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  CENX: aluminum's high beta stock

BENJ GALLANDER, BEN STADELMANN, and PHILIP MACKELLAR

Monday March 28, 2016

After an 82 percent drop in 2015, Century Aluminum has jumped more than 50 percent year to date and is up over 90 percent since it was added to our Vice-President's Portfolio at $3.57 (U.S.) in early January. That's excellent, but had we waited a bit for the bottom, the gain would have been more than 130 percent. Of course, except in the realm of wishful thinking, it is not often that we actually catch stocks at their floor.

While Century has outperformed its peers, many of them have done well, too. Alcoa, Norsk Hydro, and Kaiser Aluminum are flat on the year but are up double digits from their lows in January. Meanwhile, aluminum prices and futures have been volatile. After a strong rally in February, the commodity has given back most of its gains and is roughly back to where it started 2016.

Aluminum is a classic boom and bust commodity and currently the situation remains very challenging. China, which produces nearly 55 percent of the world's aluminum, has seen domestic demand fall since 2014. Instead of curtailing production and closing plants operating at a loss, Chinese companies have sought government assistance to maintain production and increase exports. The subsidies have raised the ire of industry participants in other countries including India, Russia and the United States.

In India, imports from China and the Middle East surged 159 percent since 2011 from 881,000 tonnes to 1,563,000 tonnes in 2015. In response, India recently hiked taxes on aluminum imports from 5 percent to 7.5 percent and increased taxes on specialty aluminum products from 7.5 percent to 10 percent. Russia has attempted to address the problem, too, and in November signed a Sino-Russian protocol on energy co-operationm which included plans to bring aluminum supply in line with demand. We remain skeptical until it is actually implemented.

In North America, Chinese imports rocketed from $6.2-billion in 2006 to $23.8-billion in 2015. Last year, American production declined 7.2 percent, forcing plant closures and curtailment of production. As a result, the United States is now producing less aluminum than at any time since the Second World War. Alcoa claims that roughly 70 percent of Chinese aluminum smelting and 75 percent of alumina refining are cash negative at current prices and is being propped up by the Chinese government. In response, Century Aluminum, the United Steelworkers union and various industry groups have increased pressure on the Obama administration to challenge China, which they accuse of relabelling products to circumvent anti-dumping duties and take advantage of value-added tax rebates. The U.S. government has started to take note and in February a new trade law was signed in an attempt to combat unfair Chinese trade practices. Although this may end up in front of the World Trade Organization along with similar grievances over steel, it appears the first steps have been taken.

According to the International Aluminium Institute, Chinese production has declined since its peak in the summer of 2015 and production in January, 2016, was lower than it was a year ago. In addition, Chinese authorities are attempting a restructuring of the economy away from heavy industry toward domestic consumption. As part of this process, the government, along with 14 Chinese aluminum producers, may decrease aluminum output as part of a plan to lay off at least five million workers by the end of 2018. While these developments are positive for enterprises such as Century, China's largest aluminum enterprise, Hongqiao Group, nonetheless has a goal of increasing production 16 percent in 2016. Despite these issues, Alcoa anticipates the market to return to balance by year end.

Even with the flux in this sector, we are very comfortable with our investment in Century. The company has a strong balance sheet with ample liquidity and moderate debt. It sells premium products and has some of the lowest-cost plants in the industry. For example, the Icelandic operation is a world-class, low-cost producer powered by zero-carbon emission geothermal. The organization also has low valuations and has a unique relationship with its largest shareholder and customer, Glencore.

This being said, given industry headwinds and the volatility associated with the stock, it would not be surprising to see Century Aluminum give back some of its gains. Even with this possibility on the table, we shall continue to hold our shares for further appreciation. The sell target range is $21 to $26, at least a triple from the current price.


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