AWC 3.03% $2.38 alumina limited

jp morgan doubts sustainability of aluminium

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    http://www.fnarena.com/index2.cfm?type=dsp_newsitem&n=2F6F059D-1871-E587-E1A1F977EC5B1F5F

    JP Morgan Doubts Sustainability Of Aluminium Price Strength
    FN Arena News - February 19 2008

    By Chris Shaw

    After being one of the worst performing base metals the past few years there has been something of a change in attitude towards aluminium in recent weeks as analysts have turned more bullish given the potential for supply side disruptions to push up the price of the metal.

    Nowhere has this been more obvious than in the share price of Alumina Ltd (AWC), which has gained 18% in the last week thanks to a stronger aluminium price on the back of supply concerns thanks to power and weather problems in China and power shortages in South Africa.

    But as JP Morgan points out, at the same time as the metal price has risen on these supply concerns actual supplies in the market have also moved higher, with LME inventories for aluminium increasing to 954,000 tonnes now from 929,000 tonnes at the start of the year.

    While the price gains in the metal suggest the new supply risks are enough to offset weaker demand side fundamentals the broker tends to disagree, seeing the latest move as not much more than short-covering on the China and South Africa news.

    In the broker’s view there is likely to be a lack of follow through buying once this short-covering process has been completed as the fundamentals still don’t stack up given on-exchange inventory levels are above one million tonnes, producer stocks are more than 1.5 million tonnes and there is likely to be a sizable amount of metal stocks presently unaccounted for.

    This leads the broker to suggest prices may well top out at around US$2,800 per tonne, which is roughly in line with the closing price for the metal last night. It is the Chinese that remain the biggest threat to the broker’s view as while it estimates there are significant stocks floating around in that market any sign of falling net exports from China at the same time as LME stocks fall is likely to see prices pushed higher.

    On the other side of the coin the broker points out the Chinese have a poor track record of restraining output, even allowing for declining margins given costs for smelting in particular continue to move higher.

    This lack of discipline among marginal producers in particular means even allowing for Chinese production losses of up to 200,000 tonnes due to weather related power outages the global aluminium market should still record a surplus of around 334,000 tonnes this year, making it difficult to argue the market is currently tight.

    So what does this mean for the Alumina Ltd share price? In the broker’s view the stock remains overvalued so it continues to go against the herd and rate the stock as Underperform, a view shared by Credit Suisse.

    In contrast, the other ratings in the FNArena database include six Buys and two Holds, so to explain its view the broker has run the numbers on a couple of different scenarios.

    The first assumes an aluminium price of US127.57c per pound, the current spot AUD/USD exchange rate of around 91c and an oil price of US$95.57 per barrel for the next two years, the result being significant increases to its earnings estimates in 2008 (up more than 50%) and 2009 (up almost 100%) and a 10% lift in valuation from its current $4.27.

    But in scenario two the broker factors in these forecasts for the life of the company and the result is a decline in its valuation of 5-6% through to 2010, as the estimates imply a higher oil price and lower aluminium price than it currently expects over the longer-term.

    The two scenarios show the leverage the company has if aluminium prices remain strong, but with the broker not prepared to accept such a view it sticks with its Underperform rating.

    Its price target is $4.27, well below the $6.27 average price target according to the FNArena database and also well below the current share price, which today is up 8c at $6.06.
 
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