Import Pressures Growing For Adbri

This story features ADBRI LIMITED, and other companies. For more info SHARE ANALYSIS: ABC

Adbri's longstanding lime supply contract with Alcoa will come to an end next year, heralding a difficult time as imports increasingly erode its business.

-De-stabilises Adbri's dominant market position in WA lime
-Imports eroding cement position in South Australia for some time
-What does this mean for the Worsley contract?
 

By Eva Brocklehurst

Alcoa has thrown a spanner in the works for Adbri ((ABC)), deciding not to renew its lime contract from June 2021 and opting for imported supply instead. This ends a 50-year uninterrupted supply contract, which provided around Adbri with $70m in revenue per annum.

Moreover, it won't be easy to replace. Lime is a high fixed cost business and, given the kiln will now be running at around 40% utilisation, Citi assesses the operating de-leverage is material.

UBS downgrades to Sell from Buy, having previously expected the lime business would be stable and a high-margin contributor that would insulate the company from any weakness in the concrete/cement division. This view has now been set aside.

The inability to renegotiate the contract is of concern given its significance, 40% of lime production. Price and quality are likely to have played a part but UBS suspects Adbri's dominant position in line could have also contributed to Alcoa seeking a new source.

However, UBS cannot rule out the chance the company can bring Alcoa back to the stable and renew at least some of the lost volume. Adbri supplies 1.0mtpa of a 1.1mtpa Western Australian lime market.

Macquarie assesses the loss of the contract implies a meaningful shift in risk profile. The lime business is now deemed vulnerable to import competition, which is also playing out in cement/concrete. Following the re-set of cement prices in 2019, Morgans suspects this is another structural reduction in the level of profitability and returns. The outlook, therefore, through to FY22 remains challenging.

Hence, the broker believes the balance sheet will need to be managed carefully and the Kwinana cement grinding facilities upgrade, which is being assessed, may be deferred in order to protect the balance sheet.

Cost Savings?

Cost savings are possible and Morgans notes there could be scope to resize the Munster lime plant in Perth which currently operates two kilns at 80% capacity. Nevertheless, given prohibitive transport costs associated with pursuing east coast opportunities and an already dominant position in the WA lime market, the broker envisages limited scope to make changes.

Ord Minnett, which downgrades to Hold from Accumulate, agrees one of the two lime kilns at Munster will need to be closed as a result of the loss of this contract. The company's profitability was bolstered for a long time by a monopoly position in both cement in South Australia and lime in Western Australia but competition has gradually eroded the market.

Issues first surfaced in South Australia, Ord Minnett notes, from late 2018 and this latest announcement reflects a similar story in Western Australia. The broker also points out a key customer of Adbri in NSW is moving to self-supply next year.

The company will have to work hard to reduce fixed costs but UBS suspects "the genie is out of the bottle" and the increase in new supply into Western Australia risks more customers shifting to imports.

UBS notes, over the last 12 months, the company has lost ground in South Australia to cement imports. From South Australia 1.0mt is exported to Victoria and the remainder of the 1.5mt produced is distributed to the resources sector and local construction.

The contestable tonnage is the local construction part, in the broker's view, and this could be at risk of lower margin should a new import terminal be built.

Worsley

The other major WA lime contract is with South32 ((S32)) at the Worsley refinery, up for renewal in five years. There are negative implications although, as Citi flags, any impact will be realised in 2024 at the earliest. However, Worsley is around 30% of overall lime sales and the company will need to price it lower to retain the volumes or risk losing this contract as well.

Ord Minnett had assumed contracts with both Alcoa and South32 were priced below import parity and the latest announcement rebuts this view. The broker now assumes pricing to customers in the gold and copper sectors will be reset by -US$10/t from July 1, 2021. From 2024 the contract with South32 is expected to be retained, but at a -$15/t discount.

The remainder of the company's contracted lime business is distributed to the WA goldfields. It seems reasonable to Morgans that the Alcoa loss will cause the market to question the security of these volumes and, at the very least, the sustainability of current prices.

The company asserts it is competitive when it comes to import parity prices, particularly when the consistency of its supply and strong distribution capability are considered. Morgans points out management signalled this in February when it noted some customers were persuaded to relinquish imports and come back to the fold.

Earnings Impact

Credit Suisse models a -$45m impact on earnings (EBIT) with an eventual recovery of the Alcoa volumes at lower prices. Meanwhile, management has acknowledged it needs to improve concrete and aggregates positioning and better compete for infrastructure projects.

Property sales in the medium term of up to $100m could partially fund a reinvigoration of infrastructure competitiveness, as operating cash flow should cover dividends, but there is little else available in the broker's view. Debt now looks elevated and may constrain management. Credit Suisse finds the dividend yield unattractive and notes the last 10 years have produced little organic growth.

Morgan Stanley agrees the impact of this higher-margin contract loss is likely to be meaningful. Assuming a 30% margin on the revenue loss implies $21m in earnings ahead of any mitigation, equivalent to 12% of the broker's FY21 forecasts. Still, the company is expected to benefit from construction-related stimulus.

FNArena's database has one Buy rating (Morgan Stanley), two Hold and three Sell. The consensus target is $2.51, suggesting 10.4% upside to the last share price. The dividend yield on FY20 and FY21 forecasts is 4.0% and 4.5% respectively.

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