Capital Raising For Alumina?

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By Greg Peel

Citi has today downgraded its global economic growth forecasts, to 2.6% for 2012 from 2.7% and to 2.7% in 2013 from 2.9%. Emerging markets see a 0.3ppt cut in both years. The new economic forecasts lead to new and lower commodity price forecasts, with base metals bearing the brunt of the downgrades. Price cuts range from 5-10% with the biggest victim being aluminium.

Last year there was some excitement among analysts as it appeared clear the global alumina market (the feedstock for aluminium smelting) would follow in the footsteps of iron ore and coal in a gradual shift towards spot pricing instead of long-term contract price setting. The alumina/aluminium price relationship at the time implied alumina prices must rise under a spot-based system. However, all things have not been equal.

The aluminium market has been in the doldrums in the interim, with the price to cost relationship hitting CSR ((CSR)) hard and prompting BHP Billiton ((BHP)) to rethink its aluminium assets. Last week US aluminium giant Alcoa released its June quarter earnings and while the result slightly “beat the Street” this was only after 44% worth of guidance downgrades to Alcoa's profit guidance in the lead-up. Alcoa's result provides a direct read-through to the fortunes of Australian alumina producer Alumina Ltd ((AWC)) via Alumina's 40% participation in the AWAC joint venture.

The read-through was not inspiring. Alumina's biggest problem is falling margins under the scenario of a depressed LME aluminium price combined with a record aluminium metal premium. In other words, aluminium may be weak but its flow-through impact on alumina has never been worse. Some of Alumina's margin problems are locally driven and some will be resolved, but on average analysts are expecting the downtrend to continue into FY13 unless something remarkable happens.

This leaves Alumina with a dilemma. The company is currently not generating any cash but retains a high level of debt. The company does have another $300m of debt facility it can draw on, but more than one analysts was surprised back in February when Alumina announced a dividend payment under the circumstances. UBS suggested last week, on the expectation Alumina will report a first half loss, that 2012 dividends are not warranted.

UBS does not at this stage, however, believe Alumina will need to raise equity. Not all brokers agree nevertheless.

It is not Macquarie's “base case” view but if current margin pressure were to be sustained for the next 9-12 months, say the analysts, then the risk Alumina will have to raise capital is “heightened”. Citi has gone one better today and suggested unless cash flow generation improves, there could be the need for equity funding to replace debt in 2013.

On weaker aluminium prices, Citi now expects losses for Alumina in both 2012 and 2013 before recovery to a “notional” profit in 2014. Citi has as a result downgraded AWC to Sell and slashed its price target to 60c from $1.00.

There were already some substantial target price downgrades affected for AWC following the Alcoa result, but Citi has established a new low with targets now ranging from 60c to $1.45 in the FNArena database for a consensus of $1.05. That's a whopping 58% above today's trading price yet AWC can only attract three Buy ratings in the database along with three Holds and two Sells.

What some analysts find it hard to get past is the “embedded value” in Alumina's assets. In short, the company's legacy assets and infrastructure are irreplaceable globally unless someone was prepared to spend an awful lot of today's dollars. It is much more likely that company would buy Alumina Ltd before doing so.

Perhaps Credit Suisse (Neutral) sums it up best by suggesting that while “deep value” is clearly apparent, investors are unlikely to have the patience to wait for it. Alcoa has always been the obvious takeover contender given the longstanding JV arrangement, but the “long” in “longstanding” just seems to get longer, and longer, and longer…

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