Aluminum: Steel Industry Deja Vu?
Masam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The aluminum industry has been going through a “prisoner’s dilemma” just like the US steel industry. Industry output has exceeded demand and therefore margins have been squeezed due to massive price cuts. Not a single player is willing to take the first step of reducing its production capacity. This has led to unfavorable returns for aluminum investors:
Noranda Aluminum (NYSE: NOR)
Noranda’s sales volumes are expected to improve in 4Q12 and beyond, with Gramercy back to full production, following electricity disruptions from Hurricane Isaac; pot relining activities at New Madrid are also making progress.
The company is expected to face costs from Gramercy repairs through 4Q12 with New Madrid pot relining costs continuing through 1Q13. While volume improvements will increase EPS and margins as costs decline, the Street sees limited upside to the stock.
Noranda will continue to face the same pressures as other US aluminum producers over the next few years. Cost reduction strategies and attempts to move up the value chain will marginally help earnings, but low aluminum prices will continue to be the larger issue. Noranda also prefers to have its electricity contract not tied to the LME aluminum prices and with the broadly held view that weak metal pricing will persist for the foreseeable future, the Street sees its margins remaining subdued. In addition, as the forward curve for aluminum flattens out or interest rates rise, more aluminum could be seen leaving the inventory houses, entering the physical market and reducing the Midwest premiums that have somewhat supported US and global producers over the past year.
Noranda is currently trading at 13X 2013E P/E and 6X EV/EBITDA, above historical multiples of 10.8X/4.5X but below aluminum peers at 23.6X/8.7X.
Downside risk comes from continued global weakness and excess Chinese capacity. Upside risk comes from higher than expected aluminum prices.
Low prices for aluminum have not only disturbed Noranda’s earnings but the stock prices of other aluminum players as well:
Century Aluminum (NASDAQ: CENX)
Given the flattish aluminum pricing outlook in 2013, Century is expected to continue to focus on negotiating a better cost position at Hawesville and Ravenswood estimated to be worth about $90 million. The market has already given most of the credit to Century for these potential cost improvements as the stock appreciated almost 60% since mid-July, outperforming its peers. If power negotiations drag on and costs savings are pushed out or not realized, there could be potential downside risk.
Alumina Limited (NYSE: AWC)
Alumina is an Australian resource company that produces alumina. The company owns about 40% of Alcoa World Alumina and Chemicals through a joint venture with Alcoa.
The Street is forecasting Alumina to report an underlying earnings loss of $84 million for 2012, compared to a profit of $128 million in 2011. The drop in earnings is driven by a lower aluminum price y/y. The outlook relies on the movement in the spot alumina price, which to date in 2013 is trading above expectations. The Street does not expect Alumina to declare a dividend in this period.
Foolish Bottom Line
Companies with a large exposure to aluminum have been having a nightmare given that the prices of aluminum have been falling mercilessly. This decline is expected until aluminum prices steady, and the decline has been fully priced into aluminum stocks.
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