Welcome to Gränges conference call for the second quarter of 2019. Here in Stockholm, it's me, Johan Menckel , CEO of Gränges, and beside me I have CFO Oskar Hellström. As usual, we will start this presentation with an update of Gränges performance during the last quarter and touch upon some important events. Then it's time for Oskar to guide you through the financial results. After that, we will conclude the presentation with a short summary and a Q&A session. Starting with the second quarter of 2019 highlights, the main theme of the quarter is undoubtedly the increasingly challenging market conditions, especially on the automotive side of our business. As a consequence of this, our sales volume declined by 6% year-over-year in the second quarter. Asia, in particular China, remains to be very challenging, but we did also see lower demand from European automotive customers in the quarter.
The demand for the HVAC and other business in Americas continues to develop positively, but we are unfortunately not able to capture this growth due to limitations of available production capacity. Due to lower sales volume and additional cost related to the ongoing expansion projects, the adjusted operating profit declined to SEK 257 million in the quarter. High prices in Americas and favorable foreign exchange rates had a positive impact on the earnings. Further on the positive side, the cash generation continued to be strong in the quarter. The adjusted cash flow before financing amounted to SEK 249 million, which is close to 100% operating profit to cash conversion. We currently have a very large focus on completing the U.S. expansion projects in Huntingdon and Newport and are currently in a CapEx intensive phase of this.
The total CapEx related to the expansion investment amounted to SEK 354 million in the second quarter. In the quarter, we have also acquired the utilities infrastructure on our site in Finspång from a third party for SEK 93 million. Early today, we also announced that our production facility in Shanghai has achieved certification in accordance with the Aluminium Stewardship Initiative Performance Standard. This is a sustainability certification standard for the aluminum value chain. I'm very proud of this accomplishment and that Gränges has managed to certify our first site only six months after joining ASI. It is a good example of our strong commitment to sustainability and to promote a more responsible and sustainable aluminum value chain. During the second quarter, we experienced continued soft market conditions for the automotive part of our business.
If we look at some more statistics, the research firm IHS has made a quite substantial revision of the estimate since we presented our outlook for quarter two in April. At that time, IHS estimated a 3% global decline for the second quarter, and that figure has now doubled to 6% decline. This is also more in line with the signals that we are picking up in the market. If we look at estimates by region, we can see that the production of light vehicle was down 6% in Asia in the second quarter. Of this, China was down 11% compared with last year. On top of the reduction in vehicle build rates, the stocking of inventory in the supply chain continued to have some negative impact on demand for our products.
The stocking is expected to continue also in the third quarter. With what we see right now, we believe that IHS positive demand forecast for Asia in quarter three seems a bit optimistic. In Europe, light vehicle production is estimated to be down 7% on last year in the second quarter. We start to see the stocking taking place also in the market. Americas is holding up better with an estimated decline of 2% for the second quarter. For the third quarter, IHS estimate a growth of 2% in light vehicle production on a global level. Based on what we are picking up in the market, we currently have a slightly more pessimistic view on the short-term outlook. For the full year 2019, IHS forecast a 3% global decline of light vehicle production.
If we look at the HVAC market, which represent a quarter of our sales, we can see that HVAC unit built in the U.S. is expected to have an increase by about 3% in the second quarter. In the coming quarters, we expect to see a continued growth in HVAC build rates. Here we need to remember that we are currently having capacity constraints in Americas. We will not be able to take part of this growth until our new production capacity becomes available later this year. If we look into Gränges sales volume development during the second quarter, we can see that the sales volume in Asia decreased by 7%. The reduction is reflecting the lower vehicle production rate and the stocking at many of our customers, in particular China. On the positive side, sales to industrial applications continue to increase, but from low levels.
In Europe, sales volume decreased by 10% in the second quarter, largely following the underlying market demand. You also see the stocking at our customers. In Americas, sales volume was 5% lower than last year, despite a stable automotive volume and a growing market demand for HVAC products. This volume decline is primarily driven by three things. First, we are shifting the mix towards more advanced products that require more rolling capacity but have a higher margin. Second, we are running close to maximum capacity in our U.S. plant and need to execute on productivity improvements to grow sales volume. With our large focus on delivering the expansion products, we have, however, not managed to simultaneously maintain the production efficiency in the current operation. Third, we are experiencing some temporary production disturbances at our Salisbury plant at the end of the quarter, which was limiting the production output.
These disruptions have been addressed now. We expect them to have limited impact on the sales volume in the third quarter. As you heard from me the last couple of minutes, we are currently facing different types of challenges in our different regions. This mean that we need to focus on different types of measures to address the respective challenges in a good way. In Americas, we continue to see a positive market development. We continue to turn down orders due to lack of production capacity. As a consequence, finalizing the two expansion projects in Huntingdon and Newport is the top priority for our Americas team. Start of production for the project in Huntingdon is planned for August, and the first commercial orders are expected to be shipped to customers in September. Sales from Newport locations are expected to gradually ramp up from October.
Net startup cost for these projects amounted to SEK 16 million in the second quarter. In the third quarter, we expect to carry additional startup cost of about SEK 10 million. For the fourth quarter, we expect the expansion products to continue positively to operating profit by about SEK 15 million. The situation in Europe and Asia looks very different to the one in Americas. In these regions, we are impacted by the weak automotive production. We are not expecting to see a significant pickup in the volume in the short term. As a consequence of this, we have taken additional cost reduction measures in our Swedish and Chinese production plants in order to align the cost base with the current market outlook for the second half of this year.
Depending on how the market will develop going forward, we are prepared to implement additional measures to bring down cost even further. With that, I hand over to Oskar for the financials.
Thank you, Johan. As Johan talked about, the sales volume continued to decline in the second quarter. As a consequence of this, we also saw the adjusted operating profit come down somewhat in the quarter. The rolling 12-month profit per ton declined to SEK 2,600. For the automotive business, the lower sales volume led to a clear margin contraction in the quarter. As you can see on this slide, this is partly offset by improved margins for the HVAC business, where we had a profit per ton increase despite the lower sales volume. Key drivers for this increase are the mix optimization and price increases in the U.S. If we look at the second quarter financials and compare it with the same quarter last year, we can see that the sales volume decreased by 6.3% to 92,900 tons, whereas net sales decreased by 7.4% to SEK 3.2 billion.
The main reason for the net sales decreasing more than the sales volume is the lower metal prices than compared with last year. The net impact from changes in foreign exchange rates was positive SEK 194 million compared with second quarter 2018. Looking at the earnings, the adjusted operating profit amounted to SEK 257 million in Q2, a decrease of SEK 44 million or 14.6% on prior year. The negative impact from the lower sales volume and slightly higher operating cost was partly offset by higher average conversion price and net changes in foreign exchange rates that was positive SEK 22 million in the quarter. As you heard from Johan, we are getting closer to start of production for the expansion projects in the U.S. The net start of costs for these projects amounted to SEK 16 million in the second quarter.
Looking at the profit margin, the adjusted operating profit per ton declined from three to 2,800 SEK in the quarter. There are no items affecting comparability in the second quarter, and the reported operating profit is therefore the same as the adjusted operating profit in the quarter. The profit for the period decreased by 20% to 171 million SEK and corresponds to earnings per share of 2.26 SEK. Cash flow before financing was negative 198 million SEK in the quarter. By the end of June, the return on capital employed was 14.1% on its rolling 12-month basis. During the second quarter, the net debt increased by 503 million SEK to 3.6 billion SEK, or to 2.6 times adjusted EBITDA on a rolling 12-month basis. There are three primary drivers behind this increase.
First, the expansion investments amount to a total of 354 million SEK, of which 310 are related to U.S. and 43 to Sweden. Second, we acquired the utilities infrastructure for a site in Finspång for 93 million SEK. This gives a total of 447 million SEK of cash outflow for expansion investments and acquisitions. Finally, we also distributed 242 million SEK to our shareholders in the quarter. On the positive side, we continued to see a very strong underlying cash generation in the quarter, where the cash flow before financing, adjusted for the expansion investments, amounted to 249 million SEK. That corresponds to an operating profit to cash conversion of 97%. As for the development of working capital in the quarter, it includes a positive effect of 85 million SEK from the removal of U.S. sanctions against Rusal earlier in the year.
Following this, Rusal reentered our supply chain financing program. We see the full effect of this in the second quarter. The expansion investments in the U.S. will be completed this year. Positive EBITDA generation from these are expected to start to bring down the leverage ratio back down towards the target range of one to two times adjusted EBITDA. I will now hand over back to Johan Menckel, who will provide an outlook for the third quarter.
Thank you, Oskar. Looking into the third quarter of this year, we expect that the challenging market conditions will continue in terms of year-over-year sales volume development. We do, however, believe that quarter three will be slightly better than quarter two, with a low single-digit growth on a group level. For automotive materials, we foresee a low mid-single-digit sales volume decrease globally. In Asia, we expect a high single-digit reduction. For Europe, we expect a stable development over last year, primarily due to weak comparables. For Americas, we foresee a mid-single-digit growth for our automotive business. For the HVAC and other part of our business in Americas, we expect a mid-single-digit growth in the third quarter as the new capacity will start to become available in the quarter. When looking further ahead, we will continue to focus on our growth initiatives.
We are taking an active part in developing solutions for electrical vehicles, where we are currently in several very interesting customers discussions. Some of these have now started to materialize into contracts. We have during the last couple of months, signed contracts for battery cooling plate materials. This is an area where we believe that our products are very competitive. Volume under these contracts will start to ramp up from 2021. To conclude 2019 second quarter report, we continue to see soft market conditions in the second quarter. Because of this, we experienced a 6% decline in sales volume compared with last year. The adjusted operating profit was reduced to SEK 257 million. The cash generation remained strong with a cash conversion of close to 100%.
Our growth products in the U.S. are proceeding according to plan. The new capacity will start to become available in the third quarter this year. Although the market conditions are expected to remain soft in the coming quarter, we continue to be positive about the medium-term outlook and are determined to continue grow and strengthen our presence and position globally. Now we open up for questions.
Thank you. Our first question comes from the line of Johannes Cornelius from Handelsbanken. Please go ahead. The line is now open.
Yes. Hi, everyone. This is Johannes, Handelsbanken. Can you hear me?
Yes.
Perfect. I have a few questions. My first question is on your comments that you will launch cost-cutting initiatives. Are these small programs or is it something bigger that will require provision in that case? Can you elaborate in that case, what sort of positive benefits you can take out of this? Thanks.
Thank you, Johannes. It's a fair question. As you probably know, a large part of our cost base is fixed or semi-fixed, that means that we need to work actively to take out costs to maintain the operational leverage if the sales volume decreases. It doesn't come automatically. This has been a high focus, of course, for us in Asia and Europe so far this year, we expect to keep that focus for the second half of the year. The program that we are currently running is at this stage about manning reductions in terms of the non-permanent employees, as well as heavy restrictions on spend in general. That means since it's non-permanent employees that are in question here, there are no provisions required for this at this point in time. I don't know if that answers your question.
Yeah, it answers my questions. You provide the year-over-year guidance in volumes, you refer to, was it low single-digit decline year-over-year? I think I heard you, Johan, in the call here that you were saying or indicating that volumes could be up quarter-over-quarter. Can you perhaps give a little bit of granularity on this one?
No, I think what we're saying or guiding for here, Johannes, for Q3, if you compare year-over-year, it's a growth actually for Q3 there. It's a low single-digit growth that we are expecting, not a decline. Just to keep that straight.
Obviously, it makes sense. I didn't
Sorry
do the math right.
Yeah, exactly. It's a low to mid-single digit decline for automotive, and it's a mid-single digit growth for HVAC and other, but it adds up to a growth.
Okay. Yeah, obviously. I have my last question on the U.S. volumes, which at least to my numbers were a bit lower, but I also understand you had some production issues at one plant, but were also volumes affected by the ongoing expansions here in some way, I guess. Can you perhaps explain a little bit or talk a little bit about that?
Absolutely. There are three drivers why we see volumes coming down year-over-year in Americas. One is the product mix optimization. That's something that we are benefiting fromProfitability perspective, but of course it means that we are delivering less volume. Second one was some smaller production issues or production disturbances in our Salisbury plant in the end of the quarter. These have been addressed, but it did impact the volume in the quarter. The third one, which was your primary question here, is regarding the expansion projects. As you know, we are running at full capacity in the U.S. and you need basically your process engineers and process technicians to work actively supporting your production in order to keep that high production output level. It's not easy to run at this high maximum or close to maximum capacity over time.
In the situation we have right now, of course, these individuals are also highly involved in making sure that we can deliver our expansion projects on time. That's why we don't have resources enough basically to spend on both ends of this for this point in time. We believe that the right prioritization here is to focus on the expansion projects.
Okay, understood. Thanks very much for answering all my questions. Thanks.
Welcome.
Thank you. As another reminder, if you do wish to ask a question, please press 01 on your telephone keypad now. Our next question comes from the line of Kenneth Toll from Carnegie. Please go ahead. Your line is now open.
Thanks. The U.S. expansion project, I had expected commercial volumes to start a little bit earlier, and also from looking at your guidance on cost and benefit from this project, it seems like it's a little bit postponed versus the view we had at the end of last year, at least. Can you talk a little bit about what the later commercial impact is? Has it taken a longer time to receive the customer clearance, or are there issues affecting this project, please?
Hi, Kenneth. It's Oskar here. It's a very good question, and I think that our target has always been start of production in the third quarter, but of course, there are three months in the third quarter, so there is some room for flexibility there. Originally, the timeline was to start the rolling mills in Huntingdon in July, and start to ramp up production as of August. We are now seeing that we will start the rolling mill in August and start to ramp up production as of September. There is one month or so delay if you compare with the very first timeline there. The reason for this, there are not only one reason, there are a couple of reasons.
There was some equipment coming in late, and we also experienced some heavy rainfall for parts of the construction period here earlier in the year, which impacted the timeline a little bit. If you compare with the first timeline, it's about a month later that we start production. We're going to be within the third quarter.
Thank you.
Thank you. Our next question comes from the line of Karl Bokvist from ABG. Please go ahead. Your line is now open.
Thank you, and good morning. I just want to follow up a bit on the U.S. expansion here. When you say first commercial orders and then the gradual ramp-up of sales volumes, I'm just a bit curious how you should think in terms of actual delivered volumes in Q3, if we could start there, please.
Yeah, absolutely. It's a good question. I think we have a guidance there for the U.S. business for Q3, which is that we expect to see a mid-single-digit growth in the quarter if you compare year-over-year. That growth is to a very large extent then driven by the volume that will be shipped from the new rolling mill that will start in September then. That I think is my best guidance on how you should think about the volume for Q3.
All right. Then I didn't really catch what you said earlier, Johan, about net start-up cost Q2, SEK 16 million, then you expected SEK 10 million in Q3, but then you said something about the positive contribution of SEK 15 in Q4. Was that from the expected ramp-up in volumes, or how should we think about the SEK 15 million?
Yes, exactly. It's a positive impact on earnings on SEK 15 million in quarter four due to the ramp-up in volumes in Americas. You're correct.
Okay. My follow-up here is that you initially, when we talked about this, you expected that you would have perhaps a neutral impact or, well, basically a net impact for the full year in terms of start-up costs and positive contribution. It seems that things have taken a slight turn on the negative side here.
You're absolutely right. If you compare with that original plan, it's slightly lower here, right? We will now looking at the scenario where we are not net positive for the full year, we will be net positive for the second half of the year. That's our latest estimate.
Okay. Is this mainly related to the reasons you just said about production delays and rainfalls and things like that, or is there anything else?
If you look at the big expansion project here, which is the Huntingdon one, that is the key drivers. We also talked, if you remember, in our last quarterly release about the Newport project, we saw that we are a little bit behind there in terms of commercial orders because we originally had a plan to ship commercial products from the old non-upgraded rolling mills. That proved to be a little bit more difficult than expected. Commercial products will be shipped from the upgraded mills only, that means that that project will start to ramp up volumes with starter production. As Johan said, starter production is going to be in September, ramp-up from October and onwards. There is a second reason also for that project.
Okay, perfect. Just my final one here. Could you just shed some more light on when you said that you had higher operating costs? If we exclude the startup costs, I would guess that is what you are referring to, that the overall business is running on a bit higher cost than you perhaps would have liked. What sort of costs are these? Are these just labor costs or higher shipping costs?
Very good question. It's a combination of things, and one of the things are, of course, connected to what I said earlier about the large part of the cost base here being fixed, if you see a decline in volume, you need to work actively to take costs out. It doesn't necessarily go down automatically with volume, all of this. That is certainly one part, an example of that is just exactly what you say. It's the manning levels. You need to work with shift planning and production in order to actively take this down, of course. We also see some impact from geographical product mix. If you remember, last year in second quarter, we had a large part of our U.S. products produced in China.
Due to U.S. anti-dumping duties being implemented, we switched this to Sweden, we have a higher cost position in general in Sweden than in China. The cost position for that volume is slightly higher than last year. We also experienced some higher freight costs, primarily in Europe and U.S., where we see rates are increasing. It's a combination of things, these are also things that we are working actively with and are addressing as a part of our cost reduction focus now for second half of the year.
Okay, my final one here. If we go back to Q1, you had a positive EBIT per ton development, partly because of the product mix optimization. If we disregard the cost issues you had this quarter, if we look a bit ahead, should we still expect a positive EBIT per ton development year-over-year, given the ramp-up volumes and also what you have done in terms of product mix, despite the perhaps weaker regional mix?
Are you referring to the U.S. business now or sort of the general group level?
Yeah, now I'm talking about the group EBIT per ton.
There are certainly different things that comes into play here now, and given the cost base that we have, of course, we are very volume sensitive. In terms of EBIT per ton for the automotive part of the business, that will be highly dependent on the market activity within light vehicle production. Of course, we can do certain actions to make that look better. Of course, if the market environment is very difficult, there is only so much we can do. For the Americas business, we expect to see a continuing profit per ton improvement driven by further product mixes, driven by increasing volumes and so forth, as we have now new and even more cost-efficient capacity coming online here in the next quarter and going forward. I don't know if that answers your question.
Yeah, that's helpful. Thank you very much.
Thank you. Our next question comes from the line of Mats Liss from Kepler Cheuvreux. Please go ahead. Your line is now open.
Yeah. Hi. Thank you. Couple of questions. First, well, if you could give some flavor regarding the volume reduction here in Asia and Europe, how much is sort of inventory related in the value chain, and how much is sort of end-user production related? Also maybe if you feel that inventories are now sort of on a stable level or if there are more need to reduce them in the value chain?
Yeah. Hi, Mats, it's Oskar here. I think that, of course, a large part of the volume reductions in both Asia and Europe, of course, are driven by the end-use demand here. We see in Asia, automotive production is down 6% in the quarter. We are down 7%. Europe is down, automotive production, 7%. We are down 10%, indicating that we have a little bit of more of a destocking taking place in Europe. That's also only natural, I believe, because we saw the market coming down later in Europe than what we saw in Asia, and particularly China. The majority here is end market driven or end demand driven, but the delta between our volume and the market automotive production volume is primarily the effects of the destocking.
As for your question there, if this will continue or not, we do expect this to continue also in the Q3, given what we see right now.
Okay, great. In China, I guess the volumes are down constantly. Do you see any change there in the competitive situation that, well, you have other competitors trying to enter your market or vice versa? I guess you've tried to sort of balance your volume decline entering new segments.
No, Johan, good question. What we see in China for the Q2 is the similar pattern that we have seen for several quarters historically. Basically the loss of volume here is related to the market, not to market share lost. The competition is basically a few actors that has been competitors to Gränges for a long time. On the other hand, which is not mentioned here in the report, we are having a positive development on our industrial products for wind powers, for instance, to the Chinese industry, where we see a strong growth, even though starting from small volume. There's no change in the competitive landscape in China.
Okay, great. Finally, just about, well, U.S. price thing development, if it's sort of experienced the same level of improvement that you've talked about in previous quarters, about 10%, or if you could add some flavor to that.
Yeah, Johan, it's the same as we talked about before. It's in the range of 10% increase for 50% of the volumes. We don't see any change there in that discussion or on the market side in U.S.
Okay, great. Thanks a lot.
Thank you. As another reminder, if you do wish to ask a question, please press zero one on your telephone keypad now. We have a question from the line of Johannes Cornelius from Handelsbanken. Please go ahead. Your line is now open.
Yes, hi again, it's Johannes. Just want to come back to something you said here, Johan, on your presentation, that you were selling volumes of cooling plates that will have a sort of 2021, I think you mentioned in your presentation, that will be the year where you deliver. Could you elaborate a little bit on this one? Who are you selling it to? Is it producer of batteries or is it OEMs for the car industry? Could you indicate what kind of? Is this very much breakthrough orders, or how do you view these orders?
Yes, sure. We are already today into EV segment with the battery cooling plate and chillers for several models. The specific contract that I was referring to is actually a contract that we've been awarded for a battery cooling plate for a large European OEM, but it will be in partnership with another supplier. It's actually a long contract that will span over seven years and in quite substantial volumes. I'm not able to disclose the name of the OEM, but for us, it's an important project and milestone that we also were able to break through into this large OEM for battery cooling plates. Basically, we'll produce this in Asia, and will be shipped mainly to Europe.
Okay, interesting. I think you might be able to follow up this one later on, right?
Absolutely. Just on that, as you all know, there is a very intensive activity right now in the automotive industry to switch to electrical vehicles. Of course, we clearly see that, and that's also why we are very active in several projects. When it comes to EV cars, of course, first you have the thermal management where we see a large demand for brazing sheet around 40%. On top of that, you also have the battery cell that needs battery foil and the battery casing that also needs plate aluminum products. There is actually, in the long term, a lot of need for our kind of products, but it's more about how we can manage to navigate through this intensive development phase right now. We are positive on that side.
Okay, thank you.
Thank you. We have a question from the line of Karl Bokvist from ABG. Please go ahead. Your line is now open.
Yes. Thank you. Just a quick follow-up here. I am curious about the development of TRILLIUM®. Can you give us an update on customer demand or winning new contracts or product development. I think we talked about this, I think it was in Q1 or Q4, about if we look a few years ahead, how large share of your volumes you see that TRILLIUM® could potentially become. It would be interesting to hear some more about this.
No, sure. We are already today in mass production of TRILLIUM® products for battery cooling and chillers and other types of heat exchanger. Today, we also recently intensified our marketing of this to expand also to U.S. and to Asia. First, we were more focusing on the European customers. Today we have a few thousand tons of TRILLIUM® materials sales. Of course, we have an opportunity or a pipeline of several thousand tons depending on the outcome of the contract. These contracts in general are very large. If we will be awarded, of course, the volume will increase quite substantially. It is also important to understand that this contract and start of production will be around 2021 or something. It is still a year from now from development phase.
We still see that TRILLIUM® will be an important part of our business going forward.
Perfect. Thank you.
Thank you. As there appear to be no further questions, I return the conference to speakers.
Okay, there's no more questions. I would like to conclude this session. I want to thank you everyone for participating today in this busy reporting day for you, even in the middle of the summer. We really received good and interesting questions, and we look forward to our next call on October 24, when we'll present our third quarter report for 2019. Until then, I wish you all a continued good summer. Goodbye, everyone.
Thank you. This now concludes our conference call. Thank you for attending. You may now disconnect your lines.