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Edited Transcript of NVL.TO^E07 earnings conference call or presentation 6-Aug-19 12:00pm GMT

Q1 2020 Novelis Inc Earnings Call

ATLANTA Aug 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Novelis Inc earnings conference call or presentation Tuesday, August 6, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Devinder Ahuja

Novelis Inc. - Senior VP & CFO

* Megan Cochard

Novelis Inc. - Director of IR

* Steven R. Fisher

Novelis Inc. - President & CEO

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Conference Call Participants

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* Abhijit Mitra

ICICI Securities Limited, Research Division - Analyst

* Amit A. Dixit

Edelweiss Securities Ltd., Research Division - Financial Analyst

* Bhaskar N. Basu

Jefferies LLC, Research Division - Equity Analyst

* Indrajit Agarwal

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Karl Blunden

Goldman Sachs Group Inc., Research Division - Senior Analyst

* Matthew Wyatt Fields

BofA Merrill Lynch, Research Division - Director

* Pinakin M. Parekh

JP Morgan Chase & Co, Research Division - Associate

* Rajesh V. Lachhani

HSBC, Research Division - Analyst

* Sean-M Wondrack

Deutsche Bank AG, Research Division - VP & Senior Credit Analyst

* Sumangal Nevatia

Macquarie Research - Former Senior Analyst

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Presentation

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Operator [1]

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Greetings and welcome to the Novelis Q1 FY '20 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded Tuesday, August 6, 2019.

I would now like to turn the conference over to Megan Cochard, Director of Investor Relations for Novelis. Please go ahead.

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Megan Cochard, Novelis Inc. - Director of IR [2]

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Thank you, Rita, and good morning or evening, everyone. Welcome to Novelis' First Quarter Fiscal Year 2020 Earnings Conference Call. Hosting our call today is Steve Fisher, our President and Chief Executive Officer, and Devinder Ahuja, our Chief Financial Officer. Following the presentation, the call will be open to analysts and investors for questions. This conference call is being broadcast on the Internet at novelis.com in the Investors section. A replay of this call will also be available on our website.

Before I turn the call over to Steve, let me remind you that today's earnings release and presentation include forward-looking statements as defined in the Private Securities and Litigation Reform Act of 1995. These statements are subject to risks and uncertainties. These risks and uncertainties include, but are not limited, to those factors identified in the release and in our filings with the Securities and Exchange Commission.

Today's presentation also includes certain non-GAAP measurements. Reconciliation of these measurements is provided in the financial statements included with our earnings release as well as in the appendix of our presentation.

Now let me turn the call over to Steve.

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Steven R. Fisher, Novelis Inc. - President & CEO [3]

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Thanks, Megan. And again, good morning or evening, everyone, and thanks for joining us today. I am pleased to share that Novelis delivered very strong financial and operational results in the first quarter of fiscal year '20. Driven by excellent operational performance through increased asset efficiency as well as a favorable market condition, we have again achieved record earnings.

The main key to our success is our focus on increasing operational efficiencies to best utilize our global rolling, recycling and finishing capacity, while also continuing to deliver high-quality products and excellent service to our customers. In doing so, we are growing shipments, optimizing our product portfolio, securing efficient metal supply and managing operational costs. On a trailing 12-month basis ending June 30, adjusted EBITDA exceeded $1.4 billion. This represents a 13% compounded annual growth rate over the past 5 years.

In addition to operational improvements to effectively and efficiently leverage our existing capacity, we have made significant progress on our previously announced organic capacity expansion projects. These include 300 kilotons of additional automotive finishing capacity between the U.S. and China, and 100 kt of additional rolling and 60 kt of additional recycling capacity in Brazil. All 3 projects are well underway and progressing on time and on budget.

And we are not just investing in capacity. We are also increasing our strategic investment in research and development. Our recently launched Customer Solution Centers in the U.S., Europe and China, demonstrate our commitment to collaborating with our customers to deliver a variety of strong, formidable and lightweight aluminum products to better compete against steel and other materials in the automotive industry. In addition, this innovation is expanding our reach in vehicle applications beyond hang-on parts.

In May, we introduce the market's first sheet-intensive battery enclosure solution for the growing electric vehicle market. And last week, we announced the introduction of a new high-strength lightweight alloy for automotive structures. Available globally as part of the advanced portfolio, this product meets exacting benchmarks for applications demanding high in-service strength such as A&B pillars, floors, roof rails and electric battery enclosures.

We have also increased the use of digital technologies to enhance our manufacturing processes and drive world-class operations that improve product quality, machine efficiency and recovery at our plants. We remain committed to optimizing our operations, completing our strategic investments and delivering high-quality product today, while introducing sustainable innovations and solutions to drive future growth.

Turning to Slide 4, I'd now like to share some more specific highlights on the key end markets in which we participate. Aluminum remains the most sustainable packaging material for beverage brands and demand trends are strengthening globally. These positive factors are a result of growth in emerging economies, including economic recovery in Brazil, urbanization in favorable package mix shift from other substrates to aluminum. New can sizes and new types of drinks - energy, sparkling water and craft beer, for example - are also driving new can demand. While difficult at this point to quantify, the industry is benefiting from increased consumer preference for more sustainable beverage package options, and there is no better choice than lightweight, infinitely recyclable aluminum.

In the automotive industry, trucks, SUVs, new energy vehicles and premium vehicles that typically have higher aluminum content, have continued to perform well globally. The U.S. market, in particular, continues to be very robust. While we are facing some challenges in Europe related to our exposure to one significant customer in the U.K., material substitution trends toward aluminum continue to grow share with OEMs. Lastly, the Chinese automotive market has also been challenging driven by the ongoing U.S./China trade dispute and lower consumer confidence. However, we do not expect this reduction in consumer demand to be prolonged. Where there are pockets of softness in automotive outside the U.S., we will utilize regional capacity to support stronger demand in the beverage, can and specialty markets.

The global specialty market is also experiencing strong demand for lightweight sustainable aluminum products. The North American market remains quite strong. However, other regions have seen increased competition from Chinese imports. With Novelis' global operations nearing capacity constraints, we are leveraging this opportunity to be more selective in the markets we participate and optimize our product portfolio to include more high margin products.

Now before I turn it over to Dev to provide a more in-depth financial review of the quarter, let me provide a quick update on our pending acquisition of Aleris. As you all know, last year Novelis entered into a definitive agreement to acquire Aleris. This is a significant acquisition for Novelis and it will drive many strategic benefits, from integrating our Asian operations to drive synergies to diversifying our portfolio to broadening our customer base.

We have received a number of regulatory approvals, including CFIUS approval in the U.S. However, we continue to work with the European Union, U.S. and China on an antitrust approval to close the transaction in a timely manner. As we work with the regulatory agencies, we now expect to close this transaction in the fourth calendar quarter of this year, subject to these approvals and customary closing conditions. And as previously disclosed, this transaction will be 100% debt financed by and integrated into Novelis.

We maintain a very diligent view to our balance sheet and are committed to staying within the net leverage parameters we have guided and reiterated since we announced this acquisition.

Now I'd like to turn the call over to Dev for a more detailed review of our first quarter financial results.

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [4]

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Thank you, Steve, and good morning or good evening. So turning to Page 7. We reported net income attributable to our common shareholder of $127 million in the first quarter of fiscal 2020, as compared to $137 million in the prior year. Excluding tax-affected special items in both years as outlined in the back of our earnings press release today, net income increased 26% to its highest ever level at $145 million. The largest of the items excluded is metal price lag, which was a positive $33 million in the first quarter of fiscal 2019, related to rapidly rising local market premiums in Q1 last year, as compared to a slight negative, $2 million in the current year period. The increase in net income, excluding special items, is primarily a result of an 11% increase in adjusted EBITDA to $372 million. I will discuss the main drivers of this improvement on the next slide.

On a per-ton basis, adjusted EBITDA increased 7% to a record high $448 in the first quarter of fiscal 2020. Net sales decreased 6%, to $2.9 billion driven by a 20% decline in both average LME aluminum prices and average local market premiums partially offset by a 4% increase in total flat rolled product shipments.

Turning to Slide 8. There are a multitude of factors impacting EBITDA this quarter, primarily related to the prior year as well. If you will remember that there were a couple of nonrecurring events that negatively impacted shipments in fiscal 2019. These included a 10-day national truckers strike in Brazil that temporarily halted production in our South American operations as well as unplanned customer downtime in the U.S. that resulted in some timing shift of North American automotive shipments from Q1 to Q2 of fiscal '19.

The positive impact from that easier shipment comp as well as continued strong demand, particularly in the global beverage can market, drove better capacity utilization and a $33 million benefit from volume. Favorable mix portfolio optimization efforts and higher specialty pricing, contributed an additional $32 million benefit.

Meanwhile, we are seeing in the cost line here, the impact from less favorable recycling benefits as compared to the historically high levels in the prior year. This is primarily the result of lower LME aluminum prices and local market premiums. While we are still seeing better-than-historical average scrap spreads in some regions based on high levels of supply, particularly in North America, these have also begun to rebalance as anticipated.

FX was a slight negative this quarter driven by negative translation in Europe and Asia, mostly offset by a more favorable hedged currency rate in Brazil.

And SG&A and other was negative $6 million, primarily driven by professional services related to strategic projects.

Now let's turn to cash flow, to free cash flow on Slide 9. Free cash flow before capital expenditures increased 36% to $68 million in the first quarter of fiscal 2020. This is mainly the result of higher adjusted EBITDA and lower working capital driven by lower aluminum prices and lower inventory levels. Partially offsetting these favorable factors is the negative $35 million metal price lag swing year-over-year embedded in the other row of this table, and other non-operational items.

Capital expenditures tripled year-over-year in the first quarter to $162 million, primarily to support significant capacity expansions underway in the U.S., China and Brazil. We continue to expect full year FY '20 capital expenditures to be approximately $700 million, which includes the significant portion of CapEx spend on those expansion projects.

Lastly, we ended the quarter with a strong liquidity level of $1.75 billion and a net debt to adjusted EBITDA leverage ratio of 2.5x.

On Slide 10, you will see some updated photos reflecting the progress we have made at each of the 3 major projects I just referenced. First is a $300 million, 200 kiloton greenfield automotive finishing line project in the U.S. Located in Guthrie, Kentucky, this facility is on track to begin the commissioning process towards the end of this fiscal year.

The $180 million, 100 kt automotive finishing line at our existing Changzhou facility in China, is also progressing well. Commissioning on this line is set to begin in fiscal '21.

And lastly, construction at our Pinda plant in Brazil, to add 100 kilotons of additional rolling capacity and 60 kilotons of additional recycling capacity is also under way. Commissioning of this $175 million project is on track to begin in fiscal 2021.

So with this, I'd now like to turn the call back over to Steve.

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Steven R. Fisher, Novelis Inc. - President & CEO [5]

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Thanks, Dev. In summary, Novelis has delivered another outstanding quarter. There is no doubt that lightweight, high strength aluminum remains a growing material of choice. With favorable market conditions, a diversified product portfolio, strong financial profile and commitment to delivering sustainable innovative solutions, Novelis is well positioned to meet growing demand in the marketplace. And many thanks to our customers and our employees around the world as we continue to deliver on our purpose to shape a sustainable world together.

With that, we're happy to take any of your questions.

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Megan Cochard, Novelis Inc. - Director of IR [6]

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Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Karl Blunden from Goldman Sachs.

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Karl Blunden, Goldman Sachs Group Inc., Research Division - Senior Analyst [2]

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Just on the regulatory approval time line there, we saw some noise, I guess some headlines from Europe indicating that potentially there'd either be some remedies or divestitures. Is that how we should interpret that?

And more broadly, what are the next milestones we should be looking at as you progress to that 4Q close?

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Steven R. Fisher, Novelis Inc. - President & CEO [3]

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Yes. So we're in continued discussions with the EU authorities. There is no public comment from either us or the commission at this point in time. So we continually are continued actively working with the DG comp in the EC as well as the U.S. and China, to constructively address any concerns that they may have and ultimately receive their clearance and close the transaction, as I said in the prepared remarks, by the end of this calendar year.

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Karl Blunden, Goldman Sachs Group Inc., Research Division - Senior Analyst [4]

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Fair enough on that. And then just on the financing [floor] with the acquisition, what are the latest thoughts there? I mean the credit market's been strong. I guess that would suggest that unsecured bonds are still your preferred means of financing.

And I guess on timing, is that something that would require final regulatory approval? Or as you get closer to that, you could potentially go ahead and raise that debt, given where capital markets are today?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [5]

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Yes, Karl. So therefore, we have already tied up our bridge financing. That is what will help us to close the transaction. That is fully in place at very competitive prices. We intend to do the refinancing as quickly as possible subject to market conditions, after we close the deal using the bridge line. Yes, we would like to really largely use the unsecured U.S. notes market, bonds market. And you're absolutely right, the market conditions are very favorable.

But then just given that we are in the middle of regulatory discussions, we would not like to rush into anything until we have clear line of sight. So we are keeping a very, very close watch on the markets, and we will strike at the right time.

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Operator [6]

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Our next question comes from the line of Rajesh Lachhani from HSBC.

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Rajesh V. Lachhani, HSBC, Research Division - Analyst [7]

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Many thanks for the opportunity and congratulation on a strong set of numbers. So 2 questions from my side. So the first one is, if we look at the EBITDA, [important] EBITDA, so the growth (inaudible) has been and value-driven by U.S., while the other regions are actually down y-on-y basis. So just wanted to understand the drivers for the same, and also whether this is sustainable. So that's my first question.

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [8]

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All right. So Rajesh, yes, your observation that U.S. has been really the big contributor is accurate. So what is really happening here? Let me try and explain to you. Number 1, you will remember that last year in this quarter, we had highlighted the fact that we are benefiting abnormally from the very high spreads. And the market conditions on the metal side at that time were very favorable. Metal prices were high and spreads were very good.

So one of the reasons why you find that in some of the other regions we have not seen the same kind of growth as we have seen in North America is that because of lower metal prices, spreads have rebounded. And this is entirely lower metal process, to be clear. The market conditions as far as recycling and availability of scrap is concerned, are still, I would say pretty good. So that is one.

The other thing is that there is also an element of other regions, like Europe, using their capacity to supply the North American market. So remember, in North America, we have no more capacity left. And therefore, we have Europe, for example, supporting North America inter-regionally. Now the dynamics that happen there is that some of the profit for Europe then gets captured because of inter-region supply and transfer pricing, it gets captured in North America. So you will see that there is a sharp drop in Europe versus last year. But part of the reason is that some benefit is being captured in North America, which enhances the profitability of North America.

But to keep it short and precise to your question, the one single largest reason for a year-on-year declining on some of the other regions, is just the rebalancing of metal prices. And that's really what is largely driving it.

Now regarding the sustainability question. You asked whether it's sustainable. This quarter is $448. If you look at it on a trailing 12-month basis, we are at the level of $425. So that should give you some indication there is some seasonality in these numbers.

What I would tell you is that we continue to assert that we will be able to sustain EBITDA per ton comfortably above $400 quarter-on-quarter, because of seasonality, because of maintenance shutdowns and other reasons, we could see some fluctuations. The level above $400 is pretty sustainable, I would say.

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Rajesh V. Lachhani, HSBC, Research Division - Analyst [9]

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Just a follow-up. So I didn't get why U.S. was already higher y-on-y basis. So Europe is already small. Like Europe, contribution will be very small, I assume. And specifically when 1Q last year was (inaudible), it shouldn't be that high. So clearly, EBITDA $170 million this quarter versus [$190] million the prior year, so . . .

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [10]

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Well, the U.S. is doing very well, Rajesh. I mean in U.S. we have great market conditions. Auto is doing very well. The demand on some of our leading platforms like F-150, is really very good, can continues to do well. The specialty market in U.S., is gaining from all the antidumping duties on China in particular. As a result of the good, favorable market conditions in North America, we are really benefiting, and that is what you see in the EBITDA.

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Rajesh V. Lachhani, HSBC, Research Division - Analyst [11]

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So can you just share the product mix this quarter versus the prior year, beverage can, auto, specialties, for all the regions combined?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [12]

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No, I will not get into precise details of the product mix. But I can give you a directional answer. As you would have seen, that can growth in this quarter is really very good. I would say that can is really doing well across all regions. In North America, we are doing very well as far as auto goes. In the other regions, we are impacted a bit. Like in China, it is really the trade war and the market conditions there are not really in the best of the times at this moment. In Europe, we are basically getting impacted by one single customer, who is experiencing some business challenges.

So largely, what I would say is that can is doing very well. We see nice tailwinds. In auto, North America is doing very well, and we continue to see an improvement of volumes and mix there. And specialties in North America is doing well, but, otherwise, we are doing some capacity optimization and bottom slicing in specialties in some of the other regions. That is a directional answer that I can give you on where the mix is going.

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Rajesh V. Lachhani, HSBC, Research Division - Analyst [13]

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Okay. So my second question is actually on Aleris [lead]. So basically, there's a delay of one quarter compared to what we were guiding earlier. So are we seeing some risk to this deal? And hypothetically, if the deal doesn't go through or there is a [remedy], we need to give some concession. So is there an option for us to go to still complete that deal with giving some of the assets and still complete the deal? Or we would take it as a whole and not leave anything out of the deal?

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Steven R. Fisher, Novelis Inc. - President & CEO [14]

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Yes. As I said on the previous question, we're actively working with the antitrust regulators in all 3 of those jurisdictions, U.S., EU and China. And I think we're doing it in a constructive manner to address their concerns. And the goal there is obviously to get their clearance and close the transaction, as we stated, in the fourth quarter of this calendar year.

Beyond that, right now we're just not going to speculate on anything else except staying focused and staying constructive with the regulators to get that clearance.

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Operator [15]

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Our next question comes from the line of Matthew Fields from Bank of America Merrill Lynch.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [16]

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Earlier you said that you're still working with authorities in the EU and in China. So I guess that implies you have not received sort of clearance by the Chinese regulatory authorities.

Can you talk a little bit about the Chinese process specifically and if you're sort of nervous that the U.S. and China tension would sort of taint that process?

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Steven R. Fisher, Novelis Inc. - President & CEO [17]

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Yes. I mean in China, the process is very similar to what you would find in the U.S. or EU, where you go through a multiple phase approach to review where there's overlap. In China, there's not significant overlap between the 2 companies, as there's primary aerospace production in China from the Aleris side and primarily or only auto on the Novelis side. There's a little bit of imports coming in that that does have just a little bit of an overlap to it.

Again, we constructively work with China. And I'd hate to speculate on anything political about that. I think we can just constructively work with them and believe that ultimately we'll receive the clearance and move forward with closure of the transaction.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [18]

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Okay. Great. Thank you. And then just for my understanding in the merger agreement. If you fail to get regulatory approval for whatever reason by any governmental agency, you're liable for $150 million termination fee to Aleris; is that right?

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Steven R. Fisher, Novelis Inc. - President & CEO [19]

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Yes, under the merger agreement that's filed, we are required, first, to offer remedies in the U.S. and Europe up to a certain threshold. To the extent that that would not satisfy a regulator, there is a break fee of $150 million in the U.S. and in Europe. In China, we are not required to offer remedies, and the break fee if we did not receive regulatory approval in China, would be $25 million.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [20]

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So it would be $150 million in the U.S. and $150 million in Europe?

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Steven R. Fisher, Novelis Inc. - President & CEO [21]

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No, they're not additive. It's only one.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [22]

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Right. Right. Sorry. And then aside from the transaction, we've been hearing a lot of complaints from can assemblers and sort of your customers on the can side, that they're almost not getting enough sheet. Specifically one that I know is buying cans from almost competitors.

Are you seeing an opportunity or a need to increase capacity on the can side? Something I guess was unthinkable 5 years ago.

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Steven R. Fisher, Novelis Inc. - President & CEO [23]

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Very true. Like our customers and, as we said in the opening remarks, we are seeing some strong demand in the mid- and I think longer term. I think globally we're thinking it's 3%. And I think what's unique about that, that's right now being driven more on package mix shift away from other substrates to cans, the introduction of new types of beverages that are coming out in aluminum cans and some potentially around sustainability. But we do think that that kind of growth could be even stronger in the event that we see even a stronger focus on plastics in the ocean and so forth, and moving towards what we see is a very sustainable package in infinitely recyclable aluminum.

We're seeing good growth rates in the U.S. I think just CMI in quarter 2 in the U.S. and Canada, saw beverage cans up 2.4%, which is year-over-year, which is 3 straight quarters of positive growth. Which to your point, we hadn't been seeing previously.

So with all of that, we are working actively with our customers trying to support them. As you know, we are expanding capacity in Brazil by 100 kt to support customer can growth. We will continue to find other ways to debottleneck, bottom slice our portfolio, if need be, and ultimately enter into whatever we need to do, JVs or alliances, in order to continue to support the beverage can growth. We do see this as a mid- to long-term strong market right now.

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Operator [24]

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Our next question comes from the line of Indrajit Agarwal from Goldman Sachs.

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Indrajit Agarwal, Goldman Sachs Group Inc., Research Division - Equity Analyst [25]

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I have a follow-up to the earlier question. Given the strong demand in the beverage can market, do you see a scenario of sustainable high price in this segment? And if you can also enlighten us on the pricing contract as in how long the contracts are? Are they revised every 6 months, 12 months, et cetera?

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Steven R. Fisher, Novelis Inc. - President & CEO [26]

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Yes. So I would say a few years back we saw kind of probably the bottoming out of prices around beverage cans. And I do think that right now we're in a more favorable pricing position as we go into negotiating with our customers. I'd specifically say that in North America and Europe. I think Asia still with over capacity remains a bit challenged. Overall, typically our can contracts vary around the world, but I would say they're typically in the 3-year range or a little bit longer. And as far as where we're at in that negotiating, all I would say right now is that we're in active discussions with a number of our customers, but we're not going to get into any further details around where those discussions lie.

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Operator [27]

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Our next question comes from the line of Pinakin Parekh from JPMorgan.

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Pinakin M. Parekh, JP Morgan Chase & Co, Research Division - Associate [28]

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My first question is on the (inaudible). Given that what we are hearing on comments on Europe and U.S., is there a clause where it allows Novelis to go back and relook at the transaction value based on the remedial measures that are being offered with the regulators? Or is the transaction value [filled] and that cannot be touched again?

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Steven R. Fisher, Novelis Inc. - President & CEO [29]

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Yes. Pinakin, we don't want to speculate on anything. As I've said earlier, we're very much actively working with the antitrust regulators in all 3 jurisdictions. I think we're doing it in a very constructive manner to address any of their concerns, and, ultimately, I believe we'll receive the clearances and, as we said, close the transaction in the fourth quarter. So I don't want to really speculate past that.

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Pinakin M. Parekh, JP Morgan Chase & Co, Research Division - Associate [30]

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Sure. And just reconfirm. Are all the approvals (inaudible) in the U.S. in place? Or are there approvals awaiting from the U.S. as well?

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Steven R. Fisher, Novelis Inc. - President & CEO [31]

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Yes. There are only 3 approvals required now in order to close the transaction, and they're all antitrust approvals. It's U.S. It's the European Union, which comes from the European Commission. And then it's China. And once we obtain those 3, then we can proceed to closing.

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Pinakin M. Parekh, JP Morgan Chase & Co, Research Division - Associate [32]

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Understood. And my last question just on North America profitability. Now the last 2, 2.5 years, we have seen a securer climb in North American profitability, combination of factors that you have highlighted, and also and the spread. Now the beverage can market is tightening, and this looks like there is not going to be an easy solution.

So if the auto sector holds out, can we see over the next 18 to 24 months, the profitability in the North American operations surge further from here, if the beverage can kicks in?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [33]

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Yes. Pinakin, how much better can it get from here? I mean we are at full capacity. We are experiencing historically some of the already best EBITDA levels in North America.

But here is how I would respond to your question. I think that one can be very reasonably sure about the fact that the can market is looking good and we see sustainably nice conditions on the can side. On the auto side, while there is a lot of talk about build rates going down, when asked to focus on the segments in which we operate, which is the large cars, the SUVs, pickup trucks, and there we see continued good market conditions. So we think that on the auto side, even if there is some slowdown, the aluminization and the fact that we are in platforms that continue to look good, means that we should be able to really continue to sustain or slightly improve the profitability levels.

On the specialty side, it is a trade situation. And who knows where this is going to go? So right for now, we are pretty optimistic. We see good pricing conditions because of things I mentioned earlier, the China antidumping duties and all the trade values. We think that at least for the foreseeable future, this advantage will continue.

Now the other optimization opportunity that we have is that we have capacities in Europe, for example, we have some spare auto capacity in Europe. And given the good market conditions in North America, we could leverage on that to further drive some more opportunities in the U.S. On specialty side as the current market conditions allow, we will continue to leverage other regions for optimizing the portfolio, using the nice conditions in the U.S. market, despite all the 10% duty and all of that.

So in short, what I can say is that U.S. should continue to look pretty good on the profitability side. Can they go much further up from here? Well, maybe not. But I think that we are at very nice levels.

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Operator [34]

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(Operator Instructions) Our next question comes from the line of Abhijit Mitra from ICICI.

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Abhijit Mitra, ICICI Securities Limited, Research Division - Analyst [35]

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Again the topic of the question is North America. So if you can help me understand. So what we read, that the specialty segment is growing double digit on the can side. And you're talking about an inter-regional transfer of spare capacity from Europe to U.S., to sort of take care of the demand in the specialty segment; is the understanding right?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [36]

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Yes. So when you say slight modification, when you say other regions to U.S., well, a bit of that is that. But the other part is that is that some of our other regions even supply directly to U.S. customers. So it is not like we supplying to our U.S. affiliate and then they're supplying to the end market. There are also direct supply opportunities. But yes, broadly, what you're saying is accurate.

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Steven R. Fisher, Novelis Inc. - President & CEO [37]

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From Europe to North America, that would be primarily auto.

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [38]

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Auto, correct.

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Steven R. Fisher, Novelis Inc. - President & CEO [39]

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Asia and South America would be helping out from a specialty standpoint.

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [40]

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Specialty side.

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Abhijit Mitra, ICICI Securities Limited, Research Division - Analyst [41]

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Got it. So this was my first question. Second question is, if you can help me understand. So earlier I remember the 10-Ks and all, used to give region-wise segmentation. Now given the buoyancy in the can segment, it can be more or less inferred that the mix in the portfolio is going to get heavier on the can side.

What sort of mix, change do you sort of foresee over the next few years towards cans, especially in North America?

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Steven R. Fisher, Novelis Inc. - President & CEO [42]

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Yes. So as I said earlier, we do see a lot of strength in beverage can on a global basis. And we certainly are doing what we can from a debottlenecking, getting more out of our assets from an efficiency standpoint, utilizing inter-regional capacity to serve the can market, expanding in Brazil right now 100 kt, primarily focused on beverage can.

So we also are expanding auto. So I wouldn't take it as can's going to grow outside the rest of the growth that we see in auto and some in specialties as well. But it's a stable, growing market. And we think that, ultimately, it'll be a significant portion, as it has been historically, of our portfolio going forward.

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Operator [43]

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Our next question comes from the line of Bhaskar Basu from Jefferies and Company.

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Bhaskar N. Basu, Jefferies LLC, Research Division - Equity Analyst [44]

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I had 2 questions. Firstly, on the product mix as you've been talking about the can business. [Backing into] some margins, auto should definitely be much better than can, isn't it?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [45]

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Correct. Yes, auto is better than can.

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Bhaskar N. Basu, Jefferies LLC, Research Division - Equity Analyst [46]

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And so in terms of if you have an option of optimizing your product mix, you would prefer more towards autos than can? And considering that your auto capacity's already constrained, the can business will not really grow; is that a fair understanding? Can volumes will not necessarily grow, given the market today?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [47]

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So Bhaskar, one thing to remember is that --

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Bhaskar N. Basu, Jefferies LLC, Research Division - Equity Analyst [48]

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Okay. Secondly --

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [49]

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Yes? Keep going.

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Bhaskar N. Basu, Jefferies LLC, Research Division - Equity Analyst [50]

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Yes. Sorry. Yes. Secondly, when you mentioned about the transfer from Europe and the profits getting captured, these are European volumes which used to directly supply to customers being replaced by Europe, North American volumes; is that what it is? Or . . .

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [51]

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Okay. So let me just answer the first question first, and then come to the second question. So want you to remember is that until the time of new auto capacities come up, we are constrained by how much capacity we have for now. We have 750 kt of total global capacity, and we are at levels which are close to 90-plus percent utilization.

So the question is that in North America, there are opportunities. But at the end, we will be constrained by how much capacities we have. So to the point about Europe, Europe has the ability for now to support North American demand, and that is what we are doing.

Now since it is connected to your second question, let me just quickly complete that. So it is thought that because we are fully utilized on capacity in North America, the extra demand that is still being generated because of good market conditions is being serviced from Europe. So it is not a replacement. It is basically additional demand. Because of capacity constraints, we are not able to fulfill it from the North American capacity, then, therefore, we use Europe to supplement that market, and, therefore, that is additional volumes coming, in short.

So on the broad question of mix, so you have to remember because all the time people seem to be thinking between auto and can, and what we are also doing now is we are bottom slicing some of the opportunistic volumes that we're slipping in just as fillers.

So in short, we are committed on the specialty side to the long-term customers to the profitable part of the business. But there is some part of the specialty business, which was basically filler volume, and that part we have the energy to move to meet additional can demand. So that is what we are doing.

So broadly what we think is that can and auto both will see some nice growth. Specialty will continue to see growth in the good markets and the profitable markets, but we will do some bottom slicing of the less profitable markets to focus on better product mix. So that is really directionally where we see things going.

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Bhaskar N. Basu, Jefferies LLC, Research Division - Equity Analyst [52]

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Understood. That's very clear. Just a clarification there. When you mentioned about Europe volumes being used to supply to meet U.S. demand, the profit's obviously captured in the European business, isn't it? Or is that [typically] U.S. business?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [53]

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I think that's exactly right. Part of it is captured there. But part of the margin is captures, especially when it's an inter-region supply, it's captured in the market where it sells.

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Bhaskar N. Basu, Jefferies LLC, Research Division - Equity Analyst [54]

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Okay. And just my final question. The Section 232 relaxation for Canada, has that helped you on your U.S. margin? Because I think you source part of the substrate from Canada.

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [55]

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Yes, for sure, it does help. And we don't have any noise of those duties, which we had a bit last year. So whatever we get from our Kingston plant in Ontario into North America, does not attract duties anymore. And in fact, in this quarter, we also got some refunds for the past duties for which we got an exemption. So that is sitting in the North American business, and that's a couple of million dollars. So yes, to your point, it has taken away from noise.

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Operator [56]

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Our next question comes from the line of Meera Midha from Edelweiss Financial.

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Amit A. Dixit, Edelweiss Securities Ltd., Research Division - Financial Analyst [57]

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This is Amit here. I have couple of questions. The first one related to your Asia division. We have seen good sequential improvement and profitability. So it has to do with the seasonality or is it sustainable going ahead? And what are the drivers for this one?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [58]

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So what I would say is that Asia is experiencing relatively better market conditions as compared to the past. We are seeing some nice demands in the Middle Eastern segment. Asia is also giving up some of the earlier unprofitable business where we were not able to pass on the local market premiums. And we are going in favor of customers, who now [observe] premium.

So overall, we think that in Asia a couple of factors are helping. One is a resurge in the can market. Of course that is an offset because the auto market isn't doing too well, but the can market has started to do very well and we are leveraging on the capacities to also supply to customers into Europe as an example.

Outside of that, the other thing that is helping the Asian markets is that they are supplying directly to U.S. customers. This is not inter-regional. But they have developed some nice sources of business in the U.S. on the specialty side, which is helping them to optimize and improve the mix. So in Asia, we are now fully capacity-utilized. And the opportunity is to bottom slice some of the low margin businesses, which is what we are doing. In short, Asia is moving to a nice sustainable level of much improved profitability.

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Amit A. Dixit, Edelweiss Securities Ltd., Research Division - Financial Analyst [59]

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Great. And the second question, sorry to push this Aleris question again. But the concern around here is that there have been [participants] the recent past wherein the similar endeavor was rejected by European Union, particularly because of auto concern, [and that in] metal space.

So how is [our] case going to be treated differently? Just wanting to understand that.

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Steven R. Fisher, Novelis Inc. - President & CEO [60]

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I mean I can't compare one case to another case. So that would be very difficult for me to do. Again, I think we're doing what we set out to do, and that's work with the regulators to help them understand the auto market, understand where the competition resides. We're doing it in a constructive manner to address any of their concerns, and believe that we'll receive the clearance and close the transaction by the end of this calendar year.

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Operator [61]

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Our next question comes from the line of Sumangal Nevatia from Kotak Securities.

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Sumangal Nevatia, Macquarie Research - Former Senior Analyst [62]

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I have 2 questions. One on the scrap space. Initially you mentioned that part of the spreads have reduced because of the [ore] prices, but some part, because of higher availability in U.S., because of the trade restrictions [are still there].

So is it possible to give a rough quantification of this contribution to the $170 million EBITDA in North America? And I mean in case (inaudible), I mean what is the headwind and what the [end] margins or absolute EBITDA?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [63]

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No. I think I need to clarify. There's nothing here to indicate any reversal. Let me just lay the situation out to you. I think what I was saying earlier is that a year ago, we had 2 conditions prevailing - one is very high metal prices and the other was very nice margins or spreads.

Now what has gone away this year is the high metal prices. And what we continue to see, not just in North America, and this has nothing to do with the duties, it is just that in North America, we have good availability of recycled material, just given that there is not enough ability to absorb the scrap that is being generated in North America. So it is good supply conditions.

So there has been a bigger rebalancing on the metal prices, which have taken away some of the margins that we were enjoying last year on a relative basis. But last year's levels were way above any historical levels, and we did not even think it was sustainable. So we clearly called it out. If you remember from the call last year, it was that there was almost like a $20 of margin sitting there per ton, and that has gone away. So you can think that that $20 sort of (inaudible) that we were enjoying is not there in the current numbers. But there's nothing that we would like to take out from the current numbers because we expect that metal prices over time will sort of balance out. They are at low levels now. They will balance out. We expect that at some point it will go up. Even if there's some rebalancing of the spread margins, it should be okay.

So in short, at least for the time being, we are seeing the recycling spread as pretty sustainable. Supply conditions should continue to look good, and that's really what it is. I would not quantify the exact impact of those margins. I mean, as I said, there's nothing very unsustainable in the current EBITDA numbers, and that's what I would stay at.

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Sumangal Nevatia, Macquarie Research - Former Senior Analyst [64]

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But this [includes] supply situation which you've explained very well. Isn't restriction by China and then [broader] scrap by U.S., isn't that a contributor to the improved supply situation in [Europe]?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [65]

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Well, absolutely. But then that condition is likely to continue. We don't expect that China will start importing scrap again. They have been very clear that they don't want to be the country which is collecting everybody's scrap. So therefore, I think that they have made their policy pretty clear.

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Sumangal Nevatia, Macquarie Research - Former Senior Analyst [66]

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Understood. That's very helpful. As a second question, under what on recycle contends, if you could share what [possibly have you] reached. And do we have headroom to increase more, leaving the Brazil expansion out?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [67]

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Yes. So we continue to grow on our recycle content. That is what I can tell you. I mean we are -- or I will not get very precise, but we are in the region of 60-plus percent on recycle content in total. And we expect that, with some new recycling capacities coming in Brazil, 60 kt of additional recycling capacity coming in Brazil, the recycle content will go up. Also in Asia, we are doing some optimization of recycling capacity, which will allow us to absorb more recycled material. So we are continuing to push for new opportunities to improve recycling. I will not get to any target number.

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Sumangal Nevatia, Macquarie Research - Former Senior Analyst [68]

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Understood. So even without the Brazil capacity, which will come next year, we have excess capacity and some optimization opportunities, to keep infusing this recycled [contend] number, right?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [69]

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Correct. I mean we are using some optimization opportunities to continue growing recycle content. I mean there's not much more, to be clear. But there is some optimization opportunity, and we continue to work towards that. We continue to focus on productivity of our recycling assets, which gives us some opportunities all the time.

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Operator [70]

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Our last question comes from the line of Sean Wondrack from Deutsche Bank.

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Sean-M Wondrack, Deutsche Bank AG, Research Division - VP & Senior Credit Analyst [71]

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Just one here. If you look at some of the major market surveys, they have North American auto production down, it looks like low single digits on average this year.

What are you seeing sort of in the U.S. and European end market? And can you continue to grow penetration in the face of a general market decline? Thank you.

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Steven R. Fisher, Novelis Inc. - President & CEO [72]

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Yes. So first of all, you have to make sure you understand the mix of where aluminum has more content on vehicle, even in the U.S. market - SUVs, trucks, larger vehicles. And that segment is still forecasted to be strong, and we've seen the strength in that in the first half of this calendar year. We see that strength continuing in the U.S. market. We do continue to see more opportunities. We're contracting very well on our new Guthrie line of 200 kt. So we continue to see the penetration of aluminum hang-ons, and now, hopefully, more structural parts coming into these vehicles over time.

In Europe, we continue to see a healthy market and broader European marketplace. We've seen that in the first half of this year as well. We have a little bit over exposure to a specific customer in the European Region that's impacting our numbers more specifically, but not the broader market condition.

And then in China, I think it's now 13 months of -- well, I think we saw the first year-over-year increase in 13 months, I think, 12 or 13 months. So we do feel as though the Chinese market has bottomed out, and we see a huge amount of opportunity there in electric vehicles as the market recovers and aluminum continues to penetrate.

So overall, we feel pretty good about the aluminum auto market, both in the near term and in, obviously, the prospects of us continuing to work with OEMs to find lighter, stronger alloys to serve them on their automobiles.

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Operator [73]

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Mr. Fisher, I will now turn the call back to you. Please continue with your presentation or closing remarks.

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Steven R. Fisher, Novelis Inc. - President & CEO [74]

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Great. I just want to thank everyone for participating on the call this morning. This is a very exciting time in our company. And thanks to our committed employees, we continue to achieve record operational performance, driving customer satisfaction and innovation, which is ultimately seen in the record financial results that we reported this quarter.

We firmly believe we are making the right strategic investments in capacity, serving our customers, innovating with our customers that's going to position Novelis for a very sustainable future growth. So with that, we'll speak with you again in another quarter.

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Operator [75]

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That does conclude the conference call for today. We thank you for your participation, and ask that you please disconnect your lines.