Australia | Apr 13 2016
This story features ALUMINA LIMITED. For more info SHARE ANALYSIS: AWC
-Cost base for AWAC lowered
-Margin expansion still likely
-Strong balance sheet, dividends
By Eva Brocklehurst
Are the closures of alumina refining capacity witnessed in 2015 turning out to be a short-term trend? Recently, the re-firing of smelter capacity in China, as prices emerge from lows of US$198/t early this year, has started to weigh on broker views.
Alcoa's alumina business experienced lower realised prices in the March quarter, and higher costs, but broker reactions were highly dependent on just how much was factored into their forecasts. Earnings margins for Alcoa's alumina segment fell by US$30/t to US$27/t, the lowest quarterly outcome since FY12. Alumina prices moderated to US$224/t versus $247/t in the prior quarter while costs moved up to US$197/t from US$190/t.
Alumina Ltd ((AWC)), the company's 40% partner in the AWAC joint venture, revealed a fall in earnings to US$8m in the March quarter, from US$98m in the preceding quarter, following the drop in the alumina price. Yet the outcome was slightly better than Ord Minnett had feared, because of the further cost savings achieved.
Hence, lower costs and higher bauxite operating earnings lead the broker to raise near-term estimates for Alumina Ltd, expecting the company to report a much stronger margin next quarter, given the alumina price is now up US$50/t from its lows.
While cost cutting initiatives have lowered the overall cost base for AWAC refineries, Macquarie observes this has not been without short-term pain. Moreover, up to 7.1mtpa of Chinese refinery additions or re-starts are scheduled to come on board in the June quarter, sapping the broker's confidence in the earnings outlook and underscoring its Underperform rating.
UBS is also cautious about the prospects for rises in alumina spot prices in the face of the re-start of capacity, noting over 2mtpa has already been re-started or announced over the past month in China. Still, the broker continues to expect Alumina Ltd can expand its earnings margin and afford to pay dividends over the next three years. UBS retains a Neutral rating.
Deutsche Bank is more upbeat, with the achieved AWAC margin above its estimates and the alumina segment outperforming expectations on both realised prices and unit costs. The broker notes the full curtailment of the high-cost Point Comfort and Suriname refineries are to be completed in the current quarter. This should cut costs by another US$15/t, with potential for this to fall to US$170/t with further productivity gains.
Deutsche Bank believes Alumina Ltd's position in the industry continues to improve despite the potential oversupply of domestic Chinese production. Furthermore, Chinese refining costs are expected to rise with the rising bauxite price. The broker sums up Alumina Ltd's business as one of expanding margins and a strong balance sheet.
The recent sale of the joint venture's gas pipeline for US$115m should boost the cash position at AWAC, which stood around US$532m at the end of 2015. This should also be sufficient to cover capex, restructuring charges and the second and final Western Australian gas prepayment, in Deutsche Bank's view. The broker expects US$134m in dividends from AWAC in 2016 and a 5c distribution to Alumina Ltd shareholders.
Ord Minnett believes there is upside potential for bauxite sales based on the outcome of WA export trials and expects markets to be broadly balanced this year. With the stock trading at an attractive price/valuation ratio, an Accumulate rating is maintained.
Credit Suisse, on the other hand, does not consider the stock cheap on traditional valuation measures, trading at nearly twice its book for a return on equity of 6.0%. Yet Alumina Ltd does have support in terms of the dividend yield. The broker assumes a US6c per share dividend in FY16 and sticks by a Neutral rating.
The Alcoa results missed Credit Suisse's expectations, with the 19% sequential decline in alumina pricing seen offsetting productivity gains. Alcoa has guided to June quarter operating income for Alumina Ltd to be up $15m on the March quarter. This implies a realised price of around US$240/t in Credit Suisse's estimates.
FNArena's database shows four Buy ratings for Alumina Ltd, with two Hold and one Sell (Macquarie). The consensus target is $1.39, suggesting 4.7% upside to the last share price. Targets range from $1.00 (Macquarie) to $1.65 (Deutsche Bank). The dividend yield on FY16 and FY17 estimates is 5.2% and 5.6% respectively.
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