The truce between the US and Russian aluminium company Rusal was initially expected to have a limited impact on the aluminium market. But it’s now threatening to lead to a large round of earnings cuts for producers of the metal. Aluminium prices dropped to a 16-month low last month.
This rules out a supply shock, which could have supported prices. With a supply shock now ruled out, prices are back to being determined by the risk of a slowdown in the global economy, especially China, where the outlook remains dull. Understandably, investors are wary. Shares of Hindalco Industries Ltd fell 4% on Wednesday.
While aluminium prices haven’t fallen sharply, the impact on earnings is expected to be relatively greater. Alongside soft prices, companies also have to contend with rising imports of aluminium scrap, which are undermining prices in the market and resulting in lower economies of scale for integrated producers such as Hindalco.
Besides, costs are rising, too. As CARE Ratings Ltd points out, local producers rely heavily on coal-fired captive power plants. With domestic coal falling short of demand, the dependence on imported coal has gone up, exerting cost pressures. Power accounts for as much as 45% of the total production cost.
Considering that realizations are linked to international aluminium prices, the continued softness in rates can impact profitability of the domestic industry, says Urvisha H. Jagasheth, analyst at CARE Ratings. Prices in the quarter ended December are down 6.4% from a year ago.
Cost pressures and low product prices are resulting in production cuts. “Recent commentary from global aluminium producers highlight the following: 1) upward shift in aluminium cost curve has rendered ~50% of the aluminium smelters (dominated by China) unviable at the current LME prices of <$2,000/tonne and a few players have already announced smelter cuts; 2) new Chinese aluminium supply ramp-up is slow due to cost pressure; 3) current LME prices in the context of higher alumina prices is not sustainable in the long term," SBICAP Securities Ltd said in a note last month. LME is London Metal Exchange.
To be sure, due to its integrated production model and focus on value-added products, Hindalco is less immune to volatility in aluminium prices. Even so, the fact that the softness in prices is accompanied by the above-mentioned headwinds, as well as concerns of a slowdown in end-user sectors such as autos, is adding to investors’ worries.