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Norsk Hydro’s (NHYDY) Q4 2014 Results – Earnings Call Transcript

Executives Pal Kildemo – Head of IR Eivind Kallevik – EVP & CFO Analysts Christian Kopfer – Nordea Markets Jason Fairclough – BofA Merrill Lynch James Gurry – Credit Suisse Jatinder Goel – Citi Amit Pansari – Societe Generale Eugene King – Goldman Sachs Hjalmar Ahlberg – Kepler Cheuvreux Rob Clifford – Deutsche Bank Jeff Largey – Macquarie Danielle Chigumira – UBS Eirik Melle – Danske Norsk Hydro ASA ADR ( OTCQX:NHYDY ) Q4 2014 Earnings Conference Call February 11, 2015 3:30 AM ET Pal Kildemo Thank you. Good afternoon and welcome to Hydro’s fourth quarter 2014 conference call. I’m sorry to inform you that our President and CEO, Svein Richard Brandtzaeg, will not be able to attend as he needs to attend his father, who is terminally ill. We will start with a short introduction by CFO, Eivind Kallevik, followed by a Q&A session. For those that did not see this this morning’s webcast of the results presentation, this is available on hydro.com. And that with that, I leave the word to you Eivind Eivind Kallevik Thank you Pal, good afternoon everyone. It is with great pleasure that we today could announce a Q4 result of 2014, which are the highest results that we reported since we became a pure play aluminum company in 2007. The underlying EBIT for the quarter was NOK2.9 billion, roughly two times the NOK1.4 billion from Q3 and up six times compared to the fourth quarter last year. The increase from the third quarter was primarily driven by an increase in all metal price, lifting the results for the primary smelters as prices increased by some 13% measured in NOK. In addition the increase in LME price list the realized alumina price through LME in the contracts, which still account for 75% of the contract portfolio for 2014. We also saw an increase in the Platts Alumina Index price, which also contributed positively. For the second quarter in the row we do see big improvements in operating cost in Alunorte, Paragominas in Brazil as well as increased production levels. The improvement efforts are continuing to come through on the bottom line and here — also here supported by the positive currency developments. I’m also happy to announce that on January 4, ESA, the European Surveillance Authority approved Enova’s NOK1.5 billion support to our Karmoy technology pilot. And provided that we are able to secure power agreements at competitive and sustainable prices this plant will be built. And it will be a vital part of our long-term agenda of reducing energy consumption. The pilot plant will be the world’s most efficient cell with the industry’s lowest CO2 footprint. Also the Board of Directors in Hydro proposed a dividend of NOK1 per share for 2014 and this is for the Annual General Meeting to decide in May. Furthermore, we have also revised the dividend policy for 30% to 40% of net income over the cycle, both measures reflecting the commitment to return cash to shareholders in addition to reflecting the strong balance sheet and positive earnings outlook going forward. If we then end up by summing up 2014, we continued to see a tightening fiscal markets as demand in the world outside China has exceeded production. It’s started to eat into the large inventories that we have seen. This has clearly been reflected in an increased all-in price and is especially enhanced when you convert and translate into Norwegian kroner. As we said at the same time last year, we would stabilize Alunorte production and we have stabilized and lifted both the Alunorte and Paragominas plants and at the same time reduced the cost basis. We have updated on the improvement programs at Capital Markets Day and all of them are now at/or ahead of the plan delivering significant contributions to the bottom line. Now if you look into 2015, we will obviously continue to work on the improvement efforts , both on the commercial and the operational side. As earnings outlook has improved, now is the time for us to really show the strength of the improvement culture, delivering when you have to deliver is one thing, but the true culture is really reflected when deliveries are done in improved times. We will also continue the strong focus on capital discipline going forward in these times of improved earnings. We will continue to high-grade ad perform selective growth in areas such as body-in-white? And recycling as well as smaller scale power operations. And as I mentioned, we will increase our technological lead through the Karmoy technology pilot as another example. The technology pilot will also affect the last point which is to lower our energy consumption and footprint to strengthen our future competitive climate [indiscernible]. And that is of course to be carbon neutral by 2020. Pal Kildemo Thank you Eivind. And operator with that we are ready for questions. Question-and-Answer Session Operator Thank you. [Operator Instructions] We now take our first question from Christian Kopfer from Nordea Markets. Please go ahead. Christian Kopfer Thanks operator and good afternoon. And my first question relates to premiums we have seen premiums coming off, I would not say dramatically, but they have still come off in Europe. So first question relates — or relates to what you see here regarding market sentiment in Europe on the premium side. Eivind Kallevik And you’re right. There is a small softening in the premium market the way we see this in Europe, but remember that the premium situation both in the US and in South East Asia remains relatively strong. And I think you also have to reflect on the fact that the premiums have been going up significantly from during all of 2014 and partly also in 2013. So even though it’s down slightly, it’s still at very high levels from a historical perspective. Now we did see — I think the market and industry saw a significant customer a destocking towards tail end of 2014 and I think it’s really — it is a little bit uncertain at the moment. We will see now when customers come back to the market and start to price metal in Q1 and Q2 as to the significance of this softening. So it’s a little bit too early to say, but it’s still at fairly high levels the way we see this. Christian Kopfer And also on your products, I guess you have already mentioned that the premium on more value added products hold up significantly better. Is that fair still to assume? Eivind Kallevik Yes, I think you shouldn’t expect over time if there is softening of the standard ingot premiums. It’s not unnatural that will have also an impact on the value added products over time. What we’ve guided upon however is that as we get into Q1, with the booking profile that we do have and the bookings that we have done for at first quarter which is roughly 80% to 90% of the production, we expect an increase in our realized premiums of another $60 in Q1 compared to fourth quarter. Christian Kopfer Thanks. And also if you look at it, the difference between the premiums on the European market and in the US, I guess is there any reason why this difference should really remain. I mean I don’t ask for a forecast on premiums but the difference is quite abnormally high at this point, right? Eivind Kallevik What we’ve seen in the past is that these things tend to balance out. I mean you saw the same thing if you go back to fourth quarter of 2013, right? When the premiums in the US started to pick up sharply and European premiums were a little bit lower and then Europe picked up shortly thereafter. So I think you will find that premiums overtime will balance out. Christian Kopfer Thanks. My final question on the Karmoy, the plant that you’re building. Just so I understand correctly, after the — or the net CapEx to Hydro is that the NOK3.9 billion? Eivind Kallevik Well the NOK3.9 billion is the gross figure and then we have rest from Enova of NOK1.5 billion. Operator We will now take our next question from Jason Fairclough from BOA. Please go ahead. Jason Fairclough I guess good afternoon. Thanks for the opportunity to ask questions. Just a couple more questions on your new toy on Karmoy. Just wondering how do you think about this? Is this an ongoing R&D drag on the business or is this a proper asset that will generate its own return on capital? Eivind Kallevik Hi Jason. Well I don’t think it is a toy to be honest, if I can reflect up on that first. It is a proper investment. First and foremost of course it is to demonstrate and verify the technology lead that we believe that we do have in this market. And that plant when operated will also yield returns. In addition of course there will be technological spinoffs from the Karmoy pilot that can be implemented in the other operating plant that we have overtime. So it is a proper investment, but it is to verify the most climate friendly and an energy effective aluminum production in the world. Jason Fairclough If you don’t mind, could I just maybe push you a little bit on how to think about this. So you said first production in 2017, how long do you think before a plant like this would be covering it cost of capital? And I guess in terms of power costs, is it appropriate to think about the power prices that we see in a Nord pool at the moment? Eivind Kallevik I think we haven’t — I mean this is one of the outstanding issues not to return our cost of capital but the power, right. So we made the investment decision basically to move ahead with the project mature it even further, but it’s still pending on what we call sustainable power supply, which certainly has to do with the power prices. And the important part for us is of course to ensure that we have a competitive power source that is sustainable and competitive in a global context where this point will compete. Jason Fairclough Okay, what about the return on capital? Eivind Kallevik This plant will ramp up and when we get there to full production, it should be able to earn its cost of capital the way we see this. And then 2017 is the earliest, right. We expect to do if everything goes according to plan in terms of power source we have a build decision in 2016, early 2016 at the earliest. 2017 is really the earliest when we will see metal out of the plant. Jason Fairclough So last question for me, is this something we should put in our models today or do we really need to wait until we get a final build decision? Eivind Kallevik I think there is no — we haven’t made a build decision. That will not be made until first quarter 2016. But I think your constructive model is from 2017 and onwards. Operator We know take our next question from James Gurry from Credit Suisse. Please go ahead. James Gurry Thanks very much guys, congratulations on a pretty good result today. Just quickly again on that same smelter proposal. So the — I think you’ve got growth CapEx this year of just under NOK1 billion. Is that — is your decision today going to affect that number at all or is it more likely to fall into next year? Eivind Kallevik There will be some growth CapEx in 2015, more to the tune of $100 million to $300 million. James Gurry So you’ll be spending above the NOK6.5 billion? Eivind Kallevik It’s also what we’ve guided on so far. James Gurry Okay, okay. And just quickly on the dividend policy, what’s the relevance of the 40% payout ratio given that your balance sheet meant that you were able to payout a lot higher than the previous 30% payout ratio. So it wasn’t really a relevant measure. Should we think about it as a — you’ve got a minimum dividend policy and perhaps you’ll aim at 40% if you ever get to a sort of steady state consistent earnings basis. Eivind Kallevik I think you have to read this two ways. I think first and foremost — at least for me, it’s important seeing that if we lift the absolute level to NOK1 per share for 2014, and of course we will work hard to maintain a stable dividend also going forward. The lift from 30% to 40% is also a signal that trying to proving that the commitment to serve the shareholders is very strong and the Company will remain also stronger going forward with cash returns. Operator We now take our next question from Jatinder Goel from Citi. Please go ahead. Jatinder Goel Hi good afternoon gents. Just two questions. And apart from seasonality, any additional comments you can make on the weakness of rolled products division for the fourth quarter and how do you see it going forward in to first quarter and rest of 2015? That’s one. And secondly just on the dividend and capital return side you said share buybacks and extraordinary dividends in the period of strong financials, anything you can share on the quantitative side how will you define that strong financials and will that be considered only at the yearend or would you look at returning excess cash by either way in the interims as well? Thank you. Eivind Kallevik Thanks Jatinder. If you look at the rolled product side, first, clearly the — I think the volume in fourth quarter is probably somewhat lower than what the market expected driven not only by seasonality but I think also by customer destocking towards the end of the year, probably to a larger extent than what we’ve seen in the past. The way we read this is this is probably also driven by some customer uncertainty, in particular in Europe as to the strength of the economy going into 2015. We do expect volumes to come back up in the first quarter of the year as normal seasonality kicks in. But remember that we’re starting from a somewhat lower volume quite first quarter 2015 compared to first quarter 2014. So probably slightly lower volumes this quarter compared to same quarter last year. On the dividend side, when it comes to share buybacks, that is something to do — have to be approved by the annual general meeting in May and if that was up for decision, it is a fair assumption that would have been commented upon in today’s presentation. So don’t think you should expect to see that for this year. Operator And we now take our next question from Amit Pansari from Societe Generale. Please go ahead. Amit Pansari Hi. Thanks for taking my questions and couple of it. First is, could you please guide us on what is the net debt levels at Sapa and Qatalum? Second question would be, what kind of interest expense on pension liability do you see in 2015 given that your pension liability has increased. And lastly on the market, what do you read from the inventory declines? What percent of it do you think is going to the market for consumption and what is going to the off market stores. Those would be my questions. Thanks. Eivind Kallevik Yes, if we start with the inventory, which I guess was your last question, Amit. Amit Pansari Yes. Eivind Kallevik We continue to see a decline in the reported inventories. We continued to see that throughout 2014 and we believe that we also see that so far into 2015. The question of course, the big question is where did that metal go. Does now go into the physical market or is it just being rolled into unreported inventories. And it’s probably a little bit of mix of that, but certainly parts of it goes into the physical market, then filling the gap of between production and demand. Besides for 2014, that the gap supply demand or production demand in the western world, world outside China was roughly [1 million] tons. And then in the same speed that we see in 2015. When it comes to the debt level, in Qatalum and Sapa, the aggregated amount is some NOK7.3 billion. And Sapa in isolation is roughly NOK1.6 billion — NOK1 billion for power share, yes. Sorry, NOK1 billion of our share in Sapa. Amit Pansari Right and on interest expense and pension liabilities, do you see any kind of an increase in 2015 compared to 2014 levels? Eivind Kallevik Not very significant change Amit. Amit Pansari Okay. And lastly just a follow up on — in the investment there is substantial increase in primary metal and rolled products in Q4 compared to previous quarter. So what was driving that if you can throw some light on that? Eivind Kallevik That is also partly due to seasonality in fourth quarter and rolled products you basically partly shutdown parts of the plant for maintenance and that’s also when you do a bigger investment upgrades. And typically also do — I think historically you will see that we also do more investments and maintenance investments in the primary smelters in fourth quarter compared to other quarters of the year. Operator We now take our next question from Eugene King from Goldman Sachs. Eugene King Hi all. A couple of questions. Just on Paragominas run rate in Q4 is about nameplate. Can we model above that or would we be safer at nameplate across the full year? Eivind Kallevik Hi Eugene. We’ve guided into Q1 on stable volumes. So I think you should — at least we plan to see the 10’s figure also for the first quarter. And then whether that is 10 even, 10.1, or 10.2 remains to be seen, but at nameplate or slightly above. Eugene King Okay. And then just a second question, just again on duties. The gross payout at the NOK1 a share is about NOK2 billion, but your cash generation is probably spotish. Everything is probably about 8 to 9, which will leave you with a really big net cash position at the end of the year. At what kind of level do you think about introducing a buyback or utilizing that cash balance? Eivind Kallevik I think it’s still early days I think, of this very positive cash generation. We do have a positive earnings outlook, as you know, for the — also in Hydro for the year of 2015. And I think we will have to come back with the cash usage and hope to spend that at the end of the year. But it’s quite clear, even with a NOK2 billion dividend payout, we will very soon be into the positive net cash balance. But we will watch that carefully and spend it wisely. Operator We now take our next question from Hjalmar Ahlberg from Kepler Cheuvreux. Hjalmar Ahlberg Thanks. First a question on Paragominas payment. How much of this payment did you do in Q4 and how much remains? Eivind Kallevik Hi, Hjalmar. We had two charges for the acquisition of the Paragominas shares. Each tranche was roughly 200 — or not roughly. It was $200 million, so $400 million in aggregate. If you do — if you look at what we actually paid for the first tranche, it’s probably — it’s not probably. It’s closer to $50 million, as we had some guarantees from Vale on those — on that asset. So that’s roughly $50 million for the first tranche. Hjalmar Ahlberg Okay. So [indiscernible] remaining or so. Eivind Kallevik So roughly 200 — not roughly. $200 million remaining for the second tranche. The first one cost $50 million instead of $200 million. Hjalmar Ahlberg Okay. Thank you. And looking at the realized alumina price, you were expecting raw material prices in primary metal [indiscernible] to go up. Would that also imply a higher realized alumina price in the bauxite and alumina division? Eivind Kallevik Yes, that is fair to assume. As you know, we sell roughly 50% of our production internally. So as you see, higher earnings and higher prices realized in bauxite alumina, that also will have a negative — positive impact in DNA and negative impact in primary metal. We also expect a somewhat higher ratio of PAX price volumes in 2015, compared to 2014, where roughly 30% will be based on the PAX again existing data, earnings and DNA, and slightly higher costs in the primary metal. Hjalmar Ahlberg Okay. And a question on depreciation. It was up a bit, in both bauxite alumina and primary metals in Q4 versus Q3. Was that due to something special? And would this level remain or would go lower or higher in the next quarter? Eivind Kallevik Well the changes you see in depreciation, Hjalmar, is very much to do with the currency development, and then let’s you translate the BRL depreciation into NOK. It has gone higher, per constant currency development. Hjalmar Ahlberg Okay. Thanks. And just one last on alumina cash cost. You expect it to go up a bit in Q1. Will it go up to those levels in Q1 to Q3, or will it still remain lower than those levels? Eivind Kallevik I think we said it will go up somewhat, compared to the Q4 results, which is not back to the Q3 results, somewhere in between. Operator We now take our next question from Rob Clifford from Deutsche Bank. Rob Clifford Yes, good afternoon. Two questions, one on strategy and one on the market. The market question, you benefited from FX but so do others. Do you think Russia will hold the line and keep production offline, and keep the market tight? And the question on strategy, Karmoy. It’s clearly a commercialization of a technology. How secret is this? Is this something that you’re looking to go on and sell? Is it something you want to use yourself? Why haven’t you gone to Qatar with this technology, given that there is power available there? Is it part of keeping the technology in house, to yourself, or is it a CapEx decision there? So just some comments around the strategy for your smelting technology. Eivind Kallevik If we start with the Russian situation, clearly the Russian production, given the — basically the collapse in the ruble has made that much more competitive, if you like. And it’s hard for us to sit on the [inside of resolve], if not impossible. And we don’t do that, of course, on the Russians’ decisions. But I think they’ve made some fairly clear comments themselves, in terms that they will not ramp up old curtailed capacity, given today’s market or given today’s prices or the market balance in the world, as it is today. So that is what we have to base it on. When it comes to Karmoy, we believe — and the way we see the power prices in Norway at the moment is that it is actually globally competitive. And as such, Karmoy is a very good place to build it, both from a logistical and competence perspective. When it comes to selling the technology, one of the pre-conditions in the approval from the European Surveillance Authority is that we have to license this technology within Europe or within the EU, should other parties want to license the technology. And that of course we would do, if that happened. But it’s only within the EU region. Rob Clifford And so that would be licensed to others. What about use for yourself, looking beyond this is a small pipeline, basically? How else would you use it, if it’s successful? Eivind Kallevik Well it is also to verify when the time is right to build a new smelter, whether that’s a full expansion of Karmoy in due time or whether that is building qatalum 2 or something else. This is the verification of the technology that we’ll be — if successful, be using at the new smelter site. But that’s a long time into the future. Operator We now take our next question from Jeff Largey from Macquarie. Please go ahead. Jeff Largey Yes, hi. Good afternoon. I just have two questions, I guess both focused on bauxite and alumina. The first is just looking at the improvement program there, from B to A, it seems to be, as you say, progressing ahead of schedule. Is there scope that — is there upside scope to this NOK1 billion program or is it just simply that you may be delivering the savings ahead of the end of next — or this year, I should say, 2015? Eivind Kallevik Good afternoon, Jeff. I think, as you say, we are ahead of plan. Original target for 2014 was 600. We have communicated that we delivered 700 at the end of the year, meaning that there is an additional 300 to be delivered for the rest of 2015. Whether there is upside potential above that is not something that we communicated so far. But from experience, it is often so that when you run these programs, you get the mentality change in how to look for improvements and sustainable improvements. And typically, you find something more. If and when we get those quantified, we will of course communicate that to the market, but not as of yet. Jeff Largey Okay. That’s helpful. The second question is just on — back to bauxite and alumina, and on ICMS. As you put in the presentation, the dialogue continues, and this — these ICMS are going to be revisited in July. Can you kind of — I guess can you shed some light on the nature of the dialogue? Is it something that’s a very active dialogue or is it something that really is — you really will kind of revisit in July and will have a decision at some point then? Eivind Kallevik No, it is clearly a situation where we have continuous dialogue. It’s not something that there’s no dialogue today and then we’ll sit down in July. As you know, the election ended not too long ago. The governor is in place. And there are several meeting places, with both the governor, as well as his people on these topics, as we speak. So it’s an ongoing and active dialogue in Brazil. Jeff Largey Is there any sense whether you think you have a case for some relief against these ICMS, or too early to say? Eivind Kallevik I think it is too early to be conclusive. I think both parties understand the importance of this topic. But we don’t — in Brazil and other places, nothing is concluded until it is concluded, in a way. So it’s too early to guide on the specific outcome. Operator We will now take our next question from Danielle Chigumira from UBS. Please go ahead. Danielle Chigumira Hi there, and thanks for the call. A couple of questions, and firstly on the market. You said that you expect a deficit, excluding China. Given the semis export data we’ve seen, as China continues to ramp up, how concerned are that that finds its way into the rest of the market and upsets the positive fundamentals that we’re seeing outside of China? And perhaps to ask the balance sheet question in a slightly different way. All else being equal, if we’re here in a year’s time and spot has prevailed, you would have a substantial cash pile on your balance sheet. Unless something else material comes up, can you see yourselves, in a year’s time, recommending a material buyback to shareholders? Eivind Kallevik Yes, on the China question first. As you know, we did see quite a big increase in semis and fabricated exports out of China, towards the tail end of the fourth quarter. And of course, it has an impact on the deficit in the Western world. The question, how sustainable is these exports? And that has very much to do with the difference or the metal advantage that the Chinese players have at the moment. We have had these situations in the past, and they’ve tended to normalize over time. But it’s a little bit too early to say, in the year, as to how this is going to play out. But obviously it is one of the concerns that we do have. Danielle Chigumira Okay. Eivind Kallevik On the balance sheet side, if we sit here with — in a year’s time with a big pile of cash. We will have the discussions on how to spend that. And it is as we talked about in the past. There is a limit to how much cash, I think, even as [indiscernible] on the balance sheet being non-productive. Whether that will point its way in buybacks or extraordinary dividends as the case, that is still too early to say. That debate we will have to take next year. Danielle Chigumira Okay. Can you give any further color on what that — the limit of that net cash would be, is it NOK2 billion, or NOK5 billion, or NOK10 billion? Eivind Kallevik Not as of today, Danielle. I think we will have to cross that bridge when we get there. Operator We now take our next question from Amit Pansari from Societe Generale. Amit Pansari Hi. I just have one last question on the CapEx plan made for Karmoy. So suppose you find the power solution. Then how do you see that ramp up CapEx? Is it 2016, 2017, 2015, 2016, 2017? So how do you see the split in CapEx? Thanks. Eivind Kallevik We said for this year that roughly 100 to 300 for 2015. Then the major part of the remaining share will obviously come in 2016, partly into 2017, as we ramp up production. But most of that would come in 2016. Operator We now take our next question from Eirik Melle from Danske Market. Eirik Melle Hi. Congratulations on the very solid results today. I was just wondering if you could just comment a little bit on the Chinese export of semis. It’s been quite vast volumes lately, and I was just wondering if you have changed any view on it. Eivind Kallevik Thanks, Eirik. Again, I believe we’ve said in the past, when it comes to primary, we believe China will be balanced on the primary side. And we will say the risk is probably higher on the semis side. And that’s partly what we’ve seen, towards the tail end of fourth quarter. I think it is too early to judge whether this will stay at these levels or increase during 2015. I think we will have to wait until we pass Q1, pass Chinese New Year, and get a little bit into Q2, before we see if this is sustainable or not. At the end of the day, I think it’s going to come back down to the price differential or the metal advantage, between the Chinese metal cost and the Western world price. That’s going to determine the level of exports. Operator [Operator Instructions]. We now take a follow-up question James Gurry from Credit Suisse. James Gurry Thanks again. I just wanted to follow up with the situation in Brazil, the potential power rationing and the higher power costs obviously impacting many, many companies. Can you give us a bit of a scenario on how much you think the cost might go up in each of those situations, just on higher power input cost? Or, if you had to restrict your activities because you couldn’t get power at all, how might that impact the earnings? Eivind Kallevik If you look at the smelter side, remember that we have a power contract with a price agreement, until 2024. So the impact from the smelter is, in a way, purely going to come if there is a curtailment or if there is a rationing of power and we don’t get the power that we are entitled to, in which case we’ll be — probably have to take down capacity somewhat. We don’t know the extent of this, if any, that this will have in the northern parts of Brazil. It’s still so that the northern parts of Brazil is in a better situation when it comes to hydrological balance, than certain other parts of Brazil, which is much more challenged. When I referred to higher power costs in Brazil, that relates more to the Paragominas, the bauxite mine, where we had the power contract that has ended at the end of the year, 2014. And they have to go to the market, to source the energy needed for the year. James Gurry Have you provided previously on what the power expense is for Paragominas? Eivind Kallevik Yes, we’ve — if you look at the power side, we expect that the impact is roughly NOK50 million for Paragominas. Operator We now take our next question from Eugene King from Goldman Sachs. Please go ahead. Eugene King Sorry, guys. Just forgot a couple of things. Just sticking with Brazil, just wondering, am I right in assuming that you’re off the real hedge now and you’re fully exposed to spot real? And then secondly, in terms of excess bauxite, given Paragominas is running slightly above nameplate, is that predominantly spot sales into China? And what kind of price are you achieving on that? Eivind Kallevik When it comes to the currency hedge, which has been in place partly for 2013 and all of 2014, that is now completely out of the books, meaning that we’re fully exposed to the exchange rates for 2015 and onwards. So there’s no new hedge in place. When it comes to bauxite sales, we do have some bauxite sales out of Brazil. We’ve had for quite some time. We haven’t been very specific, in terms of what kind of profits we have on that, but it is — in terms of EBITDA margins and other metrics, it’s a very good business at the moment. And just to be specific on it, it is not Paragominas bauxite that we can sell to the external world because that comes as a slurry to Alunorte. So it’s not allowed to ship it in that state out of the country, due to shipping regulations. So it’s really bauxite out of the mine in MRN that we would sell outside Brazil. Operator As there are no further questions in the queue, I would like to turn the call back to the presenter for any further remarks. Eivind Kallevik Okay. I want to thank you, everyone, for taking the time and speaking to us today. Thank you very much and have a nice evening. Operator This will conclude today’s conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.

To Hedge Or Not To Hedge?

This is an updated version of an ETF Specialist originally published on Feb. 19, 2014. Currency-hedged exchange-traded funds have come into vogue of late in the United States. Investor interest was first piqued by the performance of the oldest and largest of them all: WisdomTree Japan Hedged Equity (NYSEARCA: DXJ ) . The fund owns a portfolio of dividend-paying Japanese stocks that generate more than 80% of their revenue outside of Japan. It gained nearly 42% in 2013, as a massive dose of monetary stimulus contributed to an 18% decline in the value of the Japanese yen, and steady improvement in the global economy gave Japan’s stock market an additional boost. In contrast, iShares MSCI Japan ETF (NYSEARCA: EWJ ) , which tracks a standard market-cap-weighted benchmark and does not hedge its yen exposure, increased by 26% in 2013. Clearly, it paid for U.S. investors in Japanese stocks to have a hedge against a declining yen over this span. But was this a flash in the pan, or do currency hedges have value over longer time frames? With the U.S. dollar marching steadily higher–thanks in part to (relatively) attractive interest rates–and double-digit moves in major currencies making headlines, now is a good time for investors to explore these questions. Back to Basics: Return, Risk, and the Practicalities of Putting a Currency Hedge in Place In simple terms, a domestic investor’s local-currency-denominated return in a foreign security (or a portfolio of them) is equal to the foreign security’s (or portfolio’s) return plus the foreign currency return, plus the product of the foreign security return and the foreign currency return. The last part of this equation accounts for the interplay between the two, and as it is the product of these two figures, its contribution to the overall return will grow as either the foreign asset return or the foreign security return grows larger. Domestic Currency Return = Foreign Security Return + Foreign Currency Return + (Foreign Security Return x Foreign Currency Return) The effect of fluctuating exchange rates can either help or hurt returns. In the case of U.S. investors holding Japanese stocks, the yen’s depreciation hurt the U.S. dollar return for unhedged investors in 2013, as evidenced in part by the iShares fund’s relative underperformance versus the WisdomTree offering. In another extreme example, the 34% appreciation of the Brazilian real contributed to the 124% calendar-year return posted by iShares MSCI Brazil Capped ETF (NYSEARCA: EWZ ) in 2009. These examples highlight that currency effects can be extreme in magnitude. It’s also important to consider currencies’ effect on the risk of a portfolio of foreign securities: The expression for the variance (the square root of which is the standard deviation) of a foreign security or portfolio’s returns is as follows: σ 2 $ = σ 2 LC + σ 2 S + 2σ LC σ S ρ LC,S, where σ 2 $ = the variance of the foreign asset returns in U.S. dollar terms; σ 2 LC = the variance of the foreign asset in local-currency terms; σ LC = the standard deviation of the foreign asset in local-currency terms; 2 S = the variance of the foreign currency; σ s = the standard deviation of the foreign currency; ρ LC,S = the correlation between the returns of the foreign asset in local-currency terms and movements in the foreign currency. This expression demonstrates that the volatility of a foreign asset in domestic-currency terms is directly related to the volatility of the asset in local-currency terms (the first term in the expression) and the volatility of the foreign currency (the second term). It also shows that the higher the correlation between the foreign asset in local-currency terms and movements in the foreign currency, the greater the variance will be in local currency terms. (Again, take the square root and you’ll get the standard deviation.) Hedging away currency exposure will reduce risk, as measured by standard deviation–as can be seen in Exhibit 3 below. How does currency hedging work in practice? Most currency-hedged ETFs will use currency forward contracts to reduce their foreign-currency exposure. A currency forward contract is an agreement between two parties to buy or sell a prespecified amount of a currency at some point in the future (typically one month out in the case of currency-hedged ETFs) at an exchange rate agreed upon between the two parties. Because the value of the forward contract is fixed ahead of time, and the value of the fund will fluctuate during the course of a month as asset prices and cash flows into and out of the fund fluctuate, the forward may not be a perfect hedge. It’s also important to note that these hedges come at a cost, though their price tag typically amounts to just a few basis points in the case of developed-markets currencies in stable interest-rate environments. FX Effects It is useful to look at historical data to frame the effects of currency hedging on investment performance (for U.S. investors in this case). There are two key elements to consider when assessing the effects of currencies on equity portfolios: their contribution to return (as covered above) and their contribution to risk. Exhibit 1 shows “success ratios” for a trio of MSCI benchmarks over the 20-year period ended Jan. 31, 2015. These benchmarks are all tracked by one or more currency-hedged (and unhedged) ETFs. The success ratio represents the portion of the overlapping monthly rolling one-, three-, and five-year periods over these two decades during which the unhedged version of the index outperformed its fully hedged counterpart. For example, the MSCI EAFE Index outperformed its fully hedged counterpart in 59% of these overlapping rolling one-year periods over this 20-year span. In hindsight, in the case of the MSCI EAFE and MSCI Germany benchmarks, the winner could have been predicted by the flip of a (mostly) fair coin. The story is different when it comes to the MSCI Japan Index, where “getting the yen out” has clearly paid off more often than not. Exhibit 2 contains the annualized average returns for each benchmark across each of the overlapping monthly rolling one-, three-, and five-year periods dating back 20 years from the end of January 2015. The differences in relative performance vary between the hedged and unhedged versions of these indexes depending on the length of the measurement period. The MSCI Japan Index is again a unique case, as evidenced by the yawning performance differential between its hedged and unhedged versions. What about risk? Currency risk is a significant contributor to overall risk in the context of a foreign-equity portfolio. Exhibit 3 shows the trailing 20-year annualized standard deviations and Sharpe ratios for the same benchmarks featured in the first two exhibits. In the case of all three benchmarks, it is clear–as evidenced by the difference in Sharpe ratios between the U.S. dollar and hedged versions of the indexes–that currency exposure is a meaningful source of risk, currency hedging can serve to mitigate this risk, and it may ultimately result in superior risk-adjusted performance. To Hedge or Not to Hedge? The best answer to the question of whether it makes sense to hedge the currency exposure of an international-stock portfolio is this: It depends. By hedging foreign-currency exposure, investors can mitigate a source of risk–but at the expense of a potential source of return. The trade-off between the two is important, and investors’ decisions will depend on a variety of factors, including but not limited to their return requirements, risk tolerance, investment horizon, and the costs associated with hedging currency exposure. Disclosure: Morningstar, Inc. licenses its indexes to institutions for a variety of reasons, including the creation of investment products and the benchmarking of existing products. When licensing indexes for the creation or benchmarking of investment products, Morningstar receives fees that are mainly based on fund assets under management. As of Sept. 30, 2012, AlphaPro Management, BlackRock Asset Management, First Asset, First Trust, Invesco, Merrill Lynch, Northern Trust, Nuveen, and Van Eck license one or more Morningstar indexes for this purpose. These investment products are not sponsored, issued, marketed, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in any investment product based on or benchmarked against a Morningstar index.

Caveat Emptor: The 7 Most Underperforming 3x Leveraged ETFs Over The Last Year

Summary Leveraged ETFs can be dangerous buy-and-hold vehicles due to their extreme volatility and tendency for many to decay over time. Leveraged ETFs underperform when their underlying indices trade with large daily moves and have multiple prices spikes and reversals. This list highlights multiple sectors ranging from international indices to precious metals to commodities whose leveraged ETFs have underperformed the 1-year returns predicted based on their 1x counterparts. These are ETFs to be avoided by all except shorterm traders due to significant underperformance on the long side and the potential for career-ending losses on the short side. Last week I published an article entitled How To Buy And Hold Leveraged ETFs: The Top 7 Outperforming 3x ETFs Over The Past Year in which I highlighted those leveraged products that saw gains greater than or equal to three times the performance of their corresponding indices and 1x ETFs. However, as traders of these volatile funds know, these were the exceptions, not the rule: the terms “outperformance” and “leveraged ETF” do not usually go hand-in-hand. Just as important as knowing which leveraged ETFs might make good long-term holds, equally crucial is knowing which diseased ETFs should be avoided like the plague. What follows is a list of the top 7 most underperforming ETFs over the last year through January 23, 2015. Again, this is not necessarily a list of the lowest returning ETFs-Rather, it is a list of ETFs that performed below the expectations set forth by their 1x companions. That is, if a 1x ETF is down 5%, the 3x leveraged ETF “should” decline by 15% or its leveraged inverse should climb by 15%. If the ETF is down more than -15% or up less than +15%, respectively, it is said to underperform. Before I delve into the list, it is a good idea to review why leveraged ETFs underperform. For a more detailed discussion on outperformance vs. underperformance, please see last week’s article. Briefly, let’s consider a fictional sector or 1x ETF that oscillates between 95 and 100 on a daily basis, or by approximately 5% daily. The corresponding 3x leveraged ETF would be expected to oscillate between 85 and 115 day after day ad infinitum. However, as Figure 1 below illustrates, after 30 days, this hypothetical ETF is actually oscillating between 65 and 80 and heading lower, thanks to some complicated mathematics associated with leveraged ETFs. (click to enlarge) Figure 1: Sample Underperforming Leveraged 3x ETF. Sectors that oscillate-that is, have large price spikes followed by big corrections-and have large average daily moves tend to have leveraged ETFs that underperform their corresponding 1x ETFs. Leveraged ETFs that underperform therefore tend to be correlated to a single commodity or index. For example, ETFs that track silver, gold, natural gas, oil, etc are based entirely around these commodities and are therefore at their mercy. These ETFs are very vulnerable to making large moves if that commodity spikes or tanks. On the other hand, ETFs that are based on an index with many components-the Nasdaq or Russell 2000, for example-tend to track closer to their corresponding ETF as it would take all of the stocks-several hundred-to surge or tank simultaneously with minimal impact if just a single stock has a big move. Another strike against leveraged commodity ETFs leading to underperformance occurs when their representative futures markets trade in contango, or when later month contracts are more expensive than the current front-month contract. These funds must sell near-term futures contracts prior to expiration and use funds from the sale to purchase more-expensive later-period contracts. Sectors that often trade in contango include natural gas and occasionally oil where monthly contangos often range from 0.5% to about 3% on average. A 1x ETF such as the The United States Natural Gas ETF, LP (NYSEARCA: UNG ) or the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ) will see monthly losses equaling the contango, which can be unfortunate, but not devastating. But 3x ETFs such as the VelocityShares 3x Long Natural Gas ETN (NYSEARCA: UGAZ ) see losses equal to the contango multiplied by 3, meaning that some months may see as much as a 10% degradation in value of the fund and 40-50% over the course of a typical year. Without further adieu, here are the 7 most underperforming ETFs over the last year through January 23rd. To be clear, this is not a list of short sale candidates. Although these ETFs may underperform in the longer term, massive short term fluctuations of 300-500% can rapidly wipe out a portfolio and then some. Rather, this is list of leveraged ETFs that are poor long term holds, long or short, and should be avoided for this purpose and instead be used only by short-term traders. #7: Brazil: BRZU & EWZ Kicking off our list is the nation of Brazil, a country that can’t seem to catch a break. The pre-financial crisis darling of the BRIC and emerging market investors, the country is now mired in a malaise of high inflation, rising debt, and feeble growth. After holding steady during the first portion of the year, the iShares MSCI Brazil 1x ETF (NYSEARCA: EWZ ) took a beating as falling commodity prices and the re-election of president Dilma Rousseff over the pro-business challenger Aecio Neves hit the economy hard. Energy giant Petrobas (NYSEARCA: PRB ), the eighth largest component in the index, slid 42% over the last 12 months. Overall, EWZ fell 7.8% over the last year. The 3x leveraged ETF Direxion Daily Brazil Bull (NYSEARCA: BRZU ) would have been expected to fall 23.2% based on EWZ’s performance. However, the leveraged fund ended up sliding 43.9%, an underperformance of 20.7%. Figure 2 below shows the 1-year performance of BRZU vs. predicted BRZU performance vs. EWZ. (click to enlarge) Figure 2: 3x ETF BRZU Actual Performance vs. Predicted Performance vs. 1x ETF EWZ (Source: Yahoo Finance Historical Quotes) The underperformance of BRZU vs. EWZ can best be explained by the large daily moves in EWZ. Of the 252 day period of record, there were 35 days-or about 1 in 7-during which EWZ moved > 3%, corresponding to a 9% or greater change in BRZU, which, as discussed above, hastens the decay of a leveraged ETF. #6: Oil & Gas Services: ERY (Inverse) & XLE Clocking in at number six is the oil and natural gas service sector. The profit margin of stocks in this sector is tied to the price of oil, natural gas, and other petroleum-based products. Unsurprisingly, these companies had a rough tail end of 2014. The two largest holdings in the 1x ETF Energy Select SPDR (NYSEARCA: XLE )-Exxon Mobil (NYSE: XOM ) and Chevron (NYSE: CVX )-finished the last 12 months down 8.3% and 10.4%, respectively. As a result, XLE finished the year down 9.1%, its worst year since 2008. This should have been great news for the corresponding inverse 3x leveraged ETF, the Direxion Daily Energy Bear (NYSEARCA: ERY ), which would have been predicted to rally 27.4%. However, as Figure 3 below shows, the ETF gained an anemic 3.4%, an underperformance of 23.7%. (click to enlarge) Figure 3: 3x ETF ERY Actual Performance vs. Predicted Performance vs. 1x ETF XLE (Source: Yahoo Finance Historical Quotes) The reason for the disappointing return on the inverse ETF despite XLE’s poor performance is the path that the 1x ETF took to get there, which was effectively one giant reversal. XLE finished June 2014 up 14% on the year as the price of crude held near $100/barrel, and then slid 25% during the remainder of the year as oil prices collapsed. As discussed in the introduction to this article, large oscillations result in leveraged ETF underperformance. A rally followed by a large reversal such as seen in XLE is effectively an oscillatory pattern with a period of 1. #5: Silver: DSLV (inverse) and SLV On the surface, silver would seem to be an ideal commodity on which to base a leveraged ETF. It is less volatile than oil, natural gas, or other commodities and rarely trades in Contango. Unfortunately, however, ETFs based on silver are linked to silver and only silver. While equity-based ETFs have their funds distributed among up to 100 different stocks such that choppy trading in one or more equities tends to be smoothed out, commodity ETFs, as noted in the introduction, have 100% of their holdings in a single asset class. Choppy or oscillatory trading can therefore be devastating. The 1x ETF iShares Silver Trust (NYSEARCA: SLV ) traded down 9.1% over the last 12 months as the impending end of QE weighed on precious metals. However, the path to arrive at that mark was not linear. As figure 4 below shows, SLV had two small reversals in early February and June followed by a prolonged downtrend from July through mid-November, with a sharp rebound since. Overall, the ETF has been up as much as 9% and down as much as 24% over the past year. Based on SLV’s poor performance, the 3x inverse leveraged product-VelocityShares 3x Inverse Silver ETN (NASDAQ: DSLV )-should have had a gangbuster year, predicted up 27.3%. Unfortunately for DSLV longs, not only did the ETF not track SLV appropriately, it didn’t even finish with a gain, falling 7.7% on the year, for an underperformance of 34%. Particularly devastating was the snap rally over the last two months, as DSLV was up 89% as of the close on November 5, 2014. (click to enlarge) Figure 4: 3x ETF DSLV Actual Performance vs. Predicted Performance vs. 1x ETF SLV (Source: Yahoo Finance Historical Quotes) #4: Russia: RUSS (Inverse) and RSX Unless you’ve been living under a rock for the past 12 months, you know that 2014 is a year that Russia would like to forget. The conflict with Ukraine, subsequent sanctions, and the tumbling price of crude on which the Russian economy depends stretched the nation’s finances. The top two positions in the 1x ETF MarketVectors Russia (NYSEARCA: RSX )-Lukoil and Gazprom-are both oil and gas giants and were both down more than 30% on the year. Overall, RSX dropped 38.0% on the year. The 3x leveraged Inverse ETF Direxion Daily Russia Bear 3x (NYSEARCA: RUSS ) would be expected to have surged 114% based on the performance of RSX. However, the ETF only gained 42%, an underperformance of 72%. The poor performance can be attributed again to the combination of multiple large reversals and large daily moves. Figure 5 below shows the 1-year chart of RUSS actual vs predicted performance and RSX. (click to enlarge) Figure 5: 3x ETF RUSS Actual Performance vs. Predicted Performance vs. 1x ETF RSX (Source: Yahoo Finance Historical Quotes) The chart also offers a cautionary tale to short sellers targeting leveraged ETFs. Between September 15 and December 15, the ETF rallied from $10.45 to $48.14 including an intra-day high of $64.70, a climb of 522%. #3: Gold Miners: DUST (Inverse) & GDX Number three on our list is essentially a continuation of number five. The gold miners-of which GoldCorp (GG, Toronto), Barrick Gold (ABX, Toronto), and Newmont (NYSE: NEM ) are the largest holdings–represent a leveraged play on the price of gold itself. The price of gold (NYSEARCA: GLD ) is about flat over the last 12 months-up 2.0%. However, due to a longer term decline and concerns over future demand, the MarketVectors Gold Miners ETF (NYSEARCA: GDX ) is down a modest 8.0% over the same period. Once again, this should be good news for the inverse leveraged ETF-the cleverly named Direxion Daily Gold Miners Bear 3x ETF (NYSEARCA: DUST ). Based on GDX’s negative return, DUST should have gained 24%. Instead, however, it lost a massive 55% of its value, an underperformance of 79%. Figure 6 below shows the 1-year chart of DUST actual vs predicted performance and GDX. (click to enlarge) Figure 6: 3x ETF DUST Actual Performance vs. Predicted Performance vs. 1x ETF GDX (Source: Yahoo Finance Historical Quotes) While the distribution of its assets amongst multiple stocks compared to DSLV smoothed out daily chop somewhat, the fact that gold miners are very sensitive to the price of gold makes DUST a leveraged precious metals play with large daily moves. Over the last 12 months, the mean average daily move of DUST was an impressive 4.5% with 42 days with a 10% move or better. This is a daytraders delight, but spells disaster for the longer term investor. #2: Natural Gas: DGAZ (Inverse) and UNG In the same way that the leveraged silver ETFs suffer due to their dependence on a single commodity, so too do the leveraged natural gas ETFs. However, while the daily average move in the price of silver over the last 12 months was just 0.6% per day, natural gas was significantly more volatile with an average 1.46% daily change. Overall, the 1x UNG slid 34% thanks to record high production and anemic demand. However, there were two large countertrends, one in January and a second in November, each a rally of about 30%. These oscillations with large daily moves resulted in significant degradation of the Inverse 3x leveraged product, the VelocityShares 3x Inverse Natural Gas ETN (NYSEARCA: DGAZ ). Based on UNG’s performance, DGAZ would be predicted to gain 103.1% assuming perfect 3:1 tracking. However, the fund only returned 2.3%, an awful 100.1 percentage points of underperformance. Figure 7 below shows the 1-year chart of DGAZ actual vs predicted performance and UNG. (click to enlarge) Figure 7: 3x ETF DGAZ Actual Performance vs. Predicted Performance vs. 1x ETF UNG (Source: Yahoo Finance Historical Quotes) #1: Junior Gold Minors: JDST and GDXJ Holding the dubious distinction of Underperforming 3x Leveraged ETF of the Year is the Direxion Daily Junior Gold Miners Bear 3x ETF (NYSEARCA: JDST ), the 3x Inverse leveraged counterpart of the MarketVectors Junior Gold Miners 1x ETF (NYSEARCA: GDXJ ). If GDX was a leveraged play on GLD, then GDXJ is GDX on steroids. The junior gold miners-the majority of which are international companies with market caps under $2 billion-tend to leverage their operation with a fine margin and limited cash reserves, making their share prices exquisitely sensitive to changes in the price of gold. Figure 8 below compares the 1-year performance of GLD, GDX, and GDXJ. (click to enlarge) Figure 8: GLD vs. GDX vs. GDXJ over the last year (Source: Yahoo Finance Historical Quotes) Both Gold Miner ETFs track the price of gold, although GDX moved roughly 3x-5x the price of gold while GDX was closer to 2x GLD. Overall, GLD actually finished the year nearly flat, up 2%, while GDX fell 7.7% and GDXJ slid 25%. Based on this return, it would be expected that the Inverse leveraged JDST would have rallied 75%. However, thanks to the extreme volatility and large daily moves associated with JDST, the laggard ETF ended up falling 72.4%, a disastrous underperformance of 147.5 percentage points. Figure 9 below shows the 1-year chart of JDST actual vs. predicted performance and GDXJ. (click to enlarge) Figure 9: 3x ETF JDST Actual Performance vs. Predicted Performance vs. 1x ETF GDXJ (Source: Yahoo Finance Historical Quotes) Like fellow underperformer RUSS, however, JDST saw a rally from $9.6 to $41.83 from late July to early November, a 332% gain that would have destroyed any longer term short seller. Again, this is an ETF that should be avoided by all except short-term daytraders due to the likelihood of significant underperformance on the long side and the potential for career-ending losses on the short side. Table 1 below shows a summary of the bottom 7 underperforming leveraged ETFs. (click to enlarge) Table 1: Summary of underperforming ETFs I do not currently have any positions in any of the positions discussed above. I am capable of taking my own advice. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.