Stock of the Day – Alumina (AWC)

Alcoa Inc’s underlying second quarter profit more than doubled to USD 216 million, on both a sequential and year on year basis . However the important Alumina component (most relevant to Alumina Limited) fell 40% on sequential basis to USD 38 million, the first decline in six quarters. Underperformance is driven a decline in second quarter alumina pricing , a higher Australian Dollar  and unfavorable timing of maintenance.


Annual Production (Source – Company Reports)
 
Margins in underlying AWAC business have fallen with spot Alumina down and the AUD up. While we recognize a lack of identifiable catalysts to drive a share price re rating we believe a sell recommendation is now justified based on stretched valuation metrics versus mining sector peers. While we acknowledge positive share price momentum and improved sentiment towards Aluminium, we believe the stock has run too far.


Cost of alumina production (Source – Company Reports)

AWC offers a strong leverage to a likely fall in the AUD. However YTD the AUD has remained resilient highlighting the risk that the currency doesn’t weaken in the medium term. Dynamics are likely to be positive long term based on: 1) Potential rise in Bauxite prices resulting from the Indonesian export ban leading to cost inflation for the marginal cost producer 2) A lack of investment in the new Alumina capacity in the western world should ultimately result in tighter markets over long term. Near term however markets look balanced with spot alumina falling around 7% YTD.



AWC Daily Chart (Source – Thomson Reuters)
Near term Free Cash Flow (FCF) remains weak and dividend are likely to be eroded by: 1) Point Henry Closure costs, 2) Alba settlement costs 3) Likely repayment of debt within AWAC along with any working capital contributions to struggling refineries such as San Ciprian. AWC offers exposure to alumina assets that in aggregate are well placed on the cost curve. However current margins remain low and are not showing improving trend. 2Q14 earnings in Alcoa’s Alumina Division fell from US$92m in 1Q14 to US$38m in 2Q14 due to higher costs, lower production and the non-recurring gain on the sale of a gold mine in Suriname in 1Q14. We put a SELL recommendation on the stock at the current price of $1.505.

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