Base metals update. Nickel is our favorite

Transcription

1 OIL & GAS RUSSIA > EQUIT Y RESEARCH JAN 15 MAR 15 MAY 15 JUL 15 SEP 15 NOV 15 JAN 16 MAR 16 APRIL 28, 2016 BASE METALS UPDATE Base metals update Nickel is our favorite Natalia Sheveleva Natalia.Sheveleva@gazprombank.ru Forecast further price recovery for copper and nickel, aluminum price to stay close to current levels In 2015, the price environment on base metals markets was disappointing due to weaker than expected supply and demand fundamentals (excess supply amid insufficient reduction of output volumes and disappointing demand). At the beginning of 2016, metals prices declined, reaching lows. Base metals prices are now recovering and overall we expect this dynamic to continue from spot levels in 2016 thanks to gradual improvement of the supply-demand balance. We forecast nickel and copper prices to grow from current spot levels, while the aluminum price should stay in line with spot. Small deficit expected on nickel, copper and aluminum markets in 2016 We anticipate minor deficits on the aluminum, nickel and copper markets in For base metals we forecast more favorable fundamentals on the nickel market nickel prices may rise significantly in 2H16. We note that recent data on stainless steel production in China look promising as an indicator of nickel demand. We prefer Norilsk Nickel Norilsk Nickel remains our top equity pick for 2016 due to expected sharp growth in nickel prices in 2H16 (we also have a positive view on palladium), the company s recently updated attractive dividend policy (for 2016 we forecast a dividend yield of 10%, minimum of 5.5%) and the stock s relatively high liquidity. The company will hold an Investor Day event on May 16, which could serve as an additional driver. Norilsk Nickel currently trades at 2016E and 2017E EV/EBITDA of 7.1x and 6.2x, implying discounts of 17% and 16% to diversified metals peers. Rusal currently trades at 2016E and 2017E EV/EBITDA of 4.5x, implying respective discounts of 44% and 35% to aluminum producer peers. We forecast 2016 net debt/ebitda for Norilsk Nickel and Rusal at 1.3x (1.1x in 2015) and 3.5x (2.7x in 2015; covenant figure), respectively. Main risk factors to remain tied to the Chinese market. FX is also a risk Investors will continue to focus on the Chinese economy in In current conditions, this implies heightened risks for metals prices. The shares of Chinese demand in total global demand for aluminum, nickel and copper are rather large (52%, 51% and 46% in 2015). Another risk is volatility in the RUB/USD rate and Rusal is rather sensitive to this factor (we estimate that each 10% change in the ruble rate leads to a 13-17% change in EBITDA). However, Norilsk Nickel s relative sensitivity is among the lowest in the Russian metals and mining universe (5% change in EBITDA for each 10% change in ruble rate). Base metals price dynamic, $/tonne COPPER NICKEL ALUMINUM Research Department 1 Copyright Gazprombank (Joint Stock Company)

2 APRIL 28, 2016 CONTENTS Metals market overview, latest trends and China s share in demand... 3 Nickel, copper and aluminum prices fell a respective 30%, 20% and 11% YoY in China s share of demand in global aluminum and nickel markets totals more than 50%; China remains a risk factor.. 3 Nickel is our favorite relative to expected potential growth... 4 Nickel price performance was very disappointing in 2015; market expectations shifted from a deficit to excess supply, while inventories increased... 4 Deficit on the nickel market seen at 43 kt in Recent data on stainless steel market is encouraging... 6 Aluminum market... 7 Copper market... 8 Norilsk Nickel is our top pick

3 APRIL 28, 2016 METALS MARKET OVERVIEW, LATEST TRENDS AND CHINA S SHARE IN DEMAND Nickel, copper and aluminum prices fell a respective 30%, 20% and 11% YoY in 2015 In 2015, the LME aluminum price declined 11% YoY to $1,622/tonne, while the copper price fell 20% YoY to $5,503/tonne and the nickel price dropped 30% YoY to $11,835/, reaching multi-year lows. The main reasons for the deterioration were China s economic slowdown (the main factor), strengthening of the dollar, and overproduction. Excess supply was observed on all three markets in 2015 (63 kt on the copper market, 1,211 kt on the aluminum market and 36 kt on the copper market). At the beginning of 2016, metals prices decreased further amid concern about the global economy and following the FOMC s rate hike in December 2015, with nickel reaching a low at $7710/tonne, copper at $4327/tonne and aluminum at $1467/tonne. Subsequently, amid signs of better than expected global economic performance nickel, copper and aluminum prices rebounded 5.7% YTD, 5.0% YTD and 8.1% YTD, respectively. Dynamics of base metals prices JAN 15 MAR 15 MAY 15 JUL 15 SEP 15 NOV 15 JAN 16 MAR 16 COPPER NICKEL ALUMINUM China s share of demand in global aluminum and nickel markets totals more than 50%; China remains a risk factor In 2016, investors will continue to focus on the Chinese economy. In current conditions, China s significant influence implies heightened risks. China s shares in global demand for nickel and aluminum are the highest (52% for aluminum, 51% for nickel). The corresponding share in copper is smaller, but also very high (46%). China s share in global metals demand, 2015, % 53% 52% 51% 50% 49% 48% 47% 46% 45% 44% 43% 42% 52% 51% 46% ALUMINUM NICKEL COPPER Source: CRU, GFMS,Gazprombank estimates 3

4 JAN 15 FEB 15 MAR 15 APR 15 MAY 15 JUN 15 JUL 15 AUG 15 SEP 15 OCT 15 NOV 15 DEC 15 JAN 16 FEB 16 MAR 16 APR 16 APRIL 28, 2016 Metals price forecasts SPOT PRICE Q16 2Q16E 3Q16E 4Q16E 2016E 16E/15 Aluminum 1,626 2,022 1,846 1,869 1,662 1,516 1,610 1,638 1,610 1, % Nickel 9,069 17,530 15,012 16,892 11,835 8,508 9,386 10,105 10,740 9, % Copper 5,014 7,958 7,328 6,866 5,503 4,678 4,842 5,014 5,151 4, % NICKEL IS OUR FAVORITE RELATIVE TO EXPECTED POTENTIAL GROWTH Nickel price performance was very disappointing in 2015; market expectations shifted from a deficit to excess supply, while inventories increased The dynamic in nickel prices was one of the main disappointments for the global metals market in Following Indonesia s introduction of a ban on the export of unprocessed ore at the beginning of last year, market expectations shifted to a nickel deficit and market sentiment was optimistic. However, these expectations were not fulfilled due to greater than expected inventories of nickel ore in China, higher than forecast deliveries of nickel ore from the Philippines, unexpectedly sharp slowing of growth in the Chinese economy amid the country s high share in global nickel demand (51% in 2015), a strong dollar, a weaker yuan and falling oil prices. All of these factors created an exceptionally unfavorable external backdrop for nickel. According to CRU data, nickel deliveries declined 3.2% YoY in 2015, while demand rose just 0.6% YoY. Excess nickel supply in 2015 totaled 36 kt. According to CRU estimates, global nickel inventories rose from 874 kt as of end 2014 to 911 kt by end We note that LME nickel inventories have declined YTD, which is a positive factor. LME nickel price, $/tonne Balance on the global nickel market, kt 16,000 15,000 14,000 13,000 12, ,000 10,000 9,000 8, , E 2017E NICKEL BALANCE Source: CRU, Gazprombank estimates Deficit on the nickel market seen at 43 kt in 2016 We expect nickel production to continue to fall in That said, the steepest decrease will be seen in China. At the same time, nickel consumption should increase moderately. We expect to see a deficit on the nickel market in 2016 for the first time since

5 APRIL 28, 2016 We estimate the deficit on the nickel market at 43 kt in However, this will unlikely be sufficient to trigger recovery in prices from current levels to the average level for We believe that the deficit on the nickel market will persist in the medium term, especially given the low level of nickel prices in recent years and, as a consequence, insufficient investment in construction of new capacity. However, we note that expectations of a deficit on the nickel market were not met last year and thus investors could view this metal with heightened concern this year. At the same time, given clear signs of substantial growth in nickel prices, the market could see some positive surprises in terms of pricing. Low demand was one of the main disappointing factors in 2015 and will remain a risk factor in 2016 As for nickel supplies, a main focal point is forecast production of nickel pig iron (NPI) in China, as this factor remains among the most important on the nickel market. There are some risks for China's nickel pig iron production related to uncertainty regarding supplies of nickel ore, as well as environmental factors and the high production costs of many producers. According to CRU, total imports of nickel ore from the Philippines to China reached 50.2 mln tonnes in 2015 (-9% YoY), while the Philippines should supply around 46.0 mln tonnes of nickel ore to China in 2016 (-8% YoY). Out of the total amount, 7.5 mln tonnes will comprise ore with high nickel content (15% of total supplies), 22.6 mln tonnes ore with medium nickel content (45%), and the remaining 20.1 mln tonnes (40%) ore with low nickel content. CRU anticipates a marginal increase in exports of ore with medium nickel content and no growth in exports of ore with high nickel content, which would lead to deterioration of China s import structure and a higher production cost of nickel pig iron (thus supporting nickel prices). We note that such volumes of nickel ore imports would be sufficient for China to produce 350 kt of nickel pig iron. Amid a backdrop of lower nickel ore supplies from the Philippines, we believe that China s production of nickel pig iron could fall from 385 kt in 2015 (458 kt in 2014) to kt in Given that spot nickel prices reached extremely low levels in 2016 ($7,710/tonne in February), we took a closer look at cost issues. According to CRU estimates, at a nickel price below $9,000/tonne, nearly 60% of production capacities would operate at a loss, while at around $8,800/tonne about 70% of nickel producers would operate at a loss (in 1Q16, the nickel price averaged $8,508/tonne, while current spot levels are around $8,800/tonne). On the other hand, according to Norilsk Nickel estimates, of the 70% of nickel producers that face losses at a nickel price of around $8,800/tonne, approximately 44% of loss-making capacities belong to diversified mining companies; 4% are capacities that are boosting production volumes to reach designed capacity; and 5% are government-supported. Thus, only around 17% of loss-making capacities are highly sensitive to fluctuations in nickel prices. We believe that nickel prices will be supported by the closure of high-cost nickel production facilities, a process that accelerated in 2016, as prices were extremely low at end 2015 early However, there is a risk that capacities will be closed too slowly, which would lead to a smaller than expected deficit. 5

6 ,100 1,300 1,600 1,800 APRIL 28, 2016 Nickel cost curve, $/tonne, ,000 20,000 15,000 10,000 5, ,000-10,000 Source: company data, Gazprombank estimates Recent data on stainless steel market is encouraging China s stainless steel production increased 7% YoY in March According to Umetal, China s stainless steel production in March increased 7% YoY (Umetal covers around 80-85% of China s overall stainless steel output). Moreover, the production of 300-series stainless steel, which is the most important in terms of nickel demand (due to it having the largest share in total demand), increased 10% YoY in March. According to our estimates based on CRU calculations, China accounted for 51% of global nickel demand in 2015, while stainless steel accounts for 82% of China s total nickel demand. China s stainless steel production, kt Series JANUARY FEBRUARY MARCH 1Q ,045 YoY -12% 10% -5% -5% ,196 YoY -5% -19% 10% -4% ,040 YoY 8% 11% 18% 13% Total 1,499 1,112 1,670 4,281 YoY -4% -7% 7% -1% Growth of Chinese stainless steel production is a positive sign for nickel Source: Umetal, Norilsk Nickel Although monthly stainless steel production data has become too volatile, we regard the growth of stainless steel output in March as a positive sign for nickel demand. 6

7 JAN 15 FEB 15 MAR 15 APR 15 MAY 15 JUN 15 JUL 15 AUG 15 SEP 15 OCT 15 NOV 15 DEC 15 JAN 16 FEB 16 MAR 16 APR 16 APRIL 28, 2016 ALUMINUM MARKET As was the case on most commodity markets, last year was a difficult one for the aluminum market. The average LME aluminum price fell 11% YoY to $1,662/t. That said, the premium to the LME price dropped more significantly, while the all-in aluminum price declined 15.4% YoY to $1,947/t (CRU the market benchmark, LME price plus premium in US). According to CRU, global aluminum demand rose 4% YoY in 2015, while production expanded 6.1% YoY. That said, after a relatively balanced market in 2014, the aluminum oversupply in 2015 totaled 1.2 mln tonnes (according to CRU), equaling 2.2% of global demand. We note the major imbalance on the Chinese market, which showed oversupply of 1.3 mln tonnes. Net of China, the global aluminum market experienced a deficit of 870 kt in Net aluminum exports from China rose 1.6x in 2015 to 790 kt. We note that China s shares in global supply and aluminum demand totaled 54% and 52%, respectively, in 2015, and that China remains one of the main drivers of the aluminum price. According to CRU, China in 2015 closed 15% of aluminum production capacities (a record reduction of 4 mln tonnes), but further measures to decrease oversupply are necessary. Alongside capacity reduction, a number of projects in China were delayed (with an estimated impact on production in 2016 of more than 0.6 mln tonnes). In 2015, starting from November, the closure of capacities accelerated. In particular, in December 2015, aluminum production volumes contracted 8.7% MoM to a 15-month low. According to CNIA data, published by IAI, daily average production volume of primary aluminum in China decreased 2% MoM to 80 kt in January the lowest level since October On a YoY basis, aluminum production in China dropped 4.5% in January 2016 the first reduction in five years. The reasons for the decline were lower arbitrage opportunities and the week-long New Year s holidays in February. Net exports of aluminum semi-finished products continued to trend downward, falling 14.5% MoM to 235 mln tonnes in February (-37.4% YoY). LME aluminum price, $/tonne 2,200 2,000 1,800 1,600 1,400 1,200 Global aluminum market balance, kt 1,500 1, ,000-1, E 2017E ALUMINUM BALANCE Source: CRU, Gazprombank estimates We forecast a slight deficit of aluminum (526 kt) in 2016, while noting that Alrosa and Rusal recently said they expected a record aluminum deficit in 2016 at a level of 1.2 mln tonnes. According to CRU estimates, one third of producers outside China and over half of producers within China are loss-making. This could indicate that aluminum prices have already bottomed out this year. 7

8 JAN 15 FEB 15 MAR 15 APR 15 MAY 15 JUN 15 JUL 15 AUG 15 SEP 15 OCT 15 NOV 15 DEC 15 JAN 16 FEB 16 MAR 16 APR 16 APRIL 28, 2016 COPPER MARKET The average LME copper price fell 20% YoY in 2015 to $5,503/t, reaching a sevenmonth low of $4,300/t in January According to CRU, the oversupply on the global copper market stood at 63.0 kt in 2015, as supply remained high (+1.6% YoY to mln tonnes in 2015) amid disappointing demand (+0.4% YoY to 21.6 mln tonnes in 2015). We note that copper production volumes were reduced by around 5.5% of global output in 2015, which was insufficient to support the market. In 2016, we expect a slight deficit on the copper market, although this would still be insufficient to drive prices significantly higher. The key negatives include cautious investor sentiment toward copper, lower costs in the sector and USD appreciation. A decrease in costs would also be attributable to higher productivity in the sector and the completion of a number of high-cost operations. LME copper price, $/tonne 7,000 6,500 6,000 5,500 5,000 4,500 4,000 Global copper market balance, kt E 2017E COPPER BALANCE Source: CRU, Gazprombank estimates 8

9 APRIL 28, 2016 NORILSK NICKEL IS OUR TOP PICK We prefer Norilsk Nickel Norilsk Nickel remains our top equity pick for 2016 due to expected sharp growth in nickel prices in 2H16 (we also have a positive view on palladium), the company s recently updated attractive dividend policy (for 2016 we forecast a dividend yield of 10%, minimum of 5.5%) and the stock s relatively high liquidity. The company will hold an Investor Day event on May 16, which could serve as an additional driver. Norilsk Nickel currently trades at 2016E and 2017E EV/EBITDA of 7.1x and 6.2x, implying discounts of 17% and 16% to diversified metals peers. We forecast 2016 net debt/ebitda for Norilsk Nickel and Rusal at 1.3x (1.1x in 2015) and 3.5x (2.7x in 2015; covenant figure), respectively. 9

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