Southbank Victoria Aug 19, 2015 (Thomson StreetEvents) -- Edited Transcript of Alumina Ltd earnings conference call or presentation Wednesday, August 19, 2015 at 12:00:00am GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Peter Wasow Alumina Ltd. - CEO * Chris Thiris Alumina Ltd. - CFO ================================================================================ Conference Call Participants ================================================================================ * Paul Young Deutsche Bank - Analyst * Lyndon Fagan JPMorgan - Analyst * Brendan Fitzpatrick Morgan Stanley - Analyst * Clarke Wilkins Citigroup - Analyst * Paul McTaggart Credit Suisse - Analyst * Owen Birrell Goldman Sachs - Analyst * Peter O'Connor Shaw & Partners - Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Thank you for standing by and welcome to the Alumina Limited half-year results conference call. (Operator Instructions). I must advise you that this conference is being recorded today, August 19, 2015. I'd now like to hand the conference over to your first speaker today, Peter Wasow. Please go ahead. -------------------------------------------------------------------------------- Peter Wasow, Alumina Ltd. - CEO [2] -------------------------------------------------------------------------------- Thank you and good morning and welcome to our 2015 half-year results presentation. Chris will cover the financials and then I'll return to cover the market conditions and outlook. Before I hand over to Chris though, please note this disclaimer. And can I also remind you that we'll be presenting in US dollars? With that, I'll now hand over to Chris. -------------------------------------------------------------------------------- Chris Thiris, Alumina Ltd. - CFO [3] -------------------------------------------------------------------------------- Thanks, Peter. For the first half, Alumina Limited reported a net profit after tax of $122m. That's a $169m turnaround on the loss of the previous first half. If we exclude the significant items, the impact would be $175m and the improvement would be $148m, mainly due to AWAC's gains in pricing and production costs for both alumina and aluminum. Free cash flow also improved over the previous corresponding half, thanks to a $17m increase in receipts from AWAC, whilst contributions to AWAC declined by $32m. In addition, there were lower corporate costs due to currency benefits and savings in expenditure. The decline in finance cost is mainly due to lower average borrowings and lower average interest rates following the refinancing of the Brazilian loan. So after corporate and finance costs and net investments, the Company had free cash flow of $60m and net debt of $66m. Despite the current level of uncertainty for alumina prices, the Board decided the Company should stay around its current target level of net debt. In line with this, the Company will pay a fully franked interim dividend of $0.045 per share. And the shares issued to shareholders under the DRP will be at a 1.5% discount. The DRP will be 50% underwritten. Turning to AWAC's EBITDA performance bridge, we can see an operating improvement of $435m. The higher revenue is mainly due to improved pricing for both alumina and aluminum, which were partially offset by lower aluminum shipments following the closure of Point Henry. Alumina shipments of 7.8m tonnes were unchanged despite the sale of Jamalco late last year. Bauxite shipments to third party customers were 300,000 tonnes higher as the new mining business unit starts to establish itself. COGS has shown a larger improvement, mainly due to the stronger US dollar and also lower energy cost. Productivity initiatives and cost control were also a positive feature here. The alumina segment's share of EBITDA before the significant items was $788m, whilst smelting's was $31m. That leaves an $18m EBITDA loss which relates to equity investments and predominately due to the Ma'aden mine and refinery joint venture, which is in its ramp-up stage. The plant's current run rate is around 60% of nameplate capacity and is expected to achieve 90% in the fourth quarter. AWAC's average realized alumina price increased by $21 to $321 per tonne. The improvement is mainly due to higher realized prices on a spot index basis and a continued progression towards this form of pricing. For example, the tonnes that rolled off the legacy contracts achieved an additional $80 per tonne on average. During the first half of 2015, approximately 71% SGA third party sales were on a spot index basis. Given our expectation that this percentage should be an average of 75% for the year and approximately 79% is expected in the second half, the difference in weighting between the two halves reflects the maturity of an old legacy contract during June. This increased weighting will partially offset the impact from the recent fall in spot and LME prices. For 2016 we expect AWAC's third party shipments of SGA, based on the spot price, to be approximately 84% of the total and to level out at around 95% from 2017 and for many years to follow. AWAC's total alumina production was 7.6m tonnes, 64,000 tonnes more than last year's first half, and that's after excluding Jamalco. The Australian refineries, which represent approximately 60% of total production, were operating at near full capacity on average. The production guidance for this year is 15.3m tonnes, which does not include the Ma'aden joint venture refinery. And the focus in the next few years will be on creeping the capacity of the tier 1 refineries and changing the product mix of the other refineries to improve their margin. Markets permitting, it is possible over the next five years that the tier 1 creep projects could deliver more than the equivalent of the Ma'aden investment in terms of AWAC's production share, with incremental production costs that should be significantly below the costs of the tier 1 assets. AWAC's average cash cost of alumina production declined by $30 to $223 per tonne. Approximately $2 in improvement is due to the sale of the higher-cost Jamalco refinery late last year. The balance of the decline was mainly due to currency benefit and lower energy costs. The lower energy costs reflected lower prices, improved productivity and the conversion of the San Ciprian refinery to natural gas from fuel oil. The improvements in energy were partly offset by increased usage, in particular as the San Ciprian refinery went through the conversion process. There were also benefits from productivity initiatives in raw materials, maintenance and transport, which more than offset the higher prices and usage. Longer term, we expect benefits from increase in the production proportion of the tier 1 refineries and the operating initiatives in the new mining business unit. Cash from operations increased by $239m, and that's after the first instalment of the 12-year gas supply agreement. Adjusting for that and movements in working capital, there would have been an increase in cash from operations more in line with the improvement in EBITDA, excluding the significant items. AWAC's short-term borrowings were just $22m compared to $66m at December 31. The majority of the decline relates to the repayment of debt by the San Ciprian refinery business. Growth CapEx for 2015 is expected to be $20m, of which $3m was in the first half. And total sustaining CapEx is expected to be $220m. Following the sale of Jamalco and due to other initiatives, over the long term, sustaining CapEx is expected to average $260m per annum. This expectation is based on average exchange rates of $0.77 for the Aussie, [BRL3.10] for the [real] and $1.08 for the euro. As you can see from this slide, AWAC distributed 77% of its cash flow or, from our perspective, Alumina Limited received 31% against our 40% equity interest. Just coming back to the WA gas deal, Alcoa of Australia has signed up to a 12-year supply contract with the consortium that acquired the Apache domestic assets. Combined with other recent deals, AofA has now contracted nearly 75% of its needs that are maturing from 2020. This deal required AofA to make two prepayments. As I said earlier, the first one was paid in June. The second is $200m and is due next January. Given these upfront cash outlays, AofA will receive a portion of the contracted gas in 2020, against which there will be no cash outflow for several years. We believe this deal secures the low-cost position of the WA refineries because significant supply and pricing uncertainty have been removed by contracting proven reserves with multiple fields and operating plants with mature production profiles. Turning to outlook, net of its short-term debt, AWAC starts the second half with over $100m of excess cash. Although there was only $65m of CapEx in the first half, we expect there will be $175m to be spent in the second. There will also be after-tax cash payments by AWAC of up to $5m and $20m in relation to Point Henry and Anglesea respectively. We expect the second-half alumina margin to be under the first, just because of where current market prices are. However, whilst we can see that average realized price could be marginally below the low point of the last couple years, and that includes the benefit of a higher proportion of API/spot sales today, the cash cap should also be lower. Therefore, based on current prices, second-half aluminum margins are still expected to be substantial compared to that of recent history. Taking into account everything I've said, we expect that AWAC will be able to generate sufficient cash balances to meet its obligations plus the second gas instalment. And we still expect to receive distributions from AWAC and to make a small contribution towards the Ma'aden JV. Thank you. And I'll now hand you back to Peter. -------------------------------------------------------------------------------- Peter Wasow, Alumina Ltd. - CEO [4] -------------------------------------------------------------------------------- Thanks, Chris. Today I'll cover the demand, supply and cost drivers which are shaping the business. I'll then focus on how AWAC is positioned and will conclude with a look into the future of bauxite. Demand for aluminum continued to grow strongly during the first half of 2015. However, supply grew faster and the Chinese surplus exceeded the deficit in the rest of the world. As a result, China exported about 200 -- about 2.5m tonnes in the first half. Overproduction in China, an arbitrage opportunity and tax advantages led to some primary metal disguised as semis being exported from China. Together with the increased metal availability from warehouses, this led to lower regional premiums and the lowest all-in aluminum price since 2009. However, aluminum production costs in US dollars have also fallen by around $100 per tonne over the last 12 months. Significant new capacity was added in China during the half, and this is expected to continue for the remainder of the year. At the same time and as a result of low aluminum prices, the existing high-cost Chinese smelters have cut back. In sum, the net growth in smelting capacity in China over 2015 is expected to be around 11% as production chases lower energy costs and is established in new regional centers. The chart at the top left on this slide shows two forecasts of the alumina supply/demand balance for the next five years. Alumina production is forecast by Harbor to grow to 114m tonnes this year, an increase of around 9% compared with last year. And alumina demand is forecast to grow to 113m tonnes. As discussed on the previous slide, there's been strong alumina demand from smelting ramp-ups in China, and that's expected to continue. Alumina demand growth in the rest the world is also expected. Strong capacity additions and restarts in China have exceeded demand growth and the industry is operating at a historically high capacity utilization, which you can see on the chart at the lower right. Alumina demand is expected to increase further in 2016 and, subject to forecast ramp-ups and potential curtailments and foreclosures, there should be sufficient production to meet demand. The global average cash cost of producing alumina has fallen over the past 12 months by around 13% to $246 per tonne. This is mainly due to lower energy, caustic, bauxite and freight costs. Additionally, alumina refineries in Russia, Brazil, Europe and Australia have seen their production costs decline in terms of US dollars as their currencies have depreciated. For producers in the highest decile, costs have fallen even further. Merchant refineries in China, typically the marginal producer, have enjoyed even lower costs as the impact of the Indonesian bauxite ban unwound with the advent of new supply at low cost from Malaysia. And this chart shows just how much the cost of imported bauxite has changed over the past few years. The CBIX price dropped from an all-time high of around $75 a tonne 12 months ago to the current price of around $53 a tonne in light of large volumes with low value-in-use cargos from Malaysia. This reduction and the demand for alumina in China were the primary reasons for the reduction in costs and the sharp lift in China's capacity utilization shown on previous slides. Let's turn now to the key drivers of our margins. And first I'd want to point out that AWAC's costs have fallen along with those of the industry as a whole, reflecting several forces, including portfolio optimization, continued focus on productivity and the benefit of a stronger US dollar. The pie chart shows an estimate of AWAC's currency exposure. And if the current spot rates, which are better than the average for the first half, are maintained, we can expect further improvements in costs in the second half. Another important driver of margins is the continued shift to API-based pricing. The chart on the right shows how API and historical LME-linked pricing have diverged over the past few years. And it also shows how the move to API-based pricing has added significantly to average sales revenues. The difference between spot/API and historical contracts priced at around 14.5% of LME stands at more than $60 per tonne today. Turing now to bauxite, there are really two stories that need to be told. And let me start with the short-term outlook. World third party traded bauxite amounts to around 76m tonnes or about a quarter of the world's total production. China is the major importer and is expected to require around 45m tonnes of bauxite in 2015. An estimated further 14m tonnes is traded within China. And around 18m tonnes of bauxite is traded between third parties outside China. China is therefore critical to the overall market's position. And China imported 23m tonnes of bauxite in the first half of 2015, which covered their import requirement. Due to larger-than-expected import volumes, CM Group estimates that the bauxite stockpile in China was approximately 24m tonnes at the end of the first half, about 25 weeks' supply. And we saw on an earlier slide how the price of imported bauxite has moved over the past few years and how important the Malaysian trade has been for China's importers. While the advent of Malaysian bauxite exports to China has been a significant factor, there are uncertainties over how long the trade will continue. On this slide I'll make some observations from a recent visit to Malaysia. Described to us as a gold rush by the mines department, production ramped up from virtually nothing to between 15m and 20m tonnes per annum in a little over a year. The effect of this very rapid growth is a considerable amount of community disquiet which is reflected in the government's attempts to clamp down on illegal mining, although we're yet to see any reduction in export volumes. We saw first hand the very high levels of congestion and dust pollution on the limited road network. We saw, for example, mining being undertaken just meters from a new and expensive waterfront housing development as well as immediately adjacent to existing villages. You can see from the slide that margins are very low, with sales to China being tightly controlled and with costs reflecting the small-scale and low-tech mining methods employed. Ultimately, and apart from resource constraints, the balance between economic value added by mining, which is slim,and the cost to the community will be an important factor in the longevity of this trade as it proved to be for Indonesia. While there is considerable uncertainty, we expect that Malaysia will be able to continue to supply high volumes of bauxite to China for a few years, but not sustainably in the long term. Apart from the points I've made on the previous slide, the resources appear to be a limit to the current high rate of production. The small margins don't allow the Malaysian miners the luxury of better mine planning and higher wash plant recoveries. These measures would be more expensive in the short term but would prolong the life of mining in the Kuantan area. The low margins appear to be encouraging the miners generally to mine as cheaply as possible but thereby sterilizing available bauxite and reducing mine lives. As I mentioned, community opposition to bauxite mining is expected to grow given the proximity of mines to residential housing and the limited number of roads. And this is expected to cause pressure on local politicians ahead of the next state election. At the lower right we show CRU's forecast of expected Malaysian exports. But again, we need treat all forecasts with some caution. The second bauxite story is played out over a longer timeframe. While Chinese alumina production is forecast to continue to grow strongly, the volume of domestic bauxite consumed within China is expected to fall dramatically. This is primarily due to the continuing drop in bauxite quality in the Henan and Shanxi provinces. The alumina-to-silica ratio of bauxite in these provinces has been reducing, as we've shown in previous presentations. And from around 2019 it's expected that the local bauxite will be largely too expensive to process. There are expected to be limitations on the ability to buy bauxite from other Chinese provinces due to the tightly held and depleting bauxite allocations. As a result, it's expected that the cheapest alternative will be for the Henan and Shanxi refineries to import large and increasing volumes of bauxite from around 2019. The demand for imported bauxite into China is forecast by CM Group to grow to 55m tonnes in 2019 and up to a potential 104m tonnes by 2025. A number of the potential larger suppliers of bauxite to China are constrained in the medium term at least. Vietnam has a bauxite export ban, as does Indonesia. India is expected to continue to supply bauxite to China from the west coast and has been recently averaging around 5m tonnes per annum. India could potentially expand its exports, although there are a number of refinery projects in India that can't source secure bauxite supplies. There are other bauxite sources scattered throughout Asia, as we've seen with Malaysia, but that could supply volumes, although many of these have serious infrastructure impediments. Australia, of course, is expected to continue as a solid supply of both high- and low-temperature bauxite. But importantly for the Chinese, Australian expansions are likely to be priced against the alternative. Of the Atlantic Basin sources, Guinea and Brazil appear the best-positioned to be able to supply China for the long term. These countries have significant volumes of high-quality bauxite. While freight rates are low at the moment, any increases to freight rates will add to the cost of importing Atlantic bauxite compared with Pacific suppliers. The appendix has a handy map showing key freight routes and recent freight costs. By way of reference, CRU expects Guinea to eventually be the world's marginal supplier and to set the third party bauxite price. CRU expects the delivery price to China in the long run to be between $67 and $87 in 2014 terms. Let me conclude then with a summary of what we've presented today. In the short term, we believe there will be continued pressure on alumina prices. But if world demand is maintained, the current high rate of capacity utilization and the lack of new projects, particularly in the world outside China, will lead to a tightening of supply. AWAC is well-positioned in terms of both its cost base and marketing strategy. In the longer term, we're still of the view that China's bauxite problems are not solved by Malaysian production and that inevitably a deteriorating rate of self-sufficiency and more costly imports will be a positive for the rest of the industry. Thanks for your attention. Chris and I will be now happy to take questions. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions). Paul Young, Deutsche Bank. -------------------------------------------------------------------------------- Paul Young, Deutsche Bank - Analyst [2] -------------------------------------------------------------------------------- Morning, gents. A few here. First of all, what's your dividend policy or how do we think about it? -------------------------------------------------------------------------------- Peter Wasow, Alumina Ltd. - CEO [3] -------------------------------------------------------------------------------- Yes. Okay. Well, look, we've signaled for about a year that our intention is to distribute our free cash flow given that our debt is at target levels and that we have no capital commitments that would require us to contribute to AWAC. Our free cash flow, as Chris pointed out, in the year was about $66m, which would have given us a $0.022 or $0.023 per share, US cents per share dividend. What we said at the time of the Apache gas deal was that we would attempt to supplement or offset the effect of the lower cash receipts from AWAC that resulted from that prepayment. And as a result, we took the decision this year or this half year to introduce the DRP and to underwrite 50% of the total dividend. So what that means is the total dividend declared was $0.045 cents. And roughly half of that will be returned to us through the DRP and the other $0.023 or $0.022 represents our free cash flow. Does that makes sense? -------------------------------------------------------------------------------- Paul Young, Deutsche Bank - Analyst [4] -------------------------------------------------------------------------------- Yes, that does, Peter. So I probably expect the same supplement in the first half of next year, I presume? -------------------------------------------------------------------------------- Peter Wasow, Alumina Ltd. - CEO [5] -------------------------------------------------------------------------------- Not making any forecasts about future dividends, but if you look at what the effect of the $300m cash payment was, we would have been able to pay, had that money been distributed to us, a dividend in excess of $0.06. So we haven't really fully offset the payment, nor did we ever say we would fully offset it. But also, as Chris pointed out, there's a further $200m prepayment that's due early in 2016, which we'll need to factor into our dividend decision when we come to it. -------------------------------------------------------------------------------- Paul Young, Deutsche Bank - Analyst [6] -------------------------------------------------------------------------------- Right. Second question on the alumina pricing/alumina market. There was a couple of charts in the presentation, so thanks for that. But you pointed out that we're well below the marginal cost of production, particularly in China, and the alumina price continues to fall. And that's -- again, you pointed out the oversupply situation in China. So what I'm really wanting to know is do you have any view of where the price support level is for alumina? -------------------------------------------------------------------------------- Peter Wasow, Alumina Ltd. - CEO [7] |