Good day and welcome to the Norsk Hydro Q2 2014 conference call. At this time, I would like to turn the conference over to Mr. Pål Kildemo. Please go ahead.
Thank you. Good afternoon, and welcome to Hydro's Q2 2014 conference call. We will 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 in. 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. The underlying result, EBIT, was NOK 544 million, down by approximately NOK 200 million from Q1 and marginally higher than the Q2 last year. The decrease from last quarter was driven by seasonal lower power production in addition to lower power prices. We had high snow levels in southwestern Norway following Q1, and high temperatures in Q2 resulted in substantial inflows to reservoirs and high production, affecting power prices negatively. This was somewhat offset by higher realized oil and aluminum prices and higher realized alumina prices.
I'm very pleased to announce that the production increases are moving as planned in Paragominas and Alunorte, and the quarterly production of alumina this quarter is back at record levels. We are still experiencing outage related maintenance costs, which should decrease going forward, partly as a result of the From B to A program, the cost improvement program. In addition, we saw seasonal higher results from Sapa. As we also stated last quarter, demand for primary aluminum in the world outside China has continued to exceed production, resulting in a tight aluminum market. If we sum up with our main priorities and outlook going forward, first of all, we seek to continue to stabilize the production in Alunorte and Paragominas before starting the next step to increase production towards nameplate capacity.
We will continue with the forceful improvement programs across the business areas, further enhancing our competitiveness, including the $180 program and the Climb program. As I mentioned earlier, we should see cost reduction for our Bauxite & Alumina, partly due to the From B to A program in the third quarter. Finally, we continue to pleasantly observe the situation in the primary market, where demand is now exceeding production. We are harvesting from the potential this creates. So far, this has been higher premiums and LME prices, resulting in a higher all-in price, but also includes the improvement in automotive, which we are harvesting on through investing longer up in the value chain in adjustable flexible models so we can further harvest through supplying the customer with what they want and need. With that, Pål, we are ready for questions.
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 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, please press star one to ask a question. We will pause for just a moment to allow everyone to signal. Our first question comes from Luc Pez of Exane. Please go ahead.
Hi, gentlemen. A few questions, if I may. First of all, on the bauxite alumina, could you elaborate a bit more as to how much cost improvement has already been achieved as part of the B2A program and how much you would expect going into H2? Second question with regard to energy, how much production loss would you expect from the Rjukan, sorry for the pronunciation, upgrade project? Would you expect that to be limited to the Q3 only? Third question related to rolled products, if you could quantify the number of contracts which are on fixed terms in this segment and therefore suffer from a high premium environment. Thank you.
Okay. Thank you, Luc, for good questions. I will just start with some comments with regard to the capacity of bauxite & alumina in Brazil. The main target for us now is to stabilize the volumes at the current levels going forward and focus on cost reductions. You are talking about the production of 6,100,000 tons yearly speed that we have in the Q2 . The nameplate capacity is 6.3, so we will stabilize at current level before we take it up to nameplate capacity. The production in Paragominas, by the way, was 9,500,000 tons yearly speed in the second quarter. Eivind, maybe you can come back to the B2A program and the status there.
Thanks, Luc. You know, we don't really guide on quarterly basis. What we've said is that we plan to take out NOK 600 million by the end of 2014 and NOK 1 billion towards the end of 2015. It is fair to say we're quite confident that so far this year, we are well on track to meet NOK 600 million for this year.
Shall I understand that, behind your current cost of production, there is already an effect of the B2A program?
Yes, you can assume that.
Thank you.
More to be taken out in the second half.
I would just add to this comment that we have carried out extraordinary maintenance costs during the last few quarters in Alunorte. As a result of the power outage, there were a need for extra maintenance in addition to extra work that has been done in Alunorte to strengthen the energy supply system in order to have a more robust situation if we should have another externally induced energy outage in Alunorte. That has been now more or less finished. This is going to be wound down. In addition to the efforts in B2A improvement program, we should see improved cost situation in the quarter coming forward there.
On the energy side, Luc, you know, the Telemark and Rjukan area comprises approximately 1/3 of the power production that we have in Norway. We anticipate that this will be completed in the Q3 , and it should be out to the tune of 10 weeks during the quarter. I think the important part to remember is, you know, when we optimize the water reservoir levels, we optimize it so not to lose water. We pre-produced quite some water in Q2, and then hopefully there is enough and should be enough reservoir capacity to keep the water inflows in Q3 without losing water.
It should minimize the impact of the upgrade program on the actual production of power. Is it correct to say so?
On the rolled product side, in terms of magnitude of the contracts, depending a little bit on seasonality, because this is mostly related to the can volumes that we produce. It's in the range of 10%-20% of the production volumes that we have in the business area.
Thank you.
Our next question comes from Jason Fairclough of Bank of America Merrill Lynch. Please go ahead.
Yes, good afternoon, gentlemen. Thanks for the opportunity. Two questions from me. First, I guess I just wanted to congratulate Svein Richard on the new role and perhaps ask if you could give a little bit of color here on succession planning. Do you have any idea whether your successor at Hydro works for Hydro today? Second question, just perhaps a follow-up on the impact of the ingot premiums and the extent to which this is impacting the pricing of the third-party sales of alumina in your downstream products. I guess maybe it would be helpful to understand how much higher might the profit be in these businesses if we were pricing off metal transaction prices rather than LME prices.
Okay. Thank you, Jason. With regard to the first question, Hydro has a tradition to find successors for the CEO position internally. The board has now established a committee to find the next CEO of the company. They will search internally, but will also have opportunity to look for external candidates. I don't think I can comment more than that, at least the company has a tradition to find internal candidates. The board has now just started to look for the next person in my role. I don't know really how long time that may take. Of course, if it's internally, it will take shorter time than if it's external.
Okay.
We go to ingot premiums. Maybe Eivind, you can answer on that.
No, I think if I can answer it a different way, Jason. If we had assumed that all sales would be on Platts index in the second quarter, the additional earnings in B&A would be roughly NOK 1.4 billion higher with the Platts index level that we saw in the Q2 . Obviously, we sell about half the volume to primary metal, so the net effect for the company would be roughly NOK 700 million.
Okay. All right. That's helpful. That's just for alumina, is it?
That's just for alumina, yes.
Yeah. What about the downstream products? That's following up on, I think Luc's question.
I think as we said, you know, between 10%-20% of the volumes have these fixed premium contracts, typically in the can segment.
Mm-hmm
For practical purposes.
It's really [crosstalk] quite small. It's not gonna be that material at the end of the day.
At the end of the day, not. It clearly hurts the rolled products margins, of course, as it is.
Yeah.
As premiums keep on going up, that of course is good for the primary side and the metal market side. Both products will be squeezed on parts of the portfolio.
Understood. Okay, thank you very much.
Our next question comes from Rob Clifford of Deutsche Bank. Please go ahead.
Hey, welcome to London, gents. A couple of quick questions on bauxite and alumina. You did see cost increase of $5 you talked about this morning in the presentation, but you're up $6 or $7 on the alumina price. You know, your tonnage is up 9%. The earnings improvement you got in the quarter seems to be quite small relative to the tonnages and the price increase notwithstanding there. There's a bit of a cost increase there. I guess, does that cost increase include the taxes? Does it include the additional maintenance that you talked about before? And if not, why wasn't it a bit better in terms of the earnings?
The second part of that is related to the question you just answered for Jason. You know, roughly NOK 700 million ballpark you talked about for alumina uplift. Is that off a Q2 number where, you know, you had higher pricing to the index, and into the third quarter we're gonna have lower pricing, or is that just off an average for the year where we sit at the moment?
Okay, thank you, Rob, for good questions. With regard to the cost that has been presented, it includes the ICMS tax. It also includes what I mentioned about the extraordinary maintenance costs that has been carried out in the Q1 and Q2 , and that is now wound down. This is the situation with regard to the cost level.
On the alumina side, Rob, yes, it is working off the Q2 Platts index prices. As you know, as we said, coming into Q3, there will be less index volumes on the contract structure that we have for Q3 . Helping that of course is going to be the fact that LME seems to be rising quite nicely at the moment. Typically, alumina is priced at -1 , so the impact is more immediate there than it necessarily is on the metal side.
Okay, great. Just back on the first question, if all those costs are in there, you know, what else was in the costs to offset the volume and the price increases you saw in the Q2 that give you only a modest improvement in the EBIT?
There is also a currency that has changed since Q1 that is also included in this cost picture.
Sure.
You know, Rob, we have a currency hedge in place in Brazil, which is basically a cash hedge that was entered into back in 2012. It's done at slightly above 2.40 to the dollar. We're currently at 2.20 or so. That's clearly in the money for Q2 . What we did not hedge was the depreciation levels, as that is non-cash, so that has an impact when the real strengthen. Of course, we have also this additional cost for the ICMS tax that we didn't know about back in 2012 when we entered into the hedges. That's also unhedged from a cash perspective.
Sure. Okay, yeah. Look, I'll take that offline. Thanks for your time, gents.
Our next question comes from Jatinder Goel from Citi. Please go ahead.
Good afternoon, gents. A very quick one on share of profit from equity accounted investments. It's down sequentially about NOK 25 million from Q1 , while Qatalum earnings have gone up. Just trying to understand how does this work, if you could please help. Thank you.
This relates to the Søral power plant in Norway. In Norway, when you entered into it, you know, the Nordic power prices are measured in euro, entered into in euro. Then it is so when you have a power contract between two Norwegian counterparties, IFRS tells us that we have to isolate the euro component of that power contract. Between the quarters, it is so that the Norwegian krone has weakened against the euro, and as such, we have a better derivative mark-to-market loss, if you like. That is what impacts the equity accounted entities.
Is that part of the underlying EBIT then, or is it in the exceptional items?
No, this is part of the ongoing EBIT because it's equity accounted. We take in our share of the equity accounted entity when you look at the profit and loss. When you look to the items excluded table, you will see it as part of the NOK -40 on the first line of the items excluded.
Okay, great. Thank you.
Our next question comes from Anindya Panduranga of Société Générale. Please go ahead.
Hi, thank you for taking my question. My question is on the bauxite situation. After the Indonesian ban, and if you assume that ban continues, how far do you see that other countries can ramp up bauxite output? Do you also see China ramping up bauxite output to substitute for some of the effect from the Indonesian ban?
Yeah, thank you, Anindya. With regard to the bauxite, we see the import bauxite price in China is now going up. It went up $10 per ton during the quarter. It may continue due to the fact that China is now looking for alternative sources. What happens with the ban with regard to Indonesia remains to be seen. Now it's election, and it could be another election in Indonesia that takes time, and it remains to be seen if the new politicians are going to change this export policy. In the meantime, China is looking around for new sources.
They have found, for example, sources in the Dominican Republic. There are also volumes from ourselves going from Brazil to China, where we sell the bauxite with very good margins. It is right that China is also ramping up their own bauxite production. We also know that there is a quality question also here. They got how much reactive silicon or how much impurities they can carry over from the bauxite into the aluminum that goes further into the metal. Because this impacts in the end the metal quality. For certain alloys, this may not create a problem, for a lot of alloys, for high quality products, that may be a really big problem in the end. I think China is looking for high quality bauxite, and it remains to be seen where they can find that.
Okay. I have a follow-up question, if I may, on the Søral acquisition that you have done, probably you have now acquired the rest of it. So do you think it is going to impact your EBITDA by a significant amount in the next year, or not really? I mean, is it like operating at a breakeven level or you're having some EBITDA component from Søral?
Yeah, with regard to Søral, we got a temporary relief from suppliers, so we are operating Søral marginally positive. This is not a company maker as such. It's not a smelter that is going to change the bottom line of the primary smelter significantly short term. Of course, Søral is running at half speed. It is at 80,000 tons. We are able to ramp up the capacity to 100% when the time is right, but we are not going to do that before we really see that the market change now that we see is getting traction, that we see the profitability of our smelters is moving significantly in the right direction.
All right. Thanks for taking my questions.
Our next question comes from Jeff Largey of Macquarie. Please go ahead.
Yeah. Hi, good afternoon. Just along those lines, my questions were on Søral. Was this simply a case of you taking, you know, Rio's stake off their hands, or is there any consideration that, you know, might come into play, any material cash flow, like when the deal actually closes or at some future date for that increased ownership stake that you now have?
We believe that Søral will be a very positive contributor in the Norwegian smelter system. As long as we run the smelters at 50% capacity utilization, of course, this has a cost implication. The smelter will be higher on the cost curve when we compare it with the other Norwegian smelters. Saying that, Søral smelter is a one technology smelter. It is efficient. It is a smelter that produce 100% extrusion ingots for the European market with the premiums, as we see today, $800-$900 per ton. With the increasing LME, as we also see now, we are quite optimistic about what Søral can contribute with here.
There are also system effects in the smelter system of Norway. As you know, we have been quite successful in taking down the cost in the fully owned smelters. The ambitions for the part-owned smelters has not been that high, but we also see at Søral that there will be further potential for improvements. On top of that, there was also technology elements that we can add to the Søral smelter that we didn't do as long as Rio Tinto was a part owner. We believe that Søral in the future will be a competitive smelter and give a positive contribution to Hydro's bottom line.
That's helpful. I guess I just wanted to also clarify whether there was any material consideration for Rio Tinto's stake, so acquiring the 50% that you didn't own.
No, there is not, Jeff.
Okay, great. Thank you.
We have no further question at this time. As a reminder to ask a question, please press star one. We have no further question at this time.
Okay. Well, then I think we can wrap it up for today. Thank you very much for phoning in, and we look forward to speaking to you the next time. Have a nice day. Thank you.
That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.