Aluminium market update

Deutsche Bank Markets Research Global Metals & Mining Industry Aluminium Sector Date 1 March 2017 Industry Update Aluminium market update Revising aluminium and alumina price forecasts ________________________________________________________________________________________________________________ Deutsche Bank AG/Sydney Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016. Paul Young Research Analyst (+61) 2 8258-2587 paul-d.young@db.com Anna Mulholland, CFA Research Analyst (+44) 20 754-18172 anna.mulholland@db.com Patrick Jones Research Analyst (+44) 20 754-53400 patrick.jones1@db.com George Buzhenitsa Research Analyst (+971) 4 361-1734 george.buzhenitsa@db.com Grant Sporre Research Analyst (+44) 20 754-58170 grant.sporre@db.com Matthew Frydman Research Associate (+61) 2 8258-2607 matthew.frydman@db.com Key Changes Company Target Price Rating S32.AX 2.65 to 2.70(AUD) - AWC.AX 1.65 to 1.70(AUD) - NHY.OL 38.00 to 43.00(NOK) - VED.L 1,000.00 to 1,030.00(GBP) - 0486.HK 2.08 to 2.73(HKD) - S32.L 157.00 to 162.00(GBP) - Source: Deutsche Bank Companies Featured Rio Tinto (RIO.AX),AUD61.99 Buy South32 (S32.AX),AUD2.49 Hold Alumina (AWC.AX),AUD1.84 Sell Norsk Hydro (NHY.OL),NOK46.66 Hold Vedanta Resources (VED.L),GBP873.00 Hold United Company RUSAL (0486.HK),HKD3.88 Sell Source: Deutsche Bank Our commodity team has raised 2017/18 price forecasts by 8% and 7% to US$0.81/lb (US$ 1,788/t) and US$0.78/lb (US$1,728/t) respectively, but kept long-term unchanged at US$0.83/lb (c. US$1,830/t). We have also lifted 2017/18 alumina price forecasts by 6% and 4% to US$290/t and US$280/t respectively. Chinese supply side reforms hold the key to a healthier market, but we doubt practical implementation will be so simple. Earnings estimates for 2017 have generally been lifted, with significant upgrades for Rusal and AWC. We prefer RIO and have maintained our SELL recommendation on AWC and Rusal given they are pricing in close to spot aluminium/alumina. Raising our 2017 and 2018 aluminium forecasts by an average of 7.5% Despite our scepticism that aluminium can hold onto current levels for longer, the medium term fundamentals look better. There are four reasons for our forecast upgrade: 1) The near-term demand momentum and restocking cycle in China has been stronger than expected. The credit cycle likely losing steam in Q2 2017 will likely be offset by the continued wave of infrastructure projects. 2) Recent client feedback suggests commodity fund flow momentum will continue in 2017. 3) We forecast a return of an inflationary cycle in commodities and factor in inflation of 7-10% for 2017. 4) Although we doubt that trade barriers and border taxes will be successful over the longer term in aluminium, the combination of strong domestic demand and a reluctance to stoke further anti global sentiment, we think that China may temper aluminium semi's exports for 2017 and possibly into 2018. The risks of a short-term aluminium pullback are rising Although market fundamentals for aluminum have improved significantly since early 2016, we think the current prices are at risk of a correction. In our view, prices above US$0.82/lb (US$1,850/t) start to price in a structural change beyond a simple cyclical recovery. Chinese aluminum production growth has crept higher by c.2% per month over the last 6 months. At the January run rate, Chinese output would exceed our full-year forecast by 800kt (+2%). The market is already pricing in some success of Chinese supply side reforms in our view. Also, Chinese inventory has risen by c.400kt (+120%) since CNY. While seasonal, the scale of the inflows is the highest since 2014. Alumina price expected to pull back also We expect Chinese alumina prices to fall due to the ramp up of Chinese alumina capacity. Production increased from a rate of 55Mtpa in 1Q16 to 67Mtpa by 4Q, with a record 5.9Mt produced in November. We expect another 7Mtpa of new capacity to come on-line in 2017. We believe the Chinese alumina price (currently RMB2,950/t) has overshot the equilibrium price due to the lag from refinery restarts and capacity ramp-up. Our industry channel checks suggest that the Chinese alumina market is now in surplus, with production running at 71-72mtpa, implying an industry utilisation of 93%. Valuation and sector risks Our PT’s are set broadly in-lin