Earnings Drags For Alumina Ltd

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This story features ALUMINA LIMITED.
For more info SHARE ANALYSIS: AWC

By Chris Shaw

As metal prices have fallen conditions have turned quickly for aluminium play Alumina ((AWC)). ABN Amro is now suggesting that at current spot prices, all of the group’s offshore assets held in the AWAC joint venture are cash flow negative, so while the announced cut to production at the relatively high cost Pt. Comfort refinery is a positive, much more action is needed.

But as Merrill Lynch points out, it isn’t just that the company is seeing prices for its product fall, it is also enduring the classic resource sector squeeze of higher input costs at the same time. On the broker’s estimates, higher caustic soda prices, a major input in the group’s production process, will see costs come in far higher in 2009 than the market currently expects.

The broker is forecasting average caustic soda prices in 2009 to rise from a forecast average this year of US$370 per tonne to around US$548 per tonne, with the risk at present to the upside. To reflect this and lower aluminium price expectations, the broker has cut its earnings forecast next year by 59% to $123 million, which is just 8c in earnings per share (EPS) terms compared to what it notes is a market consensus of closer to 25c per share.

The tougher outlook for the aluminium market means the broker, along with ABN Amro, has removed the Wagerup expansion from its model, as it sees this as unlikely to go ahead in the medium-term. While ABN Amro expects the expansion will eventually still go ahead, it now doesn’t see commissioning before 2013 at the earliest.

ABN has also done the same as Merrill Lynch and factored in new metal price assumptions and as a result its EPS estimate for FY09 is also reduced to around 8c per share, while in 2010 it is forecasting EPS of 18c against Merrills at 15c.

In contrast, UBS has made only minor changes to its numbers to account for lower output from Pt. Comfort and is forecasting EPS of 16c in FY09 and 26c in FY10, while the FNArena database shows a consensus number for FY09 of 16c and Thomson One Analytics shows a mean forecast for FY10 of 26c.

The changes to earnings forecasts have seen price targets revised lower. Merrill Lynch dropped its target to $3.60 from $5.00 and ABN Amro to $2.41 from $3.97. This brings the average target down to $3.16 from $3.53, which is a significant disconnect from Merrill Lynch’s estimate of replacement value of the group’s assets, which adds up to more than $10 per share.

The problem, as the broker points out, is that no-one can pay for the assets at present, as the most likely buyer remains Alcoa of the US, but its balance sheet isn’t strong enough to fund a bid in the current environment. In the broker’s view, this is enough reason for a downgrade in rating to Neutral from Buy, as there are simply no positive catalysts to drive the share price at present.

Most in the market seem to agree, as the FNArena database shows the company is rated as Hold six times against two Buys and one Sell after Deutsche Bank last week downgraded its rating to Hold and cut its target by more than 40% to $2.70 to reflect cuts to its earnings estimates.

UBS also agrees the stock offers value given it is trading at a discount of around 35% to the five-year average cost of new capacity in the industry and around half the broker’s estimates net asset value, but like the others, it sees a need for further industry wide cuts to capacity to restore the market’s fundamentals and this process is expected to take some time given the costs involved in entering and exiting the industry.

Today, shares in Alumina are slightly higher and as at 1.20pm the stock was up 1c at $2.14, against a trading range over the past 12 months of $1.82 to $6.94.

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