Fiscal 2021 has started on a jarring note for aluminium makers with the price of the metal plumbing 4-year lows of $1,450 per tonne on the London Metal Exchange, and domestic demand evaporating because of the Covid-19 pandemic-driven lockdown.
While that will squeeze bottomlines this fiscal, efficient cost structure and adequate cash would buffer credit profiles and help them weather the viral disruption.
The lockdown has not affected production because aluminium is an essential commodity. However, domestic demand – largely from the power transmission, automobiles and construction sectors – has plummeted. This domestic sales loss has been offset by companies adroitly exporting more, thanks to high cost-competitiveness that stems from improved sourcing and lower input costs.
Over the past two fiscals, producers have improved their bauxite access and coal linkage to ~70%. These two account for a significant portion of input cost. While bauxite security helps maintain higher operating rates and profits, it is the improved coal linkage and cheaper e-auctioned coal that are making the big difference now.
Says Manish Gupta, Senior Director, CRISIL Ratings, “Linkage coal is 30-40% cheaper than imports and is seeing higher materialization due to lower industrial activity. On the other hand, e-auction coal has seen average premiums falling steadily from a high of 131% in December 2018 to 36% as of March 2020. This has lowered the cost of electricity, which accounts for ~40% of the cost to produce aluminium.”
That competitiveness helped smelters almost fully offset domestic volumes by exporting almost their entire production since the lockdown. Aluminium exports had already risen over the past few years to more than 50% of production in fiscal 2020.
With only a partial loss in revenue during the lockdown and continued cost efficiencies, we estimate that even at current realisations, companies will reel in operating profits of over $200 per tonne in fiscal 2021.
Says Naveen Vaidyanathan, Associate Director, CRISIL Ratings, “Current operating profitability of the industry would still be only 60% of the average per tonne profitability over the past 5 years. However, what cushions their credit profiles is the strong cash buffer, which is 3x the debt obligations for this fiscal.”
Domestic as well as global aluminium demand is expected to witness de-growth in fiscal 2021 amidst the Covid-19. However, with likely strong demand fundamentals, in the post-Covid era, global aluminium demand may grow ~3% annually, supported by increasing penetration in the automobile, construction and packaging industries. Domestic demand is presaged growing ~5%, owing to increasing penetration in the power transmission and automobile sectors. This bounce-back may see aluminium makers restore their financial metrics.
The key monitorables in the road ahead will be extent of lockdown and pace of economic recovery, which can curb demand for, and prices of, aluminium. That, in turn, would have a bearing on the credit profiles of producers.