Sims Metal's (SMSMY) CEO Galdino Claro on Q2 2017 Results - Earnings Call Transcript

| About: Sims Metal (SMSMY)

Sims Metal Management Limited (OTCPK:SMSMY) Q2 2017 Earnings Conference Call February 14, 2017 5:00 PM ET

Executives

Todd Scott - IR

Galdino Claro - Chief Executive Officer

Fred Knechtel - Chief Financial Officer

Analysts

Emily Smith - Deutsche Bank

Simon Thackray - Citi

Michael Slifirski - Credit Suisse

Owen Birrell - Goldman Sachs

Peter Stein - Macquarie

Scott Hudson - CLSA

James Rutledge - Morgan Stanley

Hugh Stackpool - JP Morgan

Operator

Good morning, ladies and gentlemen and welcome to the 2017 Half Year results briefing conference call for Sims Metal Management Limited. I must advise you that this call is being recorded today, Tuesday the 14 of February 2017 in the United States and Europe; and Wednesday, the 15 of February 2017 in Australia and Asia.

Today's presentation may contain forward-looking statements, including statements about financial condition, results of operations, earnings outlook and prospects of Sims Metal Management Limited. Because these forward-looking statements are subject to assumptions and uncertainties, actual results may differ materially from those experienced or implied by these forward-looking statements. Those risk factors can also be found on the Company’s Web site, www.simsmm.com. As a reminder Sims Metal Management is domiciled in Australia and all references to currencies are in Australian dollars, unless otherwise noted.

I would now like to hand the call over to Todd Scott, Vice President of Investor Relations for Sims Metal Management. Please go ahead.

Todd Scott

Good morning and thank you. Joining us on today’s call are Sims’ Group Chief Executive Officer, Galdino Claro and Group Chief Financial Officer, Fred Knechtel. In addition to today’s discussion we've prepared a slide presentation that has been posted to our Web site at www.simsmm.com. During today’s presentation Galdino will cover an overview of the results and the accomplishments during the fiscal first half followed by Fred, who will lead us through a more detailed discussion of our financial results and key drivers, before handing back to Galdino, for an update on today’s strategy and outlook.

I will now turn the call over to Galdino, starting on Slide 3.

Galdino Claro

Thank you, Todd and good morning. The first half of fiscal year '17 represented another important step towards our objective of generating returns of both cost of capital by fiscal year '18. Underlying EBIT of 77 million was 23% higher than the second half of fiscal year '16. The improved results was driven by discipline and execution of our internal initiatives and a 3% increase in sales volumes. Underlying NPAT of 60 million was 8% better than the second half of fiscal year '16. The improvement earnings resulted in an annualized return on capital of 6.8% this is the highest return fees based part cost of the five-year strategy in 2013. Back then volumes were 47% higher.

In the current market where volumes remain historically low. Our improved performance continues to be driven by our internal actions. During the first half of fiscal year '17 we further reduced our volume breakeven point to 7 million tonnes, as well as we commenced a number of value-added projects to be delivered over the reminder of fiscal year '17 and '18. At the same time, the Company’s balance sheet continues to be strong allowing us to recur over 37 million in capital to shareholders. Through dividends and a share buyback, which we will have extended until the end of calendar 2017.

Now please turn to Slide 4. The first half of fiscal '17 was a period of consolidation and improvement. Resulting in better financial performance across all businesses and key metrics. Despite, a small volume improvement of 3%, earnings improved materially. Underlying EBIT increased from a loss of 5 million a year ago to 77 million profit, while underlying EBITDA more than doubled over the first half of fiscal year '16, lifting underlying NPAT to 60 million. Higher net profit as well as accretion from our ongoing share buyback program translated into a strong growth in earnings per share to AUD0.30 per share.

As I mentioned on the previous slides return on capital also increased significantly to nearly 7%, representing a meaningful step towards our target of 10% for fiscal year '18. Our strong balance sheet of 311 million in net cash allows Sims to reinvest a further 69 million in CapEx into the business for sustaining and growth projects. As a result of our improving performance, the company resolved to pay an incurring dividend of AUD0.20 per share. This will be the highest dividend since the start of the five-year strategic plan.

Please now turn to Slide 5. Looking at the first half by quarter, underlying EBIT in both the first and second quarters were significant improvements on the same period of last year. Sales prices and sales volumes both dropped 24% and 11% respectively in the first quarter, compared to the fourth quarter of fiscal year '16. Despite lower volumes first quarter underlying EBIT was 41 million higher than the prior year, highlighting the meaningful improvements made across the company's operations from our recent resetting actions and international optimizing initiatives.

As we move to the second quarter ferrous prices and sales volumes rose 14% and 10% respectively. This translated in a stronger underlying EBIT compared to the first quarter and highlighted the power of the Company's increased earnings leverage. In fact, second quarter EBIT was similar to fourth quarter fiscal year '15 when volumes were 60% higher.

I'll now hand the presentation over to Fred for a more detailed view on our financial results, please Fred.

Fred Knechtel

Thank you Galdino and good morning everyone. Sales revenue of AUD2.4 billion was 6% higher than second half of fiscal year '16 due to higher sales volumes and higher non-ferrous selling prices. This was partially offset by an adverse movement in foreign exchange rates against reported Australian dollars.

Ferrous prices improved 30%, copper prices improved 14% and aluminum prices improved 4% leading to a 3% increase in sales volume and improved metal margins over the second half of fiscal year '16. Combined with recent streamlined actions, the increased volume boosted underlying EBITDA to AUD133 million. This was an 8% increase over the second half of fiscal year '16 than we spent double the prior year.

AUD153 million statutory EBITDA included AUD20 million of significant items. The significant items mostly comprised of a non-core real estate sale gain. Underlying EBIT of AUD77 million was significantly higher compared to the prior half. Normalizing for constant exchange rates underlying EBIT was AUD82 million. Below first half 14% effective tax rate is related to the utilization of previous losses in the U.S. and UK.

The effective tax rate can vary depending on regional profit mix and recognition of deferred tax assets. Excluding utilization of losses, the first half normalized tax rate was 30%. Statutory NPAT was AUD80 million which included AUD20 million of significant items after tax. Underlying NPAT was AUD60 million. On an underlying basis, return on capital of 6.8% was the highest since the start of the five-year strategic plan.

Turning now Slide 8, underlying EBIT across all businesses improved in local currency terms during the first half. Group sales volume improved 3% however normalizing for the North America central region divested assets, sales volume improved 4% compared to the second half of fiscal year '16. Intake volume was 5% lower than the previous half as intake volume was managed to match collections and inventory with sales demand.

North American Metals underlying EBIT of AUD31 million was a considerable improvement over first half of fiscal year '16. The earnings recovery was lifted by improvement across each operating region as well as the sale of central region non-core assets. With the reduction in domestic sales following the divestment of the central region businesses, second quarter North America and group ferrous export volume increased to 80% of total volume.

Australia, New Zealand Metals underlying EBIT of AUD26 million increased from AUD14 million in the first half of fiscal year '16. The improved results over the prior year related to a reduction in operational costs and higher sales volume driven by solid demand for ferrous metal.

Europe Metals underlying EBIT of AUD16 million improved from AUD2 million in the first half of fiscal year ’16. On a constant currency basis underlying EBIT was AUD20 million. Global E-Recycling underlying EBIT was AUD11 million compared to near breakeven in the first half of fiscal year '16. The improvement was led by strong performance in Continental Europe.

Turning now to Slide 9. The cumulative cost reductions and efficiency gains since the start of the strategic plan have progressively lowered the breakeven point of the business by 41% to 7 million tonnes. These actions have considerably improved the businesses profitability, while at the same time we have retained a capacity to process and sell over 12 million tonnes per year when industry conditions recover. Based on our current cost structure, we estimate an additional 500,000 tonnes of incremental sales volume delivers an additional AUD40 million to AUD50 million of EBIT to the bottom line.

Turning now to Slide 10. Net cash at the end of the first half was AUD311 million, this was a significant improvement from AUD242 million at the end of the second half of fiscal year ’16. The higher net cash balance primarily related to strong operational cash flow and proceeds from the sale of non-core assets. This was offset in part by AUD68 million in growth and sustaining CapEx. For the full year, it is anticipated that we will invest between AUD150 million and AUD180 million to support expansion investments and technology enhancements and as always maintenance, safety, environmental and replacement equipment.

Working capital investment was lowered by AUD23 million during the first half. Inventory in dollar terms decreased 3.5%. However, inventory value per tonne increased by 50% due to increased ferrous and non-ferrous prices. Higher inventory value was offset by 35% decrease in physical inventory. Physical inventory reduction was achieved by managing material purchases and inventory to support sales mix.

Going forward however, working capital investment will continue to be variable and influenced by metals prices, sales volume and customer mix. AUD24 million in dividends were paid in the first half. As previously discussed, we will distribute dividends of AUD0.20 per share or AUD40 million in the second half. The open market share buyback will continue on an opportunistic basis.

Please turn to Slide 12 for Galdino's summary.

Galdino Claro

Thanks Fred. The changes we have made to the business since the start of the five-year strategic plan have been dramatic. Our streamlined initiatives have reshaped the Company. We are now focused on core markets were competitive advantages can be maximized. With a far greater level of cost efficiency and profitability. We are also implementing new optimized initiatives over next two years.

In total, we expect our remaining internal initiatives to add a further AUD70 million to AUD95 million in annualize EBIT from our current run rate, once this projects at full implemented. And as we look forward the growth stage of our strategy is now coming into view. The Company is extremely excited and energized with our future perspectives, driven by a long-term sustainable plan to retain and expand market share in our core businesses, while developing new markets and adjacent businesses to better position seams as the circular recycling economy growth.

Turning now to Slide 13 please. The strength of our internal initiatives continues to drive our improved results since the start of the five-year strategic plan in fiscal '14. When we started the strategic plan 3.5 years ago the market was significantly stronger, with sales volumes that were 47% higher. And despite today’s much more difficult environment, our internal capital has tripled.

While the productivity of our industry can temporary disrupt this improving trend, the return on capital of 6.8% in the first half of '17 was the highest since the start of this strategy. This improvement has been exclusively driven by the streamlining and optimizing phases of the strategic plan. If current market conditions persist, we remain confident that our internal initiatives will help us towards our targeted 10% return on capital by fiscal year '18.

Turning now to Slide 14. Over the past six months, we continue to made progress on our substantial pipeline of the internal initiatives. In the first half our streamlined initiatives delivered AUD29 million in additional EBIT, over fiscal year '16, with the balance of improvement coming exclusively as a consequence of our optimizing actions.

During the first half, we finish the dredging of our water channel at our Claremont facility in New Jersey. And are also currently commissioning the MRP plant in West Australia and finalizing the construction of our rail line connection in Chicago. Starting at our first half of fiscal '17 EBIT run rate of AUD154 million we expect our initiatives of over to remainder of the five-year strategic plan to deliver an additional AUD70 million to AUD95 million in annualized EBIT once complete.

Turning now Slide 15, the first half of fiscal year '16 marked a number of significant accomplishments. Our underlying EBIT of AUD77 million was a significant turnaround from a loss of AUD5 million a year ago. Our improvement performance lifted our return on capital to 6.8%, which was the highest since the good days of fiscal year '11. Based on the higher earnings and current outlook the company resolved to pay an interim dividend of AUD0.20 per share, again the highest in six years.

While we remain mindful of global political uncertainty and the onset of the North American winter, we see several positive trends which could benefit the medium-term outlook, especially steel exports from China has heavily declined over the past 12 months due to a combination of capacity closures and increased Chinese domestic demand for infrastructure products. Lower steel exports from China particularly of semi-finished steel may help easing the competitive pressure on global steel makers outside China and therefore support a higher demand for ferrous scrap metal.

Consequently, we see opportunities for the prices of ferrous scrap to improve as the second half of fiscal year '17 progresses. We'll monitor this market conditions closely and we will update you should any material changes to our assumptions arise.

Thank you and I will now open the call for questions. So operator, may we have the first question please?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. Our first question comes from the line of Emily Smith from Deutsche Bank. Please ask your question.

Emily Smith

Just a couple of questions from me. Firstly, just looking at Slide 14 where you talked to the AUD20 million to AUD25 million in annualized EBIT, is that sort of what you're expecting for the second half versus the first half? And then as a follow from that, in terms of your overall cost reduction program that you mentioned was AUD70 million to AUD90 million which includes that second half improvement. Are you anticipating -- does that mean that to achieve your 10% return on capital employee target from here you're not expecting any further deterioration in pricing? Thanks.

Galdino Claro

Okay Emily I'll start by answering the second question, and then Fred is going to address the first one. So, yes we are expecting current market conditions to be stable as we progress towards the objective of 10% return on capital for fiscal '18. If market conditions deteriorate, we will try to accelerate the execution of our internal initiatives to offset that, as we have done consistently during the last 3.5 years of this practice. However, we are -- in our formula now, in our projection, considering a stable market condition as we evolve towards fiscal '18. So with that stated, Fred can you address the first part of the question.

Fred Knechtel

Okay, great. So for the project that how we have this setup and I think we’ve discussed this in some of our previous calls, is that, for the second half of fiscal year '17 the AUD20 million to AUD25 million of improvement is based on those specific projects that are initiated in that half, not necessarily the savings that we’re going to achieve in that half. So once all these projects are completed in the second half and then in fiscal year '18, the total accumulative impact when they are at run rate would be the AUD70 million to AUD90 million in savings.

Emily Smith

Okay. And just sorry, one last question. Do you think that in the current environment if iron ore prices fall, that scrap prices could increase?

Galdino Claro

Emily, difficult to project, but there are many variables that can impact prices and consequently volumes going forward. As you pointed out the iron ore price, coke and coal, oil and the exports from China are all positive indications in relation to potential price improvement. However, as I mentioned, the winter in the U.S. could be a negative factor and we are just in the middle of it now, we just had a substantial snowfall in the West Coast of North America -- sorry in the East Coast of North America for the last two weeks.

There are some instabilities in the global macro economy and political environment that could represent some challenges to. So what we’ve done and as a group what we have always done is to look at the market conditions we have today and consider that as a base for the impact of the initiatives we have in the pipeline and with that configuration, we are comfortable with the objective of 18% -- sorry about 10% return in fiscal year '18.

Operator

Our next question comes from the line of Simon Thackray from Citi. Please ask your question.

Simon Thackray

Just a little bit on competition from volumes unity [ph] business stronger performance in Europe and in iron, first of all in terms of employee headcount uniting across the divisional summary and the ability that the EU metals business was up again in headcount, was up in the second half, is now up in the first half. Can you just talk about that business in relation in terms of global scrap flows, has there been any change half-on-half [technical difficulty]?

Fred Knechtel

So, Simon, the Europe metals, obviously the volume is up, which would increase our intake and processing. So the employee headcount increase would be really additional employees to process the material, it's in our plant and yard cost, not support costs that would go into that metals business.

So we’re matching it very closely with the volume, and as part of our fixed cost reductions were put in place so that we would be able to accrete our profitability as volumes increase and add as little headcount as possible to support that. So we’ll continue to focus on keeping our fixed costs down and add any incremental variable cost, as far as resources go and take them out as volume changes.

Simon Thackray

Okay. I just wanted to be really clear on that one Fred. Because I think at the second half last year, I ask question specially about headcount and the comment was, you expect headcount likely to come down, which it has half [technical difficulty]. So I would actually -- I think that we should be assuming some increase in variable costs with labor as volume recovers. Is that the way we should be thinking about it? I’m just trying to understand, I don’t want to overestimate the leverage nor do I want to underestimate. I just want to understand how headcount moves with volume in each of these markets?

Galdino Claro

Well, the variable costs per ton should increase. But the headcount we are adding in circumstances like we have the UK purely to support a higher volume flow. So as we model that, as Fred mentioned, we do not expect any significant or actually any improvement in overhead cost, but on the variable costs, we will add dollars to that, but they will be not negatively impacting the variable costs per ton based.

Simon Thackray

Okay. So maybe that helps the second part of this question. When we look at the underlying EBITDA per tonne for each of the divisions comparing to second half of '16 we saw improvement in North America half-on-half improvement in the global recycling business. Europe was broadly flat and I understand that in the concepts of the increased headcount, I guess as well, but Australia and New Zealand actually fell from about AUD55 a tonne to about AUD46 a tonne despite the volumes being up 23% year-on-year. So what was the driver of the EBITDA per tonne for in Australia and New Zealand in the half?

Galdino Claro

Depending upon the market dynamics, we may decide to go further in distance, freight to pursue suppliers that we not necessarily will be handling on the normal basis. And that has an impact in costs, much more driven by -- set by freight than it does in any other aspect of our cost configuration. So I’m assuming that what we are supporting is a higher, an expansion of our supply based that may have some implications to create [ph].

Fred Knechtel

Simon we're just trying to understand your question on EBIT per tonne for Australia?

Simon Thackray

EBITDA per tonne, yes and the underlying EBITDA. It just looked to me and guess I read it completely wrongly. But it looked to me like in the first half '17, that the underlying EBITDA per tonne for Australia and New Zealand went from AUD55 in the second half per tonne to AUD46 per tonne in the in this first half so I'm just trying to understand what the driver of that AUD9 delta was. We had [technical difficulty].

Fred Knechtel

So I think one thing, well even if -- should also take a look at EBIT per tonne as well. In Australia and New Zealand, the EBIT per tonne went from 20 to 30. When you look at first half of '16 versus first half of '17.

Simon Thackray

No, no. I get that. I was actually comparing the second half versus the first half. So we finish the year at 36 and finish the EBIT per ton at 30. So I just want to understand that, but I'll take that offline because I'm consuming oxygen on the call. And then just looking at intake volume globally versus sales volumes, obviously intake volumes were lower than sale volumes in the half. Is it the usual timing or how should we be thinking about intake versus sales?

Galdino Claro

Yes it is. Based on our full system, we buy based on the order we are placing, so we buy against those orders and sometime the dynamics make the sales volume differ from the intake and vice versa. So nothing special in that difference in Sims.

Simon Thackray

Okay great. Thanks gentlemen.

Operator

Our next question comes from the line of Michael Slifirski from Credit Suisse. Please ask your questions.

Michael Slifirski

Yeah thanks very much. I wondered if you could talk a little bit about some differential global pricing. We can see that U.S. steel prices are a material premium to Asian steel prices. U.S. scrap prices seem to have been at a premium to export prices. So how do you manage that dynamic when you're competing against a fairly high U.S. domestic sales price, that potentially sell to into a lower Asian export price? Are you still able to get your share of volume and how has that played out in the first period of current outplace?

Galdino Claro

Hi Michael, the answer is yes. Theoretically, Michael, we could revert our supply chain towards the domestic market in North America at any proportion we want. Our operations are connected both to export facilities that could supply the export market as well as rail and highways to connect us with the domestic steel mill. So it's all a matter of a balance between sales price, freight cost for us to define which flow is the most possible flow.

Michael Slifirski

Yeah, I understand. But if we look at the current dynamic I know that spread is closing a little bit. So it's less unfavorable, but how much of your tonnage can you actually push into the domestic market without depressing domestic sales prices. It will look a little bit enormous right now compared to more orderly market historically where the U.S. very low scrap, U.S. prices has been lower than export price. Seems to be the wrong way around. So just interesting in how you are really thinking about that?

Galdino Claro

We need to look at that from a global point of view. For example, sometimes it's convenient for us to bring material from the UK into the U.S. because the freight equation that I just described to you make that alternative viable. So we have the flexibility to support any additional demand of domestic steel in North America with our operations based in North America as well as from Europe.

Keeping in mind that, as you know Michael, where the steel mills are located in North America. There is a certain limitation in terms of scrap availability. So if there is a higher demand in North America from the domestic steel mills, they will have to come naturally to where scrap is generated, which is coincidentally or not, where we are based. So we are very comfortable with our ability to shift from export to domestic consumption if it becomes a more attractive alternative and as I said theoretically we could shift 100%.

Michael Slifirski

Yeah, anything of that in the context your past comments where you’ve made it very clean you want to buy to committed orders, and you only buy where you got a committed order and you’ve talked about that very short lead time being able to fill a cargo, so you’re not really taking any price risk versus domestically in the U.S. where, as I understand that mills give you a price for a month and you’re effectively some short scraped for that whole period.

Galdino Claro

You are spot on. We will continue even in all our constructions to utilize the full system. So it has to be, if the domestic steel mills in North America really pull more for the domestic consumption, we're going to have to come on commercial terms in terms of pricing mechanisms that would allow us to continue to protect our margins as prices oscillate.

Michael Slifirski

Okay. Thank you and then finally with respect to the recycling business, the turnaround there, in the past you talked about the challenge when base metal prices versus metal prices fold, which you are stuck with long duration contracts that were established at a pricing basis, some in prevailing [ph] metal prices and then hurting EBIT. In the current period, how much of the uplift is attributable to improving non-ferrous prices. And are you seeing some of those contracts being reset for high prices now that [indiscernible] have adversely impacted you need for future period?

Galdino Claro

That’s it’s a combination of both Michael. Then we have done substantial risk redesign of our North American SRS business for example concentrating our recycling operations in one larger facility and the synergies helped us to improve efficiencies in North America E-Recycling, but in the electronics recycling business, the commodity prices oscillation definitely have higher impact both ways, positive and negative, depending upon the direction of the oscillation of course, because when we are buying electronics that we'll be recycling it’s much more difficult at that stage to create a hedging mechanism that is efficient enough during the course of production. When the sales materialize then it’s all hedged, but while we are collecting and processing, there is an exposure there and that exposure could be positive or negative, as you could see in this last semester it was a positive impact.

Michael Slifirski

Okay. Thank you. Just one very brief one. In the past you’ve talked a lot about the New York City recycling program and expectations for it, but I can't see any update, can you just give us a brief update on how that business is progressing?

Galdino Claro

Okay, yeah well, the New York City recycling is, as we develop our growth strategies, one of the business is that we certainly want to take advantage of having in our portfolio. We’ve been looking at additional regions in North America as well as outside of North America, in which our technology could be deployed as successfully as we deploy them in Europe. I mean it continues to be a very exciting business for us, business that currently generates returns that are above our average and consequently deserve the right to grow and its part of our growth strategy that we in turn articulate to you during the course of this fiscal year beginning of next year. We will see our plans to grow the new recycling business with more clarity by that time.

Michael Slifirski

Great. Thanks very much Galdino.

Galdino Claro

No problem. Thank you.

Operator

Our next question comes from the line of Owen Birrell from Goldman Sachs. Please ask your question.

Owen Birrell

Just I have three questions, just the first one. On Slide 5, you show the EBIT profile quarter-by-quarter. And I’m just wondering why the second quarter '17 was so much lower than the fourth quarter '17 EBIT, given that volumes are largely this time. Is that still a current issue and if so what would the EBIT number have been on a constant currency basis?

Fred Knechtel

So on a constant currency, it’s about the 4 million in total for the quarter, you can probably split it 2 million and 2 million. So it’s going to be even for the first and second quarter. But there is also, when you look at quarters, there is the mix of sales. Non-ferrous really started improving in second quarter versus the first quarter that shows a little bit more improvement and then just mix of business between domestic first quarters also included still the assets in the central region, which kept it a little bit depress and then we saw a lot of the benefit come through in the second quarter.

Owen Birrell

No. I’m really looking at second quarter '17 versus fourth quarter '16. The volumes look broadly consistent, but I'm just wondering why the EBIT is so much lower.

Fred Knechtel

Repeat that again. What are the quarters you are comparing?

Owen Birrell

Second quarter '17 versus fourth quarter '16.

Galdino Claro

Yes. But if you look at the volume, you know it is -- we talk about quarter of 2.6 million tonnes to quarter of 2.3 million tonnes, that’s a meaningful contraction in terms of price. It’s a similar profit in a relatively significant volume contraction.

Fred Knechtel

So in the second quarter relative to the fourth, there is about AUD4 million of currency impact. If you recall in the fourth quarter we had ferrous prices move quite dramatically, much quicker and faster than they did in the second quarter of fiscal year '17. And we were able to -- and we had some inventory that was a little lower value in the fourth quarter that we were able to sell it at a quite higher value.

So margins got a little better in the fourth quarter just based on those changes in prices, but relative fourth quarter to the second. Second quarter did improve, but certainly not at the rate that it in the fourth quarter. So those were the two major drivers. Cost structure is actually lower, so we had good leverage and volumes were down. On the annualized basis, I think volumes were down 300,000 tonnes or so, the volume was a factor as well.

Owen Birrell

And I'm just wondering can you -- obviously, that volume number is across the group. Can you give us a sense of what North American volumes did first quarter versus second quarter and how you’re seeing the volumes tracking into the third quarter?

Galdino Claro

Exposures there is a little bit from a competitive point of view, if we break it, volumes quarter-by-quarter, so by region, because of course we have improved market share in certain regions. So I think you understand reasons for us to be a little bit more protective in relation to that information.

Owen Birrell

But I just wanted to get a sense of, you obviously had a good second quarter period. I'm just wondering is that continuing, those volume, am I right, is that continuing into the third quarter?

Galdino Claro

If the market conditions remain, the initiatives we have in place will take us to the return on capital that we are projecting for fiscal year '18.

Owen Birrell

Okay. In term of the return on invested capital, just as wondering is that 2018, is that an average target of 10% for the full year or is it based on an exit period runrate?

Galdino Claro

No, it's the target we have for the full.

Owen Birrell

For the full year, excellent. And can you give us a sense of what that the mature run rate was at the end of the half?

Galdino Claro

Of the end of this half?

Owen Birrell

Yes.

Galdino Claro

It was 6.5%. I'm sorry 6.8%.

Owen Birrell

So that was the average for the half, so what was the actual run rate at the end, say for the second quarter versus the first quarter?

Galdino Claro

That was the average for the half. We do not disclose that number on a quarterly basis.

Owen Birrell

Okay. Do you just quantify for me on a non-ferrous? It looks like the non-ferrous volumes have fallen again half-on-half. Can you give us a sense as to why that was, was it really price driven or was it due to some of the resetting action that you guys have put through the business in terms of your ability to process non-ferrous.

Galdino Claro

No, I think the non-ferrous is also impacted by the SRS business. And as we have reduced a little bit the SRS footprint in North America, it might have an impact there. But on short term quarters it stopped to compare the non-ferrous because we may have a material that we buy with a certain amount of non-ferrous including on that mostly on zorba. And while we process that we're going to have valuations on non-ferrous. So short term valuations on non-ferrous are hard to really follow up to the precision level that you're talking about. Fred, do you want to add something?

Fred Knechtel

And there is also the dynamic of ferrous prices, non-ferrous prices go up it's the same dynamic that you're going to see ferrous. People tend to hold waiting out for the best price. So that dynamic does slow the volume and so people are comfortable with the pricing and then the volume comes back.

Owen Birrell

You mean the suppliers, right?

Fred Knechtel

Yes.

Galdino Claro

So nothing, just to clarify, we haven't divested any assets that materially impact our ability to process non-ferrous volume.

Owen Birrell

And just looking at your optimized initiatives, a lot of those are driven by non-ferrous value, I would say. I'm just wondering how many of those initiatives that you proposed are really revenue focused and hence sort of rely on some new overall sales contract for non-ferrous or is it just purely increasingly volume within your existing framework?

Galdino Claro

Yeah it is -- we will come with growth initiatives in both ferrous and non-ferrous that are more related to our growth strategy starting at the end of fiscal year '18. But when we improve recovery you take non-ferrous parts otherwise will be in your raise stream into commercialization. So there is growth from that point of view on those initiatives as well.

Owen Birrell

Okay that's great thank you.

Operator

Our next question comes from the line of Peter Stein from Macquarie. Please ask your question.

Peter Stein

Just a quick one on collection volumes, in particular, you spoke about the economics of collection and transportation of secondary metals being under pressure. I'm just curious whether you have a view sort of at what price level economics is meaningfully improved and that you think you can see a significant improvement. Intake volumes and you sort of spoke about it reaching stability, but obviously, you would like to see an improvement. So I’m just trying to bit of a read there.

Galdino Claro

Okay. On collection, history has shown and we've done some analysis that for every AUD50 per tonne change in volume -- of change in price there is approximately an 8% change in volume globally. So the relationship is held over the long run. There are short term dynamics where it doesn’t always hold, but you would expect that that intake volume would create the right incentive for our supplier's pathways, industrial accounts, what have you, to bring their material in as the prices increase. So a good rule of thumb is for every AUD50 per tonne, 8% volume.

Peter Stein

Yeah, I guess some your industrial suppliers are generally going to be less sensitive to price and the informal market would be more sensitive. Do you have a sense of -- you've previously spoken about peddlers being about 10% of your supply? I mean the vast majority coming from traders, but presumably there is a same number of peddlers that come through the trader terminal and so --?

Galdino Claro

Yeah, absolutely the fact that we have about 12% in average of our revenues generated [indiscernible] coming directly from peddlers. But the peddlers are the base of this supply chain, they are the suppliers of our customers -- the suppliers of our suppliers, I should say. So all the obsolete scrap, which represents significant part of the total volume is parts on hands of peddlers across the company -- across the globe. But the 12% we mention is what we have direct connect with -- direct connections with, but the base of the supply chain will always be the peddlers.

Peter Stein

Yeah sure. So would current prices and the volatility that we’ve seen in particularly U.S. domestic prices. And the support of the economics for the peddlers to be back in the market more aggressively in coming months?

Galdino Claro

As Fred pointed out, the relationship between price and volume exist. If you move drastically to very low prices, then you know you come to a point where the flow will continue, I mean we had material flow scrap prices where AUD100 per tonne, so it's not that that stagnates, but when the prices go up, it will increase up to a certain point where I believe that if scrap prices grow one day over AUD450 a tonne, if you put another AUD50 on that, it's not going to impact the flow and longer because the flow is already maximized to its highest level of capability.

Fred Knechtel

So it reduces the scrap reservoir, that all comes out and then --.

Galdino Claro

But anything between AUD100 per tonne to AUD400 per tonne will have a very close relation to volume flow.

Peter Stein

And then just can I ask a little more detail around your zorba de-monetization project you mentioned in your second half '17. In fact, what would you broadly mean by that just very quickly?

Galdino Claro

Yes, certainly. So the product commonly called zorba has a percentage of aluminum that is around 75%. And to be utilized by smelters, it will have to improve from that 75% to something over 90%. So that’s one of the reasons that not only it seems, but most zorba producers today have China as their major target, because the second phase of purification, if you will, of the zorba product leads to another commodity, called pitch [ph] which is than 95% -- 99.5% and therefore is the raw material for the aluminum smelters.

So what we are doing with the zorba de-commoditization is to increase that recovery and consequently create a commodity that now could be supplied to China also directly to the smelter across the globe and there is a higher margin associated of course to that more sophisticated commodity. So this is what we have behind this project of zorba de-commoditization. In simple word, it’s evolving from producing zorba to producing pitch.

Peter Stein

Okay. Thank you. Thanks very much.

Operator

Our next question comes from the line of Scott Hudson from CLSA. Please ask your question.

Scott Hudson

Two quick questions. Firstly, could just comments on, I guess current conditions in Turkey and I guess any volatility you see here in relation to I guess economic conditions? And then secondly, if you just comment on, I guess how you think about potential increased protectionism in the U.S. market and how that may impact your I guess export focus to U.S. business?

Galdino Claro

So I’ll start with Turkey. We have very important customers in Turkey and of course anything that happens there has an impact for us, as a net of proportion Turkish represents about 15% of our sales. So we have been developing alternative markets for ferrous scrap across the globe and our portfolio of customers is substantially larger than what is demand by that.

Having said that, I personally believe and the best of our intelligence in place believes that the Turkish markets and our customers will be always there and we'll be always supporting them. So this is how I see today, I think the situation in Turkey is temporary from the market point of view. But we are prepared to handle that situation for a little lower, if it becomes necessary. And the second part of your question. I’ll let Fred to respond to that.

Fred Knechtel

Well, there is some struggle. So if you look at the Turkish lira has weakened 37% since 2015 and 2017. So that all pricing being in U.S. dollar that does put a little bit of pressure on it. But so far we haven't really seen any interruptions in their buying activity there. They're volatile and they're buying, they'll buy in chunks, but we haven't seen any signs that they're weakening their demand at this stage.

Galdino Claro

And the U.S. protectionism that was part of your question too. As I was addressing Michael's questions previously, our operations are very flexible to move more towards the domestic steel mill supply exchange if it becomes necessary. I think one of the most significant strengths we have as a company is actually that versatility to [indiscernible] ourselves to the export markets and turn the flow towards the domestic markets if it becomes necessary. So listen we've have to look and watch and see what's going to happen there, but at the end of the day prices drive volumes and if the volumes are domestic or export we'll be able to respond properly to that.

Scott Hudson

Could I just, maybe just get a better understanding. I mean I always though your export network was your sort of key competitive strength. So what impact on profitability is there from I guess a switch into more domestic focused volume outcome?

Galdino Claro

Yeah if you look at our business model, our competitive advantage really is driven by a business model that has more than one element. The logistics to supply domestic -- international customers as you pointed out is one of them. But the positioning of our operations where the material is generated is at least equally important. You have to be based where the material is generated to be able to collect and become a natural end for that supply chain before the final consumption by the steel mill.

If you look where our operations are based, there are no steel mills around them. And so the steel mill demand higher levels of scrap, they will have to come to those basis anyway and this is where we have our operations. So I'm talking about the surrounding of our operations for example in the New York region with Claymont in New Jersey and so forth, our position in the West Coast. So there are no meaningful presence of steel mills in the New York City as you know. So that's the balance that has to be always considered.

Scott Hudson

Okay and also just in relation to I guess the current level of pricing of is I guess iron ore and coke and coal, how do you think about the relative competitiveness of scrap at this point in the cycle?

Galdino Claro

At this point, if you look at what is happening right now it becomes quite attractive, right. I mean you see iron ore being high, you see coke and cold following the same position, which of course reduces the little bit the competitiveness of the integrated steel mills and China is therefore reducing exports.

Now how that positive situation will balance with order variables such as the winter in North America and some economical global instability and political condition is something we have to see. That's why I'm say, I'm going to keep an eye on this. And any time we see changes that could impact our projections, both positively or negatively, we come back to you.

Scott Hudson

Perfect. Thanks very much, everyone.

Operator

Our next question comes from the line of James Rutledge from Morgan Stanley. Please ask your question.

James Rutledge

Thanks, good morning. Just briefly on the growth CapEx or the growth initiatives I guess that you are indicating your outline in light of this financial year or early next financial year. As I expect it to additive to return employed in fiscal '18 and I guess how are you thinking about what they could potentially add to that fiscal '18 target?

Fred Knechtel

Okay. So all of our projects, how we evaluate them is certainly from a return on capital and in net present value. So of all of them have to really justify themselves in a project and it has to be accretive to our current return on capital. So they -- all the projects, except for the maintenance projects and some of the safety projects, but all the growth projects will be accretive to our cost of capital.

James Rutledge

From year one, is that the cash flow?

Fred Knechtel

So once they are fully operational and at run rate, yes. So once these plans are put in place and we have a full year’s worth of improvement it will earn a return that’s greater than the cost of capital that they're expected at or in general it’s going to be, our threshold level we look at internal rates of return that are much higher than our true cost of capital.

James Rutledge

Okay. So I guess just in the context that your guidance for fiscal '18 is that you will achieve return on funds employed of 10% plus, yet it sounds like there is investments in growth will occur through fiscal '18 that potentially might be additive on a run rate, just potentially not in fiscal '18, is that the way to think about it?

Galdino Claro

That’s correct, that’s the way to think about it and it is -- you’re right, is a challenge, it required a lot of engineering and energy to make those projects happened. We have a very robust project management office behind those projects with expert dedicated to them and at this level -- at this time we are confident that we'll be able to get all those projects to generate a contribution they’re supposed to generate within the timeframe we have.

James Rutledge

Okay. Thank you.

Operator

Our next question comes from the line of Hugh Stackpool from JP Morgan. Please ask your question.

Hugh Stackpool

Just another question on U.S. domestic market. It looks like, U.S. scrap freight carloads had a couple of good prints [ph] later in the year. Just listing to how you guys are talking, obviously, is through export book. Was that you guys contributing to that or think that's more your competitors with the kind of I guess that scrap volume around a bit more?

Galdino Claro

Can you clarify, do you mean the change in price with some scrap inventory being sold into the market?

Hugh Stackpool

There is a data set on U.S. scrap freight carloads and it looks like there is more scrap floating around domestically, but I mean I guess listening to your previous comments, it sounds like it’s not been you guys, it’s been your competitors. I was just wondered if that's the right way to think about it, and just once again your kind of domestic leverage?

Galdino Claro

Yes, so again I think when you look at our full system, we keep our inventory levels pretty tight and low and we don’t -- unless we have a sale we’re not going inventory. So we’re not going to have excess inventory that floating around the market.

Hugh Stackpool

Okay. And I suppose just in regards to the AUD40 million to AUD50 million EBIT benefit on the current cost structure and for 0.5 million tonnes. How might that change when you know -- if you go above 0.5 million tonnes or that kind of cost structure obviously, I'd expect many more employees needed or things like that, once we -- we've already say that maybe in Europe. Just wondering how we can get back what additional investments might need to made over and above the current cost structure, once you hit higher tonnes?

Galdino Claro

As we have articulated, we are today reducing annualize based 8.4 million and 8.5 million tonnes. We could grow to 12 plus and -- or the only thing that we would have to add to get there are shifts in some specific bottle necks that we have, that might increase the headcount on or the provisional headcount, no substantially need of additional investments beyond that, there is no need of additional overhead costs, there is no need of additional equipment, there is no need of additional facilities. The current industrial park could evolve towards the 12 million tonnes or even more is the market demands so.

Fred Knechtel

And how we presented the 500,000 tonne increase to generate AUD40 million to AUD50 million of additional profit includes any of the variable costs associated with generating those tonnes and some of it maybe some headcount additions, but there are other things like utilities and maintenance and parts, things of that nature that are driven [indiscernible]. It’s an all-in number based on what our historical variable costs is by site, it’s a very specific calculation to our cost structure today.

Hugh Stackpool

Okay. Thanks guys.

Operator

There are no further questions at this time. I would now like to hand the conference back to today’s presenters. Please continue.

Galdino Claro

Well, thank you all very much. And we’ll be looking forward to visit with you within a next few days. Fred and I will be here to address any further questions or points that we may have and with that said, I’ll transfer it back to Todd.

Todd Scott

Thank you very much. Operator you can close this session.

Operator

Ladies and gentlemen that does conclude our conference for today. Thank you for your attendance. You may all disconnect.

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