Amid the challenges in the aluminum industry, Century Aluminum (CENX) has taken positive actions over the last few months. In June, it acquired the Sebree smelter in Kentucky. More importantly, it received approval for a new power contract at its Hawesville facility, which will improve its cost structure, and the company has similar plans for the new Sebree facility. These actions are reducing the company's cost of production and putting it in a better position to manage through the tough part of the aluminum price cycle. As a result of these actions, Century Aluminum's stock price has outperformed its peers. In this article I will analyze the challenges in the aluminum industry and the positive impact of Century Aluminum's recent actions.
Aluminum Prices
Aluminum prices have been in a downtrend for a while. Aluminum prices are based on the London Metal Exchange (LME) price plus regional premiums.
The LME prices have been falling for the last few years.
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(Source: LME.com, 3 month buyer)
I have been watching 1,800 as a key support level for aluminum prices. Aluminum prices have bounced off this level in the past, but have not made a convincing bounce over the last few months. If aluminum falls through this level there could be a lot more downside before prices eventually reverse course.
On the other hand, premiums have been strong:
(Source: Rusal 1H 2013 earnings presentation, August 19, 2013)
However, there is increasing speculation that premiums may fall. The LME is contemplating changes to its warehousing system that cou! ld result in lower premiums:
"Two-thirds of aluminum producers would be losing money because of lower premiums paid on top of exchange benchmarks if the world's biggest metals bourse approves rules to cut waiting times at its warehouses, according to JPMorgan Chase & Co.
Premiums to obtain the metal will drop 60 percent to about $100 a metric ton as a result of the new rules the London Metal Exchange is expected to approve in October, Benjamin Defay, an analyst at the bank in London, wrote in a report e-mailed today. The LME proposed to oblige warehouses where waits extend for 100 days or more to let more metal out than they take in." (Source: Bloomberg, August 30, 2013)
Supply/demand for aluminum is roughly in balance and does not seem to be a catalyst for a big move up in aluminum prices. Although there have been a lot of announced capacity cuts, they have not yet reversed the downward trend in aluminum prices. For more about aluminum supply/demand, please see: Breach Or Breakdown For Alcoa As Weak Aluminum Overshadows Downstream Success.
Aluminum is a cyclical business. Eventually, prices will recover, but there is no telling when that will happen and if there is more downside first.
This is a very challenging environment for all aluminum companies, including Century Aluminum.
Overview Of Century Aluminum
Century Aluminum was founded in 1995 as a part of Glencore (GLCNF.PK). In 1996, Century Aluminum became a public company. As of December 31, 2012:
"Glencore beneficially owned approximately 41.8% of our outstanding common stock and all of our outstanding Series A Convertible Preferred Stock. Through its ownership of common and preferred stock, Glencore has an overall 46.6% economic ownership of Century." (Source: Century Aluminum 2012 10-K)
Glencore also has three of the nine spots on the company's board of directors.
The following is an overview of the company and its key facilities:
"Century Aluminum is a primary aluminum produc! er, suppl! ying standard-grade, high-purity and value-added primary aluminum products at a rated production capacity of 785,000 metric tons per year (mtpy).
The company has operations in Hawesville, Ky., Sebree, KY., Ravenswood, W.Va., Mt. Holly, S.C. and Grundartangi, Iceland, with headquarters located in Monterey, Calif. We are constructing a primary aluminum facility in Helguvik, Iceland with an expected rated capacity of up to 360,000 mtpy.
In addition to our primary aluminum assets, we have an approximately 150,000-tonne carbon anode and cathode manufacturing facility located in Vlissingen, the Netherlands and a 40-percent stake in Baise Haohai Carbon Co., Ltd., a carbon anode and cathode manufacturing facility located in the Guangxi Zhuang Autonomous Region of south China." (Source: Century Aluminum website)
For more about the company's history, please see here.
In 2012, three main customers comprised 88% of the company's revenue:
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Stock Price
It is interesting to compare the stock prices of Century Aluminum and Alcoa (AA). While Alcoa has made a series of lower-highs and lower-lows, Century Aluminum has made higher-highs and higher-lows over the last year.
Comparison going back to the financial crisis:
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(Source: FreeStockCharts.com)
1 year comparison:
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Centure Aluminum's stock price has held up well compared to other aluminum companies:
AlcoaNoranda Aluminum (NOR)Aluminum Corp. of China (ACH)
CENX data by YCharts
The stock prices of all these companies have been moving in-line with aluminum prices. The recent developments at Century Aluminum over the summer were the catalysts for the recent outperformance.
Recent Developments
It has been a busy summer for Century Aluminum as it made a number of positive moves.
On June 3, the company announced the acquisition of Sebree aluminum smelter from Rio Tinto Alcan. Sebree has annual production capacity of 205,000 metric tons of primary aluminum.
On June 12, the company announced that it reached an agreement with the utilities in Kentucky about a new contract for power prices. The agreement was approved by the Kentucky Public Service Commission on August 14. The new agreement will allow the company to reduce its cost of producing Aluminum at its Hawesville smelter.
On the Q2 earnings call, the CEO explained the impact of the new power agreement:
"If you use an 1,800 cash LME, you use that fully delivered electricity price that I just mentioned, under those two assumptions, the plant would be profitable on a cash basis, and that's even after making an allowance for maintenance capital spending.
To give you a sense of the sensitivity there, obviously the Midwest premium and all of the premiums have gotten a lot of press here over the last couple of weeks after the LME's proposed change in the rules and we'll go through that within detail here in a few moments, but just to give you a sense, the plant would get to a breakeven level if that Midwest premium! would fa! ll by 50%. So we've still got a lot of room there, again even at an LME of 1,800." (Source: Seeking Alpha)
The company expects to implement a new power contract for the Sebree facility, which would bring down its operating costs.
The new Hawesville and (potentially) Sebree will be phased in over time. According to the company's plans, the cash costs for its US operations are expected to decrease as follows:
July - August cash costs per ton: $1,910-1,960September - December cash costs per ton: $1,850-1,900Pro-forma cash costs per ton: $1,730-1,780With aluminum prices in the $1,800 range, these reductions in cash costs are significant.
The CEO explained the transition to lower cash costs as follows:
"Moving down the chart, we've updated our net cash cost for the second half at an LME range of $1,800 to $2,000 per ton. For our U.S. facilities, we've shown it three different ways; first, on the basis of our current power contracts for both of our Kentucky smelters; second, showing the impact of just Hawesville at market power prices when its contract terminates in August; and finally, showing both Hawesville and Sebree pro forma for market power prices. So you can see here a change in just Hawesville power contract to market will decrease our average U.S. cash cost by $60 a ton, and this includes both the temporary transmission reliability surcharge that Mike mentioned as well as the anticipated step up in Sebree power cost in August.
In the final step, you can see our average cash cost going down another $120 reflecting both Hawesville and Sebree at market power. So in total, we expect our average U.S. cash cost will go down by $180 per ton which translates to in annual EBITDA impact of just over $100 million." (Source: Q2 earnings call, Seeking Alpha, bold added by author)
Please see the company's Q2 earnings presentation for more details.
The company also refinanced its debt in May and pushed out its debt maturities to 2021.
Financials
Lower alu! minum pri! ces have had a negative impact on the company's financial performance:
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First, the Sebree acquisition was only completed in June.
Second, and more importantly, the company expects to achieve $100 million of incremental EBITDA from the new power contracts on a pro-forma basis. It will take some time for the company to reach this run-rate, but the recent developments will likely have a big impact on the company's performance.
Third, aluminum prices are the key variable to the company's financial performance going forward.
Valuation
On a historic basis, the company's valuation looks high, but if/when it achieves $100 million of incremental EBITDA from cost savings, the valuation will be much more reasonable.
There are a few important points about the company's liquidity profile.
According to the 2Q 10-Q:
"We received a customer receivable payment of approximately $22 million in July 2013, one business day after its June 28th due date. The receipt of this payment is not reflected in the June 30, 2013 consolidated cash and cash equivalents balance."
The company also had $64 million of availability on its revolver as of June 30, 2013 (source: 2Q 10-Q).
Additionally, the company's new senior notes are due in 2021, which gives it a lot of breathing room.
2Q Perspective
The following is the commentary from the CEO in the 2Q earnings press release:
"We are managing through a period of uncertainty in our industry," commentedMichael Bless, President and Chief Executive Officer. "The slowing inChina's economy, the extent and impact of which remain difficult to determine, has cle! arly begu! n to impact European and other developed and developing economies. In contrast, our U.S. customer markets remain generally sound, with particular strength in the transportation and construction sectors. On a macro level, the relative strength of the U.S. dollar, caused in part by the recent rise in interest rates, has pressured the price of all commodities. Lastly, industry participants are trying to assess the potential impact of the recent proposal by the London Metals Exchange for changes in the warehousing rules. In summary, we are prepared to operate through this challenging environment in the near-term, but remain confident that attractive demand coupled with constrained supply outside of China will push aluminum prices upward over time." (Source: Century Aluminum 2Q 2013 earnings press release, July 30, 2013)
Conclusions
The aluminum industry continues to see strong demand, especially from automotive and aerospace companies. However, supply has outpaced demand and dragged down prices. The current environment for aluminum companies is challenging, but, like all cyclical industries, it will eventually turn.
Over the next few weeks/months it will be important to watch the $1,800 level for LME aluminum, which has been a key support level over the past few years. Additionally, many are speculating that premiums will decline, which would have a negative impact on aluminum producers like Century Aluminum. There may be additional headwinds, before the downtrend in aluminum prices ends.
Despite this environment, the company has takes positive actions over the last few months. Refinancing the debt gives the company a comfortable maturity profile for the next few years. More importantly, the new power contracts could generate significant cost savings. I am continuing to watch Century Aluminum closely to see if it continues to outperform its peers.
I have held a long position in the company in the past, but do not have a position now. I am very cautious on the market and want to! limit my! equity exposure. Furthermore, I am cautious on aluminum prices with LME aluminum still around $1,800 and talk about falling premiums. However, I am watching Century Aluminum closely and may invest in the future.
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