Norsk Hydro ASA
Q1 2022 Earnings Call Transcript

Published: 3 May 2022

[Therese Rod Holm:]

Good morning and welcome to Hydro's Q1 2022 Presentation and Conference Call. We will start off with the presentation, followed by a Q&A session with participants in the room. Our CEO, Hilde Merete Aasheim will start the presentation, followed by our CFO, Pal Kildemo. With that, I turn the microphone over to you, Hilde.

[Hilde Merete Aasheim:]

Thank you, Therese, and good morning and welcome from me as well. It's a pleasure to welcome you back at Vakero and that we finally can meet in person. Also welcome to all of you that are following us on the conference call. I look forward to present the first quarter update today, and let me go straight to the highlights. For Q1, we report a record EBITDA of NOK11.2 billion, while free cash flow came in at NOK1.8 billion, mainly driven by working capital build during the quarter on higher prices. Through the quarter, we experienced tight market across the value chain with record high prices in Aluminium Metal and Energy. On the back of this, we have achieved record result in Aluminium Metal, Energy and Extrusion. I'm also happy to report significant progress on both pillars in our 2025 strategy. Within the first pillar, strengthening our position in low-carbon aluminium, we are excited to report that the demand for greener products continue to be strong, increasing actually 83% year-over-year. I'm also pleased to report that we have reached a very important milestone on our path to zero carbon products this quarter, through producing the first ton of near-zero carbon aluminium at one of our recyclers in Clervaux in Luxembourg, using 100% post-consumer scrap. Talking about the recycling, I'm also very excited that we, last Friday, announced a tender offer of 100% of the Polish recycler, Alumetal, which, combined with existing ongoing projects, will contribute to reach our target of doubling our use of post-consumer scrap by 2025 and reaching our targeted EBITDA uplift from recycling. Within the second pillar, I'm also pleased to announce that we have reached important milestones towards contract certainty for the first gigawatt ambition in Rein, and are now working to grow the portfolio beyond that. Slide 3 please. In addition to doubling our EBITDA since the same quarter last year, I'm pleased to report a continued strong increase in our 12 months rolling RoaCE from around 5% in Q1 2021 to almost 23% in Q1 this year, well above our overall target of reaching a 10% RoaCE over the cycle. Extrusion volumes increased as a result of increased demand in the market, particularly from the building and construction, and the industrial markets. On the cost side, we continue to see escalating raw material costs as all energy carriers are increasing due to tightening energy market, in addition to also increasing cost in carbon and in caustic. Our drive for continuous improvement is just as strong in good markets as in weaker markets. Following a year of overdelivery in 2021, we continue to target further improvements of NOK700 million in 2022. Year-to-date, we are on track to deliver on our NOK7 billion target by 2022 with particularly procurement and fixed cost initiatives progressing very well compared to target. In addition to our improvement programs, we also have targeted NOK2.5 billion in commercial improvements, including customer-driven incremental growth, performance above average margin and contribution from greener products. And here, Extrusion is contributing well this quarter on the back of improvements in gross margin. Before I continue, let me comment on how we have responded to the Russian invasion in Ukraine. Hydro has had a consistent message since early. We condemn the Russian invasion of Ukraine and we support the sanctions which have been put in place by the European Union and the international community. Hydro has no employees, operations or investment in Russia, nor in Ukraine, but we do have trade with Russia. Since invasion, we have been very clear that we will not enter into new contracts linked to Russian counterparts. We have already reduced contractual commitments and are in the process of further reducing the remaining commitments for 2022. But since we have no contracts with companies subject to international sanctions, there is no legal basis for terminating the contract. But lastly, I would like to underline that existing contracts are limited in number, scope and time. Around 400 Ukrainian citizens are working for Hydro in Poland. I'm touched to see how our organization in Poland has mobilized to help their families to unite and offering them support in this tragic situation. In addition, a fundraising initiative was started by our European Works Council, where we together have donated NOK10 million to support UNICEF in the humanitarian efforts. Let me then turn to the macro situation and the current business environment. I will start with commenting on China and then the effect of the Russian invasion of Ukraine. The China Purchasing Managers Index has been on a downward trend since the post-pandemic high, and was below 50 in March, indicating a contraction in production. This was impacted by high raw material prices, softer domestic demand and the current most significant downside risk the ongoing Omicron outbreak and China's policy response. The firm commitment to eliminate COVID-19 has been, as we have seen in Shanghai and other big cities, being lockdown, negatively impacting consumer spending. On the back of this, the GDP forecast for China has been revised slightly downwards from December, mainly due to COVID-19 outbreaks. On the chart to the right, we show the revised GDP forecast for Europe, which has been impacted especially hard by the Russian invasion of Ukraine, with a fall in expected GDP for 2022 and 2023 of 1.2% and 0.4%, respectively. The actual outcome is highly dependent on the development of the Russian invasion of Ukraine. But if we then sum it all up and look at the world as a whole, the world was on the recovery path after the pandemic. IHS forecasted in December suggested a steady growth across most major economies. However, since December, we have got inflation in America, we have COVID outbreaks in China, the energy crisis and the Russian invasion in Ukraine. This risk has led to that IHS to revise its global GDP forecast for 2022 substantially down from December 2021 from 4.3% to 3.2%. Let me then comment on our specific markets and start with alumina. During the first quarter of 2022, PAX rallied to a three and a half year high of $533 per ton, driven by supply fears because of the Russian invasion of Ukraine and the impact of sanctions on alumina trade flows. Despite much volatility in the quarter, price averaged $421 per ton, a 3% increase from previous quarter. The shutdown of the Mykolaiv refinery in Ukraine, combined with the Australian ban on alumina export to Russia, has cut Russians' alumina supply by more than 3 million tons. Russia may be able to source its missing alumina needs from China or possibly India, Indonesia, Vietnam to keep its production unchanged. Australia's alumina export ban to Russia increased alumina availability in the Pacific, which drove the PAX below $400 per ton in mid-April. Based on CRU data, higher energy prices and raw material prices lifted alumina refinery cost in Q1 2022, up in the range from $30 per ton to as much as $100 per ton compared to Q1 2021 and Q4 2021. As a result, European refineries have seen substantial cost increases and some are loss-making at current alumina prices. Alumina production in China is increasing since mandated curtailments ahead of the Beijing Olympic games were lifted in late-February. At the same time, new capacity of about 4 million to 5 million tons per year is being commissioned. Currently, the alumina price are still supported by the Chinese COVID restrictions causing logistical challenges. Now, let me turn to the supply-demand situation in the aluminium market on the global dollars. On the left side of this slide, we show the supply and demand growth estimates. In China, demand is weakening, as the property sector responsible for 30% of total domestic aluminium demand is struggling with high debt and low building activity. However, the central government has put in place financial support measures which could offer some relief going forward. At the same time, the car industry is struggling with under-supply of semiconductors. On the top of that, recent lockdowns have prevented downstream industries from operating at optimal levels, putting further pressure on demand. Demand in world ex China is still holding up reasonably. However, the risk of recession is increasing. Production outside China is expected to see limited growth with resurge in Canada and Brazil, offset by production cuts in Europe. In addition, there is a risk of curtailments of Russian capacity due to sanctions, which could significantly impact the balances. This resulted in an estimated deficit both in the world ex China, as well as in China for 2022 with a deficit in China coming down compared to what we talked about in 2021 due to weaker demand and production ramping up. As mentioned, production in Europe have decreased. And so far, approximately 700,000 tons of European production has been curtailed due to high energy prices, with another 1.1 million tons, which is illustrated here, at high and medium risk, potentially increasing the deficit further. 2.5 million tons are at low risk in Europe due to hedged power positions mainly in Norway and Iceland, which includes our Norwegian smelters. When it comes to prices, we have experienced high volatility in the start of 2022. All-in prices reached a new all-time high in Q1 as LME and premiums climbed to unseen levels. The record increase was driven by the Russian invasion of Ukraine as Russia is the largest exporter of primary aluminium globally. LME increased to above $4,000, which we haven't seen for many years on the fare of Russian sanctions. However LME is now trading at $3,000, as Russian metal is still in the market and global demand growth expectation have come down. Premium also reached all-time high on the back of three drivers

[Pal Kildemo:]

Thank you, Hilde, and good morning from me as well. Nice to see several of you physically again. Let's move over to the results and the quarterly EBITDA bridge. Adjusted EBITDA for the first quarter was NOK11.2 billion. This is up from NOK9 billion in the last quarter. And on the positive side, we have continued to experience higher all-in metal prices within Aluminium Metal. And this quarter, it is driven by a 39% increase in realized premiums, resulting in a NOK700 million uplift. The change in realized LME and realized alumina prices had limited impact compared to the previous quarter. We also had a significant uplift of NOK1.6 billion from our mid and downstream results, which is driven primarily by higher premium, which expands our recycling margins, in addition to seasonally higher volumes. Also in Energy, we experienced higher price levels and volumes, which resulted in a NOK600 million increase and the gain from price area differences was largely stable compared to the fourth quarter. Lastly, on the positive side, we have around NOK800 million increase from FX, other and eliminations; and the main driver is positive eliminations going from around negative NOK500 million in the fourth quarter to NOK200 million positive in the first quarter. This is mainly driven by lower margins in bauxite and alumina, and in addition, there are several other larger one-off items, like, for example, the bauxite and alumina insurance payment and Extrusion asset scrapping costs, both in the fourth quarter, which net each other out to a large extent. All these positive developments are partly offset by higher raw material costs across the business area and lower upstream production volumes, resulting in a total negative impact of around NOK1.5 billion. And we will dive into these details as we go through each of the specific business areas. If we then move to the key financials for the quarter, the year-over-year revenues increased by 46% to NOK46.6 billion. But compared to the previous quarter, revenues remained largely stable. Compared to last year, the developments are mainly related to higher realized prices. Adjusted EBITDA came in at NOK11.2 billion, which, for this quarter, exclude the NOK2.9 billion, bringing the reported EBITDA to NOK8.2 billion. Adjusted items for the quarter are largely driven by unrealized mark-to-market effects on contracts with around NOK4.4 billion related to LME-related sales contracts, impacted by the strong increase in prices, partly offset by NOK1.4 billion on purchase contracts for power and raw materials, impacted by the higher energy prices and the higher raw material cost. Moving on, we had adjusted depreciation and amortization of around NOK2 billion in the quarter, resulting in adjusted EBIT amounting to NOK9.2 billion. Financial income of NOK2.2 billion for the first quarter includes a net foreign exchange gain of around NOK2.4 billion, primarily reflecting a gain from stronger NOK versus euro, affecting the embedded derivatives in Norwegian power contracts and other liabilities denominated in euro. Our tax expense for the quarter amounted to NOK2 billion or about 24% of income before tax. And the tax rate mainly reflects a higher proportion of our income in Norway, where the tax rate is 22% and the recognition of a favorable decision in a tax dispute, which is partly offset by higher power surtax. Overall, this provides a net income from continuing operations of NOK6.4 billion, which is up from NOK1.9 billion in the same quarter last year, but down from NOK8.5 billion in the fourth quarter, mainly reflecting the unrealized movements on LME contracts. Adjusted net income was positive NOK6.8 billion compared to NOK2.4 billion last year in Q1 and NOK5.8 billion in the fourth quarter. And this resulted in the adjusted earnings per share of NOK3.11 for the quarter, which is up from NOK1.15 in Q1 last year and NOK2.57 in the fourth quarter. If we then move over to the business areas and start with Bauxite & Alumina, then adjusted EBITDA increased from NOK1 billion in Q1 '21 to NOK1.3 billion in Q1 '22. Here we saw 37% higher realized alumina sale prices and around NOK300 million lower expenses related to the decommissioned crane, which impacted the results positively. This was partly offset by higher raw material prices, mainly caustic and energy, increasing costs by around NOK1 billion; around 50% of that comes from higher energy costs. This lifted our implied alumina cost from $235 to $327 per ton. Production at Alunorte was slightly below nameplate capacity at 1.5 million tons for the quarter, and this is driven by planned maintenance. If we could provide these results to the fourth quarter of '21, then adjusted EBITDA decreased by NOK1.2 billion. The non-recurrence of the NOK500 million insurance payment we received in Q4, combined with higher raw material costs and lower sales volumes, were the factors behind the decreased results. Compared to the fourth quarter, raw material costs increased by around NOK400 million. This is a NOK100 million to NOK200 million higher than we guided and that is driven by the stronger energy prices that have occurred since our Q4 reporting mainly fuel oil prices. If we look into Q2, Alunorte production is expected to continue at around nameplate capacity. In addition, compared to the first quarter, current raw material prices based on market prices indicates an increase of around NOK400 million to NOK500 million. This comes both from caustic, coal, but mainly from even higher fuel oil prices. If we move on to Aluminium Metal, then this quarter adjusted EBITDA increased from NOK1.8 billion in Q1 '21 to NOK4.8 billion. The record results were mainly driven by higher all-in metal prices, positive currency effects, but partly offset by higher raw material and fixed cost. Compared to the first -- fourth quarter of '21, adjusted EBITDA for Aluminium Metal increased by NOK89 million, driven by higher realized premiums and positive currency effects. But this was partly offset by higher raw material costs, especially alumina and carbon, amounting to around NOK600 million, in line with our guidance of NOK650 million from last quarter. The first quarter was also impacted negatively by lower primary production driven by the one line outage at our Albras smelter, which is currently ramping up. This has also resulted in around NOK100 million from sale of power in the Brazilian spot market negatively as power prices are currently low in Brazil. The outage of the Albras smelter, combined with lower liquid sales than expected, resulted in a lower open exposure to market prices for the first quarter than what we guided on, or the lower exposure was 28% compared to our guidance of 39%. This was more or less offset by higher premiums than expected due to the sharp increase in standard ingot premiums throughout the first quarter. In addition, due to our metal sales profiles, it is also important to remember that the CO2 compensation for the first quarter includes one month based on 2020 prices and two months based on 2021 prices. For Q2, 67% of primary production is priced at $3,155 per ton, while on the premium side, we have 59% of premiums booked at $1,093, while in total Q2 realized premium is expected to be in the range of $850 to $900 per ton. Compared to the first quarter, we also expect increased raw material prices in the second quarter. And if we use expectations based on current market prices, this accounts for around NOK800 million and this is mainly driven by carbon and alumina. Finally, on the 8th of April, our Albras smelter in Brazil restarted the production line that they experienced a power disruption failure in February and we expect Albras to resume full normal operations in the fourth quarter of this year. For Metal Markets then this quarter we delivered an adjusted EBITDA of NOK525 million compared to NOK78 million in Q1 last year. The improvement this quarter is mainly driven by our strategic growth area, recycling, where we saw a high demand in the extrusion ingot market, resulting in increased premiums relative to the first quarter last year. In addition, we have higher results from sourcing and trading activities, but these were offset by negative inventory valuation effects. If we exclude the currency and inventory valuation effects, the result for the quarter was NOK630 million. And this is 4 times higher than we had in the first quarter in '21. Looking into the next quarter, remember that trading results and currency effects in Metal Markets are by nature volatile. However, on the back of the stronger premiums we are seeing in the market now, you should expect continued strong contributions from our recycling operations. Last quarter, we updated the annual guidance on adjusted EBITDA. And based on our current record higher premiums, we expect an average quarterly EBITDA of between NOK300 million to NOK400 million, but with seasonally higher results in Q1 and Q2, as we see in this quarter. If premiums were to come down again, this figure will also decrease. If we then move to Extrusions, then adjusted EBITDA increased from NOK1.7 billion in Q1 '21 to NOK2.3 billion in this quarter. The main result driver here is also the higher results in the integrated recycling operations, also here, driven by higher sales premiums. As you can see from the chart to the right here, Extrusion billet production is based on a large internal recycling system, where the majority is based on process scrap, some on primary ingot for sweetening, but also a sizable and increasing part on post-consumer scrap in line with our recycling ambitions. In addition to recycling margins, higher sales volumes and increased margins were partly offset by increased variable, mainly energy cost and also fixed costs as we ramp up production again. Relative to Q4 '21, the adjusted EBITDA was higher due to seasonally higher sales volumes, margins and also higher recycling results. This was partly offset by higher fixed and variable costs. And in addition, you'll remember that in our fourth quarter, we had a negative effect of scrapping of assets, totaling NOK333 million. If we then look into the second quarter, we expect net added value margins to continue to increase driven by higher sales prices and remelt earnings. However, this is expected to be largely offset by higher raw material costs, including energy and continued higher fixed cost. The higher fixed cost also includes an estimated NOK200 million in extraordinary bonuses to all employees of $1,000 per employee. This is a bonus given to all employees in Hydro following their strong contributions through the two-year COVID period. However Extrusions will account for the majority of these, given their high manning intensity. In addition, we would like to stress that the supply chain volatility remains and that there is an increased uncertainty due to the Russian invasion of Ukraine. We end the business area walk-throughs with Energy, where the record high power prices and large gain from price area differences increased adjusted EBITDA for Energy from NOK841 million to a record high NOK2.2 billion. The significant gain from price area differences amounted to NOK790 million in the first quarter. And compared to the previous quarter, the adjusted EBITDA increased by NOK539 million -- NOK513 million due to higher power production and higher power prices. The gain from price area differences stayed largely stable as lower volumes exposed was offset by a larger spread of around NOK1,300 per megawatt hour in the quarter. If we look into Q2, the price and volume uncertainty are always large, and production and prices will depend on current quite extreme hydrological conditions. We are currently seeing a very weak balance in the south Norwegian areas where we produce, and we expect lower production in Q2 relative to Q1, and we could even end up with negative spot sales in the second quarter. As of yesterday, the quarter-to-date difference between mid Norway prices, NO3, and Southwest Norway prices, NO2, were at NOK1,350 per megawatt hour compared to NOK1,297 for the fourth quarter, implying that the high earnings from price area differences will continue at the high level into Q2. Let's then dive into developments in our net cash position. Based on the starting point of NOK3.2 billion in net cash from Q4, our overall net position increased by NOK1.9 billion quarter-on-quarter to NOK5.1 billion. And this is based on the following. In Q1, we generated NOK11.2 billion in adjusted EBITDA, but we had a net operating capital increase of NOK6.1 billion. This is a large build and we can try and break it down as follows. Firstly, we have around NOK1.5 billion, which is related to normal seasonality. We build operating capital in the first quarter as volumes increase and then we free that up towards the end of the year. Around NOK3.5 billion of this amount is related to prices, LME, premiums and FX impacts value of inventories and receivables. Then around NOK0.8 billion is due to actual inventory build non-price adjusted, which is mainly higher ingot trading stocks. And the remaining is inventory eliminations from internal trade and other minor pluses and minuses, which net each other out. And if we look at the full-year estimate for operating capital, we expect, all else equal, that the NOK build will be related to price and effect with the only sizable non-market-related build being related to receivables on CO2 compensation. Other operating cash flow adjustments amounted to negative NOK2.1 billion, driven mainly by tax expenses and bonus payments. And net investments were NOK1.2 billion for the quarter. As a result, we generated free cash flow from operations of positive NOK1.8 billion in the first quarter. In addition, we had a slight positive NOK0.1 billion in other and this is mainly reflected by FX effects and new leases. If we move on to adjusted net debt, we start by adjusting for the NOK9.7 billion in collateral in Q1. This is mainly related to strategic and operational hedging positions, which has increased by NOK4.4 billion from last quarter on the very strong prices we experienced throughout Q1. The next adjustment is NOK4.2 billion. And this reflects among else asset retirement obligations, as well as assets in Hydro's captive insurance company that are not available to service Hydro debt and is stable from last quarter. This quarter we have a net pension asset of NOK1 billion, which has increased from a net pension liability last quarter after a remeasurement gain of around NOK2 billion pretax, driven by the higher discount rate in Norway and Germany. With these adjustments, we end up with an adjusted net debt position of NOK7.7 billion at the end of Q1, which is up from NOK7 billion at the end of Q4. Let's then spend some words on strategic hedging and development the last quarter. The year-to-date has experienced a significant LME price volatility. Prices have moved more than $1,000 year-to-date and daily price movements have exceeded several hundred dollars. The Russian invasion of Ukraine has been the main contributor here on top of an already tight market. Potential sanctions on aluminium from Russia or operational disruptions represents a significant upside on LME prices. And we have seen third-party market analysts expecting prices above $5,000 per ton. On the other side, we now see increased uncertainty, we see fears of recession and we also experienced supply chain issues, which could reduce demand going forward. And in light of these continued uncertainty, we continue with our strategy of remaining largely open on the upside, while securing a certain percentage of our portfolio for the downside at what we see today to be historically very strong margins. Since last quarter, we also took some extra measures to safeguard liquidity, as we are exposed to collateral on a large part of operational and strategic hedging and we did experience extreme movements in other exchange traded commodities over the quarter. These mitigating measures included rolling off parts of May and April hedges and rolling on 80,000 tons of 2024 hedges as price movements tends to be higher in the front of the curve than the back. In addition, we have purchased 75,000 tons of coal options in the second half of '22 and full-year of 2023. Through the first quarter, we have also strengthened our liquidity in light of the extreme price volatility just mentioned. The extreme price volatility has resulted in high price-driven operating capital build and also the collateral movements just mentioned. And we do this to ensure that we are robust to deliver on our strategic ambitions, despite the current high market volatility. Last week, we signed a short-term revolving credit facility of NOK1.3 billion available on short-term basis with the sub-facilities to England with our core banks. On liquidity, I was also pleased to announce that the recent NOK200 million loan that we have signed to finance the Alunorte fuel switch project had the pricing linked to the performance of our greenhouse gas emission reduction target and that we also secured that for our interest rate swap, which is the first of its kind in the Brazilian market. This is in line with our sustainable financing framework, where we work hard and aim to lower our cost of capital through increased sustainable financing. And on that note, I would like to give the word back to you, Hilde.

[Hilde Merete Aasheim:]

Thank you, Pal. Then let me finalize the presentation today by just summing up our priorities going forward. In Hydro, health and safety is always first on our agenda. Going forward now, we will manage the geopolitical and market uncertainty in the best possible way also growing volume and margin in volatile markets with particular focus on the greener offering that we have a good traction on already; and then, which is close to my heart is also to continue the continuous improvement, let's say, culture in Hydro delivering on our improvement efforts, delivering on the commercial ambitions and then obviously also to continue to execute on the Hydro 2025 strategy, which is about strengthening our position in low-carbon aluminium and then expanding and diversify in new energy areas. So, with that, I say thank you. I look forward to have you back reporting on progress during the year.

[End of Q&A:]