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Rusal (RUAL.MM; 0486.HK) – Aluminium Steels Itself Against Challenging Conditions
Navigating short-term headwinds and leveraging greener production for future opportunities
Altraman’s Russia trip (links aggregated below) uncovered some ground truths about the resilience of local companies there and identified both direct and proxy-play opportunities available via listed Chinese companies with the aim of capitalizing on the warming ties between the two countries.
Most prominently Great Wall Motor (2333.HK; 601633.SS) stood out to us as a major beneficiary from the exodus of Western automakers from Russia - a trading position that is serving us well (stock up 17% to date from our coverage and entry last month).
Amidst the suspension and delisting of Russian companies from Western exchanges, we thought it might be interesting to investigate Russian companies listed in Asian markets. One such example is United Company RUSAL International PJS (RUAL.MM; 0486.HK) ("Rusal"), with whom we met at their Hong Kong office this month.
Third largest aluminium producer with cost advantages and diversification through investments
Rusal (market cap – USD 5.5 billion), dual listed on the Moscow (MOEX) and Hong Kong (HKEX) stock exchanges, is the world’s third largest aluminium producer. In the early 90s, the Russian aluminium industry faced severe challenges due to hyperinflation, budget cuts, and the disappearance of captive markets that made up the USSR and its allies. State-owned smelters and refineries were paralyzed and cut off from their raw material suppliers. With the implementation of economic reforms and privatization of state enterprises, Oleg Deripaska (OFAC sanctioned), a former trader and CEO of state-owned Sayanogorsk Aluminium Smelter (SAZ), took the initiative to privatize SAZ and use its profits to build an aluminium foil mill. He then formed Sibirsky Aluminium (Sibal), bringing together his various metals businesses and made further acquisitions. In 2000, Deripaska's Siberian Aluminium and Roman Abramovich's Millhouse Capital merged their assets, leading to the establishment of RUSAL, one of the world's largest aluminium producers. This merger brought together struggling state-owned smelters and refineries with private investment, creating a new powerhouse in the global aluminium industry.
Rusal’s specific shareholding structure was not publicly disclosed at the time, but the shareholder register had undergone several changes since its establishment. Millhouse Capital had divested its stake post-2003 and Rusal listed on the HKEX and MOEX in 2010. Rusal chose the former in part to tap into new class of investors and China being the Company’s main growth market. Notably, EN+ Group (ENPLq.L (suspended); ENPG.MM), a Russian green energy and metals player, acquired 47.41% stake in Rusal through the process. Rusal managed to raise USD 2.2 billion, to become one of the first non-Asian companies to have a primary listing in Hong Kong, despite scrutiny over its controversial billionaire founder and USD 16.8 billion debt load largely owed to stated-owned Vnesheconombank (VEB), previously chaired by Vladmir Putin.
As of October 2023, Oleg Deripaska and Victor Vekselberg (also OFAC sanctioned), hold 26.32% and 25.72% stakes, respectively, in Rusal. However, due to Rusal’s agreements with OFAC, they do not have any operational or directorship roles within the Company. Consequently, Rusal is not subject to sanctions despite their ownership stakes. Although the company was briefly sanctioned by the US in 2018-2019, the disruption this caused to global supply chains makes a repeat unlikely.
The Company is also engaged in coal mining through a 50/50 joint venture with Samruk-Energo, operating two mines at Bogatyr in Kazakhstan, which contributed around USD 115 million to Rusal's bottom line in FY22A. Interestingly, Rusal also owns 26.39% interest in Norilsk Nickel (GMKN.MM) (“Norilsk), the world’s largest palladium and high-grade nickel producer, as well as leader in platinum, copper and cobalt. Its effective stake added another USD 1.44 billion to its net profit in FY22A. As we discussed while covering Indonesian nickel giant Aneka Tambang (ANTM.JK, ATM.AX), sanctions on Norilsk are impacting its bottom line, and thus its contribution to Rusal. However, Russian brokers are seemingly quite optimistic of a significant catch-up in their H223e earnings. Should their forecasts turn out accurate, Rusal should rake in around USD 1.25 billion this year from its stake (H123A: USD 212m; H223e: USD 1.03 billion).
The Company is vertically integrated with production facilities across 20 countries – it owns 11 aluminium smelters (9 located in Russia), 9 alumina refineries (4 in Russia), 7 bauxite mines (2 in Russia), 4 foil mills (3 in Russia), and one plant for foundry alloys, slugs, and carbon products in Germany.
With regards to Rusal’s operations in Europe, the Company still has an aluminium smelter in Sweden (3% of Rusal aluminium production volume) and an alumina refinery in Ireland (27% of Rusal alumina production volume) that are still operational. However, keeping these facilities running has been very challenging due to high costs of doing business in Europe, such as rising energy prices and sanctions-related difficulties. As a major employer in the local regions, there are also social factors to consider if they were to shut down the plants, a fact which the EU has likely accounted for in deciding not to sanction the Company. For this year, production is expected to be similar to last year's levels, not scaling up significantly. In the longer run, high costs may force shut down of the Sweden and Ireland facilities despite their importance as local employers. But the focus for now is keeping them running.
Rusal’s highly integrated model from bauxite mining through to final aluminium manufacturing means that 5 tonnes of bauxite yield 2 tonnes of alumina and 2 tonnes of aluminium through refining. Its major inputs are electricity and alumina, which comprise roughly 35% and 40% of production costs respectively. It is noteworthy that Rusal benefits from strategic access to low-cost raw materials and hydroelectricity. It leverages Siberia's rich resources to produce 95% of its aluminium using abundant local hydropower, whereas competitors rely on more hydrocarbon-intensive energy sources. To put into context, Rusal ranks in the top quartile globally for both low production costs at USD 0.033 p/kg thanks to Siberian hydropower versus USD 0.05-0.06 p/kg in China, as well as low carbon emissions at just 2 tonnes of CO2 p/tonne of aluminium output, among the lowest in the industry compared to over 6 tonnes for Chinese producers given their reliance on coal.
As the world's third largest aluminium producer behind Aluminum Corporation of China (Chinalco) and Hongqiao Group (1378.HK), Rusal accounts for 11% of total global production. However, its market share has declined yoy as they have not been expanding aggressively. Rusal’s 3.8 million ton targeted output this year is the same as last year’s, with close to 1 million tonnes headed to China. It’s noteworthy that the Company has sufficient reserves to maintain over 25 years of production at current levels. Currently, Rusal is exercising supply control discipline given lacklustre aluminium demand. The fundamental outlook for the aluminium market should ameliorate in FY24 due to:
Improved macroeconomic outlook in China.
Limited supply growth given China’s 45 million tonnes capacity cap (assuming it’s real).
A moderate uptick in auto and construction demand in Europe and the US.
H123A interim results provide little cause for celebration
While Rusal did not hold an investor meeting post publishing their H123A interim results, our meeting with Rusal IR in Hong Kong provided a few additional insights on the stock.
While Rusal itself is not sanctioned, many customers are self-sanctioning, and thus the sales mix has changed drastically. Rusal’s sales focus has shifted from Europe (50% of revenues historically and previously its largest market) to Asia, which now accounts for one-third of revenues. The Company has also reduced its exposure to the US market from 20% historically to less than 10% due to American trade barriers and tariffs on Russian imports. Rusal’s downstream sales mix remains very balanced across all sectors and the company is not finding difficulty in selling its metals, with its revenues distributed roughly equally across the four segments of transportation; packaging; construction; and power, cable, and home appliances industries.
The Company will continue incur higher logistics costs in the current environment with larger shipping companies avoiding business with Russia, engendering a shift to small-to-medium sized ships. Adding to this challenge, Rusal’s dividend policy of up to 15% of EBITDA conditional on financial metrics remains suspended since 2018. The Company’s profitability and short-term liquidity (working capital requirements) continues to be under pressure as seen below with average days inventory and cash conversion cycles of over 143 days.
In order to adapt, Rusal seeks to conduct more sales in Yuan and other non-USD currencies, along with additional loans and bond issuances planned going forward to alleviate banking and logistics bottlenecks. Most recently, the Company raised USD 2 billion in Russian debt to boost liquidity. Its gearing has been stable, and management aims to maintain this going forward. Not surprisingly, loans as well are being increasingly priced in Yuan and other non-USD currencies as well to diversify currency risks. Just last month, Rusal placed an AED 380 million (USD 103 million) 2-year bond issue in the UAE, bearing a 5.95% coupon rate and paying interest semi-annually. There is strong demand for CNY bonds in the Russian market due to increasing trade with China in local currencies. This diversification of funding sources and currencies helps stabilize the gearing ratio and mitigate financial risks amidst the current geopolitical hostilities.
It is noteworthy that Rusal's capex averages around USD 1.2 billion annually. Annual maintenance capex is approximately USD 500 million, with rest of the balance placed towards its energy efficiency program. A multi-billion modernization effort aiming to upgrade 1.1 million tonnes of capacity by 2030, with total spending of USD 5 billion is underway. Rusal is committed to environmental initiatives through modernization. Its debt totals USD 7.8 billion, which includes USD 4.5 billion in M&A loans related to its Norilsk investment from 2008, which have been rolled over using its stake as collateral. The remaining debt is from domestic bonds. Re-financing remains manageable, and working capital needs are only USD 500-600 million annually despite higher cash reserves for risk management.
It would appear that Rusal is prioritizing internal improvements to enhance operational capacity and efficiency while managing long-term solvency. The Company has successfully reduced its total debt to equity ratio from 159% in FY18A to approximately 69% in H123A. All these strategic efforts will contribute to establishing a competitive advantage as a sustainable metals provider and position Rusal to capture market share when geopolitical conditions normalize in the future.
Stock to remain cheap with lack of catalysts to drive a re-rating
Based on sell-side consensus, the stock currently (at 26 October 2023) trades at depressed 12-month blended forward EV/EBITDA and P/E of 6.9x and 3.1x respectively, which is also 3.3 and 4.6 standard deviations below their historical averages respectively. P/BV is also 3 standard deviations below, at historical lows of 0.68x. Trading liquidity in its H-shares remains extremely thin. The IR team did mention that they’ve taken a low-profile approach regarding meeting investors given the current geopolitical environment.
On the positives, Rusal is a big beneficiary of the weakening of the ruble as indicated in H123A, seeing a net FX exchange gain of USD 214 million. The continued slide of the ruble and bottoming out of aluminium prices should support a stronger second half result. However, we have serious doubts about whether Rusal can three-fold its earnings in the second half of this year to meet full year consensus of USD 1.64 billion. If they were to achieve that, we could see a big rally in its share price, but it’s too big a leap of faith in our opinion amidst a confluence of factors negatively impacting its business.
Despite Rusal not being subject to any direct sanctions, the Company aims "to manage operations and survive under the current circumstances" rather than pursue growth. Rusal's low-cost green aluminium advantages, stable demand profile, and prudent approach position it well to ride out challenges, but macro disruption will inhibit potential catalysts on the stock. The key medium-term catalyst is a resolution of geopolitical tensions – which we also don’t see happening anytime soon.
Buying OTC corporate bond issuance - an option for the adventurous?
We were also curious about what the bond market had to offer and at first glance, Rusal bonds seem to offer a relatively attractive investment opportunity in the medium term. With foreign credit ratings agencies, such as Moody’s and Fitch having withdrawn coverage on Russian companies, China Chengxin Credit Ratings (CCXR) has assigned Rusal an AA+ rating. While Rusal has experienced occasional payment disruptions due to Euro (EUR) clearance issues, the Company has not defaulted and has a track record of honoring bond payments despite the challenges posed by sanctions.
Interestingly, over-the-counter (OTC) pricing remains very limited. There are some discounted Rusal’s bonds, making them potentially appealing for investment, although primary information and access are likely only available through larger institutions rather than readily accessible to retail investors.
Notably, Rusal's most recent bond issue is being offered as an option on Interactive Brokers at par, which is unattractive to our investment profile. Nevertheless, the Company is an intriguing stock that warrants close monitoring.
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