Rikard Lindqvist – IR
Svein Richard Brandtzæg – President and CEO
Jørgen Rostrup – EVP and CFO
Ben Defay – JP Morgan Cazenove
Neil Sampat – Nomura
Norsk Hydro ASA (OTCQX:NHYDY) Q3 2012 Earnings Call October 23, 2012 10:00 AM ET
Good day ladies and gentlemen and welcome to the Norsk Hydro Q3 2012 Conference Call. At this time, I would like to turn the conference over to your host today Mr. Rikard Lindqvist. Please go ahead sir.
Welcome to Hydro’s third quarter results conference call. To present the result is President and CEO, Svein Richard Brandtzæg; and Executive Vice President and CFO, Jørgen Rostrup. After the presentation there will be an opportunity to ask questions.
I would first like to draw your attention to the cautionary note in relation to forward-looking statements. And with that, I leave the word to Svein Richard.
Svein Richard Brandtzæg
Thank you Rikard and I would like to start this presentation with a brief recap of the deal we announced last week. We are creating a world leading extrusion company together with Orkla. We will have 50/50 – 50% ownership in the joint-venture and the new company would be called Sapa and will have number one position in Europe, North America, a strong foothold in emerging markets.
This will be a company with strong management and leading technology, leading competence and good organizational capabilities. The synergy potential is estimated to be NOK1 billion per year and it will be a company with a revenue of about NOK47 billion and 25,000 employees.
For Hydro, this is value creating from day one and I am very happy with the attractive valuation for Hydro’s assets. Hydro through this deal again taking lead in the industry and building a better industry structure. So let us then turnover to the highlights from the third quarter, where we had the underlying EBIT of NOK8 million, a weak result, very much influenced on the decline in alumina and aluminium prices. The alumina prices went down to about 10% in the quarter and the aluminium prices down to 7% in the quarter.
We had the record high bauxite production in Paragominas and the downstream were very much influenced by weaker market especially in Europe but partly offset by lower operating cost. In Energy, we had the lower prices and also lower production.
If we take a closer look at the Extruded Products business, we saw a decline in all different areas, Extrusion Eurasia minus 9%, Building Systems minus 13% in the quarter, and Extrusion Americas and Precision Tubing minus 7% on volumes. If we compare the quarter this year with the third quarter of last year, we can see a steep decline in Extrusion Eurasia and Building Systems while Extrusion Americas and Precision Tubing was quite stable. So the Extrusion Eurasia and the Building System business is of course reflecting the very week situation in Southern Europe and very much influenced by the sovereign debt crisis. All in all 9% down in Extrusion quarter-by-quarter and also this quarter compared to the third quarter of last year of minus 9%.
Rolled Product sales were more stable. Some improvements in Litho and Foil but also significant reco in the building and packaging. Can beverage, Auto and Heat Exchanger, General Engineering is stable and we had similar volumes this quarter as the previous quarter and also similar volumes this quarter as we had in the third quarter of last year. It is still a challenging market in mid 0% growth, however it’s more positive in Rolled Products and a more challenging Extruded Products market.
In the primary aluminium, the third quarter demand was reflecting normal seasonality meaning a bit lower than the second quarter which is a stronger one. The aluminium production was quite stable due to curtailments and also restart of disrupted capacity. The announced curtailments of 1.2 million tonnes will not be in full effect this year. About 700,000 tonnes will be the total added for 2012 and regard to this capacity, about 400,000 tonnes has been out of production in total as we estimated for 2012.We maintained 2% growth in aluminium demand outside China and we expect more balanced market in 2012.
Looking at the inventories, there has been some changes between reported inventories and reported inventories but all in all quite stable levels. However, with regard to ingot premiums we see that this metal is not easily available in the market so there is very high ingot premiums between $230 to $280 per tonne in different regions and demands for us to do remelting of standard ingots and producing, for example primary foundry alloys, this is not more attractive, not longer attractive so we have reduced the production of primary foundry alloys (inaudible) high premiums of standard ingots.
There has been volatile aluminium prices in the quarter. Realized price was $2,022 coming down from $2,167 per tonne in the previous quarter. It’s volatile on low levels and it’s reflecting the uncertainty and weak macroeconomic outlook. This is a good opportunity for me now to give some comments on the situation in Brazil since we acquired bauxite and alumina assets in the Vale [ph] last year. But first of all, we can confirm the strategic rationale for the deal. There is a fight for raw materials and we are also seeing the change in pricing of bauxite and alumina market and we are also seeing that there is a higher cost to build new capacity.
In Paragominas, we increased the production since we closed the deal with 42%, so I am happy to see that what we set the volumes is now confirmed that we were focusing very much on volumes and we have delivered accordingly. But the macroeconomic situation and raw material pressure is continuing to be a challenge. LME is lagging. They are (inaudible) inflation and that means that margins in this business is also under pressure.
Looking at the prices of alumina, we see that it has been quite stable during the last year while the LME has been quite volatile. We are seeing that there are – the contracts now is based on index pricing and index pricing as we see today is the new development that we are welcoming so alumina is priced on its own merit, and not linked to LME. And we expect that the long-term contracts will be more likely to be linked index linked now than the LME linked reference, as we have seen previously.
If you take a look at Chinese import and export balance, we saw a quite high demand for bauxite in the beginning of the year. In April, the import of bauxite from especially from Indonesia, also bauxite also from Australia went strong increase in import on bauxite but from May when Indonesia introduced the ban of bauxite export, they gave licenses to certain players however with this 20% excess more tax this year which is planned to be increased 50% in 2013 and the ban of export from 2014.
It seems that this change has been extremely effective. We see from June that significant decline in import of bauxite to China and China is now looking for alternatives even in the Atlantic area. So we have sold also cargos out to China showing that strong appetite for bauxite and also the challenging situation that the Chinese aluminium industry is in today.
If you look at alumina imports, there has been 200% growth in 2012 year-to-date compared to 2011. We dig onto primary aluminium, we see they are broadly balanced this year in China and really on the Semis and the Fabricated products, the exports as it is today is similar to the levels in 2011. As I mentioned, there is a raw material cost challenge and if you compare the LME for example with situation in the first quarter of 2010, it has been a reduction of 12% while when we compare the caustic price of today compared to the first quarter of 2010, there was an 119% increase.
Coal price increased in this period with 36% and there is also the increase in fuel oil price. We had ICMS tax in Brazil added to the total [ph] cost in second and third quarter of this year which would add another 30 percentage points in these two quarters but we have from the fourth quarter with reduced focus [ph] this tax in Brazil.
If you compare our position in bauxite alumina with our peers, first half 2011, second half 2011 and first half 2012, we have the highest EBITDA margin in (inaudible) compared to our peers, mainly that we keep leadership in this business and this is also confirming what we said during a presentation of the acquisition that we believe that the cost position of Paragominas and Alunorte was good and this can be confirmed also through this slide.
This doesn’t mean that we feel that this is good enough because there is weak results from this business and that’s why we are continuing our effort in improving the bauxite alumina business and we continue the NOK1 billion improvement program that is going to till about next two to three years. This is of course essential to keep our competitive position. It will be improvement of productivity, maintenance, operational performance. It will be optimizing and rightsizing of the activities and also on top of this program is to continue to commercialize bauxite and alumina and get the end of the new pricing of this materials.
If we then move to Primary Metal, we see that the cash cost has been reduced to $200 per tonne from 2011. This is due to partly one-third of the effect is due to introduction of Qatalum. This is included now. Its effect of reduced alumina cost that is one-third of the effect as mainly is related to the overall improvements and also some help from currency and raw material. The $300 product continues and it’s on track and one comment there is that the casthouse margins are challenging due to the high standard ingot premiums, however we are outperforming these costs in other areas. So we will discuss more on the $300 programs at the current Capital Markets Day later this year.
In Qatalum, we continued the strong production. We have a stable production and produced single and eight plate capacity. The seawater cooling tower is now under progress to be reconstructed. It is already in operation, parts of it, it means that we can now operate all the turbines in Qatalum, where we have four gas turbines and two steam so all the turbines are now operating. And the next step for us is to continue to optimize the operations and make sure that we reach the cash cost level which we are aiming for and there are still some potential.
Thank you. And then I leave the floor to the CFO, Jørgen Rostrup.
Thank you Svein Richard. Let me then draw you through some financial numbers and we start the slide showing the development in underlying EBIT over time and you will see the change from Q2 this year to Q3 of more than NOK500 million to zero result or close to zero result for the quarter. This is significant impacted by lower price, so the effect of LME on our earnings as well as we reduced volumes of our seasonality, lower energy result and somewhat offset then by reduced costs.
Just one reference to Svein Richard’s comments around the plant and joint-venture within extrusion with Sapa. We have this quarter reported Extruded Product as we normally do meaning that we have not reported it as discontinued business or business per se. The reason for this is that is the decision to combine our extrusion activity with Sapa was Hydro made in the fourth quarter and no conclusion or decision was made at the closing of the calendar, the 30th of September.
So we will only next quarter most likely report it as business for sale or discontinued business. We expect that closing of this transaction could result in a gain to be recognized in our books in the magnitude for NOK0.5 million [ph]. Then I will get back to the business areas later one, just say that the other elimination reporting area has a similar charge of common services and other businesses as normal, so the lower charge this quarter compared to last quarter is due to elimination of internal gains and losses on inventories, and this is the number that flips up and down every quarter according to the margins in the internal sales that is stored in inventories but the charge in the shelf is at the same level.
Then if we look at the kind of a high level of waterfall analysis of the NOK0.5 billion in change quarter-on-quarter, you see will that we allocate NOK0.6 billion, so more than change of sale NOK0.6 billion to the effect of change in LME, either changing LME directly on our metal sales or the consequence for our alumina contracts, our legacy alumina contracts. And the NOK0.6 billion is more or less evenly distributed on bauxite alumina business area and primary metal business area.
Then there are two minor changes, one is the energy earnings and the other is net number including the volumes, the volumes are a little bit down, as Svein Richard said partly because of seasonality and partly because of continued weakness in the European markets. Counteracting this is improved cost, lower cost in the quarter. This is partly variable cost but also several cost elements, fixed cost elements both in upstream and in downstream business. Some of them are one-offs and third quarter normally particularly in the upstream business has lower cost than the other quarter, so we should expect some rebound of a little bit of this part in the next quarter.
Looking at key financials, you will see that revenue is down with some 12% NOK2.5 billion. This is due to the same factors as we talked about, the combination of lower prices and lower volumes. We have the NOK8 million in underlying EBIT and minus NOK414 million in reported EBIT which means that we are excluding from the underlying EBIT the negative effects of NOK422 million in the quarter. NOK100 million of these is related to derivative effects on LME and power associated with an increasing LME over the quarter and as you know this derivative effects we always use – put in item excluded every quarter.
The remainder of this part is impairment and rationalization charges related to our restructuring programs in the various business areas. Most of this is non-cash. Now we have positive NOK245 million in financial items mainly related to the net currency gains of NOK283 million in the quarter which is influenced by the appreciated Norwegian Kroner over the Dollar so this is the impact on Dollar debt of the change of the strengthening of the Norwegian Kroner.
It gives us income before tax of negative NOK169 million, a small tax expense due to payable power surtax in the Norwegian hydropower system that we have, which again then gives a net reported loss of NOK231 million and underlying net loss of minus NOK20 million.
Then if we turn into the different business areas and starting with bauxite and alumina, you will remember that we guided cautiously on this in the second quarter and we have significant weakening in this quarter in bauxite and alumina. It’s NOK200 million to NOK386 million negative and only marginally positive EBITDA in the quarter. Prices were significantly down in the quarter in the range of 9% from $300 and down to $270. You will see from this slide that Svein Richard previously showed that the index prices are around $320 so the mix of contracts and say that we have in our portfolio is sold at $50 below the index prices in the market.
We have somewhere between 10% and 20% of our portfolio sold on index prices which means that still a majority is sold on contracts linked to LME so called legacy contracts in this context. We expect the share sold on index prices to gradually increase and after $215, $216, a large part of our contract portfolio can be renewed with different pricing structures. Then as Svein Richard was alluding to we are very pleased to have a record high production in the Paragominas mine this quarter. We are up 15% quarter-on-quarter and we are at an annual rate for the quarter at 9.7 million tonnes and for a month in the quarter we were on the implied capacity of 9.9 million tonnes annual rate so we had succeeded in bringing up the mine and stabilizing it at good production levels.
The Alunorte refinery production was a little bit more disappointing. It’s a slight decrease for last quarter. We have experienced some issues in the consigners [ph] last part of the production process in the refinery. This has led to roughly 150,000 tonnes of hydride being stored and being ready for the final conversion to alumina in the last part of the processing in the refinery which means that we should clearly see a significant increase in production in Alunorte next quarter.
Looking forward besides production, realized prices will mainly follow the LME with one month lag so that means that within the current pricing environment, it should represent an upside in fourth quarter compared to the third quarter. We also expect cash cost to come further somewhat down in Q4 mainly due to the exemption of the ICMS tax. You might recall that we discussed it in previous – last quarter and a decision has been made by the State of Pará in Brazil which will again exempt Alunorte from ICMS tax on fuel oil. It’s efficient I believe from October 1st and we expect may be only some minor inventory effects on the Q4 results, so in other words most of the NOK150 million charge due to ICMS taxes in Q2 and Q3 will not be included in the fourth quarter and onwards.
And then we obviously will focus as Svein Richard said on the continuing to stabilized improve production and bring cost further down. Moving to primary metal, negative NOK10 million versus positive NOK240 million in EBIT, so a change of NOK250 million in underlying EBIT for the quarter. Before depreciation the number is close to NOK500 million positive in Q3.
Significantly lower realized prices this quarter, going down to $2,022 so it’s $150 down compared to last quarter and price beside some sales volume effects reduced the result by some NOK300 million. Offsetting the price effect, somewhat was reduced raw material costs improving results by NOK100 million. This obviously includes alumina which is then priced linked to the LME but also some energy and pet coke prices came slightly down.
We also saw ahead of decline in fixed costs contributing positively but as I said both year and in particular in the Qatalum units these are one-off items predominantly and will change again slightly in fourth quarter but our cost focus is maintained and we don’t see any negative development, it’s just that the one-off items helped us a lot this quarter and will be of smaller effects in next quarter.
Then I will get back to Qatalum on next slide, obviously the results is included in this number so that will take a separate place so for the outlook, we have sold 80% of our production excluding Qatalum at $1,925 somewhat down from this quarter. We are expecting somewhat lower production in sales volumes for two reasons, both the Kurri Kurri, a plant in Australia had been completely shutdown now including their casthouse, there is no remelting taking place, so as of now it’s completely stopped and we also see a general reductions in remelt volumes in our global portfolio, also due to the high ingot margins which makes remelt of cold metal unprofitable.
Somewhat higher fixed costs as I said and then we also would like to say that the President Dilma of Brazil has expressed her intend to reduce the power cost in Brazil aiming at increasing their competitiveness of the domestic industry. Obviously we acknowledge the importance of the issue for the industry and we very much appreciate the initiative. We believe it will have an effect both for our refinery and our smelter but we will have to revert with more information when the process is more mature and when we have full insight into complete effects on our operations.
Then looking at Qatalum. First of all it’s very good to see that we continue with a higher and stable production in Qatalum that we are producing 2%, 3% above nameplate design capacity and at very stable rates. So that is good, running only less than a year in full production. Then underlying net income which we include in our EBIT line for the Group was down by NOK144 million from Q2. This is very much equal to the positive effect in Q2 from insurance settlement of the power outage incident of NOK140 million which means that the effect of lower LME in Q3 has been offset by a reduced cost level.
We believe that this is partly due again to non-recurring items and that the cost level in Q3 is not necessarily represented to you for the cost level going forward. This is plant running at somewhat higher than $1,500 a tonne cash cost and we are working on trimming that cost level further down, but this quarter came out maybe a little bit on the good side when it comes to costs.
The underlying EBITDA in the quarter is on our share 50%, NOK179 million, obviously the underlying net number of minus NOK129 million is including financial costs and also depreciation on the newly invested adds.
Metal markets, just two comments to that. Performance-wise, we are almost at the same level as last quarter at NOK104 million versus NOK117 million last quarter, so that is when we keep out of equation currency and inventory valuation effects. If you include those including quite high effects on inventory valuation effects, negative effects, the underlying EBIT is NOK7 million. Obviously this inventory valuation effect is due to the increasing LME in the quarter, loss on the hedge of this inventory which we have to take to our books immediately while we can’t write up the physical inventory due to the LME increase. We will only take that when we release this quarter. We expect somewhat reduced volumes for the fourth quarter as partly a seasonal effect and partly due to the higher ingot premiums for our remelters melting cold metal.
Rolled products, a good result from Rolled products. We are quite pleased with that. It’s NOK90 billion above third quarter last year. It’s somewhat higher than second quarter of this year. We have seen as Svein Richard said stable sales volume in this business, so it’s quite a different development than the extrusion business, partly due to the product mix and partly due to the fact that we have more global contracts in this business. So the seasonal decline that we saw in some segments was offset by positive effects within the Litho business and restart our production in our Hamburg rolling mill.
Again, we also benefited from revenue from overseas sales in the quarter. Operating cost was down in the quarter also affecting with some positive mix. And into the next quarter, we expect to see more of a normal seasonality, lower volumes and Q4 for our rolling business is also high maintenance season. So you should expect the result to be more in line with the same quarter last year.
If we then look to Extrusion which is obviously structurally our most troubled business and where we are hit by the European significant economic turbulence and the decline in Southern Europe in several markets, at least building and construction markets. We have made an illustration here alluding to the point that our cost program and restructuring program has picked up in speed. We have indicated EUR80 million over a two year period from ‘011 to ‘013, half of that should be delivered by 2012, so within this year and we are well underway to achieve that target within New Year.
And as you can see whether you look at the year-to-date or you look at Q3 ‘12 compared to Q3 ‘11, we are more and less now at the less speed of improvement program where we are compensating the market shortfall with measures taken in our own portfolio. This is obviously cut in capacity, reducing manning, reorganizing our distribution systems and our sales outlets, working on logistical setup and cutting fixed costs in general. So at least we see great benefits from our own program but obviously a very challenging fact is that the markets keep declining and we haven’t seen the end to that yet we believe.
As I look at Extrusion, sales volume was down 9% as I said and EBIT – underlying EBIT was half what it was in the second quarter, hit by the difficult economic situation particularly in Europe. We believe some continued weakness in fourth quarter, but we also expect positive impact by the continued rationalization that we are carrying out.
Energy, I think that the headline is high reservoirs and low prices. As you know, there is a significant volatility in the earning numbers from Energy from quarter-to-quarter both due to seasonal reasons and also due to the fact that this is heavily influenced by how much rain and snow is turn into watered as we can produce and to what (inaudible) can it be optimized and sold out in the market. Now we are in a situation with high reservoirs, Norway hydrological balance and water reservoirs are significantly above the normal 10 year average, that is also what the situation for Hydro as such.
If you look into the quarter, power production was down quarter-on-quarter and also compared to last quarter and the net spot sale is same and prices also lower for this reason of high reservoirs. We have also been in situation where we have kept out one-third of our production capacity in the second quarter, the Rjukan production system. We have had a significant upgrading, the first part of our significant upgrading. I am very pleased to see that that has gone well. We were prepared to spend 16 weeks on this but we managed to take it down to 12, 12.5 weeks until we were able to move our production again.
So all in all it went well and we are ready for higher production and also we will see higher prices in fourth quarter and there is no change in our energy setup. This is only the normal volatility in earnings that you are accustomed to.
Then I will end my part of this pointing to you our net cash/net debt situation. We started the quarter with a small net debt position of NOK0.4 billion, then we have generated little bit more than a NOK1 billion from operations divided on the three different elements that you see on the slide and we have spent NOK1 billion in investment in the quarter. Capital Markets Day last year we guided on NOK4.5 billion to NOK5 billion in annual CapEx 2012. I believe we are able now to see mould the number of around NOK4 billion. So we have taken down our investment estimate, another check-in of the cash – capital discipline that we are putting into their organization with these earning levels.
And then you have some translation effects on the dollar debt given Norwegian Kroner value and based on this we are about zero net cash, net debt on our balance sheet at the end of the quarter. Svein Richard.
Svein Richard Brandtzæg
Okay. Then that concludes the presentation and we open up for questions. Please operator, go ahead.
Thank you. (Operator Instructions) We’ll pause for just a moment to allow everyone to signal. We’ll now take our next question from Ben Defay from JP Morgan.
Ben Defay – JP Morgan Cazenove
Hi good afternoon everyone. Couple of questions from my side, firstly, you are guiding to high fixed costs in primary aluminum in fourth quarter. Is that primarily due to lower capacity utilization or is there anything else in the division which would impact fixed costs, I know you did touched on that topic during the presentation but I was wondering if we could expand a little bit? And secondly, what can you do as a company to benefit from and capture the rising premium? Thank you.
Well Ben, maybe I should start and I guess Svein Richard will comment on the premiums. On the fixed cost side Ben, first of all, the prime reason for our comment is that is if you look into in particular primary metal and including Qatalum, fixed cost is down in such a way this quarter that we were afraid you would interpret that as being a new level going forward. So we are not saying that we will have a situation where the fixed cost is brought up over and above the level where we have been operating at lately, we are just saying that there is first of all a seasonal effect due to holidays [ph] and other things that is influencing the fixed cost level in third quarter compared to fourth quarter and second that we have had some one-off items that you from time to time have that has gone more or less in the same direction in bringing down the fixed cost levels.
You will see it when you make your calculation on Qatalum. You can also see it when you look at the primary metal numbers but more important is the fact that we have wrote down our business cash cost in primary metal in total down to $1,800 in ‘012 compared to the level that we saw in 2011 for the reasons that Svein Richard was mentioning, it’s the Qatalum impact, it’s obviously the alumina impact, and it is the $300 impact.
Svein Richard Brandtzæg
Thank you Jørgen and with regard to the question about rising premiums, of course we will benefit directly from the situation in the plants where we are producing standard ingots which is done in some of our joint-venture. In product – in the metal products then we are talking about production of sheet ingot, extrusion ingot and primary foundry alloys that is the main metal products that we are producing.
We are benefiting directly from higher ingot premium in connection with production of sheet ingots to the cold link industry because sheet ingot is based on LME plus the standard ingot premium and plus the conversion premium for slabs to produce the sheet ingots. So that means we are directly benefiting there. With regard to extrusion ingots and primary foundry alloys, these products are priced on LME plus a premium for the total product that is not there, it takes some time before we get the full benefit of primary ingot premiums.
And the extrusion ingot premium and the primary foundry alloys premium is under pressure with regard to that. We see there is an increase in premiums but not sufficiently to call off for a high premium of the standard ingots and that is also why we are taking down to remelt of standard ingots to produce for example primary foundry alloys in our system so we are now reduced the primary foundry alloy production significantly during that quarter due to that effect.
Ben Defay – JP Morgan Cazenove
Okay, thank you.
We will now take our next question from Neil Sampat from Nomura. Please go ahead.
Neil Sampat – Nomura
Good afternoon. On the call I think you alluded to potential interests you’ve got from the Chinese for bauxite from Brazil. I know you are in against a small net long position in bauxite, could you explain to us roughly what an upside there and the timescale and if you’re looking at selling bauxite to third parties and on what kind of timeframe, what kind of upside that can make to the bauxite (inaudible)?
Svein Richard Brandtzæg
Yes. Neil, this is of course at an early stage and we haven’t sold huge volumes from Brazil to China yet, but it’s quite interesting to see that the Chinese are looking into the Atlantic region to get hold of bauxite and this is of course due to the fact that it has been limitations on the export from Indonesia to China. So the Chinese players are now eager to get access to new sources.
Most of all bauxite production is close linked to the alumina production and also that further linked to the existing contracts that was entered by Vale. So what we can sell now is access bauxite from increased production that we have achieved in alumina and we are of course evaluating and optimize this in the next quarters but this phenomenally interesting to see that the China always in a situation where they have to go quite far to get hold of bauxite for the whole alumina production in China.
Neil Sampat – Nomura
And in terms of the economics of that, could you just explain a little bit I guess around shipping it from Brazil to China, is that the kind of the thing holding you back at the moment to the economics work?
Svein Richard Brandtzæg
In fact we are shipping to China with good margin, so it’s clear that Chinese players are willing to pay not only the cost of shipment but also the price that its necessary for us to be active in this market.
Neil Sampat – Nomura
Okay, thank you.
(Operator Instructions) We will pause just a moment to assemble the queue. There are no questions at this time.
Okay, thank you. Then that concludes the conference call. Thank you.
That will conclude today’s conference call ladies and gentlemen, thank you for your participation you may disconnect.
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