Rusal - Stars Aligned

Aluminum has jumped to over $2,100/tonne LME, driven by the global economic recovery, the looming slowdown of capacity expansion in China and the additional boost to demand from stimulus for green economic development. This and a stubbornly weak ruble may allow the EBITDA of Rusal's aluminum business to reach $2.15 bln and its FCF to reach $0.4 bln in 2021, we estimate. Additionally, Rusal's stake in Nornickel has appreciated to almost $16 bln, or 117% of the aluminum unit's EV as of end-2020, and we see it having room to appreciate another 35%. Rusal is trading at a distressed valuation, which we see as unjustified. We upgrade our target price to HKD6.53 and open a trade idea to buy Rusal.> Aluminum market outlook. The aluminum price outlook is starting to improve thanks to a combination of supply and demand factors. Strong pent-up demand, driven initially by electronics, home appliances and construction, followed by the auto industry (yet to return to pre-Covid production levels), has resulted in high physical premiums. With rising investments in the green economy, the longer-term outlook for demand has also improved - EVs use 15-30% more aluminum than cars with ICEs, while the metal can also serve as a substitute for copper (the copper-to-aluminum price ratio has jumped from 3.3 to 4.0 in just a year). The aggressive aluminum capacity expansion in China is coming to an end. China's 2020 output reached 39 mt versus the 45 mt maximum set by the government to prevent overcapacity and higher CO2 emissions. We increase our aluminum price forecasts to $2,050/tonne in 2021 and $2,150/tonne in 2022.> Upgrade of Rusal's earnings and FCF. High aluminum prices coupled with a stubbornly weak ruble should result in a massive expansion of Rusal's earnings. We estimate EBITDA from the aluminum business at $2.15 bln in 2021, with $0.4 bln in FCF. Additionally, Nornickel's earnings keep increasing, and we project Nornickel's 2021 EBTIDA at $13.0 bln, boosted by strong commodity prices. We estimate the dividend from Nornickel to be paid this year at $1.5 bln, which may allow Rusal to end the year with net debt of just $3.9 bln.> Corporate conflict over Nornickel unlikely. We believe that Rusal's stock price has been slow to pick up due to concerns over the nearing expiration of the Nornickel shareholder agreement with Vladimir Potanin. In a recent report, we outlined the reasons why we see a low chance of a full-blown conflict and think it is more likely that a new agreement will be reached, perhaps looser than the previous one but still with certain dividend payouts fixed. The improving visibility over the prospects of the Nornickel stake could be a positive trigger for Rusal. > Valuation. If the current market value of the Nornickel stake ($16 bln) is subtracted from Rusal's EV ($8.2 bln market cap plus $3.9 bln in net debt as of end-2021), the EV will be negative $3.9 bln. If we treat the dividend flow of Nornickel as a business unit at Rusal (whereby the value of the stake is not deducted from the EV but the dividend is added to Rusal's EBITDA - see our report on Rusal, where we explained this approach in detail), the stock is trading at a distressed 3.3 EV/EBITDA and a 24% FCF yield at our base-case macro assumptions (or a 3.0 EV/EBITDA and 26% FCF yield marked to market). Using a target EV/EBITDA of 4.5 (the average of Alcoa's and Norsk Hydro's 2021E EV/EBITDA multiples as implied by the Bloomberg consensus), we upgrade our target price from HKD4.03 to HKD6.53. We reiterate our BUY recommendation and open a trade idea to buy the stock.> Risks. Despite the strong FCF generation, we think that the probability of this translating into dividends is relatively low in the short term, as the company may preserve the cash for a number of transactions. First, under the Nornickel shareholder agreement, Rusal has a ROFR with regard to an around 2% stake held by Abramovich and his partners. If they attempt to sell this stake within the next two years, Rusal may decide to buy it. At the current Nornickel share price, it is valued at $1.1 bln. Additionally, En+ (the owner of a 56.88% stake in Rusal) has been talking about a potential restructuring and consolidation of Rusal for quite a while. Although details on how this could be structured or the timeline have not been provided, one of the options could be a buyout of some of Rusal or En+ shareholders for cash. For instance, at Rusal's current stock price, SUAL's stake is valued at $2.1 bln. No indication has been given that Rusal is pushing for restructuring recently - such a deal may not be on the table yet - but with cash flow generation rising, the chances are increasing, in our view. Given the potential size of the deals, the valuation parameters would obviously be important for Rusal's stock.