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Edited Transcript of NVL.TO^E07 earnings conference call or presentation 6-Nov-19 12:30pm GMT

Q2 2020 Novelis Inc Earnings Call

ATLANTA Nov 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Novelis Inc earnings conference call or presentation Wednesday, November 6, 2019 at 12:30:00pm 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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* Amit A. Dixit

Edelweiss Securities Ltd., Research Division - Financial Analyst

* Anuj Singla

BofA Merrill Lynch, Research Division - VP in Equity Research

* Indrajit Agarwal

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Matthew Wyatt Fields

BofA Merrill Lynch, Research Division - Director

* Rajesh V. Lachhani

HSBC, Research Division - Analyst

* Ritesh Shah

Investec Bank plc, Research Division - Analyst

* Sumangal Nevatia

Kotak Securities (Institutional Equities) - Analyst

* Vishal Chandak

Emkay Global Financial Services Ltd., Research Division - Research Analyst

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Presentation

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Operator [1]

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Welcome to the Novelis Q2 FY '20 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded Wednesday, November 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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Thanks, Cathy, and good morning or good evening, everyone. Welcome to Novelis' Second Quarter Fiscal Year 2020 Earnings Conference Call.

Hosting our call today is Steve Fisher, our President and Chief Executive Officer; and Dev 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 from the Internet at novelis.com in the Investors section. The 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 good morning or evening, everyone, and thanks for joining us today.

Novelis delivered another set of very strong financial and operational results in the second fiscal quarter, the result of excellent operational performance across the business. By leveraging digital technologies and implementing world-class manufacturing processes, we are making broad operational improvements across our asset base, driving up recovery levels, safely reducing defects in improving product quality. In turn, this unlocks incremental capacity at the plants while also increasing customer satisfaction levels, allowing us to sell more product into the market.

And our key end markets of can, automotive and specialties have broadly remained favorable. While there continue to be some pockets of softness in non-U. S. auto markets, overall demand for aluminum sheet remains quite healthy. This is particularly true in the beverage can sheet market, where consumer demand for a sustainable packaging options continue to grow. With a relentless focus on operational improvement, favorable market conditions and strong customer demand for quality sustainable aluminum products, we are achieving new record operating and financial results.

On a trailing 12-month basis ending September 30, adjusted EBITDA exceeded $1.4 billion, while shipments have grown to over 3.3 million tons. At the same time, we continue to strengthen our balance sheet, enabling our business to withstand pockets of weakening economy sentiment. Not only are we sustaining very strong liquidity levels, but we further reduced our net leverage down to 2.4x by quarter end.

While the focus on improving existing operations is driving results today, we are also excited about the excellent progress we are making against our strategic initiatives to fuel future growth. All 3 of our previously announced significant organic capacity expansion projects underway remain on track and on budget. These include new automotive finishing lines in the U.S. and China, which, combined, will add approximately 300 kilotonnes of additional automotive finishing capacity as well as the rolling and recycling capacity expansion underway at our Pinda plant in Brazil. This new capacity is essential to capture growth in our key end markets as demand for lightweight, sustainable aluminum products continues to grow.

Now turning to the market update on Slide 4. While the strength of our balance sheet and diverse product and global footprint leave us well positioned to manage through economic uncertainty, we don't see significant market headwinds in the near term. With a few exceptions, demand trends remain largely unchanged from last quarter. With aluminum the most sustainable packaging material for beverages, demand for infinitely recyclable aluminum can continues to strengthen. Growth in emerging economies; package mix shift from other materials like glass, steel and PET into aluminum; and new beverage introductions such as energy drinks and sparkling waters are all driving stronger can demand. We are optimistic that further growth is possible as consumer preference for sustainable packaging continues to rise.

In the automotive industry, trucks, SUVs, new energy vehicles and premium vehicles that typically have higher aluminum content have continued to perform well. The U.S. market, in particular, continues to be robust with a seasonally adjusted annual sales rate above 17 million units.

Importantly, the mix of vehicle sales are in our favor, meaning we are not seeing material slowdown in platforms we are on. While we are facing some challenges in Europe related to our exposure to one significant customer, material substitution trends towards aluminum continue to grow share.

Lastly, we don't see -- we don't yet see improvement in China, where automotive sales have remained weak due to low consumer confidence driven by the U.S.-China trade disputes. But we do not expect this downturn to be prolonged.

Meanwhile, some specialties tailwinds are beginning to reduce as our ongoing trade tensions intensify a competition across regions. In the U.S., duties and tariffs provided favorable market conditions over the past year or so. However, those tailwinds are reducing as non-Chinese competition has increased in the North American marketplace. At the same time, competition with Chinese producers have increased in Europe, South America and other parts of Asia. However, with Novelis' global operations nearing capacity constraints, we are leveraging this opportunity to be more selective about the markets we participate in. For example, we announced in September, plans to close our Ludenscheid, Germany foil plant, which will allow us to drive more interplant efficiencies in the region and optimize our overall product portfolio towards high-margin recycled -- recycle content-friendly products.

Turning to Slide 5. I am proud of how far we have come in our sustainability journey. As the leading producer of flat-rolled aluminum products and the world's largest recycler of aluminum, we see an increased focus on sustainability initiatives everywhere from consumers demanding more sustainable packaging options to customers adopting more recycled content in their products. And I'm proud of Novelis' long-standing commitment to the sustainability of our communities and our environment.

We see tremendous opportunity in continuing to expand the use of lightweight infinitely recyclable aluminum to meet today's demanding performance standards while reducing energy use. We have increased recycled content in our products year after year, achieving an average of 61% in fiscal 2019.

Through our recently launched customer solution centers, we work alongside our customers to create innovative, sustainable aluminum solutions to the beverage can, automotive and specialty markets. Together, we explore initiatives like closed-loop recycling systems or how using more aluminum in customers' products provides value while also helping them meet their sustainability targets.

And I'm excited that our sustainability journey continues. Last week, we broke ground on a $36 million investment to expand and upgrade our current recycling capacity in North America. This investment at our existing Greensboro, Georgia dedicated recycling facility includes adding state-of-the-art equipment to allow for automated -- automotive aluminum scrap recycling as well as important environmental and safety upgrades. As more automakers turn to aluminum to lightweight vehicles, this expansion will enable Novelis to recycle the increasing availability of automotive aluminum scrap created during the production and stamping processes and insert it directly back into the supply chain.

It will also allow us to offer further closed-loop recycling with our automotive customers. Closing the loop preserves the value of the alloy, reduces recycling and transportation costs and minimizes environmental impact and establishes a secure supply chain.

Sustainability is core to our business from how we operate within our company to how we partner with our stakeholders across the aluminum value chain. I firmly believe we are making the right investments to support our customers and deliver on our purpose of shaping a sustainable world together.

Now before I turn the call over to Dev to discuss our financial results for the quarter in more detail, let me provide an update on our pending acquisition of Aleris. As you all know, last year, Novelis entered into a merger 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 made much progress working with regulators in the European Union, the United States and China to gain approval for the transaction and close by January 21, 2020, the outside date under the merger agreement. Let me share where we are in this process within each of the regions.

Starting with Europe, on October 1, we received approval from the European Commission conditioned upon the sale of Aleris' European automotive assets, which is its plant in Duffel, Belgium. While we certainly would have preferred to retain the Duffel plant, it unfortunately was not an option. We have begun the divesture process and have received interest from potential buyers. And we'll be able to provide additional details once the proposed counterparty and definitive sale agreement have been approved by the European Commission, which we expect to occur before January 21.

In the United States, we have reached an agreement with the Department of Justice and have a clear path forward and a definitive time line that will allow us to close the transaction by January 21. The only issue is whether aluminum competes with steel in the automotive body sheet market. The DOJ contends that the only relevant competition is among aluminum sheet manufacturers. We strongly disagree with their views as it ignores the competition from steel, which is currently used for nearly 90% of the auto body sheet market. This issue will be resolved through arbitration, which will be concluded after we close the transaction but before the end of our fiscal year. Therefore, closing the transaction is not dependent on the outcome of arbitration, rather that the outcome of arbitration will only determine whether we keep Aleris' Lewisport facility in Kentucky or are required to divest it.

Lastly, we continue to work closely with the Chinese State Administration for Market Regulation to obtain its approval within the next few weeks.

In summary, we have a clear path forward in all 3 jurisdictions and believe the transaction will close by January 21, 2020. 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've guided and reiterated since we announced this acquisition.

Now with that, I'd like to turn the call over to Dev for a more detailed review of our second 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 evening. So turning to Page 8. We reported net income attributable to our common shareholder of $123 million in the second quarter of fiscal 2020, a 6% increase over the prior year. Excluding tax-effected special items in both years as outlined in the back of our earnings press release today, net income increased 31% to a record high $160 million.

The largest of the items excluded is a $32 million restructuring charge related to the German foil plant closure Steve referenced earlier. The increase in net income, excluding special items, is primarily driven by a 5% increase in adjusted EBITDA to $374 million as well as a lower effective tax rate due, primarily, to the regional mix of earnings and remeasurement of deferred tax liabilities in Brazil.

We achieved an EBITDA per ton of $448 in the second quarter of fiscal 2020, up from $440 in the prior year and in line with the record result achieved in Q1 of this fiscal year. Net sales decreased 9% versus the prior year to $2.9 billion driven by an approximately 15% decline in average LME aluminum prices and local market premiums. This was partially offset by a 3% increase in total flat-rolled product shipments to a record second quarter level of 835 kilotonnes. Higher account shipments were partially offset by lower specialty shipments as we make choices to optimize our portfolio in tight capacity conditions.

Let's turn to the EBITDA bridge on Slide 9. Strong demand for global beverage can sheet and good capacity utilization drove a 3% increase in overall shipments, resulting in a $23 million positive contribution from higher volume. Favorable mix, portfolio optimization efforts and higher specialties pricing contributed an additional $7 million benefit. This is a strong result considering the prior year included approximately 10 kt of additional automotive shipments that shifted from Q1 into Q2 related to an unplanned customer downtime in North America in fiscal 2019.

Meanwhile, we see in the cost line, 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 as well as less favorable scrap spreads. While we are still seeing better-than-average scrap spreads in North America, spreads in South America and Asia have begun to rebalance as anticipated. And as a result, we are seeing less favorable recycling benefits versus last year.

Lastly, currency, SG&A and others were overall a minor contribution to the quarter as negative translation in Europe from the weaker euro was offset by a more favorable hedged currency rate in Brazil and Korea.

Now let's turn to free cash flow on Slide 10. On a year-to-date basis, free cash flow before capital expenditures increased 46% to $318 million in fiscal 2020. This is mainly the result of higher adjusted EBITDA and a lower outflow of working capital. Working capital is seasonally an outflow in the first half of the fiscal year, but it's less of an outflow compared to the previous year due to lower aluminum prices and lower inventory levels.

Capital expenditures in fiscal 2020 increased significantly to $300 million for the first 6 months primarily to support significant capacity expansions underway in the U.S., China and Brazil. These projects remain on track and on budget. We expect full year capital expenditures to be in the range of $650 million and $700 million, which includes the significant portion of CapEx spent on those expansion projects.

We ended the quarter with a strong liquidity level of $1.8 billion, and we further improved our net debt to adjusted EBITDA leverage ratio to 2.4x. This compares to 2.8x in the prior year period and is a meaningful improvement, particularly when considering the significant increase in capital expenditures.

Our strong operational and financial performance are not only enabling us to take the right steps to invest in future growth but also strengthening our current financial profile at the same time.

So with this, I'd 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 delivered another outstanding quarter as we aim to maximize operational performance through increased asset efficiency and capture growing demand for lightweight aluminum sheet. We remain focused on continuing to deliver high-quality, sustainable and innovative products, solutions and service to our customers. At the same time, we continue to progress as planned with our various strategic expansion projects, including the pending acquisition of Aleris. Ultimately, these investments will enhance our product portfolio, expand recycling capabilities and grow our footprint to strengthen Novelis and serve our customers for the long term.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions)

And our first question comes from the line of Matthew Fields with Bank of America Merrill Lynch.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [2]

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Just want to start in the U.S. I saw your EBITDA per ton was kind of probably as high as I've ever seen it, sustained from last quarter that high level in the high 500s. Is that all due to scrap spreads? Or is there kind of any new contracts in the mix that you can call out?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [3]

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So Matthew, thanks for the question. One of the big reasons for U.S. EBITDA per ton looking so good is that we have been gaining from higher specialties pricing. So after all the antidumping duties and restricted imports from China, the market turned positive for the players like us in the U.S., and in short, we gained from much better pricing and also some volume tailwinds.

Besides that, we also got some nice auto pricing from spot demand from above contract demand on the auto side. Auto, in general, continues to be a very positive story in the U.S.

Now on the scrap and scrap spreads, the market conditions in U.S. actually continue to be good. So we do gain from the nice availability, from the surplus availability of scrap in the used market. So that is also an added factor. So in short, it was a lot of positives coming together to get us to this result.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [4]

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Okay. Great. And the trade case you called out is the common alloy trade case, right?

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

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Well, yes. And in general, the very high duties coming from all the restrictions with the 150% to 200% duties on Chinese imports, all those are the ones that helped us to really gain from higher pricing.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [6]

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Okay. Great. And then I know you called out sparkling water in your prepared remarks, but can you give us maybe some trends on other products and where sort of CC (sic) [CCC], soda, beer and maybe newer categories like spiked seltzers and other premade cocktails?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [7]

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So yes, it's all going in the positive direction. We also have some launches of water happening, as we speak, in the Northeast by the big beverage makers who are trying to now sell plain water as well as -- as well in cans. And besides that, to your point, sparkling waters are taking off well. A lot of new generation drinks are coming in, in can. So although the alcohol segment is not doing as well, some of these newer generation products that beverage makers are launching are also resulting in a nice lift in can demand, and we expect this to be sustainable and continue.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [8]

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Okay. Great. And then we saw Ball announced a big aluminum cup plant in Georgia right in your backyard. Is that -- what kind of opportunity do you think that is for you? I mean I know you're not the only can sheet provider in the U.S., but is that something that you're -- you have capacity to compete for? And what kind of -- is it a body sheet product that you envision? Like can you just give us a little color on what kind of opportunity that would be for you?

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Steven R. Fisher, Novelis Inc. - President & CEO [9]

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Yes. I think it really just demonstrates the kind of sustainability trend that we're seeing across North America, across Europe and quite frankly, across the world, which is antiplastics. And it's just a replacement of plastics in stadiums in this case and other venues towards aluminum, which I think is just a positive indicator of kind of some market trends that we're going to see, both in beverage cans, as Dev just spoke about as well as cups over the next 5 to 10 years. And we need to position ourselves to -- in the marketplace to -- as the leading can sheet provider to be able to supply that. Clearly, we work with -- Ball is one of the -- one of our largest customers, and we'll continue to innovate around these type of cups and other aluminum solutions for packages going forward. And so we do see this as a great trend and a great example of what's going on in the world from plastics.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [10]

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And do you have capacity to bid for that job? Or do you -- would you have debottlenecked somewhere else in your footprint?

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Steven R. Fisher, Novelis Inc. - President & CEO [11]

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No. We would have capacity in the near term, and we continue to find ways to debottleneck and invest in appropriate places to continue to expand our can capacity where appropriate, and we have active discussions with all of our customers around kind of the new demand trends that we're seeing.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [12]

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Okay. And then moving over to the Aleris transaction. I know it's probably too early to tell, but are the potential bidders for the Duffel asset, do they already have European automotive? Or is it not possible for someone that's already kind of a producer in Europe to bid on it due to the same antitrust concerns that obviously have been foisted upon you?

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Steven R. Fisher, Novelis Inc. - President & CEO [13]

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Yes. We're not going to get into specifics exactly of who's been on the Duffel plant right now. We do have good active dialogue with a number of potential buyers. And obviously, one of the considerations in us closing a transaction or selling Duffel plant will be antitrust, and that will just be one of the considerations we'll have to take into play.

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Operator [14]

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And our next question comes from the line of Amit Dixit with Edelweiss Financial.

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Amit A. Dixit, Edelweiss Securities Ltd., Research Division - Financial Analyst [15]

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Congratulations for a good set of numbers. I have 2 questions. The first one is on European operations. So we saw a good uptick in European operations sequentially whether it is shipment or EBITDA per ton or even EBITDA in absolute numbers. So just wanted to understand the drivers behind it.

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [16]

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The European business is actually doing very well on the can side. And if you are talking about the sequential growth, it is basically because of an increase in shipments mostly driven by can.

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Amit A. Dixit, Edelweiss Securities Ltd., Research Division - Financial Analyst [17]

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Okay. Agreed. The second question is again on Aleris transaction, particularly Duffel plant. So Duffel, is it possible to quantify the capacity of Duffel plant? And what is the capacity in automotive and other products? And are there any other effects in Europe that we are looking to kind of divest apart from Duffel?

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Steven R. Fisher, Novelis Inc. - President & CEO [18]

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So starting with the Duffel plant as Duffel plant is a mix of specialty products and automotive. It is the only facility that Aleris owns that makes automotive body sheet. And that is what the European Commission is objecting to is our share of automotive -- aluminum automotive body sheet, combining the 2, the Duffel plant into Novelis. And so that requires us to divest the Duffel plant. I didn't catch the second part of your question.

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Amit A. Dixit, Edelweiss Securities Ltd., Research Division - Financial Analyst [19]

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No. No. What is the capacity of this plant? And how much would it be automotive? And how much it would be in other applications such as heat exchanger, et cetera?

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Steven R. Fisher, Novelis Inc. - President & CEO [20]

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Yes. I think we won't get into capacity. That's really for Aleris to address. But roughly, the plant's 50-50, auto and other.

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Operator [21]

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And our next question comes from the line of Rajesh Lachhani from HSBC.

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Rajesh V. Lachhani, HSBC, Research Division - Analyst [22]

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Congratulations on a good set of numbers. That question again, follows through the first question of my colleague on U.S. performance. So while the EBITDA and per ton EBITDA been quite strong in U.S. this quarter as well, I see the volume has -- this is the only region which has seen volume decline. So I wanted to understand the reason for the same.

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [23]

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Right. So the volume decline is purely because we are comparing versus the last year comp. I said it in my prepared remarks that last year because of a Ford fire in the quarter 1 of our fiscal, there was some higher pull in quarter 2 to compensate for that. So that is one of the primary reasons for volume. But to the question about why U.S. is so positive, I'll just repeat what I said earlier. We are getting better pricing on the specialty side. We are also gaining from some better volumes because of the restricted imports from China. We are gaining from better pricing due to some spot above contract demand on the auto side. And last but not the least, scrap conditions in the U.S. continue to be very positive. There is more availability than the market is able to absorb. And as a result of that, we are gaining from the better scrap conditions. So it's a combination of all these reasons, which is resulting in the EBITDA going up from last year from $512 to almost close to $600 per ton.

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Rajesh V. Lachhani, HSBC, Research Division - Analyst [24]

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Understood. Okay. My second question is with regards to Aleris. So just to clarify the date, January 21, 2020, can we extend it? Or is this a hard deadline for the merger to get completed?

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Steven R. Fisher, Novelis Inc. - President & CEO [25]

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Yes, the January 21 -- so what we're saying is that we'll close the transaction on or by January 21. January 21 is the outside date of the merger agreement, and we don't anticipate the need to extend that contract. We anticipate to be able to get the regulatory approvals and close before January 21.

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Rajesh V. Lachhani, HSBC, Research Division - Analyst [26]

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Although hypothetically, if it gets extended, like, can we still extend it if the process gets delayed -- if the approval process gets delayed?

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Steven R. Fisher, Novelis Inc. - President & CEO [27]

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Yes. I mean I guess hypothetically, we don't want to go there. We are guiding that we will be able to close the transaction on or before January 21. Any extension of that date would take both parties to agree to the extension.

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Rajesh V. Lachhani, HSBC, Research Division - Analyst [28]

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Understood. And another question with regards to when we initially announced this merger, one of the reasons was that we would be able to consolidate our leadership position in the automotive sheet segment. Do you think if in the worst-case scenario, if we have to divest Lewisport and we are already divesting automotive side asset in Europe, will it dilute the economic rationale of this merger? And what would be the approximate valuation that you are expecting from these assets?

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

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Yes. I mean obviously, we -- when we announced the transaction, we had very firm views. We still hold very firm views that we compete against steel. And unfortunately, in Europe, the European Commission has taken a narrow review of competition, and there's really no way for us to really be able to push that into arbitration or litigation like we can in the U.S. So it's unfortunate. We would have loved to have Duffel as part of Novelis, but we'll move forward with divesting that facility. We are very confident and I already mentioned arbitration around the notion of steel versus aluminum on auto body sheet. And so we fully anticipate success in bringing Lewisport in.

Going to the worst-case scenario, if we were to lose arbitration and not have Lewisport, this transaction still makes financial sense and is still accretive. And we still believe we can drive the $150 million of synergies we announced at the beginning of -- when we announced the transaction over a year ago. We can fully integrate our facility in China. We continue to diversify our footprint, and we continue to bring in good, innovative solutions for our customers with a group of talented employees at Aleris.

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Rajesh V. Lachhani, HSBC, Research Division - Analyst [30]

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Understood. But Steve, any indication or rough estimation of what is the EBITDA that we might lose if we have to give up Lewisport and Duffel? Like Duffel, we are already in the process of divesting. But if you also lose Lewisport, what is the approximate hit to the EBITDA?

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

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Now we're not going to get into specifics at this point in time because we're confident in bringing Lewisport in. And as we close out Duffel, we'll give more specifics as to exactly what EBITDA will be brought into the company.

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Operator [32]

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(Operator Instructions)

And our next question comes from the line of Anuj Singla with Bank of America.

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Anuj Singla, BofA Merrill Lynch, Research Division - VP in Equity Research [33]

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Steve, first question is for you. You talked about the tailwinds on the can side. And I think we are seeing the impact of only volumes in the numbers as of now because all of those contracts are long term in nature. So can you help us understand when can we see the pricing impact come through? Maybe is it going to be 6 months down the line or maybe 1 year down the line when these contracts come up for renegotiation?

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Steven R. Fisher, Novelis Inc. - President & CEO [34]

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Yes. I mean what I could tell you is that on the contracts, they vary around the world. And when they come up for negotiation, and they're typically somewhere between 2- to 5-year long contracts. What we are seeing as we are negotiating contracts that are coming up is we are seeing favorable pricing trends. But it will take some time to bring pricing to the level that it will make sense for new greenfield expansion for aluminum sheet. And so as we progress, and we see the trends that we talked about earlier on the call that are favoring aluminum certainly, the capacity will tighten, and we'll be able to be in a better position to see prices move in a direction that will make more sense for future growth.

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Anuj Singla, BofA Merrill Lynch, Research Division - VP in Equity Research [35]

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Okay. Great. And the second question is on the aluminum on the auto contracts in U.S. I think our negotiation with Ford, these were signed -- these contracts were signed in 2016 and might be -- these are up for renegotiation right now. So any thoughts you can share on what kind of pricing compression, if at all, we are seeing there or because of the operating efficiencies which we have seen, we are not going to see any risk to the margins we make on the auto side in the U.S.?

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Steven R. Fisher, Novelis Inc. - President & CEO [36]

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Yes. I think what I would guide there is that we feel very comfortable with our position with Ford in renegotiating the F-Series contracts at the same kind of levels of volume that we're at today. And due to operating efficiencies, what we could guide to is we won't see a material impact as it relates to anything that -- anything as it relates to pricing inside that contract.

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Operator [37]

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And our next question comes from the line of Vishal Chandak with Emkay Global.

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Vishal Chandak, Emkay Global Financial Services Ltd., Research Division - Research Analyst [38]

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Yes. Just a quick question on the Aleris deal with the...

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

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Could you speak up? We're not able to hear you.

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Vishal Chandak, Emkay Global Financial Services Ltd., Research Division - Research Analyst [40]

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Is it better now?

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Steven R. Fisher, Novelis Inc. - President & CEO [41]

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A little bit. Maybe a little louder.

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Vishal Chandak, Emkay Global Financial Services Ltd., Research Division - Research Analyst [42]

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Okay. Just give me a second. Yes. Is this okay?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [43]

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Yes. Much better.

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Vishal Chandak, Emkay Global Financial Services Ltd., Research Division - Research Analyst [44]

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Okay. Great. Just wanted to check in case we lose both Lewisport hypothetically as well as Duffel, which is we are anyways out, what would be the automotive capacity which would be remaining with Aleris that would come to Novelis after the deal?

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Steven R. Fisher, Novelis Inc. - President & CEO [45]

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I'm sorry. Repeat the question again?

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Vishal Chandak, Emkay Global Financial Services Ltd., Research Division - Research Analyst [46]

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So excluding the Lewisport and Duffel, what would be the automotive capacity that would be there available with Aleris as part of the merger?

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Steven R. Fisher, Novelis Inc. - President & CEO [47]

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So in the worst-case scenario again, we do not believe that we're going to -- we believe we have a very, very strong argument around Lewisport. But in that worst-case scenario, we would obtain 0% of aluminum or automotive body from Aleris. What that would mean for Novelis is with our expansions, we're currently at 750 kt on a global basis, with our expansions at Changzhou in China and our expansion of 200 kt in Kentucky, we will move to approximately 1 million metric tons of capacity on a global basis.

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Operator [48]

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

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Sumangal Nevatia, Kotak Securities (Institutional Equities) - Analyst [49]

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The first question is with respect to the scrap spread tailwinds which we are witnessing. Now in the last 2 or 3 quarters, is this tailwind got stronger? Or I mean if you could just directionally guide us how has the movement been? And what is the visibility for the next or at least short to medium term?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [50]

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Right. So Sumangal, let me tell you the dynamics by region. So the region that continues to see very good conditions and we do not see that changing in any foreseeable future is the U.S., where we think that the strong and good availability conditions will continue for the foreseeable future for sure. So that was positive and continues to be good.

Now in Asia and South America, in both these markets, overall, the scrap conditions compared to historical is pretty good. The drop in metal prices is not helpful as you can understand. So we have lost some of the lift that we were getting because of the softness in metal prices. Otherwise, the availability conditions, I would say, are pretty good though not at the same level as it was a year ago in the same quarter or the first 2 quarters of the fiscal.

So in short, they have settled down a bit. As far as Europe is concerned, again, the conditions are like very normal, I would say. We are not seeing any particular issue, either on the positive or the negative side. So stable to slightly positive conditions in Europe.

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Sumangal Nevatia, Kotak Securities (Institutional Equities) - Analyst [51]

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I understand. And with respect to the tariff -- tariffs being imposed against China, and what is the time line of these? I mean is it till it is changed? Or it has a fixed time of 2 years, 3 years or something?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [52]

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Well, a lot of it depends upon the shape of the trade deal that happens between the U.S. and China. So we are just watching the news on how progress is made on the trade negotiations, and everything will be dependent upon the outcome of that. So it's a bit unpredictable, I would say.

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Sumangal Nevatia, Kotak Securities (Institutional Equities) - Analyst [53]

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So can we, I mean, conclude that both from scrap and these tariffs, we will -- I mean these tailwinds will kind of reverse if there is a potential trade resolution?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [54]

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Well, here's the thing. As far as the scrap is concerned, I told you earlier. So we expect the U.S. to continue to be positive for the foreseeable future. That will not change in our view. Now as far as the impact of the tariffs and the tailwinds from there is concerned, you just need to be cautious because lately, what we see is that the non-Chinese imports into the U.S. have gone up. And the kind of pricing lift that we were seeing until even a couple of months ago is actually settling down. So as we go into the future quarters and as we start negotiating contracts for next year, we will not see the same level of pricing that we were seeing in the earlier part of this year or from the end of last year. So that will settle a bit.

Having said that, compared to historical levels, if you go back the last 2 to 3 years, compared to those levels, the pricing will still be positive. It is just that it won't be at the same level as it was in the last 2 or 3 quarters. So we should be prepared for that.

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Sumangal Nevatia, Kotak Securities (Institutional Equities) - Analyst [55]

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Understood. Next -- second question is with respect to the process of this divestments and the Aleris deal, just wanted to get a better understanding. Now with respect to the arbitration, is there a fixed time line within which this has to conclude?

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Steven R. Fisher, Novelis Inc. - President & CEO [56]

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There's a fairly fixed time line. There's some wiggle room within that time line but it's -- we're confident that the arbitration would conclude by -- before the end of our fiscal year, so March 31.

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Sumangal Nevatia, Kotak Securities (Institutional Equities) - Analyst [57]

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Okay. And for the agreement date, which you said January 21, the Europe asset, Duffel asset divestment has to happen before that. And if I've understood correctly, in case, in the worst-case scenario of Lewisport divestment, that can happen after the acquisition as well. Is that right understanding?

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Steven R. Fisher, Novelis Inc. - President & CEO [58]

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So just to make sure to be clear on the Duffel process, what we need in order to get clearance to close with Aleris is a signed definitive agreement with a buyer. And the EC's approval of that buyer. And we believe we'll get both of those before January 21, which will allow us to close with Aleris.

On Lewisport, you're absolutely -- or on the arbitration, you're absolutely right that the result of arbitration would be post us closing with Aleris. And the result of that arbitration would be either we retain Lewisport or we would have to sell Lewisport. And under the unlikely event that we're selling Lewisport, that would be done on a post-close basis after we close the Aleris transaction. And so will the Duffel sale process itself will be post closing with Aleris.

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Sumangal Nevatia, Kotak Securities (Institutional Equities) - Analyst [59]

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Understood. Understood. So currently, we have a conditional approval from U.S. We are waiting for the divestment of Duffel to get Europe approval, and China is still awaited. That's right? That would be...

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

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That's exactly right. Spot on.

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Operator [61]

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And our next question comes from the line of Ritesh Shah with Investec.

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Ritesh Shah, Investec Bank plc, Research Division - Analyst [62]

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So my first question is if I had to exclude the hedging and ForEx gains, how will the EBITDA per ton numbers look like region-wise? I think in one of the prior quarters, you did indicate that we have hedges, which are there in South America operations. And we were quite comfortable on the hedges to sustain the $750 number at EBITDA per ton. Just wanted some color on what's our strategy over here? And if one had to strip out this gain, so what the numbers would look like? That's the first question.

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

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Okay. So well, the EBITDA per ton is not going to be any different if you take out the impact of -- so when you say exclude hedges, I mean, I don't know what you mean by exclude hedges because as a policy, we stay kind of, sort of always stay hedged on the transaction side. And I'm not too sure. I mean are you telling us to take a hypothetical number as if we are not hedged? That's a bit of an impractical question for us to answer. But all that we can say is that if I were to take out translation and any hedging inefficiencies, there will not be any material impact on the EBITDA per ton. Can you ask the South America question again because I'm not sure I understood what you were trying to ask on South America?

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Ritesh Shah, Investec Bank plc, Research Division - Analyst [64]

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I'm specifically referring to the ForEx hedges that we have, specifically on the currencies. So I think on the -- one of the prior calls, you had indicated that we had certain ForEx hedges, which did contribute to a higher EBITDA. I think it was Q2 FY '19. And you had indicated that we are quite certain on our forward hedges as well. So just want to understand what would be the stripped out of -- stripped out number if we take the ForEx hedges out.

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

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Let me try to give you a different sense about this. So we are, first of all, fully hedged, almost fully hedged for this year, and we are substantially hedged for next year as a matter of policy. As we progress during the current fiscal, we start hedging for the next year. And what I can tell you is that between this year and next year based upon all the transaction hedge positions that we have, we do not see any material positive or negative impact on our EBITDA. So for the next about 18 months, you can say that this will be no news at all as far as EBITDA impacts are concerned. And the current EBITDA, you can consider your modeling without taking any volatility coming from hedges. So that's the answer that I can give to you.

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Ritesh Shah, Investec Bank plc, Research Division - Analyst [66]

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Okay. Sir, my second question is more from an industry point of view if one goes by Coke and Pepsi sustainability nodes, they have incrementally started talking about selling bottled water without the bottle. What they're referring to is probably dispensers, and they have started this on pilot basis in certain colleges in U.S. So do you see this as a threat over a longer term, which can actually question the growth rates on the can segment?

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

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So to your point about dispensers, not really. I mean companies always keep doing pilots and trying new marketing avenues. But from everything that we know from our customers, we don't see anything meaningful happening in the direction. In fact, all that we hear is positive trends of shift from plastics into can, which is created by consumer demand. So that's really the positive trends that we see. We will continue to see some nice accretions on the can side almost across the world, and that includes the U.S. So that's what we can tell you.

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Ritesh Shah, Investec Bank plc, Research Division - Analyst [68]

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Okay. And sir, just lastly, it might be a repetition but we had this contract negotiations with auto guys. So what's the takeaway over there? Last time when I've spoken with you, you had indicated, I think, on the call that there could be a single-digit percentage decline. Sir, how should one look at this?

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Steven R. Fisher, Novelis Inc. - President & CEO [69]

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I'm sorry. A single-digit decline in what?

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Ritesh Shah, Investec Bank plc, Research Division - Analyst [70]

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On the pricing contracts. On the pricing contracts.

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Steven R. Fisher, Novelis Inc. - President & CEO [71]

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For auto?

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Ritesh Shah, Investec Bank plc, Research Division - Analyst [72]

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For auto, yes, for U.S. and Europe.

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Steven R. Fisher, Novelis Inc. - President & CEO [73]

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Yes. No, I don't recall talking about a price decline. We feel very good about the contracts that we're in the middle of negotiating. We currently, obviously, have to find ways to be more efficient and drive operating efficiencies, both inside of Novelis and with our customers so that we can see a potential for overall cost savings. But the margin, which you should be concerned about, I don't think we would be indicating at this point of time in decline.

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [74]

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Yes. Sumangal (sic) [Ritesh] so I think that what you're talking about is possibly how pricing trends would behave in the future. And like in any maturing market, even if we see some softening of prices, we always maintain and continue to say that with gain in efficiencies, we do not see any material impact on the EBITDA contribution. And therefore, this is going to be sustainable. So in short, we don't expect any bottom line material impact coming from auto pricing. Perhaps that answers your question.

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Operator [75]

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And our last question comes from the line of Indrajit Agarwal with Goldman Sachs.

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Indrajit Agarwal, Goldman Sachs Group Inc., Research Division - Equity Analyst [76]

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I just have a question on the recycling as a percentage of our input material. Are we at the optimum level? Or is there scope to increase it further with the current expansion?

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Devinder Ahuja, Novelis Inc. - Senior VP & CFO [77]

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So what we are doing currently is we are expanding some recycling capacity in South America. As we are expanding can capacity by 100 kt, we are expanding the recycling capacity so that we are able to maintain the same optimal mix of recycling. Now to your overall question, we continue to make progress in our recycling operations by productivity, by asset optimization and all the operational improvements. And so the progress is steady, and it continues to happen. Now will we invest in more recycling capacity, that's a bit hypothetical at this stage. If we really see the can demand taking off as some of the trends indicate, we would be very, very open to putting more recycling capacity, particularly to take care of the can demand and the supply of recycling materials, that's what we can say. So on the whole, we continue to make good progress in keeping on inching up on our recycling content by efficiencies.

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Operator [78]

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And Mr. Fisher, I'll turn the call back over to you now.

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Steven R. Fisher, Novelis Inc. - President & CEO [79]

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Thank you. Again, thank you all for participating this morning. I'm very pleased with the result that we've seen this quarter, year-to-date, and hopefully, you also hear the optimistic view that we have on the demand trajectory of aluminum sheet for the various reasons we talked about, but we'll continue to strategically work with our customers to provide them with the high quality and sustainable aluminum products and solutions that they deserve. But thank you very much for being on the call today.

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Operator [80]

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Thank you. That does conclude the call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day.