Alumina (ASX:AWC) shares started to recover from 10-year lows late last year. Signs of improved demand/supply conditions in the alumina market and progress on cost reduction initiatives have been the main reason for the recent recovery.

With this in mind, we recently researched AWC in The Dynamic Investor. Have AWC shares simply recovered off its recent lows, or is Alumina emerging as a recovery play?

About Alumina

AWC’s sole asset is a 40% interest in the Alcoa Worldwide Alumina and Chemicals (AWAC) joint venture (JV), which has interests in bauxite mining, alumina refining, alumina chemicals and aluminium smelters. The other 60% interest in the JV is held by Alcoa. The Company has a 31 December balance date.

Key Fundamental Drivers

Lower Cost Profile Supportive for Alumina Margin Outlook

AWC reported an alumina margin of US$53/t in the three months to 31 December 2023 (4Q23), up from US$42/t in 3Q23. In recent quarters, margin has recovered from near-historical lows, having fallen from its most recent high of US$165/t two years ago.

The margin improvement was driven by a slightly higher-than-expected realised alumina price and a significant reduction in costs (-15% to US$291/t). Lower raw material costs, namely caustic soda, across the portfolio drove the decline in costs. Cash costs would have been lower (at US$263/t) if the higher cost refineries – Kwinana (WA) and San Ciprián (Spain) – are excluded. Importantly, the planned curtailment of these two refineries will likely enable the Company to restructure into a lower-cost, more profitable alumina business.

Favourable Outlook for Alumina Pricing

AWC’s average alumina price for third-party sales in 4Q23 of US$344/t was ~7% higher than expectations. An already tight alumina market impacted by Chinese production costs has seen the alumina price rally by >10% to US$370/t since AWC’s announcement early this year regarding the curtailment of the Kwinana refinery.

Both alumina and bauxite prices have been rising amid various supply disruptions recently. The alumina market is currently in tight supply, compounded by recent production cuts in China amid bauxite supply concerns and environmental audits.

While there is likely to be some short-term volatility, the global alumina market is still likely to stay in a sustained surplus position through 2024 and beyond; thus, providing further support to the alumina price. In particular, Alcoa expects alumina production to range between 9.8-10Mt and alumina shipments to range between 12.7-12.9Mt in 2024.

Further, it is estimated that approximately ~5-10% of global alumina supply is loss making. As such, the closure of Kwinana and San Ciprián will not only lower AWC into the bottom decile of the global cost curve, but should boost the alumina price.

Upcoming Environmental Bauxite Approvals a Key Share Price Catalyst

In December 2023, the Western Australian (WA) Government approved the latest 5-year mine plan, the 2023-2027 Mining and Management Program (MMP) for AWC’s Huntly and Willowdale bauxite mines. This is a low-grade bauxite area where AWC is currently mining with AWC expecting to mine the lower-grade bauxite until 2027.

AWC still needs environmental approvals by 2H25 to develop the higher-grade North Myara and Holyoake bauxite mine areas by 2027. These areas are located in areas around the serpentine dam which supplies drinking water to WA, and will supply bauxite to the Pinjarra & Kwinana refineries.

It is anticipated that AWC should receive key approvals required by mid-2025 to access higher-grade bauxite reserves. However, the approval is likely to come with concessions.

Improving Balance Sheet & Cashflow Support Resumption Of Dividends

We anticipate AWC will begin paying dividends again in late calendar year 2025 due to several factors: i) EBITDA margin is expected to expand to >US$100/t in 2H24, ii) A return to positive free cashflow in FY25, and iii) Net debt levels approaching peak levels.

Fundamental View

AWC is emerging as a solid recovery play given: i) The upside risk to FY24 EBITDA margin on the back of improved alumina pricing (as the market remains tight) and a lower unit cash cost profile, ii) Potential further newsflow on future plans for its bauxite mine operations and iii) Improved medium term fundamentals – These include a lower cost profile as a result of removal of high-cost production; and the global alumina market likely to stay in a sustained surplus position through 2024 and beyond.

Charting View

AWC has bounced well off the lows from November. However, the shares are now getting very close to a major resistance level near $1.20. The key test is whether we can see the share price get above $1.20. If so, then we can be confident that a major low is in place and that would be the buy trigger for anyone looking to invest in AWC .

 

Michael Gable is managing director of Fairmont Equities.

 

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