Norsk Hydro ASA
Q2 2021 Earnings Call Transcript

Published: 23 Jul 2021

[Line Haugetraa:]

Thank you, operator. Good morning, and welcome to Hydro's Q2 Presentation and Conference Call. We will start with the presentation followed by a Q&A session. Both will be hosted by our CFO, Pål Kildemo; while our CEO, will be present at Q1 and Q3, which will include a more strategic focus. The presentation slides, we will walk through, can be seen on the webcast. The link to the webcast as well as the slides can be found on hydro.com. Please note that you will need to dial-in to the conference call to be able to ask questions at the end. It will not possible to ask questions over the webcast. If there are any media inquiries for one-on-ones with Pål after the presentation, please contact our Head of Media, Halvor Molland.

[Pål Kildemo:]

Thank you, Line. Good morning and welcome from me as well. I hope you and yours are keeping well and healthy, and thank you for joining our Q2 presentation today. I would walk you through the financial results for the quarter, where we are pleased to report the highest quarterly results we have ever had since becoming a pure player aluminum company. Slide 2, please. Adjusted EBITDA for the second quarter was NOK 6.6 billion, up from NOK 2.8 billion in the same quarter last year. However, it's important to remember that Q2 '20 was adversely affected by COVID-19, and was also the quarter hardest hit by the pandemic. In terms of free cash flow, we see an increase compared to last year, and also compared to first quarter of '21, ending off at NOK 2.5 billion for the quarter, reflecting our strong earnings for the quarter, but also some working capital bill on higher prices and higher activity level. Total cash flow this quarter was also impacted by the sale of rolling to KPS Capital Partners, which they've completed on the 1st of June of 2020. The sale has resulted in cash proceeds of EUR 435 million and strengthens our ability to deliver on our strategic direction for 2025. Our adjusted ROACE for the last 12 months holding Q2 '21 comes in at 9%, 4% higher than Q1 and over double last year's results. If we just look at the underlying growth for Q2 alone, we would have come in at 15%, exceeding our overall profitability goal of recording ROACE of 10% over the cycle. During the quarter, we were pleased to see an overall continuation of the economic recovery, which began in the second half of 2020. The outlook for GDP growth remains positive. However, we have started seeing the pace of recovery flattening somewhat as we approach pre COVID levels. Following this, global aluminum demand was strong and in particular, in the world, excluding China, where demand rose 33% year-over-year. These fundamentals, combined with fewer new supply additions in China than expected, have resulted in a strong LME development during the second quarter with the cash price for aluminum trading at its highest level in nearly a decade. The strong demand dynamics have also elevated premium and these factors supported a record result of NOK 2.8 billion in aluminum metal. Based on these strong fundamentals, aluminum metal completed its ramp-up of Neuss line B in June. The plant is now back to full capacity of 195,000 tonnes for the first time in over a decade, producing aluminum at world-class standards in terms of climate and the raw material consumption.

[Line Haugetraa:]

Operator, we're now ready for questions.

[Operator:]

We will now take our first question.

[Jack O'Brien:]

It's Jack O'Brien at Goldman Sachs. First question is just on your renewables and hydrogen intentions. Clearly, a significant opportunity ahead, but also a frequent conversation I have with investors relates to sort of future returns given that this is such a competitive area at the moment. Just trying to understand how you think about returns in these nascent areas.

[Pål Kildemo:]

Thank you, Jack, good to speak to you again. As you know, what we're currently doing is that we're building substance in the 2 relevant companies going through the potential projects that will contribute both to delivering renewable energy and hydrogen to the Hydro portfolio. But what will also contribute to the profitability in the respective company. And return on the specific projects, we will have to get back at a later stage as these projects are sufficiently mature. But we do expect all projects or we do require that all projects meet the respective cost of capital in this particular venture. And as we have discussed earlier, cost of capital is somewhat lower in the renewables market and what we experienced in our primary aluminum market, for example, and that is one of the main reasons why we're establishing this as a separate entities with their respective return requirements. So from our perspective as an owner, there's a focus on return on equity. And then in the specific ventures, there's, of course, a focus on return on capital employed, but with a different hurdle rate than what we have in the rest of Hydro.

[Jack O'Brien:]

And can I just ask a question on your sort of existing aluminum business? Clearly, we're seeing very strong alu prices at the moment and, therefore, implied sort of returns. You're running Alunorte at nameplate. I know you've increased capacity at the Husnes Line B but just interested whether you'd be looking to invest at all in either B&A and also your primary alu production just given the price level and premium we can see today.

[Pål Kildemo:]

Yes, firstly, we are extremely happy with the current earnings level. And there's many positive signs in the market these days, which could also bode well for the future years. And there's also some elements which are more uncertain. And we content or we've consistently achieved this market insight and back into our strategic evaluations. Currently, we have bauxite and alumina and aluminum metal in what we call sustained and improved mode where the focus is to remain as low on the cost curve as possible and to also move in a sustainable direction reducing carbon emissions and also other metrics. So we have no concrete plans to increase production upstream, more than pushing our facilities to nameplate capacity and smaller debottlenecking, et cetera, with that disposal. Where we are allocating capital to benefit from the strong growth in demand for aluminum is within the recycling space. We see more scrap coming back, and we see good historical returns over the cycle, and this is where you should expect us to be placing the most aluminum CapEx going forward.

[Operator:]

We will now take our next question.

[Jason Fairclough:]

It's Jason Fairclough at Bank of America here. Two quick questions for me, if that's okay. One on the Qatalum tax and the other one Fit for 55. On Qatalum, I just want to make sure I understand. So is it correct to say that you're a JV partner, so Qatar Aluminum Manufacturing Corporation, which is controlled by Qatar Petroleum, which is essentially the government, is insisting on paying 35% tax, and you think it should be 10%. Is that a correct characterization?

[Pål Kildemo:]

Well, the different partners here have a different viewpoint on how to understand the tax regulations locally. And of course, our view point is 10% as we've communicated consistently, and the other partner, which you refer that to be 35% and Qatalum as an entity has filed for 35%.

[Jason Fairclough:]

Okay. And -- all right. And again, is it correct to say that the partners essentially are government-controlled entities?

[Pål Kildemo:]

Well, I guess most Qatarian ventures are state-owned.

[Jason Fairclough:]

Okay. All right. Just second and on the announced...

[Pål Kildemo:]

As you know as in , is partly owned by QP and partly listed on the Qatari Stock Exchange.

[Jason Fairclough:]

Yes, yes, so there are some minority investors in there. Just in terms of the announced Fit for 55 in the current border adjustment mechanism, just wondering, do you have any thoughts, any color on potential impact on your business, positive or negative?

[Pål Kildemo:]

Well, on a high strategic level, this is positive -- very positive for a company like Hydro that this becomes a global focus. This has been one of our key differentiators, which we're really starting to get paid for in the currency environment and we support the movement in a direction where you have a level playing field based on a global assumptions and rules and regulations. But the current proposal is not impacting us to a large extent as it is focused mostly on direct emissions and not the indirect emissions where the largest differences are. However, with a phaseout of compensation of reports of direct emissions, it will make it more costly for example, downstream producers, which will have to pay a somewhat higher level for aluminum within the EU, whereas nations outside the EU that do not have the same metrics would potentially pay less for aluminum. And for our primary aluminum system, getting less in compensation for direct emissions would also increase the cost. So as we've discussed several times, this is a very positive development. But it needs to be probably talked through and it needs to cover the whole value chain to ensure that we don't get unintended effects that further allow for carbon leakage or where players outside Europe are able to circumvent from any, for example, only exporting their greener material into Europe and then sitting with less green material outside there. So a long answer, Jason, I'm sorry about the in the short of things, positive that this is being focused on. We believe it will benefit the company like Hydro during the long term and then a small term negative with the fact that it's only covering parts of the aluminium value chain at current...

[Operator:]

We will now take the next question.

[Liam Fitzpatrick:]

It's Liam Fitzpatrick from Deutsche Bank. Two or 3 questions for you. Firstly, on batteries and recycling. You've given us more detailed CapEx guidance, which is good. When should we start to see EBITDA contribution from these areas kicking in? Could it be as early as 2023? And then on batteries, could you consider external capital and partners further down the line and similar to what you're planning in renewables? And then next question, just on, so you've given us some useful sensitivities there. Can you clarify the sort of range for the primary business in terms of cost uplift Q3 versus Q2? And final question on renewables and hydrogen. What is your latest thinking in terms of timing and when we could hear a bit more in terms of structures and investment figures?

[Pål Kildemo:]

Thank you, Liam. Good and relevant questions. I'll try to cover them as best I can. If we start with the contribution from batteries and recycling, of course, existing battery investments are contributing already from a valuation perspective. investments we've done so far in batteries have been very value accretive. And as you've probably seen through some of the pricing of battery ventures lately where we have an ownership stake. If you look more towards how this will impact EBITDA going forward, then that will be based on a project by project level. If we were to move ahead with the contact initiative, cash flow hit further out. If there are other battery opportunities that are more in M&A or a shorter-term context, like, for example, faster recycling, then you can see cash flows coming in already next year. And we will announce that on a project basis. We're very happy that Hydro Volt will be produced or recycling batteries already at the end of this year. Recycling is, of course, more mature to progress quite significantly on several of these. And for the ones I announced today, at least the ones in Europe, you should be seeing effects of that already in 2022. Some of these recycling investments are brownfield upgrades to equipment from debottlenecking, et cetera, and that doesn't take long to complete. So you will see a ramp-up. Of course, extrusion cash flows -- recycling cash flows and also exclusion cash flow in 2022 from today's announcement, but then still find effects are coming in some years later. When it comes to battery partners and the test and further down the line, as you've seen so far, we do invest quite similarly to what you see in Hydro REIN and also hydrogen. The projects that we have participated in and the projects that we have on the drawing board, we are either a minority partner or close to joint operator. And this is the approach that we've seen uptaking for most of the projects. So yes, we will be contributing our respective share of cash flow in, but also several of these ventures with be funded by debt on a project level also. So I guess the biggest difference there between batteries and REIN and hydrogen is the fact that we're not putting everything into 1 company at current stage and raising capital. Further down the line things may look differently, but that's how we're thinking today. If we move into aluminum metal and cost uplift from the second to the third quarter, then I guess I first said around 700 million or so in increase. And that is driven primarily by 2 areas. It's carbon and other raw materials and its energy costs. And -- the biggest impact on energy cost or price sizable impact, at least is the indication towards LME. And as you probably remember, our and some other cost elements have LME indexation on the energy side, which cut some of the pure LME offsite. Renewables in hydrogen, there is not that much news since the last quarter. We have signed some agreements and we are maturing the different MOUs that have been announced towards the final investment decision. We're also preparing for capital raise. And I guess for raise, we've said that we plan for capital raise within 2021. And in combination with that, we will, of course, provide a lot more detail to the market. The same goes for hydrogen projects are being and we haven't set a concrete capital raise date yet but are working as fast as we can.

[Operator:]

We will now take our next question.

[Amos Fletcher:]

It's Amos Fletcher from Barclays here. I just had a couple of questions. First one, following up on Jason's question about accounting at Qatalum, so can you just explain what tax rate are you using in your accounts? And what cash tax rate are you currently paying in country there?

[Pål Kildemo:]

We're currently using 35%. We have since September 2020. That is in line with what Qatalum are using locally, and we just pull it up at a the level. And they have paid their first tax, yes, but they have accrued for it and they have filed now, as mentioned in June at a rate of 35%, which will then be the cash effective tax until further notice.

[Amos Fletcher:]

Okay, and then I just wanted to ask about further increases in the hedge book. Why are you doing that when the company survived the COVID downturn unscathed and presumably shareholders would like to maximize their exposure to the metal price?

[Pål Kildemo:]

Yes. No, when markets are good, hedge positions become a bit heavy, and we have a big respect for that comment and a question. We are taking an over-the-cycle perspective, improving the likelihood of us being able to deliver satisfactory returns in the tougher year and then a bit lower in the better years. Our policy is to enter these hedges when returns are at levels and margins are at levels which are seem to be very competitive in a historical context. So if we take a 10-year perspective of that, you should be entering more positive positions and not entering those when the markets are bit poorer. But of course, I understand that in a market upturn, this limits some of the cash flow potential. But the rationale is to secure a more stable level of earnings and a more return in line with our targets over the cycle.

[Amos Fletcher:]

Okay, understood. And then last one, I just wanted to ask about the extrusions market, obviously, incredibly buoyant market conditions at the moment. Are you seeing any signs of demand destruction as a result of the run-up in premiums and any issues that could cause that move to unwind?

[Pål Kildemo:]

It's a very good question, Amos. And I ask it in every commercial meeting we have with the downstream operations because when you see extrusion ingot premiums approaching $1,100 on top of an already high aluminum, that is a significant cost uptick. But No, we're not seeing demand disruption. They are most likely able to push on that right because there's not many other good alternatives. We've even seen substitution into aluminum as some of the competing materials are moving more I guess if it was only an aluminum issue, then we would maybe having more of that discussion. But we're not having it at all today. The only were not worrying, but the only impact that we have on demand is some reduced expectations in North America on the automotive side for the market as a whole due to the chip shortage, but for us personally or as a company, we still see that the substitution effect is strong and compensating mostly further.

[Operator:]

We'll now take our next question.

[Ioannis Masvoulas:]

This is Ioannis Masvoulas from Morgan Stanley. A few questions left from my side. The first one, just on energy, which was surprisingly strong, could you elaborate a bit on the price differentials and the actual benefit you got in the quarter? And how high could that be in Q3 spot and persist? And are there any other drivers in that Q2 EBITDA figure that is worth highlighting? Secondly, in terms of the renewables IPO, you have reiterated the intention to pursue an IPO as soon as this year, as we've seen other ventures in the space that are struggling to go ahead with a similar strategy. Is there a risk that you have to delay the IPO to sometime next year, in which case you may accrue more of this CapEx on your own balance sheet upfront? And then the last question around the operating working capital build that you mentioned at $4.5 billion hypothetically, so is that incremental to what we've seen today? Or does that already include the H1 build?

[Pål Kildemo:]

Thank you, Ioannis. I'll start in the opposite direction. While I think on the operating capital, the 4.5 billion, that is for the year as a whole. So that includes the 3.8 billion we've already seen year-to-date. So incrementally from the second quarter is not that much of a build. But as you know, usually, we see quite some lease in the fourth quarter, but this is being offset now by stronger -- the strong prices and if anything, we are looking to lift the inventories a bit because we're running so low due to the very tight market. There's a comment on IPO, this is a very good question. We are seeing the same picture that you're seeing. And of course, none of these companies are directly comparable, but as an industry theme, and we see it across. So we will evaluate the timing based on what we perceive the valuation to be and we will not go ahead at any cost if the market is not present. And in that respect, you could say that there's a risk of which financing to do a longer expense if we are not lucky or the market is not there. But in general, I would say that our base case is this year, and then we're keeping an eye now on the same elements that you are referring to. When it comes to energy and area price differentials, then I'll be careful to guide on this specifically, but if you see that the market prevails at the same level that we have seen in the current quarter for NO3 and NO2, then you should expect it to come in at a similar level. And I guess that the positive effect this quarter was between the NOK 100 million and NOK 200 million level in area price differentials, but we can get back to the exact level within that range.

[Ioannis Masvoulas:]

Okay, that's great. And maybe just a quick follow-up on the alumina costs that you already mentioned about, but I'd like to confirm, you mentioned, I think, a $5 increase in caustic and energy and $12 increase due to maintenance in the boilers. Is that on a quarter-over-quarter basis?

[Pål Kildemo:]

Yes, this is on a quarter-on-quarter basis. The $5 movement is what you should expect to be brought forward into Q4 if the market remains where it is today. The $12 movement is due to the maintenance and when completed in the quarter would move out again then in Q4.

[Operator:]

We will now take our next question.

[Dan Major:]

It's Dan Major from UBS. First question, you provided the details on additional CapEx into batteries and recycling. For recycling specifically, where should we be allocating the EBITDA to in terms of business units? And are you -- or will you separately disclose the EBITDA associated with recycling in the future?

[Pål Kildemo:]

Dan, we have 2 business units. Of course, that benefits from the recycling investments. And of the projects we announced, the North American project, which is the larger of this, that will impact the metal market operations. And the recycling earnings are disclosed as part of our quarterly presentation. They also -- the drop was investment that we've made will also fall on that line within that market. Then you have the other Sjunnen and Navarra. These are extrusion investments, and they are, of course, the part of the value chain of the extruded facilities and the part of the total cost setup. So at current stage, we don't pull those out. What we at least will do is to provide an annual update as we did on last Investor Day on the total earnings from our recycling. And then let's see when we build and move forward if we should think about doing this a bit more frequently also if it's hard to model up.

[Dan Major:]

Okay, thanks, so it's basically allocated between metal markets and extruded is the way to think about it.

[Pål Kildemo:]

And we can provide you the project specific information, so you can allocate between them.

[Dan Major:]

Okay. Second question is on extruded, you mentioned a sequentially lower margin in Q3 or the expectations versus Q2. Can you give us any color on EBITDA per tonne kind of basis? What the delta might be? I think you did about $640 a tonne in Q2 and about $560 in Q3 last year. Can you give us any sense of on a sort of margin basis, what the magnitude of sort of reduction would be as we go into Q3 in extruded?

[Pål Kildemo:]

Of course, last year, we had a quite strong third quarter and the product mix was good and the people were quite desperate to get their hands on material as everything ramps up much better. So you have a product mix and an interested buy because we very high. We don't give a dollar per comp guidance. And if I should say something on a very high level basis, as we see the market today, but that could change. We're probably looking at some NOK 100 million in effect from the margin side in a negative direction. But this could very much change during the quarter.

[Dan Major:]

Okay, and then final question on the renewables, you've targeted 1 billion -- sorry, 1 gigawatt of renewables. I think you recently signed was 260. Is there any other commitments you have to getting to the gigawatt? And is the required level of agreements you need to reach before you raise finance through the IPO, et cetera?

[Pål Kildemo:]

Well, we have announced a couple of projects earlier, I guess the 3 MOUs in the Brazilian context. So we have a pipeline which fills that level and above now. And what we're doing is basically maturing these projects towards the final investment decision. If these projects mature returning look at solid prices we were able to offer to our metal operations are competitive then we would most likely look at going towards the market with something that looks like a long-term attractive business case. So we have enough projects we believe to have substance in the company. But now it's about ensuring that they are robust enough and that returns are good enough.

[Dan Major:]

Okay, and then just final 1 on that related subject. When I look at the chart of CapEx, including the sort of dotted bar for additional investments, I guess it implies somewhere in the region of 2 billion per annum investment. Is that how we should be reading it? Or is it very much indicative rather than...

[Pål Kildemo:]

No, it's indicative. What we wanted to say is that cash-effective CapEx is the level you see there. And then just ensure that there is an understanding -- as we spent quite some time on this after last quarter that did renewables on hydrogen. That will come on top of this. It will impact partly from a consolidation perspective, but not so much from a cash perspective.

[Operator:]

We will now take the next question.

[Jatinder Goel:]

This is Jatinder from Exane BNP Paribas. A couple of questions on alumina. Patch of your percentage of LME is -- has been consistently depressed? How do you read that alumina disconnect? Is it just supply demand, but would positive aluminum not put alumina along with it? And secondly, how do you see Atlantic versus Pacific spreads converging or diverging going forward would -- and especially after alumina restored, do you think the market becomes more normal.

[Pål Kildemo:]

Jatinder, good questions from your side. And of course, we're now experiencing the lowest percent of LME that we have in a very long time, and our internal reading of it is, of course, that it is very much related to supply-demand dynamics. You have extremely tight primary market, and you're not seeing a lot of capacity ramp up, whereas aluminum markets are better supplied and you've also seen the ramp-up of alumina in China. But we share your view that if we see more capacity coming back on the aluminum metal side, then that needs to be supported by increased alumina capacity. But at the same time, there is some alumina capacity that could be restarted. And so we view this market as largely balanced based on the information we did externally. The Atlantic side looks tighter based on the pricing in the market with a premium and as you referred to, it is probably also impacted by the operational issues that are publicly available from one of our competitors. And longer term, I would be careful to speculate on the exact levels but definitely tighter as we see today.

[Operator:]

It appears that there are no further questions at this time. I would like to turn the conference back to our speaker for any additional or closing remarks.

[Line Haugetraa:]

Thank you, operator, and thank you, everyone, for joining us today. Please don't hesitate to contact us in IR, if you have any further questions. And I wish you all a great summer. Thank you.

[Pål Kildemo:]

Thank you.