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Morningstar | Alumina Supply Disruptions Buoy Alumina Limited's Profits; Raising FVE to AUD 1.70

Alumina Limited reported solid results for the first half of 2018, as alumina prices remained elevated. The company's average realized price for the first half of the year was $424 per metric ton, considerably higher than $315 in the prior-year period. This sharp increase was largely due to the continued effect of supply disruptions and healthy alumina demand growth. Higher production costs served as a slight headwind, driven mainly by increased energy costs and elevated caustic soda prices. Alumina Limited’s cash cost of production increased to $224 from $202 a year earlier.

We expect supply disruptions will continue to boost prices through the end of the year. Accordingly, we've increased our 2018 alumina price forecast and are raising our fair value estimate for no-moat Alumina Limited to AUD 1.70 from AUD 1.60. Numerous factors have supported high alumina prices. In early 2018, Chinese winter supply cuts limited supply initially, before a partial outage in Norsk Hydro’s Alunorte facility further reduced supply. Additionally, U.S.-imposed sanctions on Russian aluminum giant UC Rusal contributed to even tighter market conditions. Although we previously assumed that Alunorte would resume full production within a matter of months, we now expect the situation won't be resolved until year-end 2018.

Despite current price levels, our long-term outlook for declining alumina prices remains intact. We believe demand growth for aluminum and, in turn, alumina will decelerate significantly as China transitions from an investment-led to a consumption-led economic growth model. The combination of this dynamic and waning stimulus effects will weigh on fixed asset investment growth, leading to lower alumina prices in the long term.

In contrast with the alumina segment, the Alumina Limited's bauxite segment reported soft results. Shipments to third parties decreased to 2.6 million metric tons versus 3.0 million metric tons in the prior-year period. This decrease can be attributed to Chinese alumina producers importing less bauxite due to alumina supply cuts. However, we expect demand for third party bauxite to increase in the longer term, with the quality of China’s domestic bauxite continuing to deteriorate.