Australia | Jun 20 2012
– Citi remains cautious on aluminium outlook
– Expects further margin pressure for Alumina
– Reiterates Neutral rating despite discount to valuation
By Chris Shaw
The share price of Alumina Ltd ((AWC)) has returned to GFC lows in recent months, impacted by ongoing volatility in global equity markets, falling aluminium prices and a still strong Australian dollar.
Even allowing for the recent share price falls Citi sees limited upside in Alumina Ltd at present and so retains a Neutral rating. This reflects a cautious outlook for both alumina and aluminium, little in the way of production growth for the company and a lack of earnings and cash flows.
The other issue in Citi's view is margins for Alumina remain under pressure. In the first quarter Citi notes alumina margins for AWAC were US$35 per tonne, but since the end of the March quarter the alumina price has fallen further.
This is adding to margin pressure and is offsetting some of the benefits of lower costs, while Citi sees an ongoing surplus in the aluminium market in coming years and expects this will continue to weigh on margins for AWAC, Alumina's joint venture with Alcoa of the US.
As evidence of this, Citi is now forecasting and average EBITDA margin of US$40 per tonne this year and US$55 per tonne in 2013. This compares to a 10-year average EBITDA margin of around US$67 per tonne.
Following a review of its model, Citi has cut its earnings estimates for Alumina for both 2012 and 2013. For this year the broker has moved from forecasting a profit of US$34 million to a loss of US$33 million, while in 2013 Citi's numbers have been reduced by 67% to a profit of US$63 million.
The lower earnings expectations for Alumina impact on Citi's dividend forecasts. No distribution is now expected this year, while in 2013 a dividend of US3c is now expected, which is half the previous forecast.
Citi's forecasts in earnings per share (EPS) terms stand at minus US1.3c this year and 2.6c in 2013, which compare to consensus forecasts according to the FNArena database of minus US0.4c this year and US5.0c in 2013.
The weak earnings outlook for Alumina is pressuring the group's balance sheet. Citi's forecasts suggest from a level of US472 million at the end of 2011, net debt is likely to increase to around US$600 million by the end of this year.
Alumina had US$295 million in undrawn facilities at end 2012 and around US$150 million in facilities maturing in 2013. While refinancing is not a major issue in Citi's view, it could at least result in higher borrowing costs given a current S&P rating of 'BBB' is on negative watch.
Citi's conclusion is Alumina is cheap in valuation terms given the stock is trading at a significant discount to net present value of $1.40 per share. But this valuation doesn't justify a higher rating than Neutral according to Citi given discounts to valuation are common across the sector at present.
There is also downside risk to Citi's valuation, as it is based on a long-term aluminium price of US$1.00 per pound and an Australian dollar rate of US80c. If current spot prices were factored into a long-term outlook valuation for Alumina would fall to $0.50 per share.
Citi's cautious outlook on Alumina is shared by others in the market, as the FNArena database shows the stock is rated as Hold four times, along with three Buy ratings and one Sell. Credit Suisse rates Alumina as a Hold given the view the worst has passed for the aluminium market, while BA Merrill Lynch recently upgraded to a Neutral rating on news Chinalco would cut output in coming months. This is seen as helping balance the market, which would be a clear positive for Alumina.
Macquarie's Buy rating reflects the broker's view Chinese cost push pressure is temporarily impacting on alumina and aluminium pricing and once this washes through the market the value in Alumina will become apparent. UBS offers a similar argument in support of its Buy rating.
But JP Morgan disagrees, recently downgrading to Sell from Neutral given the expectation ongoing margin pressure and the potential for weak cash flows to affect dividends will see Alumina continue to underperform the sector.
The consensus price target for Alumina stands at $1.48, ranging from Citi at $1.00 to UBS at $2.20. Shares in Alumina today are slightly higher in a stronger overall market and as at 10.45am the stock was up 1.2c at $0.937. This compares to a range over the past year of $0.89 to $2.29, the current share price implying upside of around 60% relative to the consensus price target in the FNArena database.
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