CENX - Century Aluminum: Upside Potential Is Currently Idled (Rating Downgrade)

2023-07-10 10:59:32 ET

Summary

• CENX's financial performance feels significant pressure due to the offline Kentucky facility, despite a suppressive tilt to the value-added mix.
• The strong automotive sector is not enough to make up for the sluggish construction.
• Although the positive price lag is coming into the second quarter results, the downward trend in aluminum prices suggests a prolonged idling of Hawesville.
• I am downgrading CENX to sell recommendation to the point when the EBITDA line could reach $150 million.

With the continued operations under the trimmed production capacity, I believe that the upside potential of Century Aluminum Company ( CENX ) is not going to be online as well. The rebound of aluminum prices at the beginning of the year could roll over in the company's financial results for the second quarter of 2023, but with the current downturn, the positive surprise from the price lag is unlikely to be expected in the back half of the year. In addition, this provides uncertainty about the timing of the potential Hawesville restart. The strong performance of the automotive sector may not be enough to offset the weakness in the construction industry, which could put further downward pressure on the premiums on value-added production. My calculations show that a Hold rating for CENX stock could be justified with at least $150 million profit on the EBITDA line for the full year, which despite the acquisition of a majority stake in Jamalco couldn't be the case without bringing online the Kentucky plant.

Searching for an upside trigger

The market profile of the aluminum industry exhibited a sight of improvements during the first quarter of 2023, but the company is still running in trimmed capability to benefit on this trend. The idled Hawesville facility drove Century's financial results for Q1 into a dense red zone when compared to the year-ago period, aggravated by the record-high aluminum prices at the beginning of 2022.

Total sales came to $552 million , which is 26.7% short YoY, but a 4.2% sequential improvement. By the way, shipments trend could be used as evidence of the supportive demand profile. On a level playing field (on a sequential basis), realized volumes increased by 7% in the first quarter with 14% growth in the U.S. But on an annual basis, U.S. shipments fell by 24.1% due to the idled Kentucky facility, while Iceland volumes were up by 3%.

However, following the negative announcement from Hawesville in August 2022, the European auto market started to gain momentum with strong-double digit growth rates from the fourth quarter of last year. And looking at this strong trend of recovery from chip shortage, it gives a reasonable assurance that volumes on the Iceland market could remain resilient going forward. In addition, the prices of aluminum improved during the quarter as well as regional premiums, but it was primarily the favorable energy prices that brought an adjusted EBITDA gain of $24 million.

Now back to the shipments trend to examine whether the company could sustain it against the backdrop of trimmed capacity. The continued high energy prices in Europe added up to the curtailed smelter capacity to reach up to 1.2 million mt. In addition, the energy prices are still far from the levels needed to start bringing that capacity online. The same relates to Hawesville as well, as the facility is not in the condition for restart yet. Overall, the supply chain challenges remain a supportive factor for the inventory reduction, which is now believed to be at historically low levels.

We can also turn to the downstream companies Constellium SE ( CSTM ), Arconic ( ARNC ), and Kaiser Aluminum ( KALU ) in order to assure that the stockpile is currently tilted downward, which could give significant support to the LME prices and regional premiums once the market demand profile improves.

The rebound of aluminum prices up to $2 600/mt in the first three months of the year could support the company's financial results in the Q2 fiscal quarter, while going beyond, there is no point to expect a surprise in the realization prices for the second half of 2023 since the aluminum is trending down to $2 100/mt levels currently. Despite the recent uptick in the automotive sector, with registration volumes in the US up by more than 20% for commercial and passenger vehicles in May, it's not enough to make up for the sluggish construction sector. As a result, I would not say that the company may be able to support the increase in volumes in 2023 at the rates we saw in the first quarter.

In searching for an upside, we could turn to Century's strong portfolio of value-added production, which, according to the company's expectation, should amount to 450k mt in 2023 and account for 63% of total output. The latter clearly suggests a favorable production mix, which, however, may be undermined by the ongoing downward trend in the billet premiums.

A bright point could be the recent acquisition of the majority stake in Jamalco, which has been through significant operational challenges since August 2022, while CENX is committed to bringing it up to the nameplate capacity of 1.4 million tons of alumina. The move could be considered as strategically important to strengthen the company's supply chain, since Jamalco is known for high-quality alumina, which is crucial to powering the Century's premium value-added production.

Investment takeaways

Finally, we are arriving at what could be the most prominent upside factor for the company, the Hawesville production facility. The fact that it's running dry, without real prospects for being restarted, puts uncertainty in the EBITDA line. This is clearly reflected in the valuation, where the EV/EBITDA forward multiple declined to 8.9x from 11.7x at the time of my previous article.

The current valuation represents an 18.3% premium (compared to 38% in the previous piece) to the sector's median of 7.6x, the level that Alcoa's ( AA ) valuation is quoted at. I expect $120 million on the FY2023 EBITDA line of Century, since the contribution of Jamalco is expected to be limited. Applying the figure to the median EV/EBITDA should yield an enterprise value of $908 million and $491 million equity value following the adjustments. This represents a $5.32 fair value per share, implying a 36.8% downside potential.

As a result, I am downgrading my call on CENX stock from Hold to Sell, since going through the upside potential it's coming down to the Hawesville, which is idled with unclear prospects of being restarted. Despite the executive's bullish commentary on the aluminum market environment and low Kentucky energy prices, the aluminum prices are clearly trending not in the target range to justify the cost of the plant's restart. The automotive sector is delivering strong growth numbers, which apparently is not enough to offset the weakness in the other aluminum-using sectors. Century currently operates with a favorable production mix tilted to premium production, while the declining value-added premiums are actually frustrating the company's financial performance. Favorable production locations in terms of proximity to the customer base allow Century to capture maximum from the regional premiums, which is still not the point when it comes to the idled Hawesville.

Risk factors

The ongoing macro weakness could restrain the positive momentum in the aluminum-using sectors and result in a prolonged idling of the Hawesville facility. In addition, decreasing value-added premiums could bring further weakness to the financial performance and bring the EBITDA line into a red zone.

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