Australia | Jun 08 2012
– Aluminium market conditions still tough
– Weaker cash flows and rising debt expected for Alumina Ltd
– Company should avoid the need to raise equity
– Few catalysts see JP Morgan downgrade to an Underweight rating
By Chris Shaw
The near-term operating environment for Alumina (AWC)) is difficult, as overcapacity is driving down prices, aluminium inventories are at near record levels and capacity closures haven't yet been enough to tighten up the market.
In JP Morgan's view this tough near-term outlook for Alumina Ltd should not necessitate an equity raising, as undrawn debt facilities are likely to be enough to ride things out in coming months even if market conditions worsen further before improving.
While this is a positive, the issue in JP Morgan's view is weak near-term cash flows are likely to mean an increase in group debt levels. The broker's estimates suggest dividends received from AWAC won't be enough to cover interest, corporate costs, capital calls and remaining dividend payments.
This leads JP Morgan to suggest Alumina's net debt will rise from US$472 million at the end of 2011 to around US$562 million by the end of this year. This will leave Alumina with around US$170 million in undrawn debt facilities at the end of 2012. Group debt should improve in 2013 thanks to higher alumina prices.
With debt levels expected to increase this year, JP Morgan sees scope for Alumina to look at cutting dividends. The final dividend for 2011 equated to US$73 million, so in the view of JP Morgan the likelihood is no interim or final dividend will be declared in 2012.
Forecasts have been adjusted to reflect these expectations and changes to aluminium and foreign exchange assumptions. JP Morgan is now forecasting underlying net profit in US dollar terms of $5 million this year and $85 million in 2013, which compares to previous estimates of minus $1 million and $168 million respectively.
In earnings per share (EPS) terms this equates to results of US0.2c this year and US3.5c in FY13, which compares to consensus EPS forecasts according to the FNArena database of minus US0.1c this year and US5.6c in 2013.
The key for JP Morgan is while Alumina Ltd is unlikely to require an equity raising this year, there continues to be the risk the company remains unprofitable or capital call requirements increase in coming months. Any slowdown in macro economic growth that pressures aluminium prices could generate such an outcome.
This risk leads JP Morgan to suggest while shares in Alumina Ltd look cheap relative to valuation, this is based on long-run earnings margins for the company returning to normal levels. Current market conditions suggest this may occur later rather than sooner given the excess supply in the aluminium market.
In such an environment share price outperformance is regarded unlikely. To reflect this, JP Morgan has downgraded to an Underweight rating from Neutral previously, seeing better value from companies such as Fortescue ((FMG)) that offer better margin and production growth stories.
This leaves JP Morgan's as the only negative view on Alumina among brokers in the FNArena database, which shows three Buy ratings and four Hold recommendations among the others offering coverage. The consensus price target in the database is $1.52, which is broadly in line with JP Morgan's target of $1.50. Targets range from BA Merrill Lynch at 1.20 to UBS at $2.20.
BA-ML had rated Alumina as Underperform until earlier this week, when the broker upgraded to Neutral on news Chinalco was to cut production. The move was seen as helping to balance the aluminium market moving forward.
The Buy argument in the market is largely a valuation call, Macquarie for example suggesting Chinese cost push pressure is impacting on pricing in the alumina and aluminium markets at present but this should normalise at some point. When this occurs Macquarie suggests Alumina Ltd shares offer upside on a replacement value basis.
For Credit Suisse current aluminium market conditions remain tough and so share price outperformance remains unlikely, but the broker suggests the worst may have passed for the company. Given few obvious positive catalysts a Neutral rating is appropriate in Credit Suisse's view.
Shares in Alumina Ltd today are down slightly in a weaker overall market and as at 10.40am the stock was 0.5c lower at $0.965. This compares to a trading range over the past year of $0.89 to $2.29, the current share price implying upside of more than 50% relative to the consensus price target in the FNArena database.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
