With the worst appearing to be over for the aluminium giant, upbeat sector sentiment caused mining stocks to rally in the UK and Europe on Thursday morning. However, while a massive inventory overhang did not affect Alcoa's third-quarter prices much, it will need to be absorbed some day, and this will drag out aluminium market recovery, our Morningstar analyst says.
Alcoa reported a third-quarter profit of $0.08 per share due to recovering aluminium prices and an asset-sale gain of roughly $100 million (about $0.10 per share). Average selling prices for aluminium recovered by roughly 30% from second-quarter levels, largely in line with spot price improvements between July and September. This price improvement is odd given record high inventory levels on the London Metals Exchange (LME). One big reason for this discrepancy is that much of the LME inventory is tied up in financial contracts for long-term delivery, and thus is not available in the spot market, driving up spot prices. Although this massive inventory overhang did not affect third-quarter prices much, it will need to be absorbed some day, and this will drag out aluminium market recovery.
It is impossible to discuss aluminium outlook without touching upon China, as China produces and consumes roughly 30% of the world's aluminium. Chinese demand was an important force behind third-quarter price recoveries, as imports soared since March. However, the Chinese market had moved to a near-term surplus by the third quarter due to domestic smelter restarts and six months' worth of high imports. In fact, Chinese imports have been on a declining trend since July, and this contraction will likely ease the aluminium market further going into the fourth quarter. (In fact, spot aluminum prices have been correcting downward since mid-August.) Longer term, though, we think Chinese aluminium production will not threaten the global supply-demand balance, as the government refrains from giving out new smelter permits in the next three years and will slowly curtail low-technology smelters. Therefore, we believe the worst is over for Alcoa, although recovery will most likely take a long time.
A bright spot within Alcoa's results is on the alumina side. Operating margins improved to 12% from the second quarter's negative 2%, due to better prices and lower costs. In September, Alcoa opened the Juruti bauxite mine in Brazil. This places Alcoa's upstream assets in the first quartile on the global production cost curve. The refinery expansion is on schedule for commissioning later this year. Bauxite mining and alumina refining are the more attractive businesses in the aluminum value chain, and we expect Alcoa to remain a viable low-cost competitor on the alumina side over the long run. We are keeping our fair value estimate unchanged.
Min Ye is a Morningstar stock analyst based in the United States.
