Aluminum Price 'Slingshot' to Boost Earnings for Rio, Alcoa

MELBOURNE, June 8 -- Rio Tinto Group's $38 billion takeover of aluminum maker Alcan Inc. in 2007 is looking more like a money spinner for the world's third-biggest mining company as forecasts show prices for the metal will increase.

The metal "is going to go up because almost all of the people that use aluminum are using more of it, and lots more of it," said Frank Lucas, a director of London-based fund manager and adviser Loeb Aron & Co., which holds Rio shares. "You are going to get a slingshot in the price and then because Rio doesn't hedge it will be the biggest beneficiary."

Profits at United Co. Rusal, the world's biggest aluminum maker, and Rio's Alcan unit are forecast to surge in the next two years as demand gains from aircraft and automakers. The price of the lightweight metal may rise 30 percent by 2015 as demand accelerates, according to Macquarie Group Ltd., which made Alcoa Inc. its top mining stock pick on May 26.

Airbus SAS, the world's biggest maker of commercial aircraft, in February raised its forecast for demand in the Asia-Pacific region, estimating airlines will buy about 8,000 planes worth $1.2 trillion over 20 years. Global demand for aluminum may double in 10 to 15 years as use soars in developing countries, Jacynthe Cote, Rio Alcan's chief executive officer, said in April.

"We are bullish on aluminum prices in the long run, say three to five years," said Wan Ling, a Beijing-based analyst with CRU International Ltd. "It may be a good time now to buy aluminum plants or equities."

Only once in the past seven years have aluminum prices outperformed copper prices, according to data compiled by Bloomberg.

China Conference

Alcan and Alcoa executives are scheduled to attend Beijing Antaike Information Development Co.'s China aluminum fabrication forum, which starts today in Shanghai.

The metal may rise 14.3 percent in three years, compared with a 2.1 percent drop in copper, according to forward price curves for both metals.

China's decision last month to raise power charges for high-usage companies will drive up prices in the world's biggest user, according to Rusal, which swung to a first-quarter profit. Energy accounts for as much as half the cost of producing aluminum.

"The situation for China is an interesting one and could potentially be a catalyst for a real aluminum bull market," said Alan Heap, Sydney-based head of global commodities at Citigroup Inc. "The balance of risk is shifting in its favor."

'Tremendous Leverage'

Rio's aluminum unit swung to a $111 million profit in underlying second-half earnings from a $689 million loss in the first half last year as the company saved $1 billion in costs and prices rose. The unit's earnings may rise to $1.86 billion in 2012, according to Royal Bank of Scotland Plc estimates. Net income at Alcoa is forecast to more than double by 2012, while Rusal's is tipped to advance 51 percent in the same period, according to Bloomberg earnings estimates.

"Aluminum, which accounts for about 50 percent of Rio's net asset base but contributes about 7 percent of earnings before interest and tax, provides tremendous leverage when aluminum pricing eventually recovers," JPMorgan Chase & Co. analyst David George said in a May 25 note.

While Lucas at Loeb Aron is predicting higher aluminum prices, he said Rio overpaid for Alcan and the purchase may take as long as 20 years to pay back.

The acquisition caused Rio's debt to balloon 19-fold, forcing the sale of assets and shares and prompting an abortive $19.5 billion investment from Aluminum Corp. of China. The debt was also cited by BHP Billiton Ltd. as a factor for scrapping its hostile takeover proposal for Rio in 2008. This combination of events angered shareholders.

'Too Much'

"They paid too much," said Olivia Ker, a London-based analyst at UBS AG. "Longer term you can kind of build a positive story, but I think it's more than 10 years away."

To be sure, global aluminum inventories remain high and demand outside of China is weak, Standard & Poor's said in a May 15 report. Prices may drop if there's no easing of unfavorable economic conditions and high inventories levels, it said.

"We remain cautious towards the industry, largely as a result of new supply emerging in the Chinese market place," said Neil Boyd-Clark, managing partner at Arnhem Investment Management Pty Ltd., which has about $4.2 billion under management.

Rio is among producers that will benefit most from rising aluminum prices, said Helen Lau, a Hong Kong-based analyst at UOB-Kay Hian Ltd.

"Companies such as Rusal and Alcoa have good cost structures" and will get a "free ride" from their higher profit margins," Lau said. Aluminum Corp. of China Ltd., or Chalco, the country's largest producer, and Hindalco Industries Ltd., India's largest producer, "will suffer as they are totally subject to rising coal costs," she said.

"BHP Billiton wanted to buy Rio after the Alcan acquisition, so the industry does view them as quality assets," said Andrew Keen, head of metals and mining research at HSBC Holdings Plc. "The vindication, though, will take longer."