Aluminium price 'slingshot' to boost Rio's profit

Rio Tinto’s $US38 billion takeover of aluminium maker Alcan in 2007 is looking more like a money spinner for the world’s third-biggest mining company as forecasts show prices for the metal will increase.

The metal “is going to go up because almost all of the people that use aluminum are using more of it, and lots more of it,” said Frank Lucas, a director of London-based fund manager and adviser Loeb Aron. “You are going to get a slingshot in the price and then because Rio doesn’t hedge it will be the biggest beneficiary.”

Profits at United. Rusal, the world’s biggest aluminum maker, and Rio’s Alcan unit are forecast to surge in the next two years as demand gains from aircraft and automakers. The price of the lightweight metal may rise 30 per cent by 2015 as demand accelerates, according to Macquarie Group, which made Alcoa its top mining stock pick on May 26.

Airbus SAS, the world’s biggest maker of commercial aircraft, in February raised its forecast for demand in the Asia-Pacific region, estimating airlines will buy about 8000 planes worth $US1.2 trillion over 20 years. Global demand for aluminum may double in 10 to 15 years as use soars in developing countries, Jacynthe Cote, Rio Alcan’s chief executive, said in April.

"We are bullish on aluminum prices in the long run, say three to five years,” said Wan Ling, a Beijing-based analyst with CRU International. “It may be a good time now to buy aluminum plants or equities.”

Only once in the past seven years have aluminum prices outperformed copper prices.

The metal may rise 14.3 per cent in three years, compared with a 2.1 percent drop in copper, according to forward price curves for both metals.

China’s decision last month to raise power charges for high-usage companies will drive up prices in the world’s biggest user, according to Rusal, which swung to a first-quarter profit. Energy accounts for as much as half the cost of producing aluminum.

"The situation for China is an interesting one and could potentially be a catalyst for a real aluminum bull market,” said Alan Heap, Sydney-based head of global commodities at Citigroup. “The balance of risk is shifting in its favor.”

Rio’s aluminium unit swung to a $US111 million profit in underlying second-half earnings from a $US689 million loss in the first half last year as the company saved $US1 billion in costs and prices rose. The unit’s earnings may rise to $US1.86 billion in 2012, according to Royal Bank of Scotland estimates. Net income at Alcoa is forecast to more than double by 2012, while Rusal’s is tipped to advance 51 per cent in the same period.

"Aluminium, which accounts for about 50 per cent of Rio’s net asset base but contributes about 7 per cent of earnings before interest and tax, provides tremendous leverage when aluminium pricing eventually recovers,” JPMorgan Chase analyst David George said in a May 25 note.

While Lucas at Loeb Aron is predicting higher aluminum prices, he said Rio overpaid for Alcan and the purchase may take as long as 20 years to pay back.

The acquisition caused Rio’s debt to balloon 19-fold, forcing the sale of assets and shares and prompting an abortive $US19.5 billion investment from Chinalco. The debt was also cited by BHP Billiton as a factor for scrapping its hostile takeover proposal for Rio in 2008. This combination of events angered shareholders.

"They paid too much,” said Olivia Ker, a London-based analyst at UBS. “Longer term you can kind of build a positive story, but I think it’s more than 10 years away.”

To be sure, global aluminum inventories remain high and demand outside of China is weak, Standard & Poor’s said in a May 15 report. Prices may drop if there’s no easing of unfavorable economic conditions and high inventories levels, it said.

"We remain cautious towards the industry, largely as a result of new supply emerging in the Chinese market place,” said Neil Boyd-Clark, managing partner at Arnhem Investment Management.

Rio is among producers that will benefit most from rising aluminum prices, said Helen Lau, a Hong Kong-based analyst at UOB-Kay Hian.

"Companies such as Rusal and Alcoa have good cost structures” and will get a “free ride” from their higher profit margins,” Lau said. Chinalco, China’s largest producer, and Hindalco Industries, India’s largest producer, “will suffer as they are totally subject to rising coal costs,” she said.

"BHP Billiton wanted to buy Rio after the Alcan acquisition, so the industry does view them as quality assets,” said Andrew Keen, head of metals and mining research at HSBC. "The vindication, though, will take longer.”