An aluminium lever for the diversified miners: key for Rio and VED
The market consensus on aluminium is bearish, and there is perhaps good reason,
given the large inventory levels. Due to financial arbitrage of the forward curve, we
believe that aluminium prices will be higher for longer than the market expects and
this will provide earnings upside surprise and importantly a catalyst for the
aluminium equities. Both Rio Tinto and Vedanta are trading below our DCF
valuations, hence we maintain our Buys on both names.
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LOCATED IN APPENDIX 1. MICA(P) 106/05/2009
Industry Update
Top picks
Rio Tinto (RIO.L),GBP2,946.00 Buy
Vedanta Resources (VED.L),GBP2,369.00 Buy
Companies featured
BHP Billiton Plc (BLT.L),GBP1,811.50 Hold
2009A 2010E 2011E
DB EPS (USD) 1.92 2.21 2.59
P/E (x) 11.2 13.3 11.4
EV/EBITA (x) 6.8 9.4 7.8
Norsk Hydro (NHY.OL),NOK43.71 Hold
2008A 2009E 2010E
DB EPS (NOK) 2.65 -1.38 1.15
P/E (x) 21.6 – 38.1
EV/EBITA (x) 58.2 – 29.6
Rio Tinto (RIO.L),GBP2,946.00 Buy
2008A 2009E 2010E
DB EPS (USD) 7.99 2.73 3.75
P/E (x) 8.7 17.5 12.8
EV/EBITA (x) 8.1 14.9 9.0
Vedanta Resources (VED.L),GBP2,369.00 Buy
2009A 2010E 2011E
DB EPS (USD) 1.19 2.01 3.21
P/E (x) 19.5 19.1 12.0
EV/EBITA (x) 12.1 11.7 7.7
Global Markets Research Company
Aluminium prices to surprise on the upside… for longer
With record high aluminium inventories, the market is anticipating record low
prices and the recent run is being considered an anomaly. However, we believe
that 65-75% of the stockpiles are tied up in financing arrangements and the
conditions for this (a price contango and cheap money) remain very much in place.
While we think the fundamentals of a physical surplus will ultimately re-assert
themselves, we believe prices will be higher, for longer than expected and lead to
surprises on near-term earnings. In an environment of softening metal prices, we
believe aluminium could outperform copper in 2010.
Rio and Vedanta to benefit the most from the upside
We have a number of stocks under coverage with Aluminium exposure including
Rio Tinto, Vedanta, BHP Billiton and Norsk Hydro. Vedanta has the best growth
prospects, and Rio is the largest of the producers under our coverage. Both Rio
and Vedanta remain cheap relative to valuation 0.94x and 0.98x P/NPV respectively
and the market has low expectations from the aluminium divisions in our view and
earnings upside is likely to be a catalyst for re-rating. Both companies can deliver
value through their aluminium divisions – Vedanta by delivering growth on budget
and on schedule, and Rio cutting costs, to achieve similar margins and returns as
were achieved pre the Alcan acquisition. While Norsk Hydro has the most
exposure to the aluminium price and would benefit from a higher aluminium price,
it is already trading at a 15% premium to NPV. BHP has a good quality, upstream
focused business, but it is relatively small compared with the rest of the business
(circa 8%).
Risks of an unwind
Rising interest rates and a closing contango would curb the investment appetite,
however the aluminium currently in the trade would remain locked up for some
time and LME warehouse restrictions on removals would moderate the outflow...
so while these represent a risk we do not see them as a collapse. The key risk in
our view remains the USD – a strengthening in the USD would remove appetite
for the sector and override the opportunity described above.