Australia | Jul 13 2016
This story features ALUMINA LIMITED. For more info SHARE ANALYSIS: AWC
-Bauxite proportion accelerating
-Low debt balance sheet
-Potential AWAC cash distribution?
By Eva Brocklehurst
Alumina Ltd ((AWC)) has enjoyed a recovery in margins in the June quarter, with the benefit of higher spot pricing and tight cost control. Alcoa, the company's 60% partner in the AWAC joint venture, reported alumina segment earnings rose to US$109m, also benefitting from a slightly higher bauxite contribution.
The increase in the alumina price was augmented by productivity savings and Alcoa has indicated it is on track in the broader upstream business to reach US$550m in savings in 2016, having delivered US$379m in the year to date.
Ord Minnett estimates the alumina price achieved was US$250/t, with cash costs around US$195/t. Looking ahead, the broker expects costs to be lower again following the closure of Pt Comfort, along with increased bauxite sales but also sightly lower prices for alumina.
The bauxite segment is expected to grow as a proportion of earnings. Alcoa has secured another third party contract of US$60m over two years bringing the total to US$410m. 2016 bauxite sales are set to be three times the 2015 volume as the JV pushes further upstream to meet market demand. For the second half Ord Minnett forecasts AWAC earnings per tonne of US$59/t, inclusive of bauxite at US$11/t.
The majority of bauxite sales are coming from the Guinea and Brazil assets but, with the first trial bauxite shipment from Western Australia occurring in June, Ord Minnett believes there is upside potential for more third party sales going forward. Moreover, the broker maintains the market will begin to attribute more value to the mining segment within the AWAC joint venture as bauxite sales grow.
Ords retains an Accumulate rating on AWC because of the valuation support and dividend yield, as well as the strong balance sheet. Although Citi forecasts a recovery in alumina spot prices to US$260/t in 2017 and US$270/t in 2018, this is considered already priced into AWC stock. Hence, this broker maintains a Neutral rating.
The production report delivered the margin recovery Morgan Stanley was looking for after a low point was reached in the prior quarter. The broker has a positive view on the stock based on further margin gains, a balance sheet that is almost debt free, and the potential yield.
Annualising the Alcoa cash flow statement and converting at spot prices suggests 5% pay-out capacity but the broker's base case is higher than this, as it also captures the benefit of the AWAC sale of its 20% stake in the Dampier gas pipeline, from which AWC garners a 40% share of around US$58m. This should come through in the second half and support the broker's forecast dividend.
Morgan Stanley expects cost improvements will also come as Ma'aden production replaces the high-cost Pt Comfort tonnage. Cost performance, price realisation and bauxite contributions were all ahead of UBS estimates. At spot pricing the broker envisages the earnings per tonne margin is running at around US$57/t.
AWC's 40% share of the second quarter distribution is calculated at US$14m. Once AWC reports the receipt of distributions this should provide greater clarity on the dividend potential in the first half, UBS maintains, as AWC has indicated it intends to maintain net debt levels and pass all available free cash flow to shareholders.
Macquarie maintains the operating results were widely anticipated, given the improvement in spot alumina prices in the quarter. Yet the result was below forecasts and the broker reduces earnings estimates, amid increases to cost assumptions.
Macquarie reduces its first half AWC dividend forecast to US18c from US45c. The broker's previous assumption was based around Alcoa distributing cash from AWAC to increase its cash balance and reduce net gearing prior to separation, but now Macquarie expects Alcoa will achieve this via its second half US$400m asset sale.
Macquarie also expects normalising freight rates will be a headwind to AWAC's expected margins from bauxite and alumina. The broker remains bearish on alumina, expecting prices will fall 6% in the September quarter to average US$225/t and retains an Underperform rating.
Deutsche Bank maintains it is possible AWAC will distribute additional cash and a high proportion of its US$550m cash balance back to JV partners in the second half ahead of the Alcoa de-merger, in order to strengthen the downstream balance sheet.
The broker increases 2016 and 2017 earnings estimates on lower refining costs but remains cautious about the outlook for seaborne alumina in the second half because of refinery re-starts in China and new low-cost supply emerging. The broker cites Alcoa's assessment that around 40% of curtailed Chinese refineries have re-started production.
What of the risks in the planned Alcoa de-merger? Macquarie expects the de-merger will be a negative catalyst for AWC. while even the looming court case over the AWAC JV terms and rights does not alter Morgan Stanley's fundamental view. Yet, the potential for a debt-carrying new JV partner to trade in lower multiples and be translated back to market views on AWC is a concern, the broker acknowledges.
AWC believes it has rights over the various AWAC assets and has made several claims in its filing against Alcoa. Credit Suisse suspects AWC is not seeking to expand its ownership of these assets but wants to confirm its legal rights and for Alcoa to negotiate an amendment to the JV agreement to strengthen the rights. The trial is scheduled for September 20 2016.
FNArena's database has two Buy ratings, three Hold and two Sell for AWC. The consensus target is $1.36, signalling 3.7% in downside to the last share price. Targets range from $1.00 (Macquarie) to $1.60 (Ord Minnett, Morgan Stanley). The dividend yield on FY16 and FY17 forecasts is 6.0% and 4.7% respectively.
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