By Georgina Prodhan and Tom Käckenhoff
ESSEN, Germany (Reuters) - German industrial company Thyssenkrupp reported a 12 percent fall in annual operating profit and gave a cautious outlook that underlined the urgency of finding a lasting solution for its struggling steel business.
Backed by activist investor Cevian, which has increased its stake this year to almost 20 percent, Thyssenkrupp is striving to merge its European steel operations with those of India's Tata Steel to combat overcapacity in the industry.
Thyssenkrupp's Steel Europe division, which accounts for about a fifth of overall sales, reported a 36 percent drop in adjusted operating profit for the year to the end of September, despite a rally in steel prices towards the end of the period.
"The large fluctuations in raw materials markets show that we must pursue our transformation into a strong industrial group," Chief Executive Heinrich Hiesinger told a news conference at the company's headquarters on Thursday.
Chief Financial Officer Guido Kerkhoff left open the possibility that Thyssenkrupp could keep a majority of the European steel business, telling analysts that the key issue was not its ultimate ownership but removing overcapacity.
"The most important thing for us is that by a consolidation and by the underlying plan we can address the issues of overcapacity," he told a call with analysts, adding that a listing would also not resolve the capacity problem.
He said the company had never stated whether the steel business would be consolidated or not, or what percentage ownership it might consider, declining to elaborate further at this point.
Shares in Thyssenkrupp, which have outperformed the German blue-chip index by 20 percent this year on hopes of steel consolidation, fell as much as 2.9 percent in early trading to be the worst performer in the DAX.
By 1412 GMT, they had pared some losses but were still down 1.9 percent at 21.54 euros.
Thyssenkrupp - whose other businesses include elevators, car parts, submarines, plant engineering and metals distribution - said annual adjusted earnings before interest and tax (EBIT) fell to 1.47 billion euros ($1.55 billion).
The Essen-based company forecast a recovery to 1.7 billion euros for the current fiscal year starting in October but that fell short of average analyst expectations of 1.89 billion euros, according to a Reuters poll.
"Thyssenkrupp management are known to provide conservative initial guidance and we do not expect material consensus estimate downgrades," wrote Jefferies analyst Seth Rosenfeld, who rates Thyssenkrupp "buy".
He noted the company had unexpectedly strong free cash flow before mergers and acquisitions of 198 million euros for the year. That was its second year of positive free cash flow, after nine years of negative results, which was helped by a reduction in working capital and real-estate disposals.
The success of Thyssenkrupp's steel merger talks hinges on Tata achieving a deal with the British government to lower the deficit of the British Steel Pension Scheme, which Tata inherited when it bought Corus in 2007.
The two sides were close to a deal but it was derailed by Britain's surprise vote in June to leave the European Union.
The Tata group has since been riven by an acrimonious power struggle but Hiesinger said he had been given personal assurances by the new management that the rationale for the deal remained in place, and said talks had not been disrupted. [L8N1DP1TN]
Thyssenkrupp said cost cuts would again be key to meeting its targets against a backdrop of volatile raw material prices, and targeted savings of 850 million euros this fiscal year, driven by procurement efficiencies.
The company blamed a slower than expected recovery in raw material prices for last year's profit fall, as well as problems at its submarines-to-plant-engineering business, whose CEO had to resign this month in the middle of a restructuring drive after accepting a gift from a business partner.
"The Industrial Solutions business area also registered a weakening of the markets for chemical plants and mining equipment as well as an absence of major naval shipbuilding projects," Thyssenkrupp said in a statement.
The company said it was sticking to its long-term target of at least 2 billion euros in adjusted core earnings, which it has said will be necessary to pay a meaningful dividend.
It proposed an unchanged dividend of 0.15 euros for the 2015/16 financial year, which was below expectations.
This quarter, Thyssenkrupp expects adjusted EBIT of about 300 million euros, up from 234 million euros a year earlier.
($1 = 0.9468 euros)
(Editing by Jane Merriman and David Clarke)