We recently reviewed Alumina (ASX:AWC) following the release of 3rd quarter (3Q20) results for AWC’s partner Alcoa. Whilst the share price has struggled to regain traction and remains well below market valuations, we assess whether AWC presents an attractive opportunity at current levels.
Alumina’s sole asset is a 40% interest in the Alcoa Worldwide Alumina and Chemicals (AWAC) joint venture (JV). This has interests in bauxite mining, alumina refining, alumina chemicals, and aluminium smelters. The other 60% interest in the JV is held by Alcoa.
The AWAC JV is the world’s largest producer and 3rd party seller of alumina. Ninety percent of this alumina supplied is to feed smelters that produce the aluminium used in transport, aerospace, building, construction and packaging. The current refining portfolio is comprised mostly of Tier 1 assets. Around 75% of AWAC’s annual alumina production is generated from alumina refineries in Western Australia (WA), namely the Pinjarra, Wagerup and Kwinana refineries.
Key Fundamental Drivers
Outlook for Alumina Prices
AWC reported a realised alumina price of US$269/t for 3Q20, up 7% from US$252/t in 2Q20. The alumina price is currently US$274/t amid continuing signs of a promising economic recovery in China and higher LME aluminium prices. Alcoa sees improving global aluminium demand, with a major inflection from transportation customers evident in 3Q20, compared to 2Q20.
Spot alumina prices have fallen from ~US$470/t for the most part of 2018 and have hovered around US$270/t since 4Q19. So far there hasn’t been much of a signal of a sustained outbreak in either direction. This trend is despite production/capacity cuts announced this year and Chinese aluminium demand remaining very strong and manufacturing activity outside of China is showing signs of improvement.
Cost Pressure to Cap Earnings Growth
The AWAC JV’s first-quartile cost curve position keeps the Company profitable through the cycle. This means that: i) There is limited financial risk despite exposure to fluctuating commodities, ii) The AWAC JV can compete effectively against Chinese and other alumina producers and iii) The AWAC JV is well leveraged to an improvement in alumina prices.
Earnings are supported by record alumina production for the AWAC JV in 3Q20, with the higher production rates expected to hold into FY21. Having said that, margin expansion is expected to be limited by additional cash costs and the prospects of additional restructuring charges. These would arise out of a potential closure of alumina smelters as part of Alcoa’s current review of its global production capacity.
Debt Levels are Manageable and Refinancing Risk is Minimal
Net debt as at 30 September 2020 was US$98.7m. While this increased from US$77.4m as at 30 June 2020 the level of net debt is actually lower than more recent elevated levels. Net debt also remains below the targeted net debt gearing range of ~US$120m-US$130m.
Refinancing risk is minimal. AWC has a US$350m syndicated bank facility with tranches maturing in October 2022 (US$100m), July 2023 (US$150m), and July 2024 (US$100m).
The shares are currently trading at a substantial discount to market valuations (which currently average $2.02 per share and range from $1.54 to $2.30 per share). However, there are a number of factors which have held it back:
i. The market continues to value AWC assuming an alumina price at spot levels (currently US$274/t), as opposed to longer-term forecasts of ~US$320/t.
ii. Notwithstanding that AWC’s valuation is highly leveraged to alumina price, the currently depressed alumina price also impacts distribution yields. With alumina spot prices broadly in line with the current Chinese marginal cost of production of ~US$275-290/t, there is downside risk to earnings (and therefore distributions) especially as the Company is facing higher CAPEX, as well as higher one-off & restructuring costs from asset closures.
iii. A potential tax liability from the ATO remains an overhang on the stock, from the viewpoint that it impacts cash generation and future distributions. In addition, an equity raising may be needed to partially/fully fund any penalties imposed by the ATO.
AWC’s share price appears to be on the move now. It retested the March lows and is now pushing beyond some nearby resistance levels. The recent close above $1.50 was a particularly bullish sign. We could now be seeing a decent recovery in the share price. The initial targets would have to be a retest of the July peak.
Michael Gable is managing director of Fairmont Equities.
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