Aluminium’s day dawns as iron ore dims

RIO Tinto’s much-maligned aluminium business could be a surprise saving grace for the miner as iron ore prices soften, with the company’s cost-cutting drive set to produce strong cashflows and boost the chance of big returns to shareholders.

The turnaround in aluminium, which Deutsche Bank is forecasting will contribute $US2 billion ($2.1bn) of annual free cashflow to Rio by 2017, comes as chief executive Sam Walsh predicts an end to the Chinese overcapacity that has hobbled the industry in recent years.

While there is no hope of recovering the $US25bn of value wiped from the aluminium unit’s book value since Rio paid $US40bn in cash for Alcan just before the global financial crisis, some investors are positioning themselves for a rebound.

“We have shareholders on our portfolio because they ­believe our aluminium business is going to be very prospective,” Mr Walsh told the company’s annual meeting in Melbourne last week. “That’s their call, but it is an indication that people ­expect there will be improvement in the business.”

Deutsche Bank analysts also sense a change.

“The value of Rio’s aluminium business has been mentally written-off by the market,” analysts Rob Clifford and Paul Young said last week in a detailed report on the business using new information provided by Rio.

“We expect this to change in 2014, with the division close to completing the majority of its transformation.”

A focus on cost-cutting and the closure of high-cost assets led Rio to report a $US550m aluminium profit last year, when most analysts were expecting it to just break even.

After redoing its Rio numbers last week, Deutsche has boosted its 2014 aluminium forecast to $US955m this year, up nearly $US300m on its previous forecast.

“After years of generating negative cashflow, the long process of restructuring Rio’s aluminium division is about to pay off,” the analysts said.

“The improvement in aluminium free cashflow will offset the slide in iron ore prices in our view.”

Rio’s Alcan acquisition was made as China started building enormous aluminium capacity.

Half of this is now thought to be losing money, but there are no signs it will be shut down in the short term.

This has depressed prices, which have fallen from about $US3000 a tonne in 2008 to about around $US1800.

At Rio’s London AGM last month and again in Melbourne last week, Mr Walsh spoke of an end to the Chinese aluminium overcapacity, which he says is partly the reason the investors he spoke of are backing Rio.

The reason is that the growing Chinese middle class, like aluminium production, is energy- hungry.

“The increasing middle class will buy refrigerators, televisions, airconditioners, you name it, and they’ll need to power those up,” he said.

“I believe there will be a transition from using stranded power in China to power aluminium smelters to actually using that power to provide power for middle class houses and for small and medium enterprises.

“It’s what happened to Japan in the 1970s — Japan had a very vibrant aluminium smelting industry back then; today they have none.”

Mr Walsh expected this to happen within the next decade.

Billionaire fund manager Kerr Nielsen, who runs Platinum Asset Management, is also a believer in aluminium.

In a recent fund update, Mr Nielsen said a bigger Chinese focus on returns on capital, pollution abatement, an export ban in Indonesia and reduced alumina supply following the closure of Rio’s Gove refinery were all set to slow capacity growth.

“The industry itself has seen demand growth of 6 to 7 per cent per annum and any slowing of capacity additions could see a strong move in the metals price.”

Deutsche Bank is forecasting prices will rise to $US3000 a tonne again by 2020.