Good day, and welcome to the Norsk Hydro ASA Q1 presentation. 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 Norsk Hydro's first 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, Pål, and good afternoon, everybody. I will just make a brief summary of the first quarter results before we open up for questions. About two and a half months ago, I presented the highest results we have reported since we became a pure aluminum company in 2007 with great pleasure. I'm therefore very pleased to present an even higher results today. Underlying EBIT for the first quarter of 2015 was NOK 3.2 billion, up from NOK 300 million from fourth quarter and up NOK 2.4 billion from the first quarter of last year. There are several elements which influenced the results this quarter through our value chain. If we start with the oxide and the alumina, we see higher total sales as well as positive cost and revenue effects.
As we sell in dollars and we have a large share of cost elements in BRL. Also in Primary Metal, currency plays a large role. We know that the LME price has fallen in U.S. dollar terms, but when translated into Norwegian kroner , we see a positive development resulting in improved earnings. This is largely offset by a higher raw material cost, also affected by the strengthening U.S. dollars. In both of our downstream operations, we see seasonally stronger sales volumes, which is normal for the first quarter compared to the fourth quarter. Also in these operations, currency plays a role, a positive role. I'm also happy to announce that we during the first quarter acquired WMR Recycling in Germany, Dormagen, giving us the most advanced aluminum scrap sorting technology in the world.
If you finish off with the markets, we are still seeing demand exceeding production in the world ex China. However, the market tightness was somewhat reduced this quarter as we saw an increased amount of semis believed to be disguised primary coming out of China at the end of the fourth quarter. As you know, the Chinese changed their export tax rules in some aluminum products, excluding standard ingots last week. They reduced the export tax from 15% to 0% from May first. This adds further uncertainty to our marketplace as the world ex China and China become closer connected. Price differentials and arbitrage possibilities become increasingly important, and the price between these two marketplaces has tightened lately.
If we then end with our priorities going forward, into the second quarter, we will continue to deliver on the NOK 1.5 billion improvement, as we promised for 2015 and 2016. At the same time, we are looking at additional measures to expand the efforts which are already in place as part of the scope. As part of the improvement work, we will continue our high focus on operating capital and work on reducing inventories to release capital. As we are approaching July 2015, one of our top priorities is to maintain full focus on the dialogues regarding the ICMS deferral. We have experienced more uncertain markets through the first quarter, enhanced by changes in the Chinese tax regime, which again proves the importance of our continued effort to strengthen competitiveness.
We have some ongoing high-grade investments, including the used beverage can recycling facility and automotive line in Germany, which we will deliver on as planned, improving our market position and margins. Finally, as the premiums drop, trade flow shifts and market dynamics change, continuous and flexible margin management is as important as ever.
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 star one on your telephone keypad. We will now take our first question from Daniel Major from UBS. Please go ahead.
Hello, good afternoon. A couple of questions from me, both focused on China. Given the increasing volumes that we've seen over the past few months, are there any conversations ongoing with policymakers on implementing anti-dumping measures? Or is the industry as a whole still waiting to see how things play out? Secondly, you've been very clear in terms of updating what you think the China metal advantage is currently. Could you give any color on the effect you think that the reduction in the export taxes will have on China's metal advantage?
Thank you, Danielle. With regard to the anti-dumping and Chinese volumes, I think it is too early to see the effects of the changes in the export tax regime. Of course, we are following carefully the volumes that are coming out of China. There are, as I have seen so far, no initiatives from the industry. If you take a closer look at the incentives, I think the change in export duties are not necessarily very dramatic. We have seen a lot of Chinese metal coming out already disguised as primary metal. Well, the producers in China has taken advantage of the situation for the fabricated products.
If you look at the situation for fabricated, semi-fabricated products coming from China, the metal advantage has been reduced significantly in parallel with the reduction of the standard ingot premium lately. With the falling standard ingot premiums and closer distance, I would say, smaller gap between Chinese prices and Western prices, the incentives has been reduced. Even we are reporting some incentives for downstream products from China into the West.
It has been reduced, and if you look at the products that was included in the new tax regime, which is, by the way, excluding sponge iron ingots, for the products that are now benefiting from this tax regime, the incentives are even smaller than what we see for the fabricated products. I think the effect may be limited, but it's still too early to say.
Okay, thank you.
We will now take our next question from Robert Clifford from Deutsche Bank. Please go ahead.
Good afternoon, gentlemen. Couple questions around trading 'cause going through the numbers, it appears to me that's where there's some pretty big differences. In bauxite and alumina, your earnings were up quite a bit. That was volumes, but the volumes were on purchased ore, and it also appears you've made some pretty good margins there on that. I just wanted to confirm that and how you go about sustaining those if that's the case in alumina. The second is on you know, the metals trading business or the Metal Markets division. That was quite a bit lower, and it was you know, described as having been impacted by the fall in the ingot premiums.
Can you just go through for me again what the mechanics are that drive that loss based on the lower earnings based on the drop in the premiums? Because you mentioned in your preamble as well that, you know, the price arbitrage is becoming pretty important globally. I guess, you know, maximizing price arbitrage is back to your marketing team. It's a division which appears to be becoming increasingly important for your earnings. How are you maximizing that through that division? That'd be great.
Hi, Robert Clifford. Now if you look at the alumina part first, we had one shipment which is sourced from a third party, that was moved from fourth quarter into Q1. It's an old legacy contract, so I think your assumption that it's fairly low price is correct, and that's moved into Q1. We could resell that at the index prices, you know, indicating that there were quite good margins on that sourcing contract. That's a contract that's been in place for many years, and we still have a long way to go before that is finished. That's a good sourcing contract we hold.
When it comes to your second question on Metal Markets, you're quite right, and I think I also said that, you know, we're fairly disappointed with the results out of sourcing and trading in Q1. You know, part of the reason is that we were sitting with a long ingot position. As the premium has fallen pretty, you know, pretty sharply during the quarter, we had to take a mark-to-market loss on the premium side at the end of the quarter, which is really the explanation behind the weak result.
Okay. Within that, I mean, my understanding is the Metal Markets business really was set up for you to help facilitate product movement and sales globally, not actually to be a, you know, almost a speculative business. Or is that not the case? You know, do your guys there take positions based on a view on the aluminum price rather than just taking volumes to help, you know, assist with your own product sales?
No, that's right. I mean, they're the sourcing arm for all standard ingots that we also use internally in our own remelt system of the cast houses. They're also the unit that buys all the standard ingots from Albras and all of that, if you like. It's not a speculative position. It's really sitting with the produced inventory of what's needed in the cast house system. Again, they sit with the exposure over the quarter, and as such, they have to take the mark-to-market loss on that exposure. It's not a speculative long position that we hold on the books.
Okay. Have you made any changes to that division, such as potentially, you know, short-term hedging to prevent these swings again in the future? Is this just the nature of the business, and we-
It's-
expect that in the future?
I mean, it's really the nature of the business. Of course hedging away the premium exposure, it's not really feasible in the market at the moment, or hasn't been.
Okay. Great. Thanks for this.
We take our next question from Hjalmar Ahlberg from Kepler Cheuvreux. Please go ahead.
Yeah, just a question on value-added premiums are still quite okay. Could you, I mean, compare supply and demand on value-added products compared to standard primary aluminum, or is that will they move in the same direction? If you understand my question.
Yes, thank you, Hjalmar. When you got the value-added premiums, so then I assume you are thinking about the metal products.
Yeah.
Well, we create value-added both standard ingots and, of course, we are producing mainly metal products in our system. Looking at the tightness in the market, we still have, I would say, a good situation. The premiums on these products are very much influenced by the standard ingot premium. I showed a graph earlier today where we saw the development on the value-added premiums, which comes down more or less in parallel with the standard ingot premium. If we separate out, for example, the extrusion ingot premium above standard ingot, then the extrusion ingot premium above standard ingot keeps up very well.
Due to the fact we have a fall in standard ingot premium, then the total premium for extrusion ingots also are going down in parallel.
Okay, thanks. Regarding China and potential increase of exports, would you see any risk that China would remove their value-added tax or would there be any reason for them to do that in your view?
I wouldn't speculate in that. I think what they've done now to change the tax regime for some of their products and remove the export duty for metal products excluding standard ingots. I think it's not very dramatic as we see it, because there has already been available metal products from China in the market, which has been, as I mentioned, disguised primary metal, but they benefited from some of the export tax benefits of fabricated material as if it was fabricated. Now with the new legislation or new tax regime, the producers can more easily export, and maybe we avoid the volumes that are circumventing the tax rules.
Saying that, I think it depends very much on the incentives. As I also showed earlier today in the presentation, we have seen a quite steep fall in incentives, which again is based on the drop in standard ingot premiums. The price differentials between China and the Western world is reduced, and therefore also the incentives are reduced. That will also be one of the leading factors there.
Okay. A question on Rolled Products division. The margin was quite good this quarter, but you're now seeing some lower margin next quarter, if I remember correct. Shouldn't it be getting better if premiums are going down? Or so how is that affecting going forward?
This will have some effect on the contracts that we talked about last year, the so-called fixed premium contracts. There will be some better margins on those. The offsetting factor of course is within the Rheinwerk metal in Germany, where they will then realize lower premiums. Net effect probably a small benefit, but nothing significant expected for the second quarter.
Okay, thanks. That's it for me.
Thank you. We will now take our next question from Amos Fletcher from Societe Generale. Please go ahead.
Hi. Good afternoon. Thanks for taking my question. I have three questions. First one is on Chinese exports. Is it correct to say now that China has effectively put a cap on the all-in aluminum price? Because right now we know that all-in aluminum price is low and exports could decline, incentive is not there. But if the all-in aluminum price increase, there could be again an increased incentive to export. Second question would be, if you consider a normalized period without a lag, what could be the premiums like if standard ingot premium stays at current levels? Can you give some color in the second half, what kind of premiums would you see, ignoring the lag effects of premiums?
Finally, are there any plans for any currency hedging in the short term, given the weakness in the Norwegian krone? We have seen that Norwegian krone has diverged from 8.4 to now 7.5 levels. That would be my questions. Thanks.
Yeah, I can start with the currency question, Amos. The policy of Hydro over time is not to hedge the currency. We have some exceptions in the past where we've done it. As you know, we did it in Brazil for 2014 and part of 2013, which is really an exception. The policy of the company is to float with the currency markets and take what they give us. You shouldn't expect that policy to change.
Okay.
Yeah, with regard to the Chinese export then, and the question about the capping aluminum price, I wouldn't speculate on that. We are still too early to conclude about any total effect. Of course, it depends very much on the development in China. I think what we are seeing now is that the domestic demand in China has been reduced and with the overcapacity in China, I think Chinese authorities now are helping the Chinese aluminum industry to make it easier to export. Of course, that has an influence on the premiums and in the end also on the LME.
There are certain effects that Chinese is playing, but that has also been the case up to now. As I mentioned, they have already exported quite a lot of metal, not only fabricated metal, but also primary products as I mentioned. How dramatic the change is going to be, I think is too early to say.
Okay.
Just on your premium question, I think when you think about Hydro's premium, you should expect that these will come down to a large extent together with the market, you know, with a one to two- month lag that's been indicated today. When you look at this from the peak, remember that the standard ingot premiums have come down some $300 compared to where we were.
Right.
As I said, you know, we've booked so far 50% of the volume for second quarter at $650. The other 50% to a large extent is exposed to the standard ingot premiums. There is, again, that significant downside for the other part, for the other half.
Okay. I mean, I just had a follow-up question. Like, I just was trying to guess what kind of delta do you have on the product premiums compared to standard ingot premiums on a normalized basis? I mean, is it like $100 is a fair assumption or can't really say anything about that, it keeps changing?
It keeps changing to a large extent. I mean, if you look, say between, you know, from 2012 up to this year, you know, the delta between the standard ingot and the product premiums is typically around $200 to $400 per ton.
Okay. Thank you.
We will now take our next question from Jeff Largey from Macquarie. Please go ahead.
Yeah. Hi, good afternoon. Just to return on the subject of the premiums, I just wanna understand more, like how the time lag or the duration of the premiums has evolved. I mean, you now guide to kind of a one to two-month lag in the overall realized premium. I recognize they all kind of follow over time the standard ingot premium. But that duration, that time lag seems to have shrunk overall. I'm just curious if that's been driven more by your side or if it's driven by the customers. If it's driven more by the customers, are there certain products, you know, whether it's, you know, extrusion ingot or foundry alloys or sheet ingot or some of...
You know, which of your sort of value-added products where customers are kind of driving this more, I guess, real-time pricing, if that makes sense?
Right. Jeff, I would say that this is to a large extent driven by us as we've over time wanted to get our price exposure closer to the to the market development. Of course, that gives us the benefits close in time when prices goes up and you know, the delta when it goes down. It's really been driven by the company and not from the customer perspective. There's not any you know, real big differences in terms of how we play this in the market, whether it's extrusion ingot or VFA. That, I think, answers part of your question. I think another differentiator is that to a large extent in the past certain markets where you know, it's been price, extrusion ingot has been the price.
What you see more developing today is that you see an upcharge over standard ingot to a larger extent, which means that you also get the standard ingot element into your premium formula quicker than what you did a year or two years ago.
Okay. I guess if this, I mean, it seems a little bit counter to, I mean, your business model's typically been a little bit more, I would say, defensive versus others, say maybe competitors. This move makes you, I mean, driving the move closer to like real time or, you know, say, shorter duration, does that kind of, I mean, is that, you know, obviously, you benefited, say, last year as premiums went up, but now you're sort of feeling the pain, if you will, as premiums come down. I mean, is this just kind of going forward how we should think about the business model moving, that it should be a more sort of real-time pricing effect?
Yes, I think that's the way to think about it, Jeff. I think also if you go back a year, two years, three years, you will find that, you know, you also had a lot longer customer contracts, if you like, where you fixed the prices for longer periods of time. Of course, you were hedged against premiums, so prices going up or down, but you know, more often than not, we were missing opportunities when prices were moving in the right direction, which is also part of the reason why we want to move to shorter price duration.
Okay. All right. That's clear. Thank you.
We will now take our next question from Jatinder Goel from Citigroup. Please go ahead.
Hi, good afternoon, Jatinder. Just a quick one on aluminum capacity, given Alcoa and Rusal are contemplating further capacity closures. Do you think anything in your portfolio needs a further review to maximize profitability per unit? Thank you.
Thank you, Jatinder. With regard to overcapacity, we took out 26% of our capacity during the financial crisis in 2009.
After that, we also closed on our smelter in Australia, another 180,000 tons. In total, we have cleaned up the portfolio quite well. Looking at our assets today, we are quite competitive. In our books, we don't have any plans to curtail capacity as it is now.
Sure. If I could just follow up. Do you have any opportunity to convert all your volumes to value-added products rather than selling any standard ingots just to capture more value per unit?
Yeah, in theory, we could do that. We have the main focus for us is to produce value-added products as well as standard ingots. Alba is one example where we are producing standard ingots. There are also some Alouette smelter capacity in Canada, in the joint ventures there. Seen from the Norwegian smelters, for example, also from Qatalum, we have the capability to produce 100% of the volume into value-added metal products. Sheet ingots, primary foundry alloys, and extrusion ingots.
Sure. Thank you very much.
We now take our next question from Daniel Major from UBS. Please go ahead.
Hi there. Thank you. One follow-up question around the balance sheet. You flagged in the presentation earlier today that the working capital increase that you saw in Q1 was larger than you would usually expect on a seasonal basis. I wanted to find out if you could give us any further color on the drivers behind that move. Specifically, is there an issue in terms of you being able to place your products in the market given the increased availability of product from warehouses and from China?
Thanks, Daniel. The inventory buildup, as I said, it fits within Metal Markets, Primary Metal and Rolled Products for different reasons. I don't think there's really a fundamental problem of placing the metal in the market. It's more a timing issue than anything else. We will have a keen focus on this in the second quarter and going forward to ensure that we, you know, get the net operating working capital back to the levels where we would like to see it.
Thanks. Just one final follow-up. Could you give any color in terms of how long you think it would take to reverse that capital build that we saw in Q1?
I think, as I said, we will have very keen focus on this in the second quarter, and then we will tally up at the end of the quarter and see how far we've gotten.
Okay. Thank you.
As a reminder, if you would like to ask a question, please press star one. There are no further questions in the queue at this time. I would like to turn the call back to the presenters for any further remarks.
Okay. Thank you very much for joining us today. We wish you all a nice evening. Thank you.
This would conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.