Fortum Oyj

Mans Holmberg - IR Pekka Lundmark - CEO Timo Karttinen - CFO

James Brand - Deutsche Bank Lueder Schumacher - Societe Generale Mikko Ervasti - DNB Bank Dario Carradori - Goldman Sachs

Hello and welcome to Fortum's Third Quarter Result Presentation. And my name is Mans Holmberg, Investor Relations.

Today's presentation will be webcast and you'll have the opportunity to ask questions after the presentations. Our results will be presented by Fortum CEO, Pekka Lundmark and Fortum CFO, Timo Karttinen.

Operator we're ready to start.

Thank you very much, Mans. Dear investors I will go through the third quarter breakout highlights.

We of course have the Capital Market Day upcoming on November 16 and that will really be the day when we will then discuss our strategy in more detail. So, that's why we're in this call today going to focus mostly now on the Q3 issues.

To summarize first, of course as we know the third quarter is always challenging due to seasonality. This year it was actually pressed down a little bit more by significantly lower hydro production volumes, they were down 35% year-over-year.

And the good and positive effect which was that the achieved power price was 10% higher than a year ago, was not enough to compensate for the lower hydro volumes. But I want to highlight that this was actually the first time for a long time when the achieved price was higher than in the previous -- in the corresponding quarter a year before and that's of course very good news.

Another piece of good news was on the nuclear side, that the availability was very good and we had 10% higher volumes then a year ago. Also, today [ph] on the positive side was the Russian performance, I will go through the numbers soon.

We have now completed our investment program and now the CSA payments are starting to come in in higher volumes. We have continued very high focus on operating business in general but fixed cost in particular as you remember we have the ongoing €100 million cost reduction program and that is proceeding according to the plan and we are happy with the progress.

This was an important quarter from strategic expansion point of view as well because we finalized the acquisition of Ekokem, we will discuss at the Capital Market Day more in detail what's we are going to do with Ekokem and how that will be a key part of strategy going forward. Now in this quarter the result effect is very small because it was consolidated from the beginning of September, so it was only about a month.

One this to note is the IFRS account in treatment of electricity hedging instruments which was of course into the P&L negative effect to €57 million pushing down earnings per share, this is the flip side of the coin when the prices are going up as they have been going lately, then we get this type of non-cash charge into that P&L. And still on the list of positive -- actually strongly positive things was the new Swedish tax decision which was now explained in more detail during the quarter, which has to do with both nuclear capacity tax and hydro power property tax both being reduced significantly.

And the importance of this is so big for us that I want to spend few minutes going through the latest details of this and also its importance to our result. If I take the nuclear capacity tax first, it will firstly reduce by roughly 90% to SEK1,500 per megawatt per months.

This reduction will take place on the July 1, 2017 and after that it will be completely abolished from the January 1, 2018. This means that the tax that we this year expect to pay at the level of €84 million will be completely gone from the beginning of 2018.

And we have currently estimating that the positive effect in 2017 will be roughly €32 million and then the rest will take place in 2018. So this is the nuclear capacity tax.

In addition to this there will be a significant reduction in the hydro power real estate tax, it will be gradually reduced from the current 2.8% to as low as 0.5% by 2020. This will be a gradual reduction of tax.

The amount that we expect to pay this year is roughly €115 million. And just mathematically then calculating that how much the combined effect of these two will be, if we are talking about once the whole capacity tax has been reduced -- no sorry the real estate tax has been reduced to 0.5 level, the combined effect of these two nuclear and hydro will be roughly €180 million.

These does not include the expected tax rebasing which will take place in 2019. That may give some additional benefit, but that is still unclear because it will also depend on how the power prices development will be between now and then.

But overall this is a very positive package for us. The package also includes an ambition to add new renewables production at 18 terawatt hours between the years 2020 and 2030.

We expect the Swedish government or the energy agency to publish more details about how this will be done between these year, sometime during the month of October or quite soon in any case and then we will be in a position to estimate more how that will affect the balance in the Nordic system. But clearly overall this was a very positive thing for us.

Moving on then to the market conditions, they were quite important positive signs in the power market during the quarter. You have of course seen what has happened to the commodity prices, emission prices have been increased also a little bit and especially the forward market prices increased towards the end of the quarter.

When we look back to February this year, the forward prices for 2017 system price forwards were below €17 and now they are slightly over €30. So, this is a significant change.

When it comes to the emission prices, they were at €4.9 per ton at the end of the quarter, now the latest is somewhere around €5.8, close to €6. So there's some modest increase also on the emission prices.

The average system spot price in the quarter was up a lot from last year's extremely low level, it was 25.3 -- €25.2, while it was only €13.3 last year. This difference came mainly from Sweden, the Swedish area price was 29.6 when it was 15.5 last year.

The Finnish price also increased a little bit, but much less then in Sweden, it was 31.6 compared to 30.1. In Russia, the average electricity spot price in RUB1,298 while it was RUB1,184 a year ago.

So, there is some 10% improvement in the Russian price situation as well. Then if I move onto the water reservoir and hydrologic situation.

As you can see on this chart, the 2016 curve has been more or less flat for some time now, and we now have a situation where the roughly 95 terawatt hours that there are in the reservoirs are below a normal level and there is a structural thing here, adding the effect in such a way that Norwegian reservoirs are in relative terms on a somewhat higher level than the Swedish reservoirs which are even more below the normal than is the system average. And this of course has been a direct connection to the volumes as you have seen in Q3.

This is the hydrologic situation and then still on the market environment side the chart showing the commodity fuel and CO2 allowance prices, of course the commodity prices have increase quite fast in the last few weeks. The coal price is now almost $80 per tonne which is a very steep increase.

The same type of increase almost has been seen in the gas prices as well in of course both of these do support power prices. CO2 price in historical terms of course is still despite is very, very small increase is still on a low level.

The wholesale price for electricity in the Nordic system in North Pole [ph], as you can see there was a long down going trend that then resulted in extremely low levels in the summer of 2015, now I am not going to start the discussion whether or not this is trend change that we have seen when you look at the market forward as you can see on this picture, they are not really supporting their assumption of any trade change and we of course need to remember that the coal and the commodity situation is playing a role here and that is one of the reasons why this peak is so strong. But there are also other factors.

There are concerns about the European supply demand balance during the summer for various reasons, et cetera. But quite strong development in the past few weeks.

Then the Nordic and Russian comparison to the previous year. I already mentioned this numbers, but here you have the same in a graphical format.

We have a 20 -- no sorry, €35.2 -- no sorry -- €25.2 which is of course almost 90% higher price than the €13.3 last year in the Nordic spot system price and then the achieved price which I was referring to earlier that was 10% higher than last year and that was my comment in the beginning that this is the first time for quite some time when we have a higher achieved price than the corresponding quarter last year. And in Russia, our achieved price including capacity payments was 10% higher than a year ago.

Then if we move on to P&L, EBITDA -- comparable EBITDA for the quarter was 151 million, that’s 7% down from last year and year-to-date we are at 717 million which is 9% down year-over-year. The operating profit comparison is this time challenging because in the third quarter last year we had 748 million Swedish nuclear related write off, that’s why it makes more sense to focus on the comparable operating profit which was at 58 million compared to 79 million.

Then moving onto earnings per share, the reported earnings per share is €0.03 negative, while it was €0.74 negative last year. If eliminating all items affecting comparability from earnings per share and this number you do not have on the screen, but we would for this quarter be looking at €0.03 positive earnings per share while the corresponding EPS for last year would have been €$0.04 per share.

So, €0.03 compared to €0.04 would give a more honest picture of the operating performance during the quarter. Then I have one brief slide about each segment, I'll start from generation, which of course was burdened by low hydro volumes, I already commented that they were 35% lower, 4.3 terawatt hours compared to 6.6 terawatt hours.

Now that 6.6 terawatt hours last year was extremely high, but this 4.3 is then again quite low in historical comparison. So, we went from one extreme to another during the quarter because of the hydrological situation.

Market prices started to increase but they only partially compensated this drop from the hydro and also the fact that nuclear production was 10% up was not enough to compensate for the drop. And that's why we have for the quarter, an EBITDA of 104 compared to 131, and comparable operating profit at 77 compared to 102.

City Solutions had a typical weak third quarter when the demand for heat is low, we integrated Ekokem from the beginning of September, of course the fourth quarter will be the first quarter when you'll then see in a way a more complete picture of what Ekokem will contribute. City Solutions result was weak as is typical to the third quarter.

EBITDA slight increase from 12 million last year to 15 million this year, but then mainly because of the depreciation from the acquisitions, the comparable operating profit then was minus 16 while it was minus 13 last year. But of course the relative importance of the third quarter in the overall City Solutions result for the year is only very small.

Then moving onto the Russia segment, we are actually quite pleased with the recent development in this segment, we have now completed the multi-year investment program through which we have more than doubled our capacity in the country. We have now comparable EBITDA for the last 12 months at approximately €300 million.

We're now receiving higher CFA [ph] payments, and also the Russian ruble has strengthened a little bit. And that's why when we look at this quarter we now have a comparable operating profit at €12 million while it was zero last year.

The ruble effect is about €4 million in this quarter. Overall quite encouraging development in that segment.

And then finally before I ask Timo to continue our traditional waterfalls, first for the quarter compared to third quarter last year, we had continuing operations Q3 comparable operating profit of 79 million last year, generation was minus 25 million because of the reasons that I already explained. Lower hydro volumes, but higher achieved price.

City Solutions more or less the same as last year. But then definitely on the green side to 12 million improvement in the Russia segment.

And finally the first three quarters for the year there we have seen the generation 89 million lower result. On the year-to-date level the achieved price is still €1.7 lower and also on the year-to-date level we have lower hydro volumes.

So the combined effect of these two mainly explains the 89 million. But then the other segments are close to last year's performance.

Here also I want to highlight Russia because the reported €7 million decline in the year-to-date comparable operating profit does not give a true picture of the operating performance, because last year there was a €32 million capacity supply agreement for recent release that’s in last year's numbers. And then on the year-to-date level we still suffer actually from unfavorable currency exchange rate development that’s a level of 15 million in Russia.

So eliminating for these two, we actually are looking at an operating improvement in Russia for the first three quarters at €40 million which is quite significant. Now I would ask Timo to continue and then after that we are ready for questions.

Thanks, Pekka and good afternoon everybody on behalf as well and welcome to this conference call. Let's now spend some more time with our numbers, starting to look at the difference between the comparable and reported operating profit, items affecting comparability.

As Pekka told now it's minus €65 million all in all and in that we have two larger items minus 57 fair values changes and then minus 12 Ekokem transaction cost. As a reminder, majority of our electricity hedges when we hedge the forward Nordic market production they get hedger count treatment and therefore the fair value changes of those hedges go into our balance sheet.

But some of the hedges do not get hedger count treatment and those fair values we take through the P&L and those are the impact we look at here in the items effecting comparability. Now typically as we sell forward when the prices increase we get negative impact in these fair values when of course if prices would fall in the forward market then we would get typically a positive impact and that is the fluctuation we see, of course then that goes out when the products go to delivery and when we then produce the physical spot and sell that to the spot market.

Then moving on to our income statement, we have already discussed items up to the operating profit line, share of profit of joint ventures and associates, 11 million third quarter. This year this is in a more normal level, one can say for third quarter last year this minus 95, that included roughly 100 million negative for the decision of prematurely close Oskarshamn 1 and 2 nuclear units in Sweden.

So, that is towards the comparison there. Our net financial expenses, we have lower interest expense during the quarter because of our lower bid level and also lower average interest rate.

On the other hand we also have lower interest income because for instance we don't anymore have any shareholder loans [indiscernible]. But when you look at last year's number minus 42, it's good to remember that that minus 42 includes plus 11 from the compensation as [indiscernible] was paying back to shareholder loans and they were paying those back prematurely.

So, we received during third quarter last year 11 million compensation, so taking that the way last year's number would have been minus 53 and that gives a better comparison and shows that the finance cost is going down. Then our income tax expense minus 54 million accumulatively first three quarters and that equates roughly 19% of corporate income tax rate when you exclude the impacts of non-taxable sales gains and then profit from joint ventures and associates.

Then to the cash flow statement, first the realized foreign exchange gains and losses, this is the cash flow effect we get when we finance internally our operating companies in Russia in rubles and then in Sweden in Swedish kronas and then we take the external loans into the parent mainly in euros and some part of that's also in Swedish kronas. When we do the internal financing, we then hedge for the currency exchange rate changes and when we rollover those hedges we get the cash flow effect.

Now the Russian ruble has strengthened a bit towards euro and that means that we have needed a bit more euros to rollover the hedges for the internal financing and therefore we have a slight negative there, minus 16 and all-in-all the delta is minus 60 compared to same quarter last year. Other funds from operations we had a slightly lower EBITDA, as Pekka explained, and then also we have paid the Ekokem transaction costs.

Partly offsetting these two but not wholly is that that we have positive development in our working capital and then this all leads that we have €101 million cash from operating activities during the quarter. Then as we look at the cash used in investing activities, till this other investing activities line includes as a biggest component, the amount of money that we paid for the Ekokem shares during the quarter.

Moving onto to our debt portfolio, and average interest rates, we have total interest bearing debt at the end of the quarter of roughly €5.2 billion, the average interest rate at the end of the quarter, 3.4%, it was 3.7% at the start of the year, so declining during the year. As said we bake the money mainly in euros, some also in Swedish kronas and that part of the portfolio had average interest cost of 2% at the end of third quarter, when it was 2.6% at the start of the year.

And then for this Russia financing at the end of third quarter, we had €734 million worth of financing in ruble into our operative company in Russia. And the average cost of that financing including the currency hedging cost 11.7% compared to 12.8% at the start of the year.

Then about the maturities, you can see that we don’t have any more bonds maturing during this year, next year we have roughly €300 million worth of Swedish Krona bonds that are maturing during the first quarter and then roughly €50 million worth of Norwegian Krona bonds maturing during the second quarter. We have and we continue to have a strong financial position.

Our comparable EBITDA, last 12 months a big over €1 billion. At the end of third quarter we had €137 million positive net cash position which than translates into comparable net debt to EBITDA ratio or minus 0.1.

And as you remember our target there is to be around 2.5 in a normal leverage situation. Our external capital employed during the last 12 months, 2.3.

There -- our long term target over the cycle is to be at 10 or above. Liquid funds at the end of the quarter in our balance sheet totaling €5.3 billion and then we have committed credit lines totaling €2 billion as you remember we renewed our revolving credit facility during the second quarter.

And then back to Pekka for the outlook.

Thank you Timo. Dear investors, I go through the main points in the outlook and then after that we will take questions.

On the Nordic consumption we maintain our overall longer term trend forecast of 0.5% on average electricity demand growth and electricity of course will be expected to continue to gain share of the total energy consumption. In Russia we confirmed what we have said earlier that we believe that this RUB18.2 billion operating profit target will be or is expected to be reach during 2017 or 2018, either of these two years.

CapEx, we remain with the same forecast or guidance as previously 650 million, including maintenance CapEx of approximately €300 million to €350 million. Then hedges, we have a hedge for the last quarter -- out of the last quarter, we have hedged approximately 80% at €29 per megawatt hour.

Then 2017, we are now at 50% that €28, a quarter ago we were at 45% at €27 so 5% it's once more and €1 more for a next year. And then 2018, approximately 30% that €25 per megawatt hour.

I want to just remind you that this is the first time we published the 2018 hedges, this of course does not mean that we would not have had any hedges already earlier in the previous quarter, this is now the first time when we published this hedging percentage and the price. Taxation, tax rate guidance unchanged at 19% to 21% and then I already discussed the Swedish nuclear tax change effect on such level of detail that I will not start repeating that anymore.

So, that is the summary of our guidance and now if Timo joins me here, we would be ready for your questions.

Alright operator we're ready for questions from the lines.

Two questions if I may the first is just on the hedging, I was wondering if you could just remind us how much of your hedging is I guess to some degree commercially sensitive, but roughly what degree of your hedging is made against the [indiscernible] price and how much is against area prices, just so we can have a better judge of the kind of the numbers that you're achieving? The second question is on CapEx and as part of the [indiscernible] with the Swedish government, it was a quarter at a time that there would be CapEx requirements attached to that, both in terms of the nuclear power stations and obviously you've mentioned the additional kind of the new safety standards in the segment today, and then also the hydro plants.

I was wondering if you could just give us some details both in terms of the consolidated assets and also your share of the associates what you might be looking at in terms of CapEx over the next few years in Sweden?

I take the first question and Timo takes the second. You're absolutely right that there are some area price hedges also in here, but that is something that you're quite correctly anticipated, that we're not disclosing that what the exact compensation of that package is.

And then the nuclear CapEx, yes of course formally the Swedish government decision or the agreement in Sweden which is also participated by many political parties in the opposition, so formally that doesn't tie into any investments in the nuclear power plants. This is a decision about the taxations, specific and separate taxation on the nuclear and hydro.

Then of course on the other hand after the Fukushima accidents, so as in every country where there is nuclear there has been a process to look at the nuclear safety and deem whether more investments would be needed and that has been happening also in Sweden. And in that process there are some new investments that are needed and required and those investments -- additional investments are actually already decided in Forsmark where we are minority owner and -- but [indiscernible] has not yet decided those.

Of course this overall framework which takes away the special and separate tax on nuclear, clearly makes it more viable to do these and plan long term for the nuclear capacity, but as said there's no formal link. Likewise also for the hydro there is no formal link for any additional investments in the decision about the real estate tax.

Separately, there is a discussion on going about what the directive or the future of how the hydro is regulated and that may bring some additional things in the future, but that process is ongoing in Sweden. And still on the first question about the hedging, just to sort of note so that the prices that disclosed, those average hedging prices, they include both the system price that we have hedged and also the area price component that we have hedged.

And then the percentage what we give is simple percentage on the Nordic level which corresponds to the system price level of hedges that we have.

And we will continue with questions on the lines.

Good afternoon and just two questions from my side. The first one is on the operating cash flow of 471, I mean this is of course notoriously volatile through the quarters, but should -- is this the number that should normalize by the end of the year?

Or should we expect a similar developments at the full year phase two, what we have seen at the nine month stage? That’s a first one and the second, just to clarify on the guidance you are giving for the tax rate basically19% to 21%.

I take it that also on an effective underlying basis, or not the headline numbers -- in another words the headline number could be significantly lower than the 19% to 21% you are forecasting, is that correct?

Yes, that is correct. So the 19% to 21% is on the basis where we have taken away for an instant all the impacts of possible sales gains and also the impacts of the profits from associate and Joint Ventures that have already being taxed there.

So that is correct what you say. And also about the cash flow, so of course the cash flows continue to fluctuate around -- for instance on the prices that we get in the Nordic market and then of course on the other hand looking at our investment activities.

But it is normal fluctuation that we are seeing around the trend that we have.

Just a follow up question. And so you would expect the yearend net cash number to improve from the nine months stage?

We are not specifically giving any guidance over the last quarter or yearend numbers. But I have said of course they fluctuate around the market condition and of course what has been happening in our own operations.

Okay, thank you.

I am looking at the Nordic water reservoirs charts and yes it is perhaps below the referenced levels, but there is nothing that dramatic actually. And some of your competitors actually have been able to produce quite that high volumes in the Nordic market from hydro.

So is this really just some kind of a tactical choice to wait for better pricing and keep those -- keep that storage there in your case or is it this slight deviation from the referenced level that’s forcing you to be lower in the volumes? Thanks.

Okay, you are getting quite much into details now. But when you look at the overall reservoir level, I just want to remind you of what I said earlier that the chart is on the Nordic level, and in relative terms the shortfall from the average is more severe in Sweden where we have our big reserves.

This is the first thing. Then to much -- how much there are tactical aspects or whether there are not tactical aspects?

That is of course something that we unfortunately do not want to comment.

I just have one question on Russia and specifically on capacity payments, if I remember correctly at the end of last year the capacity payment in Russia was revised upwards because of higher cost of capital, because of government bond yields in Russia increased significantly, now government bond yields have come back down, I was wondering whether you expect a cut in the capacity payment by yearend and if you can quantify that? If there is anything, any significant raise [ph] form that or not?

The most important thing there is that we have a profit target for our capacity that we have installed and that is the RUB80.2 billion and we are confident that that'll be reached. You're of course correct that there are some government bond yields, it's a key component in the development of this prices.

But that is something that we cannot anticipate on beforehand, how that development will go in the future. Do you -- Timo want to comment this more, or?

No, I mean this is the case. Obviously the basic mechanism what it is is that they take the long term Russian government bond and take the changes of that -- the average of the past year and then they apply that to the next year when they deem the possible changes in the cost of capital that is used in the CSAs.

And exactly as you said we're getting higher capacity payments this year compared to last year because of the bond rate has increased, like I think if I remember correctly we got higher last year then the year before. Now if you look at what is the running average for this year compared to last year and then make your projections what the end of the year could be, so of course if it is lower than it might be that it's -- it could be lower also next year, but I said that's been at the end of the year and then dependent on the decision made by the authorities after the end of the year.

And if I still continue a little bit, of course now when we have the new units receiving capacity payments, we start to have the full picture and even taking into account different scenarios for the bond rate development, we're quite confident that this 18.2 is a reachable target.

Okay, so thank you very much for the questions and have a nice evening.

Thank you.