has to do with, I would say to a large extent, timing of the red mud deposit that we're doing at Alunorte and the new tailings dams that we're doing at Paragominas. That will to a large extent be postponed into 2016 and partly into 2017 instead.
Smaller parts will probably disappear in the totality of this, but the bigger part is more timing issue than anything else. LME to index contracts. We are at roughly 70/30 this year. That will continue to increase in the next couple of years. In 2018 we will get more to the 80/20 rule. In 60/70, roughly 60%-70% will be towards index. It's hard to guide on a quarterly basis because it all depends on shipping patterns and so on. You should rather look this on an annual perspective.
Okay. 2016, 60%-70% will be LME links.
No, will be on the.
Links.
Yeah.
Okay.
Index. Will be index.
Index link.
Right.
Okay.
Yeah.
Thank you.
to about 80% in 2018.
Okay. Thank you.
We will now take our next question from Jatinder Goel from Citigroup. Please go ahead. Your line is open.
Good afternoon, gents. A couple of questions. Firstly on MRN, what happens if you don't buy it out? Is there a mandate? Because it doesn't appear that there is any put option in the hands of Vale as they had for Paragominas. Do you have an option not to buy it and continue with the volumes? Or is there CapEx which needs to be spent in the mine for which you need to actually get involved as an owner rather than an offtake partner? Secondly, just on the Rolled Products divestment, what kind of unit profitability uptick do you see after the divestment? And are there any other assets within Rolled Products or anywhere else in the portfolio which you think are non-core or low margin, which you probably want to divest going forward? Thank you.
Okay. Thank you, Jatinder. With regard to MRN, not to buy out is first of all an option, depending very much on what comes out from the due diligence. The reason why we want and are looking at acquiring this mine is the fact that we have 5% ownership today. We have the offtake of 45% in total. We will have a stronger voice, of course, with the 45% ownership. We will take more actions with regard to improvements, development of the mine. Of course, also taking responsibility of sustaining CapEx going forward.
We will benefit from the income flow, which is then the difference between the sales price of bauxite and the cost of production of bauxite. All in all, we feel that this will be a good fit with us. This is the first quartile cost from the cost curve, very efficient mine. It has a very good strip ratio and with the high quality bauxite. I think it fits very well with our strategy and operations in Brazil. The fact that we also have a 2.5 billion tons-3.5 billion tons surplus in offtake that we sell to the market is one point there.
Also the fact that the majority of this bauxite goes into the world's biggest refinery, Alunorte, which also needs sourcing from MRN. With regard to SLIM, this is, I would say commodity standard rolling mill, which has been operating in Italy, in a low margin market for several years, and struggling with the utilization of capacity. The capacity is 92,000 tons, and the production has been between 50,000 tons-70,000 tons during last years. This is defined as non-core, and we are now divesting it. There are no other rolling mills that are defined as non-core.
Of course, there are different market segments that we are serving from the different rolling mills, but we continue to high-grade the product portfolio in the rolling mills that we have still as a part of our strategic development for Rolled Products going forward.
Okay. If I could just quickly follow up on the rolling side, would you say your overall EBIT in absolute terms doesn't change post the divestment? And just on MRN, is the amount you paid for Paragominas for the remaining 40%, 20% you have already paid and 20% you're supposed to pay, a good guide for the valuation of MRN? Or do you think these are two very different assets and need to be looked independently under the light of current market conditions for valuation?
Hi, Jatinder. It's Eivind. On the rolling side, you know, as you know, we don't guide specifically on the margins on the individual plants. As Svein has indicated, this is a rolling plant that's been operating sub nameplate capacity, and it's also relatively standard products. It's fair to assume that it's been below the average margin realized in Rolled Products for quite some time. I don't expect this to have a significant impact on the EBIT performance of the business area going forward when this is divested.
When it comes to the acquisition price of MRN, I don't think we will give any further comments and guidance on the acquisition price until we have completed the due diligence and we see the results of that. We will do that in a good and orderly fashion.
Okay, great. Look forward to CMD then, if you might have more comments then. Thank you.
Look forward to seeing you there.
As a reminder, if you would like to ask a question, please press star one on your telephone keypad. If you find that your question has already been answered, you may remove yourself from the queue by pressing star two. We will now take our next question from Menno Sanderse from Morgan Stanley. Please go ahead. Your line is open.
Yeah, thank you. Two questions, please. The first is on rolling and on downstream. Clearly, there may be a strategic decision to make in that area in the next couple of quarters. Has anything changed in terms of your views on that business? It clearly had a decent quarter, but that just could be cyclical. Just interested to hear where you see that business in its life cycle, and if you have altered your views fundamentally. Then secondly, or second and third, a few smaller ones. The EUR 40 million-EUR 50 million of cost that the company highlights related to the Slim asset. Is that all non-cash or are there some cash related losses in that? Finally, the working cap.
Is the company confident it can hold on to this working capital inflow in the fourth quarter, so should we assume that really helps to reduce net debt for the year?
Thank you, Menno. I'll take the first question related to the rolling and downstream. I would say that it is encouraging that we are improving the results in Rolled Products. That doesn't mean we have changed the view here because we are continuing as an integrated company in Hydro. We see the benefit of managing the total value chain as also customers are really appreciating that Hydro is a company that can offer downstream products and have full control of the full value chain. We are not
Mm-hmm.
Past the core mine of the Q3. Of course, encouraging to see that the record results in the second quarter was improved total in the third quarter. Eivind, you can ask and answer the two other questions.
Okay. When it comes to the EUR 45 million-EUR 55 million amount that we or EBIT loss or impact on the sale of the Slim plant, that is a non-cash figure, Menno.
Good.
On the net debt in terms of net operating capital, you know, I think there's a large likelihood that we will be able to keep that towards the end of the year. As Svein Richard said, you know, optimizing working capital is high on the agenda for the management, so we will continue to work to find more than the NOK 2.1 billion that you saw this quarter. You can read that as being quite confident that we will be able to keep that target and that we will look more.
Okay. The NOK 2.1 billion was largely you said price related, no? Am I fair to assume 80% or so?
Well, it's a split. It's partly physical inventory coming down, and it's partly price driven.
Gotcha. Okay. Thanks a lot.
We will now take our next question from Hjalmar Ahlberg, calling from Kepler Cheuvreux. Please go ahead. Your line is open.
Hi. You had a quite high bauxite production this quarter, and I guess you're selling more of this on the spot market. Can you say something on the development on prices on bauxite that you're selling on spot?
Hi, Hjalmar. Yeah, we did have high bauxite production. That of course frees up some of the MRN volumes that we produce to be exported out of Brazil to our bauxite customers. I think on average for a year, we have about 3 million tons that we have as a long position that we sell. That of course will swing somewhat from quarter to quarter, depending on the production volumes.
Did it have any material impact on the B&A business area this quarter in earnings-wise?
Not really, no. Not so that we would find a significant variance from Q2 to Q3, for instance.
Okay. Just another question on CapEx. I mean, you said you deferred some to 2016. Could you say some new guidance on what kind of levels we should expect in 2016? Will it be higher than 2015 or, I mean, in line or so?
No, I think we've guided in the past, Hjalmar that, also 2016 and to a certain degree also 2017, there is still, quite some investment that needs to be done in the Alunorte and the Paragominas area in Brazil. Then of course, it also depends a little bit on how we, decide on the, on the Karmøy pilot. I think we will in terms of specific guidance of that, we will come back in, on Capital Markets Day. But again, there will be a relatively high CapEx levels for 2016.
Yeah, last, have you yet made the last payment for the Paragominas mine now, or is that still to be made?
No, this is still to be made. The put call option is really a 2016 discussion on the NOK 200 million. Of course, there is a put call between the two parties in 2016.
Okay.
From a CapEx perspective, you will not see that on the invested amount in here, though, because that's already been booked as investment. Of course, you will see the cash impact of that on the net cash balance.
Yeah. Yeah. All right. Thank you.
As a reminder, if you would like to ask a question, press star one on your keypad telephone. We will now take our next question from Christian Kopfer from Nordea Markets. Please go ahead. Your line is open.
Okay, thanks, operator. Good afternoon. Just to follow up on the market pricing dynamics. I mean, looking at the LME price, current ingot premium prices are basically at the same level as beginning of the century. Obviously, you showed the graph today showing that some 20 out of 60 million tons in the market is running at losses. I hear that the U.S. industry is calling for some actions. I mean, rationally, the Chinese, I mean, from my perspective at least, they are dumping material on the global market. Well, I mean, what is your reasoning on, I mean, on possible anti-dumping measures or in Europe? Thanks.
Well, thank you for the question, Christian. With regard to market pricing dynamics, as I said, this is very much a supply demand game. It's right, Chinese ore production is one of the real issues related to this. At the same time, as we see that up to 30% of the capacity in the world that are now below water, 60%-70% of this is in China. Why doesn't China react, which would be quite logical in this situation. For a dumping case in Europe, it is at least two criteria that has to be fulfilled.
One is that there are some actors that are selling below cost of production, and that could be possible to prove, although it could be difficult. We know that the Chinese companies are losing money, and they still export. The second criteria that has to be fulfilled is related to that this is damaging for the industry. After several closures during the last years, what you see now is that it would be difficult for the moment to prove that this is damaging the industry. It is of course reducing the prices, but that is not enough. We have to prove that this is also really damaging the European aluminum industry.
Again, it could be more difficult in Europe than in the U.S., because in the U.S., they are absolutely driving for dumping duties against China. It remains to be seen. Of course, the main price signal and the fact that companies are losing money every day should call for some action. We don't have any control of this, of course, and we have to leave that to our competitors.
Okay, thanks.
No further questions in the phone queue at this time.
As there seems to be no further questions, I suggest we end this quarter's call. From all of us here in Oslo, I would like to thank you for your attention today. If you have any follow-up questions, please do not hesitate to contact us. Have a nice evening, and hopefully we'll see you at our Capital Markets Day on the 3rd of December at the London Stock Exchange. Thank you.
That will conclude today's conference call. Thank you, ladies and gentlemen. You may now disconnect.