Norsk Hydro ASA

Stian Hasle - IR Svein Richard Brandtzaeg - President & CEO Eivind Kallevik - EVP & CFO

Jason Fairclough - BofA Merrill Lynch James Gurry - Credit Suisse Menno Sanderse - Morgan Stanley Daniel Lurch - Exane Fraser Jamieson - J. P.

Morgan Jatinder Goel - Citigroup Eivind Veddeng - DNB

Thank you, operator. Good afternoon, everyone.

Welcome to Hydro's fourth quarter 2016 conference call. We will start with a short introduction by President and CEO, Svein Richard Brandtzaeg, followed by a Q&A session also joined by CFO, Eivind Kallevik.

For those of you that did not see this morning's webcast of the result presentation, it is available on hydro.com. And with that, I'll leave the word to you, Svein Richard.

Good afternoon. Let me start with a brief overview of the key developments in the fourth quarter.

The underlying EBIT for the fourth quarter of 2016 was NOK1.8 billion, up from 1.5 billion in the third quarter. The main explanation for the improved result is that we experienced higher realized prices in the quarter both for aluminum and for alumina.

This improvement was partly offset by reduced results in rolled due to lower volumes and margins in addition to increased costs. It is very positive to see that Alunorte and Paragominas are keeping up the strong operational performance with record high quarterly production in Paragominas with more than 12 million tonnes of bauxite and also Alunorte with the 6.5 million tonnes as we saw in previous quarter, both well above nameplate capacity.

I'm also pleased to say that our improvement efforts have shown significant results in 2016, delivering a total of NOK1.4 billion in improvements and that we are also well on our way to reach our 2019 ambition of NOK2.9 billion improvements. Our two large projects are running as planned.

The Karmoy technology pilot is now 70% completed and is on schedule for first metal in the four quarter this year. At the automotive line number three, we have been running trial productions and we'll be wrapping up during this year.

The Board of Directors have proposed a dividend for 2016 of NOK1.25 per share, demonstrating Hydro's commitment to provide predictable and competitive cash return to shareholders while also taking into account the volatility in the aluminum industry. I would also like to mention that the Sapa Board of Directors has proposed to pay a dividend of 3 billion to the owners, which means Hydro's share is NOK1.5 billion from Sapa.

And finally, we are maintaining our expectation of 3% to 5% global demand growth for primary aluminum in 2017 and expecting a largely balanced market in line with what we said at our Capital Markets Day in London in December. I would then like to end my introduction today by summarizing our key priorities going forward, which is always to improve.

Our improvement ambition to 2019 remains high on our agenda. Our Better program is about taking control of what we can influence ourselves by reducing cost and improving efficiency in our operations, exemplified lately not least by the strong operational performance in Brazil.

The ambition is also about maintaining our technological leadership and high-grading our product portfolio towards attractive, high margin, high growth markets. Another priority for us is to deliver our two main growth projects, the Karmoy technology pilot in Norway and the automotive line 3 in Germany, which is on schedule and on budget.

The technology pilot is expected to deliver the first metal in the fourth quarter of 2017. And this pilot plant is crucially not to improve cost in itself for the entire portfolio but also to stay ahead in the game in the long run.

The new automotive line, which we'll be ramping up during 2017, will allow us to establish a strong presence within the high growth automotive segment by becoming the second largest body-in-white supplier in Europe. We will deliver on all this while, at the same time, ensuring that we maintain the financial strength to be able to handle the volatility in our cyclic industry.

Our financial strength is key, to provide predictable payout to our shareholders in the short term as well as to maintain flexibility necessary for creating the most value for our shareholders in the long run.

Thank you, Svein Richard. Operator, we're now ready for questions.

Just a couple of quick questions for me. One is just on Sapa.

I'm sorry we couldn't listen in to your call this morning, but how are you thinking about Sapa? We know that Orkla is a seller.

The business seems to be going well. It's paying dividends.

How do we think about the path from here to there? Because right now it's just something sitting there with a question mark over it.

And then secondly, just on bauxite and alumina, could you give us any feel for how much higher EBITDA would have been if you didn't have legacy contracts in that business?

With regard to Sapa, the situation is exactly the same today as it was in the Capital Markets Day when we discussed it. It is an option for Hydro.

That was, in a way, the strategy behind this, first of all, to create a world leader in extrusion, which has been very successful. Sapa has delivered good results ahead of plan, also with the [indiscernible] and improvements, NOK800 million better than the previous year in 2016.

We still see potentials, although we cannot promise the same speed of improvements in Sapa for the coming years, because now we have taken out a big part of the potentials. But still there are opportunities for us to improve the business in Sapa going forward.

I'm sure that you are thinking about the ownership and what are we going to do with the shares in Sapa. That is very much again an option for us.

We have three opportunities. One is to join Orkla with an IPO.

Another opportunity for us is to partly do an exit through an IPO and have a minority share or we could also then when the time is right to take over the Orkla share if that becomes more attractive. So again this is still open, and still an option for the Company.

With regard to bauxite and development there, I will say that I'm very happy for the performance in Brazil. The fact that we produced 12.2 million tonnes of [indiscernible] in the fourth quarter shows that the progress has been quite substantial.

Again, this is a result of the Hydro performance system, the Hydro business that we have introduced and that we'll still maintain and develop further. So maybe, Eivind comment further on the bauxite story?

Sure. On the alumina side, Jason, the average price that we realized in the fourth quarter was some $255 per tonne or roughly 15% of alumina.

Spot price right now, say $335, $340, so there's a gap of $85 per tonne. In 2016, we had roughly 50% on the alumina index, so roughly 4 million tonnes times $85 per tonne would be the improvement in B&A.

So it's a pretty big number.

Yes, it is.

That's still to play for.

Yes. In the 2017, 65% of alumina will be sold on index, so coming up from 50% last year.

Thanks, guys, for my questions. You've been busy down in Brazil, obviously ramping up volumes in a good pricing environment and getting to the end of your agreements with Vale.

And just on the latter, can you explain what the situation is with the envisaged CAP project, because I think previously you thought that you might have to build a project that's 2 million tonnes and you'd have to expand the Paragominas mine at the same time. Also being able to come to these agreements in Brazil, does it mean anything for the MRN mine that you were attempting to purchase last year?

Just in relation to the market in China, did you say this morning that you expect Beijing to implement those pollution-easing policies potentially this time next year, next winter?

Thank you, James. With regard to the CAP project, we have decided to put the CAP project on ice and did the downwriting of what has been done so far.

It is still a very attractive alumina project, but the basis for this investment would be that the market really needs more alumina. And there are enough alumina capacity in the world today, so we don't foresee that this will be a project that will be executed for at least the next few years.

It could still come up again as a good alternative in the future, but we have decided to put this on ice. And then with regard to MRN, you probably know that we did not agree with Vale last year.

The MRN shares of Vale is representative of the percent of their ownership. And we have an evergreen agreement with Vale, so we are taking the bauxite anyway.

We still feel that it could be of interest for us to take more operational responsibility in MRN. There also based on the experience we have in Norway and Paragominas where we, through the Hydro production system are able to lift performance to higher levels that we also would like to see in MRN.

But it is not a critical situation for us as such, so we are still open for discussions with Vale if they come back again. But again, we are not in a situation where we again are going beyond our principles with regard to valuation of acquisitions.

With regard to the questions on China, it remains to be seen. But you have probably heard the same as we have done with regard to pollution and possible closures during the wintertime next year, that will be the winter 2017, '18, which could have an impact on the volumes from at least three different provinces where there are a lot of aluminum capacity.

So I wouldn't speculate if this is going to happen or not, but again China is representing 50% of the global aluminum market and more than 50% of the global capacity, so any shutdowns in China will impact the global market. So we are following carefully the development in China.

Okay, that's great. Can I just follow up and just ask on what's the level of undrawn debt that you have at the moment?

Of undrawn debt? We have a revolver of 2.7 billion first maturing in 2020, which is undrawn.

It's fully undrawn?

Of 1.7, sorry, 1.7 fully undrawn, yes.

Yes, hi there. I just wanted to dig into the not-so-well-performing business unfortunately, so rolling, it was a bit of a disaster, down NOK180 million year on year on EBITDA and NOK200 million on EBIT.

Can you please help us understand the bridge of the EBITDA and the EBIT levels split between the auto line, the UBC, the legal measures that you mentioned, the [Noy] smelter and the margin pressure so we get a better idea of how long this will last for?

Of course, rolled products was a real disappointment in the quarter. We are not happy with the performance in this business area.

There are several reasons and Eivind may go through it in more details. But it's clear that this is a result of, among many factors, also pressure on margins, which is the reason why we are now investing in the automotive body-in-white market which is more, of course, demanding.

It requires more competence but also where we get more value in the market.

Menno, I think it's almost easier if we look on that on a year-by-year comparison, if we compare 2015 to 2016. The average shortfall is roughly 400 million between those two years.

Roughly half of that relates to lower all-in metal prices at the Noy smelter, in a way leaving you with 200 million shortfall. A big part of that is margin decline overall, average margins between 2015 and 2016.

Okay. Okay, and then on the depreciation charge you mentioned, how much is that in total?

Yes, in the quarter as such, it's roughly NOK16 million in Q4.

Okay

Comparing Q3 on a yearly basis between 2016 and 2017.

'16 and '17, okay, great. Okay, then the follow-up question to this is do you think this high-grading strategy is going to work, because clearly you have to put a lot of capital in.

It takes a long time. In the meantime, everything else is commoditizing at a pace that you can't keep up with.

Are we going to face a situation here in the next two years where the Company's high-grading on the one hand, on the other hand, the rest is falling off a cliff so quickly that the overall result is very poor and therefore is this still an attractive business in your view?

Of course, we are quite optimistic with regard to the automotive volumes, because even with the capacity we are now building up there are still demand for more. Of course, this is a trend based on the market development.

The automotive industry is now moving from steel to aluminum, also because of the trend in the market, the demand, but also the requirement from authorities. In Europe, their limitation will be 95 grams CO2 per kilometer in 2021.

It is not possible to reach that level without much more aluminum. So again, your question is then related to what is going to happen with the rest of the business?

Of course, we should expect that the margin pressure will still be there, but we will also probably see that Hydro is not the only company that will now use the capacity for falling into other products than the low margin products. When we see the growth in automotive, our customers are really concerned if there are enough capacity in our products in general however, because they need much more aluminum than the capacity is with that today.

What we are doing is to cannibalize on the low margin products and then taking optimal capacity, which is stable, from low margin products towards high margin products. So again, the strategy is to produce more complex, more advanced products and, from that, also get more value from it.

So we will probably still see margin pressure in some of the commodity areas, but at the same time, we are working towards high-grading the whole product portfolio and the whole products.

Final one on this particular topic, you don't see China moving downstream aggressively and therefore causing even more margin pressure than you already see today in the commoditized products?

The margin pressure today in some of the obviously commoditized products is not from China; it is from the competing industries in Europe.

Just two quick ones, the first one of alumina. Your costs have come down again in Q4.

Can you remind us where you see cost inflation at the Brazilian operations for 2017? Can you explain how you will offset this inflationary pressure?

How do you expect the costs to develop? The second question just quickly on Sapa, you mentioned that there are a couple of options on the table, which you can decide on.

Could you remind us again whether there are any or where you see synergies between your other downstream businesses like the rolled product business and the Sapa extrusion business? Are there some and where would you find them?

With regard to the alumina situation and the cost inflation, I would say that we are mitigating that through the improvement programs that are in place. I would say that the bauxite alumina organization did a good job in 2016 and we expect that they will continue to do a good job also in 2017, not only with volumes but also on the cost level which is partly also correlated.

So again, we have introduced Hydro business system or the bauxite alumina production system which is focusing very much on performance improvements, several areas where we are looking at improved operations. So that will continue, but we also took a big part, a big share of the Better program in Brazil during 2016.

But the improvements will continue. On Sapa, we are now talking about the biggest extrusion company in the world.

There are some synergies between rolled products and Sapa in some areas, like heat exchanger, automotive. We have the same customers, similar challenges and opportunities.

But I would be careful to over-exaggerate how much synergies there are here. Because there are also several market segments that are very different between these businesses.

And like building and construction for example, is much bigger in Sapa than in rolled products because they're very different products. So there are some limitation with regard to synergies, but you could also say that in the areas where there are synergies, there are also good opportunities.

But this is in itself not an argument to say that we are going to take Sapa for any price. It is very much a value question for me and for Hydro.

If it makes sense for value creation, then Sapa could be interesting. But again it could also be the all connectivity creates more value to do an IPO and we will do that.

Firstly, on the CapEx guidance for 2017, could you give us a rough breakdown there on a divisional basis, please? And then secondly just around the balance sheet, whichever metric we look at, whether it's your net debt equity, FFO to adjusted net debt.

The balance sheet looks incredibly comfortable. You've obviously boosted the dividend a bit today.

What further kind of metrics, milestones are you looking to reach before you would consider even more enhanced payouts and would you consider one-off specials, etc., if you could maybe make some comments around that, please?

In terms of the metrics, Fraser, as you will see, we're quite comfortable within any metric that the rating agencies would put up in order to stay BBB flat. What we've said for a long period of time and we will continue to say this is that we will again strive to keep Hydro's financial strength.

And Then, of course, you can argue whether you need NOK6 billion in the bank to have financial strength. This is a cyclical business.

We want to have a strong enough balance sheet to ensure that we can cater to any situation that is thrown at us. That being said, clearly if we go through this year with the current pricing that we see both in alumina and aluminum, this will very much be a renewed discussion during the year and towards the end of the year.

So we'll have to come back to that at the relevant point in time. In terms of CapEx for 2017, I don't have the detailed split in front of me.

But still remember that in those CapEx figures there's two large maintenance projects that need to be completed in Brazil in the tailing dam and the red mud and certain other projects. So a big part of the CapEx goes to Brazil.

We have the Karmoy technology pilot where we have NOK1.1 billion still outstanding in addition to sustaining capital. And that will be the second largest capital offtaker in 2017.

Okay, thank you.

Two questions. First on 500 million improvement target for 2017, are you able to give a split between three business areas as you did for 2016?

Secondly, on the first quarter maintenance at bauxite and alumina, any indication of number of days or volumes that can be impacted by these shutdowns? Thank you.

Yes, in terms of the improvement programmes, probably north of 60% of this is going to come out of primary metal and then the remaining 40%, say about 25% is going to come from rolled and the remaining is going to come out of B&A. I lost your last question, Jatinder.

Can you repeat that?

Yes. On the first quarter of 2017 maintenance shutdowns at bauxite and alumina division, any EBIT impact, volume impact or number of days of shutdown you can provide?

Yes, there will be some EBIT impact and some maintenance cost impact. But we expect the mine to be shut down for less than two weeks for this maintenance and then there will be less impact in Alunorte.

Just a follow-up on the raw material cost guided higher in Q1 for bauxite and alumina, can you give some color on which raw materials? Is it possible to quantify by how much you expect them to come up in Q1 and for the rest of the year, please?

Also the second question on the dividend -- oh, sorry, Eivind, go ahead there.

We haven't quantified the cost, but what you will see is that there is an increased fuel oil cost in Brazil coming from an increase by Petrobras who wants now to float closer to market prices than what we have seen in the past. So there will be an uptick on that and then there will be a slight uptick also on [indiscernible] costs coming in Q1.

Okay, thank you. On the high dividend, is it fair to assume that the dividend was -- the hike was on the back of a better performance from your underlying business or was it as a result of the proposed Sapa dividend?

This very much comes on the basis of the performance that we've had during the year, Eivind the cash position that we have at the end of the year and the overall performance of all our businesses, not only Sapa. Obviously, the fact that we can take out now NOK3 billion of dividends from Sapa later on this year is the strength of the great performance that they've had and the turnaround that they've delivered this last couple of years.

It is based on overall performance.

Yes, just on the dividend again, have you adopted a progressive dividend policy for the years going forward? What's your thinking behind that given that aluminum is typically or can be quite a volatile industry as you would be well aware?

Well, I think we fully agree that this industry is very volatile. It has been and probably will continue to be.

What we will continue to be. What we have done now and the way we see it is basically formulate in the dividend policy what we have been stating verbally at least for the last three years, is that the NOK1 that we paid out in 2015, for instance, was to be considered as a floor and that we intended to lift that when we had a sufficiently strong cash position and where we were sufficiently confident about the future for our industry.

Now we lift that to NOK1.25, again indicating that we believe that that's a sustainable level over time. When we will lift that again is a big question mark for the future.

We will do that again when we have sufficient visibility and sufficient financial strength to uphold that for a period of time. So basically what we're doing is formulating in word and in writing in the dividend policy what we've been saying verbally for the last three years.

Thank you for the questions. That will conclude the call for today.

From all of us here, I would like to thank you for joining us. If you have any follow-up questions at a later stage, please do not hesitate to contact us.

Thank you and have a nice evening.