Tumbling Aluminium Prices Plunging Earnings; ATO Transfer Pricing Radar  

Australia ranks top in alumina export and second in alumina production in the world. The primary source of aluminium is bauxite ore, which is mined and then refined to produce alumina, which is, in turn, smelted to produce aluminium – majorly used in transport (28%), construction (23%), electrical (13%), packaging (12%), machinery (10%) and other sectors (14%).

The key consumer markets for aluminium are China, followed by the United States, Germany, Japan, South Korea and India. Most of the alumina deposits in Australia lies in Queensland, Northern Territory and Western Australia.

Aluminium Prices Expected to Continue Falling

Aluminium LME prices started to fall in 2018 from a maximum of US$2597.5/tonne on 19 Apr 2018 to US$1868.5/tonne on 31 Dec 2018 due to increase in supply than demand. The prices further fell by ~4% in 2019 and an additional ~7% YTD to US$1671.5/tonne on 24 Feb 2020.

The decline in prices has been attributed to factors including trade tensions between the US and China and lifting of US trade and financial sanctions on the most significant Russian aluminium producer, Rusal. The rising global uncertainty and recently, an outbreak of Coronavirus, has slowed down the world economic growth, which, in turn, has dampened the aluminium demand, especially from China — the largest aluminium consumer in the world.

LME Alumina (CRU/Fastmarkets MB) price tumbled by ~30% from US$410.56/tonne on 11 March 2019 to US$288.5/tonne on 24 Feb 2020. Apart from global turmoil, higher supply due to the commencement of 2Mtpa Al Taweelah refinery in the UAE and return of full production at Brazil’s Alunorte refinery after more than a year of restricted operation added to the weaker commodity price.

The LME aluminium spot price is likely to decrease further by 5.1% to an average of US$1,700/tonne in 2020 and drop by an additional 5% in 2021 to average of US$1,615/tonne in 2021 due to rising aluminium production and falling demand. For instance, sluggish automotive sector is impacting global aluminium demand and prices.

Aluminium – Supply and Demand

The world production in 2019 increased by 0.4% from the previous year and consumption reduced by 3.8% during the same period. As per the Department of Industry, Innovation and Science, production is expected to continue increasing by 3.6% in 2020 and 4% in 2021 from respective previous years. Whereas, consumption is likely to fall by 0.7% in 2020 and 1.8% in 2021 concerning the past year. The detail Supply Demand of World vis-à-vis Australia is given below.

Let us now gauge through ASX-listed aluminium company Alumina Limited (ASX: AWC) and how it has performed in the scenario of falling prices.

Alumina Limited Performance

Listed on the ASX and OTC market in the US, Alumina Limited is a leading company in the area of bauxite and alumina production. AWC operates in bauxite mining, refining of alumina and few aluminium smelting operations through its 40% stake in Alcoa World Alumina & Chemicals (AWAC) - the western world's largest alumina business.

Alcoa Corporation (NYSE:AA), known for excellent operational performance and a leader in the production of Bauxite, Alumina and Aluminium products, owns the remaining 60% of AWAC.

Operational and Financial Performance

Alumina production of AWAC in FY19 was 12.6Mt, up by 0.4% from the previous corresponding period (pcp) and aluminium production down by 3% to 161 thousand tonnes.

EBITDA and NPAT fell by 52% and 66% for AWAC to US$1260.7 million and US$565.1 million, respectively, in FY19 from pcp. Net cash inflow dropped by 60% to US$730.7million from pcp. The fall in profit was driven by the 2019 trade tensions between the US and China, and it is expected to remain low because of the ongoing outbreak of Coronavirus in 2020.

Alumina Limited also declared a final dividend of US$3.6 cents per share for FY19, down by 74% from pcp.

The average realised price for alumina tumbled by 25% from US$447/tonne in FY18 to US$336/tonne in FY19 while cash cost per tonne of alumina produced improved from US$226/tonne to US$210/tonne during the same period.

The FY20 guidance for alumina production is ~12.7Mt and aluminium production is approximately 162,000 tonnes.

Please click to know about Q4 performance: Alumina Limited Provides Q4 2019 Earnings Release

Stock Performance

The stock of AWC has returned -22.26% in a year and -7.39% in year-to-date. It closed the day’s trade at A$2.030 on 26 Feb 2020 and its 52 weeks high and 52 weeks low was noted at A$2.78 and A$2.02, respectively. The company has a market cap of A$6.13 billion with a P/E of 20.17x and EPS of A$0.106.

Transfer Pricing Probe by ATO

Australian Tax Office (ATO) recently unveiled that the department is worried about the deals in which Australian companies sell intellectual property (IP) such as patents to foreign affiliates for less than the actual IP cost. And, these are later leased back, thus reducing the total profit and tax for the Australian government.

In the milieu of which, it is pertinent to mention that recently US aluminium giant Alcoa came under such probe by the ATO. The transfer pricing probe on Alcoa has complicated the discussions regarding subsidy extension by the Victorian state and federal governments to loss-making Portland aluminium smelter. Interestingly, the extended subsidy package is almost same as the ATO led inquiry of previous years’ tax evasion of A$212 million (excluding interest and penalties).

Allegation by ATO on Alcoa of Australia

Portland smelter uses alumina for production of aluminium, which is owned by the Alcoa joint venture Alcoa of Australia (55%) followed by China's CITIC (22.5%) and Japan's Marubeni (22.5%).

The dispute between Alcoa of Australia (AoA) and ATO is focused on the way the company sells alumina to its third parties, i.e. Portland smelter. The seriousness engrossed more because Portland had received a grant of ~A$240 million in 2017 as a rescue package from the Victorian Government (A$200 million) and Federal Government (A$40 million) to subsidise the business’ major cost centre, i.e. electricity from AGL Energy.

A statement of audit position (SOAP) has been issued by ATO on AoA, subject to the independent review process within the office. Post the review, if tax assessment is issued then AoA will be liable for 50% of the disputed tax to ATO.

Alumina Limited (as the 40% owner of AoA) disagrees with the stance taken in the SOAP and understands that AoA will defend its position. As of now, no charge has been recognised by AoA about this matter.

Other Transfer Pricing Cases: BHP and RIO

Transfer pricing cases are not new. In 2018, BHP Billiton (ASX: BHP) paid A$529 million in settlement to ATO over the company's controversial Singapore marketing hub.

Recently, Rio Tinto Limited (ASX: RIO) was also subject to a transfer pricing probe by the ATO. The allegation by ATO is focused on the Singapore hub transactions with Rio's aluminium business, especially the Boyne smelter in Queensland, adding complication to the government's talks over a probable rescue package for Rio's loss-making local smelters because of high electricity prices.

Rio owns 59.39% of the Boyne smelter while remaining is owned by six minority holders such as Sumitomo. Presently, the company is in conversation with the federal and state government along with utility providers to devise a suitable plan for the long-term sustainability of loss-making smelters.

Interesting Read: Mining Stocks and Impact from Coronavirus - BHP under the spotlight

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