Credit Rating Initiation: Century Aluminum

Morningstar is initiating credit coverage of Century Aluminum CENX with an issuer rating of B. Our speculative-grade rating reflects Century's exposure to highly cyclical aluminum prices, unfavorable position on the global cost curve, and weak coverage and leverage ratios. The conflicted relationship with commodity trading house Glencore, a major Century shareholder and customer, is also a concern from a credit perspective. While we view Century as a relatively weak credit over the full cycle, its solid liquidity （$265 million in cash as of Sept. 30） and limited principal payment obligations until 2014 partially damp our near-term concerns about its creditworthiness.

Aluminum manufacturing is a tough business: Producers sell undifferentiated goods into extremely cyclical end markets and have essentially no pricing power. Only those with sustainable cost advantages can expect to generate attractive returns through the cycle. Energy is the key cost differentiator in aluminum production. While Century does own capacity in Iceland, which benefits from cheap geothermal energy, this constitutes a relatively small share of total output. Century's U.S. facilities account for the majority of sales and are much less cost competitive because of high energy costs. Consequently, Century, unlike peers that use lower-cost energy sources, will require strong aluminum prices to generate respectable returns on capital.

But aluminum prices have been anything but strong as of late, translating to dismal profits and weak credit-relevant ratios for Century. EBITDA covered interest expense a mere 3.1 times in the 12 months to Sept. 30, and debt/EBITDA was 3.8 times. We expect improvement from trough conditions predicated on healthier global aluminum demand, which should translate into stronger prices and volume for Century