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Executives

Pål Kildemo - Head of Investor Relations

Svein Richard Brandtzaeg - President, Chief Executive Officer, Member of the Management Board

Eivind Kallevik - Executive Vice President, Chief Financial Officer, Member of the Management Board

Analysts

Luc Pez - Exane

Jason Fairclough - Bank of America Merrill Lynch

Rob Clifford - Deutsche Bank

Jatinder Goel - Citi

Amit Pansari - Societe Generale

Jeff Largey - Macquarie

Norsk Hydro ASA (OTCQX:NHYDY) Q2 2014 Results Earnings Conference Call July 22, 2014 10:00 AM ET

Operator

Good day and welcome to the Norsk Hydro Q2 2014 conference call. At this time, I would like to run the conference over to Mr. Pål Kildemo. Please go ahead.

Pål Kildemo

Thank you. Good afternoon and welcome to Hydro's second quarter 2014 conference call. We will start with a shortest adoption by President and CEO, Svein Richard Brandtzaeg, followed by a Q&A session where also CFO, Eivind Kallevik will join in. For those that didn't see this morning's webcast of the results presentation, this is available on hydro.com.

And with that, I leave the work to you, Svein Richard.

Svein Richard Brandtzaeg

Thank you, Pål, and good afternoon, everybody. I will just make a brief summary of the second [ph] quarter results before we open up for questions. The underlying results EBIT was NOK544 million, which you will know, is down by approximately NOK200 million from first quarter, and marginally higher than the second quarter 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 negativity.

This was somewhat offset by higher realized all-in aluminum prices and higher realized alumina prices. And I am 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. Yet still, we have been 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 and we will continue with forceful improvement programs across the business areas further enhancing our competitiveness including the 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 continued to pleasantly observe the situation in primary metal market where demand is now exceeding production. We are harvesting from the potential this creates. So far this has been higher premiums in LME prices resulting in higher all-in price, but also includes the improvement in automotive which we are harvesting on to investing longer up in the value chain in adjustable flexible mode so we can further harvest through supplying the customer with what they want and need.

So with that Pål, we are ready for questions.

Pål Kildemo

Thank you, Svein Richard. Operator, we are now for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from Luc Pez of Exane. Please go ahead.

Luc Pez - Exane

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 B to A program and how much you would expect going into H2?

Second question. With regards to energy, how much production loss would you expect from the Rjukan, sorry for the pronunciation, upgrade project? And would you expect that to be limited for the Q3 only?

And the 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.

Svein Richard Brandtzaeg

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. We are talking about production of 6.1 million ton yearly speed we have in the second quarter. 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 9.5 million tons yearly speed in the second quarter.

So Eivind, you can come back to the B to A program and the status there.

Eivind Kallevik

Thanks, Luc. We do not really quote going on quarterly speed. But what we have said is, we plan to take out 600 million by the end of 2014 and 1 billion towards the end of 2015. It is fair to say, we are quite confident of that so far this year. We are well on track to meet the 600 million for this year.

Luc Pez - Exane

So should I understand that behind current cost of production, there is already an effect of the B to A program?

Eivind Kallevik

Yes, you can assume that.

Luc Pez - Exane

Thank you.

Eivind Kallevik

And then more to be taken out in the second half.

Svein Richard Brandtzaeg

I will just add to this comment that we have carried out extraordinary maintenance cost during this last few quarters in Alunorte. As a result of the power outage, there were need for extra maintenance in addition to extra work that has been going on at Alunorte to strengthen the energy supply system in order to have a more robust situation, if we should have another external induced energy outage in Alunorte. And that's been now more or less finished. So this is going to be winded down. And in addition to efforts in B to A improvement program, we should see improved cost situation in the quarter coming going forward.

Eivind Kallevik

On the energy side, Luc, the Telemark or Rjukan area comprises approximately one-third of the power production that we have in Norway. We anticipate that this will be completed in the third quarter and it should be out in the tune of 10 weeks during the quarter. I think the important part to remember is, when we optimize the water reservoir levels, we optimize it so as not to lose water. So we produced quite some water in Q2 and then hopefully that was enough and should be enough reservoir capacity to keep the volley inflows in the third quarter without losing water.

Luc Pez - Exane

So it should minimize the impact of the upgrade program on the actual production of power? Is it correct to say so?

Eivind Kallevik

Yes. On the rolled product side, in terms of magnitude of the contracts, depending a little bit about seasonality because this is mostly related to the can volumes that we produce. So it's in the range of 10% to 20% of the production volumes that we have in the business area.

Luc Pez - Exane

Thank you.

Operator

Our next question comes from Jason Fairclough of Bank of America Merrill Lynch. Please go ahead.

Jason Fairclough - Bank of America Merrill Lynch

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?

And then the 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? And 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?

Svein Richard Brandtzaeg

Okay. Thank you, Jason. Regarding fro the first question, Hydro has a tradition to find the 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 they would also have opportunity to look for external candidate. So I don't think I can comment more on that. At least the company has a tradition to find internally candidates but the board has now just started to look for the next person in my role and I don't know really how long time that may take. Of course, if its internally, it will take shorter time than if its external.

Then with regard to ingot premiums, maybe Eivind, you can answer on that.

Eivind Kallevik

I think if I can answer it in 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 and A would be roughly NOK1.4 billion higher with the Platts index level that we saw in the second quarter. Obviously we sell about half the volumes to primary metal. So the net effect for the company would be roughly NOK700 million.

Jason Fairclough - Bank of America Merrill Lynch

Okay. All right. That's helpful, and that's just for alumina. Is it?

Eivind Kallevik

That's just for alumina. Yes.

Jason Fairclough - Bank of America Merrill Lynch

Yes, and then what about the downstream products? Just following up on, I think, Luc's question?

Eivind Kallevik

As we said, between 10% to 20% of the volumes have these fixed premium contracts typically in the can segment for practical purposes.

Jason Fairclough - Bank of America Merrill Lynch

So it's really quite small. So it's not going to be that material at the end of the day?

Eivind Kallevik

At the end of the day, not. But it clearly hurts the rolled products margins, of course, as it is. Then as premiums keep on going up, that of course is good for the primary side and the metal market side but then rolled products would be squeezed for parts of the portfolio.

Jason Fairclough - Bank of America Merrill Lynch

Understood. Okay. Thank you very much.

Operator

Our next question comes from Rob Clifford of Deutsche Bank. Please go ahead.

Rob Clifford - Deutsche Bank

Welcome to London, gents. A couple of quick questions on bauxite and alumina. You did see cost increase, the $5 you talked about this morning in the presentation, but you are up $6 or $7 on the alumina price, 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. So 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?

And the second part of that is related to the question you just answered for Jason. The roughly NOK700 million ballpark you talked about for alumina uplift, is that off a second quarter number where you had higher pricing to the index? And into the third quarter we are going to have lower pricing? Or is that just off an average for the year where we sit at the moment?

Svein Richard Brandtzaeg

Okay. Thank you Rob for good questions there. With regard to the cost that has been presented, in includes the ICMS tax and it also includes what I mentioned about the external maintenance costs that has been carried out in the first and second quarter, that is now winded down. So this is the situation with regard to the cost level.

Eivind Kallevik

On the alumina side, yes, it is working off the second quarter Platts index prices. And then as you know, as we said coming into Q3 there will be less Platts index volumes on the contract structure that we have for third quarter. Helping that, of course, is going to be the fact that LME seems to be rising quite nicely at the moment and typically alumina is priced at minus one. So the impact is more imminent there than necessarily it's on the metal side.

Rob Clifford - Deutsche Bank

Okay. Great, and just back on the first question there. If all of those costs are in there, what else was in the costs to offset the volume and the price increases you saw in the second quarter to give you only a modest improvement in EBIT?

Svein Richard Brandtzaeg

There was also the currency that has changed since first quarter. That is also included in this cost picture.

Rob Clifford - Deutsche Bank

Sure.

Eivind Kallevik

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 little slightly above BRL2.40 to the dollar. We currently have BRL2.20 or so. So that's going to be in the money for second quarter. Then what we did not hedge was the depreciation levels, as that is non-cash. So that has an impact when the reais strengthen. And then 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. So that's also unhedged from a cash perspective.

Rob Clifford - Deutsche Bank

Sure. Okay. Look, I will take that offline. Thanks for your time, gents.

Operator

Our next question comes from Jatinder Goel from Citi. Please go ahead.

Jatinder Goel - Citi

Good afternoon, gents. A very quick one on share of profit from equity accounted investments. It's down sequentially about NOK25 million from first quarter, while Qatalum earnings have gone up. Just trying to understand how does this work, if you could please help? Thank you.

Svein Richard Brandtzaeg

This relates to the Søral power plant in Norway. In Norway, when you entered into the -- the Nordic power prices are measured in Euro, entered into Euro. And then it is sold when you have the 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 kroner has weakened against the Euro and as such we have embedded derivative mark-to-market loss, if you like, and that is what the impact of the equity accounted entities.

Jatinder Goel - Citi

Is that part of the underlying EBIT then? Or is it in the exceptional items?

Svein Richard Brandtzaeg

No, this is part of the underlying EBIT, because its equity accounted. So we take in our share of the equity accounted entity when you look at the profit and loss. But then when you look through the items excluded table, you will see it as part of the minus 40 on the first line of items excluded.

Jatinder Goel - Citi

Okay. Great. Thank you.

Operator

Our next question comes from Amit Pansari of Societe Generale. Please go ahead.

Amit Pansari - Societe Generale

Hi. Thank you for taking my question. My question is on the bauxite situation. So after the Indonesian ban and if we assume that ban continues, how far do you see that other countries can ramp up bauxite output? And do you also see China ramping up bauxite output to substitute some of the effects from the ban from Indonesian ban?

Svein Richard Brandtzaeg

Thank you, Amit. 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 its election and it could be another election in Indonesia that takes time and it remains to seen if the new politicians are going to change this export policy. But in the meantime, China is looking around for new sources. They have found for example sources in Dominican Republic.

There are also the volumes from ourselves going from Brazil to China, where we sell bauxite with very good margins. But it is right that China is also ramping up their own bauxite production. But we also know that there is quality question also however with regard to how much reactive silicone or how much impurities they can carry over from the bauxite into the alumina that goes into the metal.

Because this impacts, in the end, the metal quality. So for certain alloys, this may not create a problem but a lot of alloys, for high quality products, that may be really a big problem in the end. So I think China is looking for high-quality bauxite and it remains to be seen where they can find that.

Amit Pansari - Societe Generale

Okay, and 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 are having some EBITDA components from Søral?

Svein Richard Brandtzaeg

We did not sell all. We have got a temporary release from the supplier. So we are operating Søral marginally positive, but that is not a company maker, as such. It is not a smelter that is going to change the bottomline of the primary smelters significantly short-term. But that of course, Søral is running at half speed. It is at 80,000 tons and 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 has changed. However that we see is getting traction as we see the profitability of all smelters is moving at a significant in right direction.

Amit Pansari - Societe Generale

Okay. Thanks for taking my questions.

Operator

Our next question comes from Jeff Largey of Macquarie. Please go ahead.

Jeff Largey - Macquarie

Yes, hi. Good afternoon. Just along those lines, my questions were on Søral. Was this simply a case of you taking Rio's stake off their hands? Or is there any consideration that 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?

Svein Richard Brandtzaeg

We believe that Søral will be a very positive contributor in the Norwegian smelter system. But as long as we run the smelters at 50% capacity utilization, of course this has a cost implication and so the smelter will be high on the cost scale when we compare it with the other Norwegian smelters. But saying that, Søral smelter is one technology smelter. It is efficient. It is a smelter that produces 100% extrusion ingots for the European market with premiums as we see today, $800 to $900 per ton. So with increasing LME, as we also see now, we are quite optimistic about what Søral can contribute here. So they are also systematic in the smelter system of Norway. And 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 we feel a potential for improvements. So 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 part owner. So we believe that Søral in the future will be a competitive smelter and give a positive contribution to Hydro's bottom line.

Jeff Largey - Macquarie

That's helpful. I guess I just wanted to also clarify whether there was any material consideration for Rio's stake? So acquiring the 50% that you didn't own?

Eivind Kallevik

No. There is not, Jeff.

Jeff Largey - Macquarie

Okay. Great. Thank you.

Operator

We have no further questions at this time. (Operator Instructions). And we have no question at this time.

Svein Richard Brandtzaeg

Okay, well then I think we can wrap it up for today. Thank you very much for calling in, and we look forward to speaking with you the next time. Have a nice day. Thank you.

Operator

That will conclude today's conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.

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Source: Norsk Hydro's (NHYDY) CEO Svein Richard Brandtzaeg on Q2 2014 Results - Earnings Call Transcript

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