Why Nomura Is Downgrading Alcoa, Century

• Shares of both Alcoa Inc AA and Century Aluminum Co CENX have been on a downturn through the year, having lost 42 percent and 82 percent, respectively, YTD.
• Nomura’s Alexander M. Burnes downgraded the ratings on both companies from Buy to Neutral, while reducing their price targets.
• Burnes expects primary aluminum surplus to persist through 2017, limiting any significant improvement in prices in the coming years.

The market seems to be expecting changes in Chinese supply to balance the market. Analyst Alexander Burnes pointed out, however, that Chinese production is “relatively price inelastic” due to factors like state subsidization. He believes that low prices would need to be sustained in order to balance the market

Markets To Remain Oversupplied

Burnes reduced the price target for Alcoa from $14 to $8. He mentioned that the market seems to be “awarding too much value” to the company’s downstream businesses.

The primary aluminum and alumina markets are likely to remain oversupplied in the next couple of years. This would limit any potential “split-driven valuation uplift,” the analyst said.

There is continued erosion at Engineered Products & Solutions, despite favorable top-line trends in aerospace, which contributes 92 percent of the segment’s sales. Firth Rixson could miss Alcoa’s revenue and EBITDA targets.

“Within Global Rolled Products (GRP), we are concerned by the continued secular decline in packaging markets (~40% of GRP revenue) and see limited upside from AA’s recent automotive investments,” Burnes wrote.

Among The Most Impacted By Pricing

Nomura reduced the price target of Century Aluminum from $12 to $4. Primary aluminum values are structurally depressed and could remain under pressure in the coming years. Burnes believes that this would “weigh more heavily” on Century Aluminum, since it is a pure-play smelter.

Century Aluminum has already reduced its US production base drastically, on account of the depressed aluminum markets. This is not merely a costly process, but also results in a business “with reduced upcycle earnings power.”

“Recently, CENX has lowered operating rates at Hawesville by 60% and issued a WARN notice for Mount Holly and Sebree, and we are concerned that the end game for CENX revolves around its sole Icelandic smelter, Grundartangi,” Burnes added.