Street Watchdog Starts Century Aluminum at Buy
Price Target $13.50

January 12, 2017

Century Aluminum Company (NASDAQ:CENX) has had a rough patch recently.  For the last four fiscal years, the company has shown a net loss in three of those years.  This current fiscal year promises to be no different.  Unless the company can show a net profit of about $84 million in the fourth quarter of 2016, this fiscal year will end in the red.  Despite all of this, we have reason to be cautiously optimistic regarding Century Aluminum with a $13.50 price target.

Image from company website

Background Information :  Century Aluminum is a global producer of primary aluminum in the United States and Iceland.  The company operates two aluminum smelters in Kentucky, one in South Carolina, and one in Iceland.  Its primary aluminum facilities produce standard grade and value-added primary aluminum products.  The company’s primary aluminum production capacity is approximately 1,013,000 tons per year (tpy), and it  produced approximately 936,000 tons of primary aluminum last year.
In addition to its primary aluminum assets, the company also owns a carbon anode production facility located in the Netherlands and a 40% interest in Baise Haohai Carbon Co., Ltd. in China.  Carbon anodes are essential to the production of primary aluminum in the smelting process.

There are several reasons we are bullish on the aluminum sector as a whole, and on Century Aluminum in particular:

Strategic Objectives :  In addition to safety optimization and environmental performance, Century Aluminum is committed to improving the cost structure of its existing assets by improving production and efficiency as well as pursuing upstream investment opportunities in bauxite mining alumina refining and the production of other key operating supplies. 

Good Corporate Citizen :  The company recognizes that its financial success is tied to the health and well-being of the communities around its plants and offices.  According to the company’s website:  “From a financial standpoint, our operations boost the economies, living standards, business and employment opportunities in the communities in which we do business.  The ripple effect generated by our property taxes, employee salaries and medical benefits is significant.  But with operations around the world, we have the opportunity to make more than an economic impact.   At the local level, our plants support activities like sponsoring sports teams, blood drives and charity walks.  We are also members of community groups like local Chambers of Commerce.  A number of our employees are also involved in activities like leading Girl Scouts troops and coaching sports teams.  We believe that through these activities we can make a positive difference to our communities to the benefit of our many stakeholders.”

Stable Cash Environment :  The company has a stated goal of making each plant cash flow positive, even in the challenging environment of these  last two fiscal years.  As of the end of the third quarter, Century Aluminum had approximately $432 million in current assets (versus only $175 million in current liabilities) with $118 million in cash.  The company also has $90 million of revolver availability.  Despite a challenging environment in 2016, net cash provided by operating activities exceeded $15 million for the first three quarters of this year.

China Compliance May Be Forthcoming :  Earlier this week, China’s top economic planner pledged to continue cutting steel and coal production, which have been a source of friction with many countries.  According to Xu Shaoshi, chairman of the National Development and Reform Commission, hundreds of thousands of steel and coal workers have been transferred to other jobs.  Xu said cutting production capacity of steel by 45 million tons and coal by 250 million tons in 2016 affected the jobs of 800,000 steelworkers and miners, with the government resettling 700,000 of them in new jobs by the end of last year. 

While Xu did not specifically mention aluminum, China's rising exports of aluminum are an irritant for Europe and the United States, but the industry has so far not been forced to restructure.  Evidence continues to mount that the illegal government subsidies for aluminum and other practices underlying this supply growth are in violation of China's WTO obligations and have materially injured the industry around the globe. 

The U.S. is getting serious with China.  Within the last three months, eight U.S. senators have asked the Obama administration to take action against China over what they say are unfair subsidies to the Chinese aluminum industry.  In an Oct. 21 letter to U.S. Trade Representative Michael Froman, the senators said China’s “unfair trade practices” are “undermining the entire U.S. aluminum value chain.” Federal officials recently opened investigations into aluminum imports originating in China.  Added to that mix, President-elect Donald Trump is taking a no-holds-barred approach to China’s unfair trade practices and has repeatedly threatened punishing tariffs. 

Increasing Automotive Use :  Aluminum simply builds a better vehicle.  Aluminum’s use in autos and commercial vehicles is accelerating because it offers the fastest, safest, most environmentally friendly and cost-effective way to increase performance, boost fuel economy and reduce emissions while maintaining or improving safety and durability.  From mass-market vehicles like the Ford F-150 and Tesla, to luxury cars like Audi, Mercedes Benz, and Land Rover, aluminum is increasingly the “material of choice” for automakers thanks to its strength and environmental advantages.  Rolls Royce recently announced it has started testing its new aluminum space-frame architecture, which the company states will underpin all future Rolls-Royce model lines and arrive in the market in early 2018.  The new F-150 truck shed 700 pounds (approximately 15 percent in vehicle body-weight) with a high-strength, military-grade all-aluminum body. This weight reduction will enable Ford’s trucks to go farther on a gallon of gasoline and will open the door to other changes, like smaller engines, that can further boost fuel economy.

Aluminum is now second only to steel as the most used material in vehicles.  Compared with a fleet of traditional steel vehicles, aluminum use saves the equivalent of 108 million barrels of crude oil in energy.  At the end of a vehicle’s life nearly 90 percent of the aluminum, on average, is recycled.  Pound for pound, aluminum can absorb twice the crash energy of mild steel. Larger crush zones can be designed without corresponding weight penalties.  Because aluminum is lighter, it allows automakers to increase dent resistance—they can make body panels thicker while still lowering weight.  And a lower weight vehicle has better acceleration, better braking and better handling.  In addition, lighter vehicles can haul and tow more because the engine isn’t carrying unneeded weight.  When applied to an optimized automotive body structure, aluminum can provide a weight savings of up to 50 percent compared with the traditional mild steel structure.  One study conducted by the Department of Energy showed that an aluminum-intensive vehicle can save up to 20 percent of a reduction in total life cycle energy consumption and as much as 17% reduction in CO2 emissions throughout its lifetime.

Looking Forward :  Looking forward, we are optimistic that the rough patch for Century Aluminum is about to diminish.  While we don’t foresee blowout earnings per share of $1.16 like in 2014, by assessing the company’s financials from 2012 to 2016, as well as modeling pro forma numbers for the next two fiscal years, we are looking for a modest profit in 2017 (EPS of  $0.00 - $0.25) and a more optimistic figure for 2018 (EPS of $0.75 - $1.00).  At a modest 2018 forward PE ratio of 18, we derive a fair price range of $13.50 to $18.00.  As such, we are most definitely cautiously optimistic.