Third quarter 2008: Result hit by falling markets and input cost pressures

Hydro's underlying income from continuing operations was NOK 968 million in the third quarter of 2008, down from NOK 1,335 million in the previous quarter and NOK 2,114 million in the same quarter last year, mainly due to seasonally lower demand in weakening markets and continued pressure on upstream input costs.

October 21, 2008

 "The global financial crisis and uncertainty in world commodity markets have affected our results for the third quarter and will continue to do so in the coming quarters," said Hydro President and CEO Eivind Reiten.

"Our solid financial position and strong operational performance are even more valuable in today's challenging environment, enabling us to pursue growth opportunities that may arise."

Underlying EBIT in the third quarter was NOK 1,490 million, compared to NOK 1,619 million in the second quarter and NOK 2,686 million in third quarter 2007. Hydro's commercial activities, which include the company's sourcing and trading activities, are heavily exposed to market volatility and incurred an underlying loss for the quarter.
 
"Cost and margin management remain on top of our agenda," Reiten said. "Presently, we are cutting costs and reducing production of remelted metal in response to market developments. Operations that do not deliver sufficient returns over time will be restructured."
 
Underlying EBIT for Aluminium Metal's upstream operations increased from the previous quarter due to higher realized aluminium prices, but these gains were partly offset by higher operating costs and lower casthouse sales volumes in a difficult market for metal products. Results for bauxite and alumina operations rose due to the successful start-up of the third expansion of the Alunorte alumina refinery. Results for commercial operations dropped significantly reflecting weak market conditions and negative trading and hedging activities.
 
Hydro's joint venture with Qatar Petroleum on the 585,000-tonne Qatalum smelter project, in which Hydro owns 50 percent, was about 41 percent complete by the end of the third quarter. The plan for start-up is around year-end 2009 with ramp up to full production during 2010.
 
Results in Aluminium Products declined compared to the previous quarter due to lower seasonal demand. Overall operating performance remained strong, with stable margins and sales volumes outperforming the market in important segments. Margins remained firm for Rolled Products and European extrusion operations, but the US extrusion business remained at depressed levels. Automotive incurred an underlying quarterly loss due to a sharp decline in key European markets and in the United States.
 
Energy delivered strong results in the third quarter, mainly due to higher electricity spot prices. Power prices rose in the quarter due to lower overall hydropower production in Norway and Sweden and continued high fuel costs and power prices in continental Europe. Hydro's hydropower production was above normal during the third quarter, but production volumes declined somewhat from the unusually high levels seen in the previous quarter.
 
Net cash provided by operating activities was NOK 3.8 billion for the first nine months of 2008, down from NOK 10.1 billion in the same period last year, mainly due to increased inventory levels and lower realized gains on currency derivatives, in addition to the development in EBIT.

Key financial information
NOK million, except per share data Third quarter 2008 Second quarter 2008 % change prior quarter Third quarter 2007 % change prior year quarter First 9 months 2008 First 9 months 2007 Year
2007
                 
Revenue 21,765 23,980 (9) % 21,966 (1) % 67,275 72,665 94,316
Earnings before financial items and tax (EBIT) 2,414 708 >100% 2,013 20 % 4,300 8,687 9,025
Items excluded from underlying EBIT (924) 911   673   840 (233) 1,128
Underlying earnings before financial items and tax (EBIT) 1,490 1,619 (8) % 2,686 (45) % 5,141 8,454 10,153
Underlying earnings before financial items and tax (EBIT) :                
Aluminium Metal 932 953 (2) % 2,182 (57) % 3,139 6,931 8,265
Aluminium Products 322 535 (40) % 288 12 % 1,228 1,278 1,352
Energy 475 270 76 % 207 >100% 1,144 842 1,184
Corporate, other and eliminations (239) (140) (71) % 9 >(100)% (371) (598) (647)
Underlying earnings before financial items and tax (EBIT) 1,490 1,619 (8) % 2,686 (45) % 5,141 8,454 10,153
Income from continuing operations 233 902 (74) % 2,792 (92) % 2,578 8,631 9,158
Underlying income from continuing operations 968 1,335 (27) % 2,114 (54) % 3,745 6,611 8,015
Earnings per share from continuing operations 0.10 0.70 (86) % 2.20 (95) % 1.90 6.80 7.20
Underlying earnings per share from continuing operations 0.70 1.00 (30) % 1.60 (56) % 2.90 5.10 6.20
Financial data:                
Investments 2,443 1,553 57 % 1,305 87 % 6,264 3,033 5,206
Adjusted net interest-bearing debt (5,455) (2,051) >(100)% (3,841) (42) % (5,455) (2,051) (757)
 
Operating statistics 
  Third quarter 2008 Second quarter 2008 % change prior quarter Third quarter 2007 % change prior year quarter First 9 months 2008 First 9 months 2007 Year
2007
Realized aluminium price LME (USD/mt) 2,846 2,699 5 % 2,597 10 % 2,664 2,597 2,559
Realized aluminium price LME (NOK/mt) 15,112 14,008 8 % 15,512 (3) % 14,202 16,633 15,522
Primary aluminium production (kmt) 439 437 0 % 435 1 % 1,309 1,304 1,742
Rolled Products sales volumes to external market (kmt) 240 259 (7) % 254 (6) % 752 784 1,030
Extrusion sales volumes to external market (kmt) 122 133 (8) % 123 (1) % 385 391 508
Automotive sales volumes to external market (kmt) 26 31 (15) % 29 (10) % 87 87 117
Power production (GWh) 2,677 3,021 (11) % 3,294 (19) % 8,548 8,697 11,018


 
Reported EBIT and income from continuing operations

EBIT for Hydro amounted to NOK 2,414 million in the quarter, which was substantially higher than second quarter EBIT of NOK 708 million. EBIT was impacted by significant net unrealized gains on power contracts of about NOK 1 billion compared with unrealized losses of about NOK 2 billion in the second quarter of 2008. The substantial unrealized gains resulted primarily from a decline in the forward price for coal during the quarter. The second quarter of 2008 also included substantial unrealized gains on LME derivatives of NOK 340 million and divestment gains amounting to about NOK 390 million.
 
Income from continuing operations amounted to NOK 233 million in the third quarter compared with NOK 902 million in the previous quarter. Income from continuing operations included net unrealized and realized foreign exchange losses amounting to NOK 2,015 million in the quarter compared with net foreign exchange gains of NOK 298 million in the second quarter.

Market developments and outlook

In July, LME three-month aluminium prices increased sharply reaching a new all time high of USD 3,380 per mt in July. However, turmoil in the financial markets and growing concerns and uncertainty about the future development of the global economy sent the price downward closing the quarter at USD 2,425 per mt. Since the end of the third quarter prices have weakened further. For Hydro, the strengthening US dollar has mitigated the effect of the price decline to some extent, when measured in Norwegian kroner. The lower price environment compared to production costs for the industry is expected to lead to capacity curtailments and a potentially more balanced aluminium market over time..
 
Activity in the main European markets for metal products (extrusion ingot, sheet ingot, foundry alloys and wire rod) was seasonally low during the summer months and did not recover as expected in September. We expect a more significant weakening of market conditions for the remainder of 2008 due to slowing demand from all main end use segments for metal products in Europe, in particular the automotive and building market segments which we expect to be heavily impacted by the turbulence in the credit markets. Weak market conditions in the US are expected to continue and deteriorate further.
 
Our business activities expose us to the risk that one or more counterparties will default on their obligations, resulting in direct financial loss, unexpected increase in market exposure or higher operating costs. Weak and deteriorating economic conditions on a global, regional or industry sector level, combined with challenging financial markets, increase the risk of defaulting counterparties. We have not experienced any significant defaults at present. We are carefully monitoring the situation and are not aware of any such defaults.
 
Hydro has a strong liquidity position. Due to our planned investment level and potentially lower cash generated from operations in the challenging market situation, we expect a reduction in our cash position over the coming quarters.

Aluminium Metal

Underlying EBIT for Aluminium Metal was impacted by higher aluminium prices but also higher operating costs for our primary metal operations and lower volumes from our casthouses. Results for our commercial operations declined significantly resulting in an underlying loss for the period. Our bauxite and alumina business delivered improved underlying results following the start-up of the third expansion at the Alunorte alumina refinery.
 
Underlying EBIT for Bauxite and Alumina improved from the second quarter of 2008 and was slightly lower than the comparable result in third quarter 2007. Underlying results for Alunorte improved due to higher production volumes and somewhat higher alumina prices. Underlying results for Alpart were down compared to the second quarter of 2008 and third quarter of 2007 due to higher energy costs.
 
LME prices increased both in US dollars and Norwegian kroner during the quarter from the previous quarter, positively impacting underlying results for our primary metal operations. Variable costs relating to the production of primary metal increased, mainly due to higher alumina costs which are indexed to primary aluminium prices, and substantially higher carbon costs. Fixed costs declined partly due to an adjustment in the allocation of corporate overhead costs. Production volumes were stable, but sales volumes of casthouse products were seasonally lower and impacted by increasingly difficult market conditions. Underlying EBIT declined compared with third quarter 2007, impacted by lower realized prices measured in Norwegian kroner and higher operating costs.
 
Our Commercial operations delivered an underlying loss in the quarter impacted by seasonally lower volumes and an increasingly difficult metal products market. Results for the quarter also included net negative realized and unrealized effects of about NOK 160 million relating to derivative instruments used to mitigate the risk of backwardation losses on our operational hedging and aluminium trading activities.
 
Underlying EBIT for Aluminium metal for the first nine months of 2008 was heavily impacted by lower realized aluminium prices measured in Norwegian kroner due to the significantly lower US dollar.

Outlook

During the quarter, the deepening financial crisis and increasing economic uncertainties had a negative impact on aluminium price developments while activity by financial investors exacerbated market volatility. This situation will likely continue while governments work to stabilize and reinforce the financial markets. Over the longer term, prices will be influenced by the effect of the financial crisis on general economic developments. However, the strengthening US dollar has mitigated the effect of the price decline when measured in Norwegian kroner.
 
The aluminium industry has experienced an unprecedented increase in the price of key cost components driven by higher prices for energy and natural resources. The current low aluminium price environment compared to high production cost for marginal capacity presents a challenging situation for aluminium producers and is likely to result in capacity curtailments. Over time, cost input-factors for aluminium smelters will be affected by the deteriorating economic developments. However, contractual arrangements and time lags in production and logistic processes will result in relatively higher costs in the next quarters.
 
In China, aluminium producers are affected by Shanghai Futures Exchange (SHFE) prices that are presently below production cost for a large number of smelters in China. The new Chinese export duty on alloyed primary aluminium has lead to a surplus of metal, putting additional downward pressure on domestic Chinese aluminium prices. China's apparent consumption of primary metal is forecasted to increase by 10 to 12 percent for the full year of 2008, down from an extraordinarily high annual growth rate of 38 percent in 2007. Estimated production growth of 12 to 14 percent will depend on the energy supply situation and ongoing efforts by the Chinese authorities to moderate the expansion of primary capacity and primary metal exports. Forecasted production and consumption were adjusted downwards since the last quarter partly due to voluntary reductions in production, for energy conservation due to China's hosting of the Olympics. In addition, the negative economic developments have also affected China. We continue to expect a gradual increase in Chinese net exports of flat rolled semi-fabricated and fabricated products due to cost advantages and export duty incentives.
 
At present, global consumption of primary aluminium is estimated to grow approximately 5 percent in 2008. In general, the financial crisis may have a substantial negative impact on the global aluminium demand in the short and medium term. 

Aluminium Products

Underlying EBIT for our Aluminium Products business decreased from second quarter of 2008, mainly due to an expected seasonal decline in demand during the quarter. However, our overall operating performance remained sound with good margins and volumes outperforming the market for important regions and market segments.
 
Due to the seasonal decline in shipments, our Rolled Products and Extrusion businesses delivered lower underlying results for the quarter compared to the second quarter. Margins, however, remained firm. Results for our North American operations remained at depressed levels, while the positive developments for our South American business continued. Our Automotive operations incurred an underlying loss compared to a break-even level in second quarter of 2008 due a sharp decline in key European markets and in the US.
 
Margin improvements, mainly in general engineering, offset lower volumes and higher energy and raw material costs for our Rolled Products operations, but a softer US dollar had a negative impact on the results compared to the third quarter and first nine month of 2007. Our European extruders delivered continued high margins and stable volumes compared to the third quarter and first nine months of 2007, outperforming a generally declining market in certain areas. Our recent acquisitions in Spain contributed positively to results for the periods. Underlying EBIT for the first nine months for our US extrusion operations improved substantially compared to the same period of last year. Results for our Automotive operations declined compared to both the third quarter and first nine months of 2007 mainly due to reduced volumes and costs related to start-up activities for new product lines in our automotive structures business as well as costs to align capacity to current market conditions.

Outlook

Market demand for flat rolled products in Europe is expected to decline beyond normal seasonality during the coming months, mainly driven by lower demand from the automotive and engineering market segments. The current strengthening of the US dollar should reduce pressure on margins from potential US exports into Europe. Increasing cost pressure above the current rate of inflation, mainly driven by increasing energy and raw material prices, continues for the rolling industry. However, volatility and uncertainty in the commodity markets will impact cost developments going forward.
 
The overall outlook for the European extrusion market indicates a further softening of demand driven by a weak automotive and construction market, particularly in southern Europe. The negative market outlook could put further downward pressure on margins in the months to come. The outlook for the US extrusion market remains depressed, with no signs of recovery. South American markets are expected to experience continued growth, but at a lower pace.
 
The European automotive market is experiencing a significant downturn and most of the original equipment manufacturers have announced production cuts to compensate for the decline in the demand for new cars. The North American market is showing no signs of recovering from the low demand levels of previous quarters. The formerly robust markets in Asia and South America are also showing signs of weakening.
 
The expanding world-wide financial crisis is resulting in significant market uncertainty, in particular the capital intensive transport and building markets which we expect to be heavily impacted by the turmoil in the credit markets.

Energy

Underlying EBIT for Energy improved significantly from the second quarter of 2008 mainly due to higher electricity spot prices. Although power production has been higher than normal during the third quarter, production volumes declined somewhat from the second quarter, partly offsetting the effects of increasing prices. The improvement compared with the third quarter of 2007 is explained by substantially higher spot prices in southern Norway.
 
Direct power production costs were largely unchanged from the second quarter, but lower than in the third quarter of 2007 due to lower transmission costs.
 
Hydro's solar activities recorded an underlying loss of NOK 19 million in the third quarter of 2008 compared with a loss of NOK 36 million in the second quarter and a loss of NOK 11 million in the third quarter of 2007.

Outlook

Lower than normal reservoir levels, colder weather and high thermal fuel costs indicate support for continued high electricity prices in the Nordic region through the fourth quarter and into the winter season. The Nordic power market is, however, expected to remain highly volatile due to uncertainty in hydrological conditions and other factors.
 
Water reservoir levels in Norway were reported at 82 percent of full capacity at the end of the third quarter, which is 6 percent lower than the normal level at the time of the year. The transmission import/export capacity from southern Norway is still significantly reduced, but the Norwegian system operator, Statnett, expects all lines to be fully operational before year end.
 
Due to lower than normal water levels in the reservoirs, Hydro's power production is expected to be significantly lower in the fourth quarter compared with the preceding quarters of 2008. However, production volumes will also be influenced by precipitation and electricity price developments during the period.

Corporate, other and eliminations

Underlying EBIT for Corporate, other and eliminations amounted to a negative NOK 239 million in the quarter compared with a negative NOK 140 million in the second quarter of 2008 and a positive NOK 9 million in the third quarter of 2007. The amount for the third quarter included charges of NOK 150 million relating to a change in the allocation of corporate overhead costs. This amount is offset by positive adjustments included in underlying EBIT for the business areas, mainly Aluminium Metal (NOK 89 million) and Aluminium Products (NOK 76 million). Legal costs relating to the investigation pertaining to our former Libya operations of approximately NOK 40 million also impacted underlying EBIT for Corporate, other and eliminations in the third quarter. Total cumulative legal fees relating to the investigation were about NOK 100 million of which NOK 93 million has been charged in 2008.

Items excluded from underlying EBIT and income from continuing operations

To provide a better understanding of Hydro's underlying performance, the items in the table below have been excluded from EBIT (earnings before financial items and tax) and income from continuing operations.
 
Items excluded from underlying EBIT are comprised mainly of unrealized gains and losses on certain derivatives, impairment and rationalization charges, effects of disposals of businesses and operating assets, as well as other items that are of a special nature or are not expected to be incurred on an ongoing basis.
 

Items excluded from underlying income from continuing operations
NOK million Third quarter 2008 Second quarter 2008 Third quarter 2007 First 9 months 2008 First 9 months 2007 Year
2007
             
Unrealized derivative effects on LME related contracts 35 (340) 333 (864) 31 131
Unrealized derivative effects on power contracts (1,038) 1,997 265 2,249 262 928
Unrealized derivative effects on currency contracts 150 (110) (35) 50 (132) (137)
Metal effect, Rolled Products (38) (247) 55 (171) (65) 235
Significant rationalization charges and closure costs - - 20 - 169 224
Impairment charges - - - - 144 144
(Gains)/losses on divestments (34) (389) 40 (423) (636) (641)
Correction of elimination of profit in inventory - - (5) - (5) 291
Germany, change in tax rate - - - - - (47)
Items excluded from underlying EBIT (924) 911 673 840 (233) 1,128
Net foreign exchange (gain)/loss 2,015 (298) (1,199) 862 (2,180) (2,254)
Calculated income tax effect (355) (181) 98 (536) 643 283
Germany, change in tax rate - - (250) - (250) (300)
Items excluded from underlying income from continuing operations 735 432 (678) 1,167 (2,020) (1,143)

Finance

Net foreign currency losses for third quarter 2008 mainly related to the effects from Hydro`s hedge program as a result of the strengthening of US dollar against Norwegian kroner and Euro.

Interest income declined in the third quarter compared to the second quarter of 2008 mainly due to lower cash balances. Interest income was lower compared with the third quarter of 2007 due to lower cash balances following the payment of the demerger debt to StatoilHydro. Interest income for the first nine months of 2008 declined compared to the same period of last year for the same reason.

Tax

Income tax expense amounted to NOK 201 million in the third quarter compared with NOK 248 million in the second quarter of 2008 and NOK 765 million in the third quarter of 2007.
 
Income tax expense was 46 percent of Income from continuing operations before tax in the second quarter compared with 22 percent in the second quarter of 2008 and 22 percent in the third quarter of 2007. The high percentage in the quarter resulted from relatively high results from our power operations which is subject to sur-tax of 30 percent. The relatively low tax percent in the second quarter resulted mainly from the effect of a tax free gain on the sale of Hydro's former internal service units. Income tax expense in the third quarter 2007 was positively impacted by a reduction of statutory tax rates in Germany.

Press contact
Contact: Erik Brynhildsbakken
Telephone: +47 22538301
Cellular: +47 41751271
E-mail: Erik.Brynhildsbakken@hydro.com

Investor contact
Contact: Stefan Solberg
Telephone: +47 22539280
Cellular: +47 91727528
E-mail: Stefan.Solberg@hydro.com


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Certain statements included within this announcement contain forward-looking information, including, without limitation, those relating to (a) forecasts, projections and estimates, (b) statements of management’s plans, objectives and strategies for Hydro, such as planned expansions, investments or other projects, (c) targeted production volumes and costs, capacities or rates, start-up costs, cost reductions and profit objectives, (d) various expectations about future developments in Hydro’s markets, particularly prices, supply and demand and competition, (e) results of operations, (f) margins, (g) growth rates, (h) risk management, as well as (i) statements preceded by “expected”, “scheduled”, “targeted”, “planned”, “proposed”, “intended” or similar statements.

Although we believe that the expectations reflected in such forward-looking statements are reasonable, these forward-looking statements are based on a number of assumptions and forecasts that, by their nature, involve risk and uncertainty.  Various factors could cause our actual results to differ materially from those projected in a forward-looking statement or affect the extent to which a particular projection is realized.  Factors that could cause these differences include, but are not limited to: our continued ability to reposition and restructure our upstream and downstream aluminium business; changes in availability and cost of energy and raw materials; global supply and demand for aluminium and aluminium products; world economic growth, including rates of inflation and industrial production; changes in the relative value of currencies and the value of commodity contracts; trends in Hydro’s key markets and competition; and legislative, regulatory and political factors.

No assurance can be given that such expectations will prove to have been correct.  Hydro disclaims any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.


Updated: October 11, 2016