ArcelorMittal's (MT) CEO Lakshmi Mittal on Q1 2016 Results - Earnings Call Transcript

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ArcelorMittal SA (NYSE:MT)

Q2 2016 Earnings Conference Call

July 29, 2016, 09:30 PM ET

Executives

Daniel Fairclough - Investor Relations

Lakshmi Mittal - Chairman and Chief Executive officer

Aditya Mittal - Chief Financial Officer and Chief Executive officer of Europe

Simon Wandke - Executive Vice President of Mining

Genuino - Head of Finance

Analysts

Mike Shillaker - Credit Suisse

Ioannis Masvoulas - RBC

Cedar Ekblom - Bank of America.

Alessandro Abate - Berenberg

Seth Rosenfeld - Jefferies

Anthony Rizzuto - Cowen

Rochus Brauneiser - Kepler

Luc Pez - Exane

Carsten Riek - UBS

Roger Bell - J.P. Morgan

Philip Gibbs - KeyBanc

Patrick Morton - Macquarie

Daniel Fairclough

Great, thank you very much. Good afternoon and good morning, everybody. This is Daniel Fairclough from the ArcelorMittal Investor Relations team. Thank you very much for joining us today on our conference call to discuss the second quarter 2016 results.

First, I would like to remind you that this call is being recorded. We are going to have a brief presentation from Mr. Mittal and Aditya followed by a Q&A session. The whole call should last about one hour [Operator Instructions]

With that, I will hand over the call to Mr. Mittal.

Lakshmi Mittal

Thank you, Daniel. Good day to everyone and welcome to ArcelorMittal’s second quarter 2016 results call. I’m joined on this call today by Aditya Mittal, CFO and CEO of Europe; Simon Wandke, EVP Mining; Genuino, Head of Finance and Daniel Fairclough.

I would like to begin with some introductory remarks. This was a solid quarter for ArcelorMittal. This is the best operating results in six quarters. We have reported comfortably positive net income and generated positive free cash flow. Secondly, ArcelorMittal now has a balance sheet to reflect its industry leadership status. Net debt now stands at $12.7 billion, this is 1.8 times based on run rate EBITDA.

Moving to the operating environment, we have clearly seen improvement over the past three to four months. However, China remains a threat, production is higher than domestic demand and exports are elevated. We must continue to encourage China to deliver on these plans to deal with over capacity. In the meantime, we'll continue to work with the governments in our various operating jurisdictions to ensure that appropriate protection measures are in place to ensure a fair and level playing field.

This quarter, there have been positive developments on trade measures both in the U.S. and Europe. Clearly, pricing has recovered sharply during the second quarter. In recent peaks, we have seen steel spreads moderate marginally.

But if real demand continuous to be positive and impose contained, then steels spread should main supported by good levels of inventory and extended order lead times. Finally, I'm pleased to report that Action 2020 is progressing well. The business is fully focused all plans are on course and the business is motivated to deliver success.

I will begin today’s presentations with a brief overview of our second quarter 2016 results, followed by an update on our recent developments. I will then spend some time on the outlook for our markets, before I turn the call over to Aditya. He will go through the results in greater detail and provide an update on our guidance and targets for 2016.

Next slide, as usual, I will start with safety. The lost time injury frequency rate in second quarter 2015 was 0.79 times as compared to 0.72 times in Q1 2016, and 0.68 times for the second quarter of 2015.

For the first six months of 2016, health and safety performance was essentially stable at 0.78 times as compared to 0.79 for the first six months of 2015 with improvements within NAFTA, Brazil and Europe offset by the durations in the mining and the ACIS segments.

On April 28, 2016 ArcelorMittal marked the company's 10th Annual Health & Safety Say under this years' team together for safety Take Care. With a focus on the importance of systematically following safety rules and procedures. We remain committed to the journey towards zero harm and must ensure that all levels of the organizations are focused on the primary objective.

Now moving to the operating financial results for the second quarter as summarized on slide number four, we have reported EBITDA of $1.8 billion for the second quarter 2016. This is a clear improvement on the exceptionally weak Q1 performance, but also represents a 27% improvement on the same period of last year.

We have reported operating income of $1.9 billion in second quarter of 2016 this includes a onetime exceptional gain of $800 million following the signing of the new labor agreement with the United Steel Worker.

You can now see more evidence on the improved pricing involvement on our steel segment results. Mining EBITDA also improve due to seasonally higher volumes, 23.2% plus and higher seaborne and iron ore prices by 15.2%.

We reported net income of 1.1 billion as compared to a net loss of $400 million in Q1 2016. We also made a notable progress in debt reduction as promised. Net debt decline by $4.6 billion this quarter following the process of the right issue, the receipt of the Gestamp sale proceeds and positive free cash flow.

On Slide five, I will walk through more details on our steel performance by segment. Steel only EBITDA improved significantly from $800 million in Q1 2016 to $1.6 billion in Q2 2016, primarily driven by a 7.7% improvement in the steel selling prices and 2.9% high shipments. All segments showed improvements relative to Q1 2016.

On a per ton basis, the sharpest improvement was in ACIS. As you know ACIS is a fully spot based business and therefore immediately benefitted from the rising price involvement in Q2 2016. Europe had a strong quarter reflecting improved volumes and prices, but also tangible benefits of the transformation plan.

NAFTA also showed a strong improvement in EBITDA due to higher price levels, but given contract lags, the full benefit of higher prices have not yet been fully captured. Brazil segment performance showed an improvement in the second quarter. Domestic demand remains depressed business the premium over imports was reestablished and profitability of exports benefited from higher international pricing.

Moving onto the mining segment performance on Slide 6, mining EBITDA was 67% higher than Q1 2016 driven by higher volumes mainly at Mines Canada and higher seaborne iron ore prices. We continue to focus on aggressive cost cutting and remain on-track to achieve our year end 2016 unit cash cost reduction of more than 10% - year-on-year basis reducing our free cash flow breakeven level to $40 per ton.

On Slide 7, I would like to provide an update on the strategic progress we have made on our Action 2020 plan particularly in NAFTA. Firstly, as I have already mentioned that a new contract with the USW was signed and ratified during second quarter. This is a positive, as this will enable us to leverage the core strengths of our various U.S. facilities. We have lowered the cash cost for the post-retirement benefits and there will be no wage increases during the contract period.

In the labor agreement ratified, we are now progressing with our footprint optimization project at Indiana Harbor. In a small simple term, this is about idling less competitive finishing assets while making important investments in more efficient asset to improve the configuration of the Indiana Harbor plant.

Let me now address demand, ArcelorMittal shipment weighted global PMI at 51.3 in June, continues to indicate growth in demand for our steel. Increased uncertainty post Brexit is likely to weaken European PMIs. The largest impact will be on the UK, which represents only 2% of ArcelorMittal sales and our forecast for European apparent steel consumption growth remains unchanged.

In the U.S. we have lowered our forecast for flat and long apparent steel consumption to positive plus 2% to 3% primarily due to tightening of supply resulting in lower inventories and longer lead times. Our forecast for demand in Brazil and ACIS are unchanged as growth begins to stabilize as expected. Our view on demand in China is also the same as last quarter as robust infrastructure and the automotive continue to support steel demand while growth in the real estate has lost momentum as expected.

Now, I’ll hand it over to Aditya for financial results and guidance.

Aditya Mittal

Thank you. Good afternoon. I'll discuss the second quarter financial results and guidance in a bit more detail. So turning to Slide 10, I will reflect some of the key elements from EBITDA to a net income in this quarter. During the quarter, we recorded an impairment of $49 million related to the sale of our ArcelorMittal Zaragoza facility in Spain. Zaragoza as I mentioned, borrowing facility in Spain primarily producing about 0.5 ton of commodity loan products.

The largest item this quarter was an exceptional income of $832 million as you viewed earlier relating to a one-time gain on employee health benefits following the timing of our new U.S. labor contract. Income from investments was $168 million benefitting from improved performance of Calvert, Spanish as well as our Chinese investees, and also includes the annual dividend received from Erdemir. The man item in our ForEx line is the $230 million one-off premium expense we incurred on the early redemption of our bonds. As a result, we reported net income of $1.1 billion for the quarter.

On Slide 11, let me review the order fall taking us from EBITDA to free cash flow. During the quarter, we had approximately $0.2 billion release of operating working capital. The third bar on the slide shows a combined impact of net financial costs, tax expenses and other items totaling $1.1 billion. This includes the $237 million one-time premium and early retirement of debt. Cash flow from operations of $0.9 billion combined with CapEx of $0.5 billion resulted in free cash flow of approximately $0.3 billion.

On Slide 12, we show the bridge of our change in net debt from Q1 to this quarter. The main component of the debt movement during the quarter were the free cash flow we just reviewed. As you know we had a proceeds of approximately $3.1 billion from the rights issue and M&A in flow of $1.1 billion. Dividends of $41 million were paid out to minority shareholders in ArcelorMittal Mines Canada as well as our joint venture in Brazil with Bekaert. ForEx and other impacts was $100 million. The combined results of these movements was a debt to reduction to $12.7 billion in the second quarter compared to $17.3 billion in Q1 2016.

On Slide 13, we show a summary of the deleveraging that has been undertaken this quarter. Growth that has been reduced by $5.1 billion during the quarter to 15.1 at the end of June 30, 2016. As you can see on the chart, we have illustrated our new debt maturity profile showing what has been repaid or prepaid and what is left outstanding. The takeaway here is that we have significantly reduced on year-term maturities and our average debt maturity has been expended to 7.1 years.

Now to conclude with our guidance for the full-year, what we said at the beginning of the year remains valid. In 2016, we will do more than $4.5 billion in EBITDA. All the cash use of the business and this include the expected investments in working capital will be recovered by our EBITDA. And as a result, I continue to expect that we will again be free cash flow positive.

As we said last quarter, we are consciously moving away from giving very specific quantitative guidance and certainly do not want to be marking our guidance to market every quarter. What I will say is that despite the steel spread recovery in losing momentum in recent weeks, the impact of lagged prices will be an important support for operating results as we move into a period of seasonally slower steel demand. There is nothing yet that we can see to suggest that results should significantly deteriorate.

That concludes our presentation. Now, we are happy to answer any of your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take the first question please from Mike at Credit Suisse.

Michael Shillaker

Yes thanks a lot for taking my questions and well done on the numbers. And first question really on cash flow, if you take your cash flow breakeven model of $4.5 billion and then looking at the Q2 EBITDA of around 1.8, in principle that should give around $650 million of free cash. There is no obviously one-offs in there, because the net working capital release offsets versus the premium payment and yet we are running at about half that number. So, A, I guess the question part one, is what is the delta between the 350 or so and the 650? And B, assuming EBITDA run rates remain the same versus Q2 through the second half of the year and that avoids any conversation on guidance, so that would my assumption for now. Would you expect free cash flow to improve in the second half of the year is the first question?

The second question, I guess, I mean the company is very familiar with [indiscernible] its probably been the most successful rewriting story of the whole resources sector in the last few years and if you look at what they have done, cash flow discipline, focused on debt pay down, debt now running at about 50% of EBITDA, and a willingness to pay a dividend when they decided the time was right. Is this the type of model that you would actually now like to think about for ArcelorMittal, I think steel companies generally have been over willing in the past to stand on acquisitions, over willing certainly to spend on CapEx.

But if you look at what Aperam has done with the discipline it's had, its rerated to the equity massively. So, A, is this something that you would like to follow now with ArcelorMittal in terms of the focus on debt pay down even further. And B, shareholder returns and on that concept of shareholder returns, would you now given what you see on cash flow, debt and visibility of your earnings to be prepared or be thinking about reinstating a dividend either at the end of the year or as Aperam did last year potentially early?

Aditya Mittal

Hey Michael, I'll start with your free cash flow question. So, just to be very clear on this question, we expect cost of the business to be $4.5 billion for the year. This excludes the early prepayment of our bonds, which is about 237. If you look at Q2, I would not annualize that number, I would look at the first half, I think the first half is more representative, we had less cash payable outflows in Q1 then we have had in Q2.

So if you combine that number, we are running very close to $4.5 billion, the major delta between the first half and the second half is interest expense, interest expense will come down in the second half, we also had higher cash interest expense and in the first half of this year. So, we are very comfortable that our free cash flow breakeven including CapEx is $4.5 billion and that has not changed.

In terms of your other questions let me address Aperam I think look we are already proud of Aperam, we are on the Board of Aperam as well. And I think when we did the rights issue, we spoke about the potential that ArcelorMittal to follow what Aperam has done. The stainless cycle clearly recovered both from a trade perspective and the market perspective earlier than the steel cycle, before china could dump steel into Europe Aperam had put in place fade measures that is ongoing in Europe and now we can see some of those benefits that are occurring in our North American business.

Our Action 2020 is very powerful at ArcelorMittal it's price structural improvement. What we see in this quarters result, is the structural improvements are coming through. When you look at our year-on-year performance or second quarter 2015 compared to second quarter 2016, you can see that even those steel selling price are down 12%, our EBITDA is up 27% just demonstrating that there is significant structural improvement underway in business.

In terms of value creation, I think we are going to do what is right for ArcelorMittal. I don’t believe that is necessary minimizing CapEx and not doing acquisitions, I think what we are focused on is for the strengthening the balance sheet and making the right decisions to create value for shareholders.

In terms of the dividend question, clearly when we reach a level of net debt to EBITDA of less than two times, this topic comes on the agenda of our board. I believe at that point in time, the board will take that as a consideration that we have achieved a decent leverage our relative to earning, but we will also look at the sustainability of those earnings, the structural improvements that we have made to free cash flow and also review where we are in terms of our rating vis-à-vis the credit agencies.

Michael Shillaker

Okay, Thank you very much for the color.

Aditya Mittal

Sure.

Daniel Fairclough

Great, thanks Mike. So we will move to the next question please from [Indiscernible] at Morgan Stanley.

Unidentified Analyst

Yes, hi good afternoon ladies and gentlemen. I'm going to ask you two questions from my side. Firstly on the percentage of the group exporter to the automotive sector, how much of your volumes grow to the automotive. and second the part of this question is are you seeing any signs of the slowdowns from this end markets in light of what we have been seeing in the company's results. And the second question is on the pricing go into Q3 now I presume most of your contract would have been concluded for the current quarter, how would you quantify the price increases versus the second quarter in light of the spot prices as well. Thank you.

Aditya Mittal

So thank you. Overall automotive shipments are approximately 20% for ArcelorMittal, but they clearly are much more concentrated in our NAFTA and Europe business where they are averaging around 40%, so the impact on automotive is felt much more in those segments. We had not just seen a slowdown in automotive, we are still very cognizant or constructive I should say in terms of automotive production rates, both in Europe and in NAFTA. Inventories remain low through the system the supply demand balance is good. So we have a constructive year on automotive growth in 2016 relative to 2015.

In terms of pricing, look these are all confidential contracts, I would not get into many more specifics. I think the general comment we made at the end of our presentation remains valid that the biggest driver in terms of earnings improvement and the second half is not necessarily coming from contract improvement but from lag pricing.

So what is lag pricing, that's basically orders we have taken in the second quarter, which are being shipped into the third quarter. We have certain contracts non-automotive, which had lag pricing. So, in Q1 when we deliver those, they are based on Q4, Q2 is based on Q1 and so on. So that will be a positive impact into second half and our results. Offsetting some of that will be the fact that the second half is seasonally weaker and so we will have lower volumes.

Unidentified Analyst

Thank you.

Daniel Fairclough

Great. Thank you. So, we'll take the next question please from Ioannis at RBC.

Ioannis Masvoulas

Good afternoon gentlemen. Three questions from my side, first of all in the U.S. you highlighted tight supply and some destocking as reasons for slightly lower demand for cash for 2016. At the same time, last quarter you indicated you have the blast furnace which 1.5 million tons capacity idled. Any thoughts on restarting that facility? Second question can you give some indication on current lead times in Europe both for [indiscernible] and also cold rolled and coated sheet and have you seen any softening over the past weeks? And third question again on Europe, strong numbers in Q2, has there been any notable change in product mix during the quarter? thank you.

Aditya Mittal

You are right that our blast furnace three is idle at this time, but this is a commercial matter where we do not provide when do we start and how do we start. So we will inform the market what is the future development on this issue.

Lakshmi Mittal

So, lead times in Europe are stronger then when they were at this point in time last year. I would not provide a breakdown by product, I think that's commercially sensitive. In terms of mix, the improvement is marginal. And obviously every quarter we are trying to improve our share of HAV product, but there's no significant change in mix in Europe from Q1 to Q2.

Ioannis Masvoulas

Thank you.

Daniel Fairclough

Thanks Ioannis. We'll take the next question please from Cedar of Bank of America.

Cedar Ekblom

Thanks very much guys. Two questions from me. Can you touch on the trends in Brazil that business made close to $1.9 billion only two years ago? And obviously your shipments is still going down there year-over-year. Can we just get an update to where you see the market? And then on the U.S. with the agreement now agreed with the U.S. Steelworkers Union, is there any clarity you can give in terms of timing for plant closures, how we should think about phasing the cost savings that should be coming through there?

Aditya Mittal

First on the U.S., we have got the agreement signed with the union. And some of the downstream facilities are being closed, that is the 84-inch hot strip mill and some finishing lines. At the same time, we have an investment program to invest in steel shop and discussing to optimize the footprint of Indiana Harbor and some of the other sets in U.S. We have said during this that this will give us a benefit of about $200 million from 2017 onwards, but some of the benefits will also come this year. Maybe close to $50 million to $100 million, we are not sure yet. But we are expecting some benefits to come this year.

Clearly Brazil is affected by the domestic weakness, but our plans are operating at full capacities and flat at least, because when we are not able to cater to the domestic market due to its weakness we are exporting. At the same time, you will find that our profit is not as affected as it should be, because in dimensional export prices have also improved, which has helped in improving our EBITDA in flat.

In long, we are operating at less than full capacity or less than 90% and that will depend on the market, but we are quite confident that at this time we are seeing things that’s kind of bottoming out. We see improvement in Brazilian market slowly, we have to be patient about it, but we are confident that demand will be restored. We have lost about 30% of demand since 2013. So we feel confident that this will be restored and then we will operate at the high capacity and will participate more on the domestic market.

Cedar Ekblom

Perfect. Thank you.

Daniel Fairclough

Thank Cedar. So we will move to the next question please from Alessandro of Berenberg.

Alessandro Abate

Good afternoon gentlemen and congratulations on solid set of results. Just a follow-up question to one of Cedar’s. On Brazil we have seen also demonize that is calling for an H2 2016 that definitely is stronger, in terms of recovery of domestic demand and continuing the U.S. [indiscernible] additional rates at the moment. I'm expecting clearly a recovery of the premium in terms of domestic price. These I just want to know that the feel on this issue is.

The second is on the restructuring, because your Action 2020 seems to be early now showing some kind of a sign of significant implementation. Would it be possible to understand how much of your Q2 very strong results is the results of operation and how much is basically related to these Action 2020 and if you may yes, you are speaking about the lag effect of steel prices. How much of the Q2 strong steel price increase in the U.S. and also Europe is being captured in terms of pricing to Q2. Thank you very much.

Lakshmi Mittal

Today in Brazil we already see the higher premium to IPP and I think that kind of higher premium is not very sustainable, there could be some correction at the same time Real has also appreciated. So we will come back to normal premium in the Brazilian market. More important is the improvement in the domestic demand, which will help us in improving now profitability. Our market shares are not changing it's all domestic demand, which is poor. Action 2020.

Aditya Mittal

Yes, so Alessandro. Thank you for your question. In terms of action 2020 I think there is a significant impact in our Q2 results already, if you remember when we announced 4Q performance, we talked about a billion dollar structural of improvement. It was focused on Calvert, it was focused on improvements we are making in ACIS, it was focused on the European transformation plan, we also said that once the U.S. AOPs is underway there will be certain benefits this year on U.S. AOP.

The best way to think about it is to just look at our second quarter 2015 performance versus second quarter 2016. Shipments are more or less flat there, slightly down this quarter by about 0.3%, but what you will find there is selling prices were down by 12%. That's clearly very significant drag or significant headwind.

Even if you were to normalize for cost, you would see there was a significant price cost squeeze that occurred between Q2 2015 and Q2 2016, yet EBITDA is up by 27%. And when we look at what are the attributes of that EBITDA growing by 27%, clearly it's the initiative that we have embarked upon in our Action 2020 plan.

So in a nutshell, we are very confident, very comfortable, we are very pleased with the execution that we have achieved so far as well as on our ability to deliver the full plan in the medium-term. In terms of more quantitative updates for the market, our intention is to do that on an annual basis. So, we should be doing that when we report year-end results and we can lay out much more clearly exactly how that has impacted our results.

In terms of the lag effect, I think there is a significant portion of price improvement that has already occurred in our NAFTA as well as in our European business, the business which has very little lag effect is really our ACIS business and to some degree our Brazilian business.

Going forward, we think that is going to support our business into the second half. And that may offset or close to offset the impact that we will have from lower volumes due to a seasonally weaker second half.

Alessandro Abate

Thank you very much for details.

Aditya Mittal

Sure.

Daniel Fairclough

Great. We'll move to next question please from Seth at Jefferies.

Seth Rosenfeld

Good afternoon. A couple of question first on outlook for European imports then moving onto Calvert. And that looks for imports it seems you have we see a number of quite significant announcements from the European Commission in the last six to nine months, yet imports continue to be rising to mostly from data that we can see. Do you have sense of whether or not the recent activities are starting to impact on your buyers and whether or not we might see a bit of a shift in the import volumes in the H2?

Also wondering the outlook for galvanized deal, certainly the one major plus steel greed where there is no case at this yet, then area of interest where you are perhaps doing work to request an investigation? And then separately on the U.S. business for Calvert, if you can provide an update on the ramp up of that plant in terms of volumes or profitability would be interesting. Obviously given how strong domestic CRC galvanized spreads are present above HRC for example, is it perhaps one part of the business that is already at peak margins or is there more upside to come from Calvert?

Aditya Mittal

Thank you sir. In terms of Europe you are right imports are still increasing, imports have increased if you compare first half of 2016 compared to first half of 2015 by approximately 15%. So clearly, this remains an issue and an area of focus for the commission as well as various steel companies through Europe there. In terms of galvanized product, I think your question is very fair and very appropriate.

I don't want to comment on it at this point in time, because I would rather that information is made public and then the whole market is aware of the developments that are occurring in terms of trade cases. At this point in time, the trade cases that are sitting with the commission are anti-dumping and countervailing case against China on hotrod coil, as well as in antidumping case against various other countries about five countries on hotrod coil. And so I think your question is, is there an opportunity on galvanized steel is an appropriate question.

Lakshmi Mittal

On Calvert ramping up is progressing very well. Even the second quarter we have improved our volumes, our campus utilization was 85% during Q2 versus 72% in Q1 and we expect that this continues to improve even by when we exit 2016 we should be operating around 90% of its capacity.

You are right that there is a straight improvement between hot roll and cold roll. Calvert is continuing to work on obligation of its products with its customers. About 90% of its product have already been approved by the customers and now we are continuing to supply them those volumes and our target is about 60% to be supplied to automotive customers when it's reaches its peak capacity.

Simon Wandke

So, just to conclude, so that implies that there is further upside in Calvert as we sale more value added products and that's part of the Action 2020 plan.

Seth Rosenfeld

I guess last one, one quick follow up sorry. When you look at outlook for those spreads for galv versus HRC or cold roll coil versus HRC. How sustainable do you think those spreads are in the market right now and is there any concern that by adding additional capacity at Calvert in terms of your peers are also doing similar things that initial supply could ultimately dampen then the spread outlook?

Lakshmi Mittal

I think these spreads are because of trade action as well as the supply in management, in the sense that there is not enough capacity in the market and Calvert has a capacity to further improve its volume and I think that this is sustainable for the time being.

Seth Rosenfeld

Thank you very much.

Daniel Fairclough

Thanks Seth. So we take next question is from Tony at Cowen.

Anthony Rizzuto

Thanks Daniel and hello everyone. I have got just three questions here. First, are you any maintenance work on your blast furnaces or hot strip mills in your U.S. system beyond Indiana Harbor works footprint optimization that's my first question. And then I have got a question about your NAFTA operations. We have always thought that your firm or annual contracts are approximately around 40% of your volumes. I was wondering if you can tell us what percentages on a quarterly basis.

And then third, I'm curious as to your thoughts on the rather large jump that were seeing in the license data on imports into the U.S. about 25% rise if we look at where the June preliminary imports are shaping up to be and where they licensed data at least is indicating for July and a lot of that seems to be on the hot roll and the cold roll side. So interested in thoughts there as well. Thanks.

Aditya Mittal

Thank you for your questions. I don't want to get specific on what our maintenance schedules are for our U.S. operations. As we take or not take facilities into maintenance, we will update the market accordingly. In terms of NAFTA what is the split of contracts? It's quite simple, 40% is annual contracts, 60% is spot. Out of the spot 60% roughly 30% is contracts using our lag contracts, so let's say 40% annual, 20% lag and 40% spot. So, those are the numbers that you can work with.

In terms of import pressures, I think look in terms of the U.S. marketplace our view is still constructive. Supply demand balance is quite constructive, inventory levels remain low and so far we are seeing some stability in pricing with some downside risk. To your specific question of import licenses, we have to recognize that physical imports are lower than license data that's what we saw in June there could be some spillover into July.

Anthony Rizzuto

Thanks Aditya.

Aditya Mittal

Sure.

Daniel Fairclough

Great, thanks Anthony. We'll move to next question please, from Rochus at Kepler.

Rochus Brauneiser

Yes, hi everybody. Just a few brief one to you. Based on the pricing structure you have, would it be a fair assumption that did realize effect would be higher in the third quarter versus the second quarter? Can you help a bit on the strong performance in the NAFTA segment and looking at the volume performance and seeing that your average revenue per ton was only up 20. How can you get through these strong increase in the EBITDA? Would it be fair to assume that there has been some carryovers effect from previous inventory write-offs?

Aditya Mittal

No, I think you have increase in shipments, you have improvement in Calvert, you have a significant increase in revenue per ton and costs are remaining stable. So we in terms of third quarter, you would tend to see even higher pricing environment. The only negative on that pricing environment would be the change in volume levels as the second half is usually weaker.

Daniel Fairclough

Great, thanks. We'll move to next question from Luc at Exane.

Luc Pez

Hi gentlemen. One question if I may, related to volume I feel that the Q2 volume was a bit lower than the usual seasonality, should we read that as meaning that the Q3 seasonal drop in volume will also be less than seasonally usual?

Aditya Mittal

Thank you for the question. I don't have that reading. So I think Q3 will exhibit the normal seasonal pattern relative to Q2.

Luc Pez

Thank you.

Daniel Fairclough

Great, thanks Luc. So we'll move to next question please from Carsten at UBS.

Carsten Riek

Just on the question from Luc, we have seen that you announced the [indiscernible] blast and as we ramped up [indiscernible] its fully running now in the third quarter. I would also at least to see you on the production level that you have coming out of a little stronger than the usual seasonal pattern here. That's a first question, whether you would share it at least on the production level even though on the shipment level do you might see the seasonality.

Second question I have is on the free cash flow generation it look like the inventories were comparably stable, you still manage to release 235 million in net booking capital. So it came out off the receivables and payables, is that sustainable or do we see here the reversal.

Third question on the price differences, we have seeing some big price differences in steel between Europe and U.S. actually the highest ever since at least as I have records in 1985. Do you take advantage of it, because not all the European countries are actually locked by the U.S. because it's a nice margin so that are pretty much my three question. Thank you.

Aditya Mittal

Thank you Carsten for your questions. So in terms of your three questions, I'll start with the first one. So in Europe the inventory cycles are different than perhaps what you see across ArcelorMittal, so let me just address your European question. In Europe, we typically build inventory in the second half and we got down inventory in the first half. This is because the seasonal impact also is much more pronounced in Europe and in other markets.

And so the fact that we are ramping up on [Indiscernible] we are going to be completing the realign of the [Indiscernible] does not necessarily mean increased shipment, it just means that we are on-track in terms of our inventory build. We had a significant draw down of inventory in the first half of this year in the European segment.

In terms of free cash flow and moving into working capital, look we have invested over billion dollars of working capital in the first half of this year and we are suggesting that we should be releasing - the net investment for the year would be 0.5 billion, which implies that we should be releasing 0.5 billion in terms of working capital in the second half. That will be some of it will be obviously not in Europe, but in other segments and also perhaps better receivable and payroll management.

In terms of the price differential in the U.S. and Europe, you are right that does exist and it is an attractive opportunity. All companies and all countries in the world have to be cognizant that carry the U.S. is moving very aggressively on any surge of imports or any new countries which would bring in a lot of steel and we are aware of that plus we have a larger operations in the U.S. so we put all of that into consideration before deciding on what the appropriate export strategy is for European facilities.

Carsten Riek

Okay, that helps already. Thank you.

Aditya Mittal

Sure.

Daniel Fairclough

Thanks Carsten. So, well take the next question please from Roger at J.P. Morgan.

Roger Bell

Yes good afternoon gents. Thank you very much for taking my questions. Most have been answered, but just looking at your cost province, it was a bit better than expected and was down a little bit quarter-on-quarter, I mean how much of headwinds did you see from rising raw material costs or were the lags still working in your favor at quarter-on-quarter on the raw materials front. And then second question just on Ilva, you committed to running that plant at 6 million tons per annum if your proposal is successful, would acquiring Ilva make you reconsider capacity elsewhere in your Southern European portfolio? Is that capacity at risk?

Aditya Mittal

Okay. So, in terms of raw material and the cost impact clearly iron ore prices are more elevated then they were in the past, we are seeing some of that in the core business as well, scrap is slightly down or stable. The impact is not that significant that we are forecasting into our business. We will review that obviously further when report results perhaps some of that is because of the cost reductions, we are doing across our business and the structural improvements, perhaps some of that is because some of the lag impact or the impact of raw material costs already captured into the second quarter.

The biggest impacts we are seeing in the second half is the benefit of lag prices in terms of revenue offset by seasoning over volumes. In terms of your second question, about Ilva, sorry, in terms of Ilva you are right we had made a bid along with [indiscernible], old news but perhaps what's repeating since we are addressing the topic is that we don't expect our bid to threaten or impair our strong balance sheet or its credit metrics.

In terms of its impact on other operations in ArcelorMittal in Europe, we believe Ilva is complementary, we don't see an impact on our existing businesses. Perhaps you are aware, but Italy is the second largest market in Europe for steel and even though ArcelorMittal is the largest steel producer in Europe, we have virtually very limited presence in Italy. So clearly, this is an opportunity for us.

Roger Bell

Great. Thanks very much.

Daniel Fairclough

Thanks Roger. We'll move to next question from Bastian at Deutsche Bank.

Bastian Synagowitz

Yes, good afternoon gentlemen, I have got two question left. My first one is one CapEx where you obviously demonstrated to the market, how you can run the business if it needs to be negative quite impressive considering that this is essentially representing almost a 40% cut on discount compared to most of your peers. Since you have put together the budget for 2016, it's probably fair to say that the market conditions has not just improved drastically, I guess certainly in the U.S. also much more than any could have expected. It's still very early days, but could you give us some obvious sense for whether you plan to keep the budget as tight as $2.4 billion next year or so, any project in the pipeline which would imply that we may step up from that level? That is my first question.

And then my second question is again coming back toward the outlook and guidance, clearly we have not yet seen this full impact of higher gas prices which as you pointed out after Q1 results, will only see in the third quarter for the spot business and then for the annual contract business in U.S. this will be even Q1 next year and the same applies essentially for Europe. Although volumes here maybe seasonally weaker, I guess what was the pricing impact clearly should be over compensating that, you said that we should not see deterioration in earnings but why were we not seeing additional improvement in EBITDA in Q3? I appreciate that you want to remain slightly higher level, but any direction would be great and helpful.

Aditya Mittal

Sure. So in terms of CapEx every time we look at our asset base and the products that we are producing and the acceptance of our products and technology. We rank the highest relative to our competition, I mean we did a survey with 23 OEMs recently in 21 out of the 22 ranked us as number one in terms of technology. So our facilities are well maintained, we are producing the most demanding products at relatively good costs.

Perhaps there is a difference in accounting measurements, relative to the competitive landscape. Perhaps we are expecting more items, which others are considering as CapEx or perhaps not, but that could be one explanation. In terms of CapEx going forward and I would just add that part of the deflation that we have seen in CapEx is not only efficiency measures we have puts in place in terms of re-scoping and better negotiations. But also that we operate in various jurisdictions which have seen various account devaluations right. So that's Kazakhstan,. Ukraine, Brazil. And so as a result the CapEx cost in dollars has come down as seems in Europe.

In terms of going forward apart from significant currency impacts we are not forecasting dramatic increases in CapEx, we are forecasting small increases, the exact number was that smaller obviously we would inform you at the appropriate time. But there is no CapEx out there that we can see which we are dramatically change approximately $2.4 billion number.

In terms of the same question of selling prices weaker volumes and all of that I mean I can just reiterate what I said. The only thing I would add is that you had mentioned that we would see the full impact and spot in Q3 in the U.S. and Europe we have already seen the impact of spot in Q2 there is some lag effect of certain contracts and maybe some lag effect of some spot order.

But a significant portion of the spot impact we can see in our European and NAFTA results in ACIS it's a very clear path through same in Brazilian operations. So just to reiterate in terms of the second half, yes, we will have benefit of improve pricing which we expect to be offset by choosing lower volumes.

Bastian Synagowitz

Okay, thank you.

Daniel Fairclough

Great, thanks Bastian. So we’ll take the next question comes from Phil at KeyBanc.

Philip Gibbs

Thanks very much. How much of the 1 billion in cost savings announced in the third quarter earnings call last year have been seen in current year-to-date results and are there any more benefits to come on that?

Aditya Mittal

So I had mentioned some of the key drivers of why we had seen a significant portion of that already in the second quarter results. There is still some left in the second half primarily the benefits of the U.S. footprint as we have just done in the second quarter where we buy those various facilities and we will see some reduction in their cost base in the second half.

Our ramp up at Calvert continues, so that should be another positive development into the second half. Remaining programs I think we are on track and we are making good progress but in terms of what would change first half or second half I would highlight more potential in Calvert in terms of higher value added volumes as well as some cost reduction within the U.S. AOP.

Philip Gibbs

Okay and on Calvert specifically as you grow that business how much over the intermediate term would you expect to be shipping into the Mexican market? And then where right now if you could give us any color about where you are getting your subs rate from in terms of the majority of that feed?

Aditya Mittal

Not too sure. So in terms of where we are going to be shipping our products I think that's commercially sensitive so, I'm not able to get into that discussion with you. Substrate is much easier. So, as you know we have a contract with [indiscernible] which covers about 2 million tons of slabs.

So we get 2 million tons from their operations in Brazil call CSA, we get a significant portion roughly a 1 million tons from our U.S. operations and sorry 0.5 million tons from our U.S. operations and the remainder comes from our slab businesses in Brazil and Mexico.

Philip Gibbs

Terrific and then just for clarification and I'll jump off. The 60% in NAFTA that is non annual contract how much of that mix again is that quarterly lag?

Aditya Mittal

40% is auto, 60% is spot, out of the 60% spot, 30% is the lag contract. Operator And we'll take the next question please, from Patrick at Macquarie.

Philip Gibbs

Thank you.

Daniel Fairclough

Great, thanks Phill. So we’ll take the next question comes from Patricl at Macquarie.

Patrick Morton

Thanks guys. With regards to the mining division it seems like a number of the really large scale iron ore producers in particular are rapidly moving their cost structure downwards. I believe you haven't as yet changed your breakeven target for the iron ore business. Do you see more opportunities for cost savings there going forward?

Simon Wandke

Hi Patrick, its Simon speaking. If you get back overall four or five years, you will see in fact we probably get tightened some of their assets to bigger ones who have actually outperformed the majors in terms of cost reduction on that quarterly basis. That work continues that we are not letting up, it’s part of the DNA of our company. Really where we see the next level is the sustainable structural changes is the Action 2020 topic again.

So, across the Board you are seeing if it's in their minds particularly in Canada and then MMC, Liberia other assets where we have structured programs now underway that are footprint based, autonomous and semi autonomous equipment drivers, trucks etc. being used. Conveyors other methodology is which will take us to the next step and that’s really the focus for the next two to three, four years is keep hacking away of the cost reductions. We know that it gets harder and harder to reach up the tree to reduce costs but that's doesn't stop us but really now it's chasing those material structural changes which will force us to a new level around cost competitiveness.

Patrick Morton

Great, thank you. And then finally apologies, this is a bit repetitious, but can you talk a little bit about your philosophy on the dividend policy going forward again?

Aditya Mittal

If you know it's repetitious, what else do you want to hear? So, look, we will, it'll be on the Board's agenda when met that level of net debt to EBITDA of less than two times. At that point in time it's important to review both the structural improvements we had made to our business, the sustainability of our cash flows and we are also taking the conservation where we are in terms of our ratings vis-à-vis the various credit agents.

Patrick Morton

Thank you guys.

Daniel Fairclough

Great. So will move to the next question comes from please from [Indiscernible].

Unidentified Analyst

Just on the Asia its division you have done figures in your improvement in the second quarter. What the pricing looking like in general both South Africa and the Eastern Europe. Given the turmoil close to spot price season, I guess the spot price would be under pressure in Asia and other side of question read that you may be considering participating into the restart of [Indiscernible] South Africa is any relevant to these. Thank you.

Lakshmi Mittal

To comment as Aditya said before that our Ukraine and Kazakhstan business is on the spot based price basis and there is the lag of on a two weeks forward. So, I really believe that so this is the this will follow the market trend whatever is the international price and on the high value added products. What we are saying is that be I think that we will start some electric hot furnace operations and [Indiscernible] which will produce a special to billets to be rolled in high felt heavy section mill.

And this would allow us to enter into heavy section market, which we are not dealing yet. So this will help us to improve our volume and create value. At the same time, this will also allow our new castle plant to produce fully and they can produce more of the long product and can from new customer can produced more long products which is where things have growth and demand.

Unidentified Analyst

That would be [indiscernible] or for the local market?

Lakshmi Mittal

In South Africa this product is for domestic market.

Unidentified Analyst

Thank you.

Daniel Fairclough

Great, thanks So we’ll move to last question from [Indiscernible].

Unidentified Analyst

Hey guys thanks for taking my questions. Most of them have been answered. First off, you guys gotten your debt level down to where you wanted to be you have articulated the desire to get down below $15 billion well beyond that on a net debt basis. Has any of the rating agency sort of started to talk to you guys about positive outlooks or they have even ask moving towards investment grade. And then also just talk a little bit about this user [Indiscernible] in the automotive market how big is that can it be. Is it going to be something that will effect that we stay on other competition from aluminum. So the two questions as sort of new products on the automotive sort of arms race as it were with aluminum and then also the rating agencies dynamic.

Aditya Mittal

Sure. Thank you, Brett. In terms the rating agency dynamic at this point in time we have many thing to report but purely these are the conversations we will be having up to the various credit rating agencies. In terms of new products, as I had mentioned earlier we are the technology leader that's what the automotive consider us as we invest about $230 million a year in terms of research and development.

And as you correctly pointed out, we have been rolling out new products. Apart from rolling out new products we have been working very closely to ensure that new vehicle design uses advanced high strength steel appropriately to stable off the usage of aluminum. I think post [indiscernible] loss we are making good progress. We see that in terms of the order intake for advanced high strength steel products, the level of demand that we are seeing relative to what would have been the forecast maybe two years ago.

So, what we are seeing more is that the aluminum uptake is not more on the lower case scenarios that perhaps you had envisioned two years ago then the base case. So, that's the progress we have made through the launch of these various new products and the launches and developments in new products is continuing. So, we should expect to see more of those initiatives succeed in the medium term.

Unidentified Analyst

Thanks very much and congrats on a strong quarter.

Aditya Mittal

Great. Thank you.

Daniel Fairclough

So there being no more questions. Thank you all for joining today's call. This was a solid quarter for ArcelorMittal. We have shown good progress on all fronts. EBITDA is recovering, balance sheet is strong and we are making progress with our Action 2020 project. And look forward to speaking to you at our next results and wish you all a very happy and safe summer. Thank you. Have a good day.

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