Good day, and welcome to the Norsk Hydro ASA Q2 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 Second Quarter 2015 Conference Call. We will today start 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, these are available on hydro.com. With that, I leave the word to you, Svein Richard.
Thank you, Pål, and good afternoon, everybody. I will just make a brief summary of the second quarter results before we open up for questions. Underlying EBIT for the second quarter of 2015 was NOK 2.7 billion, down by half a billion from first quarter and up NOK 2.1 billion from the second quarter last year. There are several elements which influenced the results this quarter throughout the value chain. If you start with the bauxite and alumina, the results are down on lower LME-linked alumina prices as well as declining index prices for alumina. However, we are happy to have observed that the May, June production at Alunorte has recovered well following the boiler maintenance that we had in April.
We are now operating Alunorte at impressive speed of 10.4 million tons, which is above nameplate capacity. In Primary Metal, the falling LME prices influenced earnings negatively. However, the biggest contributor was the lower realized premium that was down $100 in the quarter. I'm happy to see the effects of improvement programs and portfolio optimization paying off as we report record high downstream results on seasonally stronger sales in the quarter. This includes both the joint venture, Sapa, and the Rolled Products business. In Energy, we experienced lower production on late snow melt and seasonally also affecting the price level. I am satisfied to announce that following the expiry of the previous ICMS deferral in power, we have now secured a 15-year ICMS framework for operations in Brazil.
I'm very happy to announce that we have secured parts of the long-term sourcing framework required for Rheinwerk after the current solutions expires in 2017. At a very attractive price level, bringing the Rolled Products smelter further down their cost curve. If you finish off with markets, then the challenging markets we started to experience in the previous quarter have continued with a growth in the estimated level of global overproduction. China's export are still at high levels, and the global dynamic seems to have altered somewhat in the short to medium term, making us more cautious about the outlook for demand in this period. We expect the global demand to be around 5% this year.
If you then end with the priorities going forward, we see that in the third quarter, we will continue to deliver on the NOK 1.5 billion improvement programs that was promised for 2015 and 2016. At the same time, we are looking for additional measures to expand the efforts, which are already part of the scope. As a part of the improvement work, we will continue our high focus on operating capital and work on reducing inventories to release capital. We reduced inventories to the tune of NOK 800 million in the second quarter, and we seek to continue this positive development in the coming quarter. The ICMS deferral discussion is now settled, but we still have many targets to deliver on in Brazil.
The organization's biggest area to focus in this region is to lift production in Alunorte. We see great volumetric potential here, and we will move upwards in a stable and controlled manner. We are high-grading our portfolio through some very interesting downstream growth projects, including the automotive body-in-white line in Grevenbroich, as well as the UBC recycling facility in Rheinwerk. These will be delivered on time and on budget and contribute towards the high-grading of our portfolio in the current markets, which can be described as challenging. Prices are now at levels where an increasing share of the industry is moving into cash neutral or cash negative territory. As we have worked upon improving our relative cost position through improvement programs as well as portfolio optimization, we are in a much better shape to take on these markets than we were five years ago.
As we know, there are still more to deliver.
Thank you, Svein Richard. Operator, we are now ready for questions.
Thank you. If you would like to ask a question at this time, please press the star or asterisk key followed by the digit one on your telephone. Please ensure that the mute function on your phone is switched off to allow your signal to reach our equipment. Again, please press star one to ask a question. We will now take our first question from Danielle Chigumira from UBS. Please go ahead. Your line is open.
Hi there. Good afternoon. A couple of questions from me. First of all, you highlighted the potential for the nameplate Alunorte to get up to 6.6 million tons. Can you give us some color in terms of what timeframe you'd expect to achieve those production levels, given we aren't quite yet at the current nameplates of 6.26? In Rolled Products, you obviously had much stronger margins than consensus was perhaps expecting. How much of the margin strength that you realized there was due to the positive impact of declining premiums? Can you give some color how much was the mix, and if there's also some underlying strength in those end markets?
Okay, thank you very much, Danielle. With regard to the Alunorte debottlenecking up to 6.6 million tons, this is potential going forward, and we see that toward 2018 that could be realized. That is the sort of timeframe we are working with in this respect. Again, this is additional capacity, where we are utilizing the existing infrastructure in an even better way with some minor investments that can take the refinery up to 6.6 million tons yearly alumina capacity.
Great.
With regard to Rolled Products, the stronger margin is absolutely affected by the declining premiums. We also see improvement in some of the Rolled Products market, like in, as I mentioned also earlier today, in the general engineering market, we have seen that there are higher demand. We have increased volumes significantly during the quarter also, not only from the first quarter this year to the second quarter this year, but also comparing with the second quarter last year. In general engineering, we have in fact also observed higher margin.
Great. Thank you.
We will now take our next question from Menno Sanderse from Morgan Stanley. Please go ahead. Your line is open.
Hey, good afternoon. Two very brief ones. First, on Brazil, clearly an interesting and long-term tax settlement has been agreed, but could you give us some more clarity on if this led to any change in the degrees of freedom that Norsk Hydro has with respect to the timing of all these compelling projects? In the past, you said we will only do this, although they are compelling, if the market demands it. Is that still the case, or have you now committed yourself to timetables that may not correspond with market demand? That's the first one. The second question is, the reservoir levels clearly in the zone two are going up, are still far below 2014.
Nevertheless, prices are also far below 2014, which suggests there's huge overcapacity. Do you see any way out of this very big overcapacity and very weak energy price situation in Norway?
Okay. Thank you, Menno. With regard to Brazil and ICMS, that has been now decided on for the coming 15 years. We have in the agreement with the authorities promised to look into different projects that we have already been talking about with you also previously, like the CAP project, the expansion of Paragominas. Of course, this is we can only do that provided that we have the right market conditions, that the market needs the volumes, and that we also have profitable projects. We are not committed or decided on anything beyond what we have talked about previously.
The fact that we have discovered the potential of debottlenecking in Alunorte to 6.6 million tons is something we will do anyway.
Yeah.
That is something we will target to do towards 2018. Again, we have not delinked from the market with regard to the potential projects in Brazil. One element in this is, for example, that we will invest in it. It's a minor investment in primarily for the alloy facility in the existing casthouse in Albras, which will be for the domestic market, which is definitely a good business opportunity for us. Again, there are some opportunities that we will do that, but that we also will take anyway. I think the ICMS settlement is something we are quite happy with.
With regard to the reservoir level in Norway, we are in a very special situation this year because of a very cold spring and early summer in Norway. If you come and visit us in Norway and drive your car across the mountains, you will see that there are extremely high levels of snow in several areas, especially in areas where Hydro has the main power production. We have in the NO2 area, for example, we have two-thirds of our power production. In this area, there are in some of the precipitation areas for us, there are 300% more snow than in normal level at this time of the year.
Right.
There has been no incentives to hold back power production because we have to give space for this water in our reservoirs. There has been not incentive to hold back production even when the prices has coming down.
Mm-hmm.
We are now trading around NOK 85 per MWh, which is, I would say, extremely low prices.
Mm-hmm.
We're also waiting for quite a big amount of water coming from the mountains now. To have space for that, we need the reservoir level to be quite empty.
Okay. When that reservoir fills up again, then, I presume producers will go back to a more normalized production rate.
Yes.
which is more in line with the market demand rather than-
Yeah. Exactly. Yeah.
Yeah.
That is what has not been done up to now because the possibility for flooding.
Mm.
has been at a quite critical level.
Mm.
I think we are beyond the critical level now, but we will still have to make room for a lot of water that is coming from melting of snow going forward.
Okay. Understand. Thank you.
We will now take our next question from James Gurry from Credit Suisse. Please go ahead. Your line is open.
Thanks very much. I just want to ask, we seem to be back in, sort of a 2012 situation where the industry is clearly in overcapacity. We seem to be waiting around for your peer group to potentially curtail production to restore some balance in the market. But China seems to progress unabated. Can you sort of tell us, in your view, what might break this vicious chain or cycle that we're in at the moment for the industry?
Thank you, James, for a good and important question. Of course, we are in a situation now where we have, we are facing global overcapacity. As you probably know, Hydro took out 26% of our capacity during the financial crisis, and we closed down finally the Kurri Kurri smelter, which was another 180,000 tons in 2013. That means that, with regard to our company, we have taken out all the high-cost smelters and at the same time improved the cost position for the smelters that we are operating quite significantly through the $300 program that we have delivered on and also the $180 program that is for the joint ventures. We are in a much better cost position.
We know that there are bigger and bigger share of the global capacity that is now moving into, due to the negative location situation, and some of these smelters are located in China. It depends very much on the financing going forward if these smelters will be able to operate at full speed or if something will happen. It is too early to say what will be the outcome there. I think the fact that there are some, I would say, some U.S. dollar exposed smelter capacity that is also in negative territory. I don't know what the competitors is going to do with that. With regard to overcapacity, we don't have any plans to curtail any volumes as the situation looks now.
Okay, thanks. Sounds like a challenging situation.
Yes, absolutely. It is still a challenging situation to develop there.
Right.
We will now take our next question from Jatinder Goel from Citigroup. Please go ahead. Your line is open.
Hi, good afternoon. Just two questions from my side. Firstly, on value-added premiums, you mentioned a continuous decline there as well. Do you have a sense of where these might stabilize as a percentage of either LME or standard ingot premiums or in absolute terms, where the historical number has been somewhere between $150-$400 per ton? Secondly, just a financial question. You've laid out a couple of financial ratios, funds from operations to net debt and net debt to equity. At what point do you believe that your balance sheet will get healthy, in terms of either these ratios or anything else which you measure internally?
For how long will you continue with the lazy balance sheet, given the difficult market environment? Thank you.
Thank you, Jatinder. I start with the premiums and the decline that we have seen. Of course, if you look at the level we have today, it is more or less on a historical normal level. It was quite unusual observing $525 per ton in premiums in the European and U.S. market. That was reflecting very tight physical market. What we see now is that we are back to normal. The adjustments has partly been as a result of export from China into our markets. It is difficult to predict what is going to happen going forward, if the premiums is going to weaken further is one possibility or if it will be stabilized or again.
The development is very much a correlation or a function of the tightness we see in the marketplace there. With regard to Chinese export that is influencing this, we saw a very high level in June, 450,000 tons. Probably these volumes were booked in a situation where the premiums were higher than what we see now. I showed in my presentation earlier today that the incentive now for China to export downstream material is close to zero.
The gap has been closed after a period of time where the incentives were quite significant. I think we need still some months to go before we see what is now the result of the closed gap with regard to incentives or exports, which I think is a major factor that will in fact influence on the premium level going forward.
So it should-
Let's see.
My question is more about value-added premiums, which are on Slide nine of your presentation. Do you have a sense of the product premiums over and above LME stabilizing at a particular level which has been in a volatile range as well historically?
Yeah. As you see on this slide, we have observed reduction of the value-added premiums, not only on the back of the standard ingot premiums, but also the relative difference between the value-added premium and the ingot premiums has been reduced. We see that there is a softening in this market. We still see that the markets where we are operating, where we have our main exposure is still moving positively. U.S. market is strong. Also in Europe, we see still positive development. It's again a bit early. We have seen, I would say, a significant reduction during the last couple of months.
It's too early to say if that is going to continue in a negative direction or not. Of course, we are also now in a seasonally stronger period. The third quarter could change this as there will be at least some seasonal effect in Europe. We expect that U.S. could continue at a similar rate as we have seen. In the fourth quarter, we expect both the U.S. market and the European market to be weaker than what we have now. With regard to the balance sheet, you are right, we have a very strong balance sheet. We have seen that this has been also an advantage for us to have a strong balance sheet.
You can always argue that this balance sheet is too strong and what should we do with that. Of course, this is something we are discussing also with the board of directors on the corporate level. We will come back to more information about that at a later stage.
Great. Thank you.
As a reminder, to ask a question, please press star one on your telephone keypad. Again, as a reminder, to ask a question, please press star one on your telephone keypad. We will now take the next call from Menno Sanderse from Morgan Stanley. Please go ahead. Your line is open.
Yeah, sorry, gentlemen. Don't want to drag this out, but while you're there. Just on the CapEx ramp, obviously you answered it partly this morning, but you did NOK 2 billion in the first half. NOK 6.5 billion is the target for the full year. That suggests a pretty big ramp up of spending in the second half. What are the projects in particular that will be spent on in the second half? Is it body-in-white? Is it Karmøy's test smelter? Can you give us a bit more insight there?
Sure, Menno. It's very little. Let me start with that. It's very little on the Karmøy project, this year.
Mm-hmm. Okay.
It's mostly related. In terms of growth projects, it's related to the body-in-white line in Germany.
Yeah.
That's the UBC line in Germany.
Okay.
Bear in mind that there's normally a seasonality when it comes to maintenance projects in our line of industry, meaning that you spend more capital in the second half of the year than what you spend in the first half of the year.
Okay. Thank you.
We will now take our next question from Hjalmar Ahlberg from Kepler Cheuvreux. Please go ahead. Your line is open.
Yeah, thanks. Just a question on alumina cash cost. You were down at $225 per ton in Q1 and up to $233 in Q2. Will you be able to get this down again in Q3 and onwards when volumes ramp up and maybe due to some positive currency benefit?
Hi, Hjalmar. I think obviously we are working hard to get the cash costs down again. I think you have to look at the, you know, the particular challenges or the particular issues that hit Q2. Part of the reason for the cost increase is the Reintegra tax refund that was reduced from 3% to 1%. That is the level that we will expect it to continue throughout the year. That's not gonna come back. Another part that impacted the cost adversely was the energy consumption in Alunorte. Of course, we're working quite hard to get that back down to the levels we also saw in Q1. The third part impacting the cost was also somewhat higher bauxite cost for the period. That has to do with the pricing mechanism for the bauxite that we buy.
You should not expect that to come down, at least not before, towards the end of the year into 2016.
Okay, thanks. Just a question on Qatalum. It seemed to hold up margins very well. Was that the premiums lag is even more there compared to the main Primary Metal division or anything else impacting?
Oh, this is pretty much a volume-driven effect in Q2. We have higher sales volumes in Q compared to Q1. The premiums and the LME impact impacted Qatalum negatively in the quarter.
Okay, thanks.
Again, as a reminder, to ask a question, please press star one on your telephone keypad. There are no further questions coming into the queue at this time.
Okay, with that, I thank you very much for calling in. Have a nice day.
Thank you. That will conclude today's conference call. Thank you for your participation. You may now disconnect.