Even though we read about how depressed the aluminum market is, there is still ample opportunity to invest in certain segments of the industry. Refining and smelting the metal continues to be cost prohibitive but you may be surprised to find that there are some areas of the aluminum industry that continue to prosper and grow year-by-year. Let's take a look at the industry as a whole and then at how some companies struggle while others prosper.
Aluminum Prices Squeezed by Surplus
Aluminum was a hot commodity during the housing-led economy, before the financial crisis in 2008 that led to its price collapse. The most abundant metal on earth is known for its low density and high resistance to corrosion. The metal is found in everything from soda cans and airplanes to automobiles. Unfortunately the prices have not rebounded, as producers would like.
One of the problems that the aluminum producers have been facing is low demand. Prices have not been able to stabilize, because the demand is so low compared to production. In fact, the surplus has been getting bigger year-by-year. Look at the surplus numbers over the last three years:
- 2011- 889,000 tons
- 2012- 1.5 million tons
- 2013- 1.8 million tons (Est.)
With the continued growth in surplus, it is no wonder that the average price of aluminum has fallen by 16% the last couple years. The average price for a ton of aluminum in 2012 was $2,017, its lowest price since 2009.
In January of this year, Citigroup projected consumption growth at an anemic 1.3% because of the continued slowdown in China and the mild recession in Europe. For the year, they expect the average price per ton to be $2,100. Barclays Research forecasted $2,000 per ton. Barclays went on to assume stable aluminum demands in 2013 of 6%. But this was not expected to be able to absorb the excess supply that already existed and a ton of aluminum may even drop below $2,000.
The Actions to Cut Surpluses
China, which accounts for 40% of global output, will continue to have a huge effect on the price of the metal. In order for aluminum prices to increase to levels production companies deem acceptable, excess tonnage needs to be reduced. One of the reasons that we have this excess supply is because the Chinese government had been weary of closing smelters as recently as 2012 even though they were losing money. The central government was encouraging overall expansion to maintain self-sufficiency.
It is unlikely that non-Chinese companies would reduce production enough without China's cooperation. China needs to reduce its production in order to reduce the over abundance. If this happens, it is plausible to see the price increase to up to $2,200 a ton by the end of 2013.
It appears this is exactly what has been happening as of late.
Recently, Chalco, the top Chinese aluminum producer announced a temporary shutdown at its facilities to reduce production by 9%. Alcoa (AA) and Rusa (Another global aluminum producer) also announced production cutbacks as all three companies attempt to battle weakening prices and falling demand. With the top global aluminum manufacturing companies cutting back on production, Alcoa still believes the demand for aluminum will increase by 7% this year as bulging inventories start to dwindle, especially in China.
I Don't See Significant Price increases in 2013
I am convinced these actions will not be enough to significantly affect prices in 2013. Even though the stockpile has fallen in China the London Metals Exchange-registered facilities had a record high 5.45 million tons at the end of June. Even though manufacturers are cutting back production, the excess supply is going to make it hard to create any significant price rally in the short term.
Cutting the excess is one part of the solution to bring prices up, but the demand also has to increase. Presently the United States' economy is the only one that has a sense of growth taking place and that's not even worth boasting about. We are ready know where Europe stands. China's economy has been in deceleration mode for the last eight weeks and the other large emerging markets like Brazil, Russia, and India are also decelerating. This poses a challenge for lifting aluminum's prices.
As we have ended the first half of 2013, this is where we are with the state of the aluminum industry: aluminum prices continue to be a challenge for producers. They are attempting to battle weak prices and the falling demand by cutting production in an attempt to lower the excess supply. The weakening economies around the globe are posing a challenge to increasing prices because the demand is not expected to increase enough to significantly lift prices. I wouldn't be surprised if we still see prices fall a little more.
Even though aluminum prices are depressed, not all aluminum companies are doing poorly. The difference is between aluminum smelting and selling aluminum products on the end market.
Where Aluminum is Depressed
The area of depression for the lightweight silver medal is in refining and smelting. This news is not new but it's important to understand if you are interested in investing in the metal. Back at the end of 2011 when aluminum was trading at $2,135.50 a ton on the LME, it was estimated that 25% of the world's smelters may be losing money making aluminum. There are two reasons for this: the cost of aluminum going down and the cost of making the metal increasing.
This can be confirmed as companies that have focused on refining and smelting have struggled financially.
Alumina Ltd. (AWC)
Alumina is a company headquartered in Australia that trades on the NYSE. The company's focuses on three areas: bauxite mining, aluminum refining, and aluminum smelting. The company also has a 40% equity interest in Alcoa World Alumina.
With a market cap of $2.73 billion, the global company has struggled since aluminum prices have dropped because its main business is refining and smelting.
While the company's general and administrative costs have nearly doubled in the last four years, revenue has all but dried up. Net income in 2012, according to Yahoo finance, came in at a loss of $62.1 million.
Century Aluminum (CENX), which focuses on producing aluminum and selling it to the United States and Iceland, is another example of a company struggling in this area. In the last three years, its EBITDA (operating income) has dropped tremendously. Look at these final numbers for the last three years: (priced in the thousands)
- 2010- $102,980
- 2011- $47,296
- 2012- ($7,274)
Both Alumina ltd. and Century Aluminum focus on refining and smelting the metal for sale and both have seen operating income and sales dry up. This strengthens the point that these types of companies have been challenged and would make it hard to invest right now.
After looking at these two companies, we can observe another more familiar company that is more balanced in the aluminum industry. Everybody is familiar with Alcoa (AA). Not only does the company have a smelting and refining business, but it is also involved in end product markets.
In its 2013 2Q presentation (pdf), all its "end product markets" were up in both sales and growth year-over-year.
A large piece of Alcoa's "third-party" revenue comes from "primary metals" (28%) and "Alumina" (14%). Up to 42% of the company's third-party revenue is challenged by deflated aluminum prices and the increased cost of manufacturing.
When the company recently reported its 2Q 2013 earnings results, profits beat estimates by one penny per share and sales also came out on top reporting $5.85 billion verses $5.79 billion from analysts. Even though sales were down 1.9%, the markets appeared to be happy.
The company is trying to reduce its reliance on aluminum smelting and focus growth on its "downstream segments/end product markets." This is where the aluminum market is profitable. While Alcoa's "primary metals segment" took a $32 million loss, its downstream business battles to negate these losses with profits.
We have seen companies like Alumina ltd. and Century Aluminum struggle with revenue and increasing costs because the majority of their business is focused on smelting and refining. While Alcoa still struggles with losses, its downstream/end product markets help offset its production business. Then we have a company like Kaiser Aluminum Corp (KALU) that focuses on end product markets and has been doing quite well.
Kaiser Aluminum Corp engages in the production and sale of semi-fabricated specialty aluminum products. The company produces rolled, extruded, and drawn aluminum products used principally for aerospace and defense, automotive, consumer durables, electronics, electrical, and machinery and equipment applications. Notice the company's revenue growth.
You will notice year over year Kaiser Aluminum increased net income each quarter from 2011 through 2012. Revenue also increased quarter by quarter in the same period.
There is a big difference between how profitable downstream/end product markets are compared to the manufacturing of aluminum. The markets are not favorable to refining and smelting aluminum right now-and it doesn't look like they will be for the next 18 months. End product markets, especially segments like aerospace, continue to look strong and this is the part of the aluminum industry that potential investors should consider doing more research.