Alcoa World Alumina and Chemicals, or AWAC, in which no-moat Alumina AWC owns a 40% stake, has announced it will fully curtail production at its Kwinana alumina refinery, beginning in the second quarter of calendar 2024. Alumina’s sole asset is the 40% stake in AWAC.

Kwinana is an old, high-cost refinery that posted a pretax net loss of USD 130 million in calendar 2023, and management has previously raised the possibility of curtailment or closure. Kwinana’s annual nameplate capacity of 2.2 million metric tons would represent around a fifth of AWAC’s calendar 2022 global refining production; however, the refinery has operated at 80% capacity since January 2023.

AWAC is expected to incur cash outlays related to the Kwinana curtailment of around USD 130 million in calendar 2024 and around USD 60 million in calendar 2025, with annual cash costs reducing further in 2026. Calendar 2024 curtailment costs should be fully funded from the cash flows of Alcoa’s remaining, lower-cost Pinjarra and Wagerup refineries in Western Australia.

We don’t expect the closure of Kwinana to materially affect our $1.18 fair value estimate for Alumina.

AWAC primarily operates across the first two stages in the aluminium production chain: bauxite mining and alumina refining. Alcoa’s refineries are, on average, just inside the lowest quartile of the cost curve.

Australian refineries constitute slightly more than 50% of the company’s alumina capacity and have gas contracts with the North-West Shelf. An agreement in 2015 secured gas for the majority of Australian production until 2032.

AWAC says it continues to make progress with relevant government agencies in support of the annual approval process for bauxite mining. It has submitted a revised mine management program for the period 2023-27, working toward approval for at Myara North and the plan during the fourth quarter of 2023. But the company also says it now doesn’t expect improved grades versus recent lesser-grade material until 2027 at the earliest, with that coming via access to bauxite at new regions Myara North and Holyoake. We consequently increase alumina operating cost expectations out to 2027.

Alumina’s cost-efficient refining operations stem from proximity to bauxite mines and access to cheap power. However, prolific growth in Chinese alumina refining capacity means that future returns on invested capital are likely to remain below historical averages. But Alumina's returns should regardless exceed its cost of capital in a midcycle environment.

We assign a no-moat rating to Alumina Ltd. For alumina refiners, we apply the moat framework for commodity manufacturers, which indicates that cost advantage is the only potential route by which the company could establish an economic moat. While it does operate with an attractive cost position, the industry cost curve is relatively flat. Therefore, we contend that only the absolute lowest-cost bauxite mining and alumina refining assets on a global scale would enjoy a maintainable cost advantage.