articles Ratings /ratings/en/research/articles/190401-global-trade-at-a-crossroads-section-232-tariffs-leave-dents-in-u-s-aluminum-credit-quality-10910865 content
Log in to other products

Login to Market Intelligence Platform

 /


Looking for more?

Request a Demo

You're one step closer to unlocking our suite of comprehensive and robust tools.

Fill out the form so we can connect you to the right person.

If your company has a current subscription with S&P Global Market Intelligence, you can register as a new user for access to the platform(s) covered by your license at Market Intelligence platform or S&P Capital IQ.

  • First Name*
  • Last Name*
  • Business Email *
  • Phone *
  • Company Name *
  • City *
  • We generated a verification code for you

  • Enter verification Code here*

* Required

Thank you for your interest in S&P Global Market Intelligence! We noticed you've identified yourself as a student. Through existing partnerships with academic institutions around the globe, it's likely you already have access to our resources. Please contact your professors, library, or administrative staff to receive your student login.

At this time we are unable to offer free trials or product demonstrations directly to students. If you discover that our solutions are not available to you, we encourage you to advocate at your university for a best-in-class learning experience that will help you long after you've completed your degree. We apologize for any inconvenience this may cause.

In This List
COMMENTS

Global Trade At A Crossroads: Section 232 Tariffs Leave Dents In U.S. Aluminum Credit Quality

Beyond The Buzz: The Geopolitics Of Water

COMMENTS

Table Of Contents: S&P Global Ratings Corporate And Infrastructure Finance Criteria

COMMENTS

This Time Is Different: An Anemic And Uncertain Passenger Recovery Will Challenge U.S. Airports' Credit Quality

COMMENTS

Leveraged Finance: Monitoring Middle Market Entities Amid COVID-19


Global Trade At A Crossroads: Section 232 Tariffs Leave Dents In U.S. Aluminum Credit Quality

Section 232 tariffs on aluminum have barely registered in credit ratings for U.S. or foreign aluminum producers, as the industry marks one year since the trade action was implemented in March 2018. Earlier this year, S&P Global Ratings analysts discussed the trade file with aluminum producers, buyers, and other industry participants at S&P Global Platts 2019 Aluminum Symposium, which confirmed our views that tariffs are not likely to spark meaningful new primary production in the U.S., while consumers are absorbing higher costs for tariffs and regional premiums. Meanwhile, a glut of raw material is building in the world's largest aluminum scrap basket, as downstream aluminum rollers shift to higher value-added automotive products that consume primary metal from more commoditized products made from recycled metal. Finally, many participants believe that higher aluminum costs from tariffs could erode the metal's cost competitiveness as a lightweight alternative to steel, where U.S. domestic output is on the rise and more technologically-advanced capacity is on the horizon.

Tariffs on aluminum are unlikely to boost domestic primary aluminum capacity or production, because high power costs make commodity aluminum production globally uncompetitive in much of the U.S., even with 10% import tariff protection. Meanwhile, downstream aluminum buyers are trying to pass along higher metal costs to their customers, and they remain confident enough to expand U.S. operations.

Chart 1

image

Aluminum tariffs aren't helping the credit quality of U.S. producers.

We've upgraded primary metal producer Alcoa Corp. and downstream aluminum roller Novelis Inc. since tariffs took effect, but neither rating action was caused by tariffs: we telegraphed the upgrades with positive outlooks more than a year before tariffs were even proposed because of improving profitability from investments or divestitures and declining debt or pension obligations. Ultimately, tariffs would only affect a wide range of credit ratings if they lastingly alter the profitability of a large, mature fixed asset base, which appears unlikely given the overwhelming comparative advantage of producing primary metal from lower power costs in other countries. Higher value-added downstream metals producers, however, are having margins or liquidity pinched by higher input costs in the U.S., but most anticipate relief in early 2019 as price increases roll through.

Table 1

Global Aluminum Producer Ranking
Issuer Issuer Credit Rating Outlook/ CreditWatch Business Risk Financial Risk Industry Segment

Rio Tinto PLC

A Stable Strong Modest Primary aluminum and diversified mining

Norsk Hydro ASA

BBB Stable Satisfactory Intermediate Integrated aluminum

Aluminum Corp. of China Ltd. (Chalco)

BBB- Stable Satisfactory Highly Leveraged Primary aluminum

Arconic Inc.

BBB- Watch Neg Strong Significant Rolled products

Alcoa Corp.

BB+ Stable Fair Intermediate Integrated aluminum

Novelis Inc.

BB- Stable Satisfactory Aggressive Rolled products

China Hongqiao Group Ltd.

B+ Stable Fair Significant Primary aluminum

Vedanta Resources Ltd.

B+ Negative Fair Highly Leveraged Primary aluminum and diversified metals

Century Aluminum Co.

B Positive Weak Highly Leveraged Primary aluminum

Constellium N.V.

B- Positive Fair Highly Leveraged Rolled products

Aleris International Inc.

B- Positive Weak Highly Leveraged Rolled products

JW Aluminum Continuous Cast Co.

B- Stable Vulnerable Highly Leveraged Rolled products

Qinghai Provincial Investment Group Co. Ltd.

CCC+ Negative Weak Highly Leveraged Primary aluminum
Ratings as of March 14, 2019. Source: S&P Capital IQ

Tariffs have not altered our view of Alcoa's credit quality, partly because the company produces most of its aluminum outside the U.S., and the impact of tariffs on profitability is small compared to the 20%-25% rebound in aluminum prices on the London Metal Exchange (LME) since 2016 and the 2018 spike in alumina prices. More to the point, we estimate Alcoa has only generated about one-third of its EBITDA from primary aluminum in the last few years, with earnings from its 45 million tonne bauxite mining operations that feed 15 million tonnes of alumina refinery capacity outstripping about 3 million tonnes of primary aluminum production. The company estimates a $27 million net benefit from tariffs in the third quarter of 2018, or about 3% of reported EBITDA for the quarter, although it reported tariffs as a contributor to higher costs by year-end, mostly because its low-cost output from Canada remains subject to tariffs.

By comparison, higher aluminum costs (including tariffs or Midwest premiums) for U.S. downstream companies like Novelis and Arconic Inc. consume cash for working capital and increase noncontrollable costs when these issuers are committing new capital to meet growing demand. Novelis' improved credit profile is a function of favorable automotive demand for aluminum, stable conditions for beverage can sheet, and lower net debt at Novelis' parent, Hindalco Industries Ltd. Although Novelis consumes more recycled aluminum than primary metal, the company still estimates that every $100 per tonne of metal price change (about 5% of today's primary aluminum price) affects working capital by about $50 million. Most aluminum-consuming manufacturers expect some price relief in the coming quarters as contractual pass-through takes effect, but Arconic, which is on CreditWatch with negative implications, has reported margin pressure from higher aluminum prices, including tariffs and elevated regional premiums, along with competitive pricing in its aerospace segment. The company--which uses last-in-first-out (LIFO) inventory accounting that exacerbates input cost volatility in this commodity pass-through business--estimates that a $100 per tonne of primary aluminum price increase negatively affects operating income by about $10 million, or about 1%. Both companies consumed cash for net working capital as LME aluminum price rose in 2017 and early 2018. Included in this cash flow drain (see chart 2) is an outsized impact from U.S. operations, with Midwest U.S. regional premiums running at 10%-20% of the LME benchmark, as well as higher tariff-in costs. In contrast, aluminum prices have declined about $200 per tonne in the last few months, which should ease the pressure on margins and working capital.

Chart 2

image

Norway-based Norsk Hydro ASA has had a mixed exposure to volatile industry conditions. The upward swing of aluminum prices was surpassed by the effect of increased input costs compared to the year before. Much of this has been attributable to uncertainties on availability of Rusal's produced alumina due to the U.S. sanctions (as Rusal is not only a producer of about 3.8 million tonnes of primary metal, but was also an exporter of up to 2.2 million tonnes of alumina per year before U.S. sanctions), on top of alumina market tightness following Norsk Hydro's halved operations at the Alunorte alumina refinery. We think the alumina market should stabilize in the coming quarters as the sanctions on Rusal have been now lifted, alleviating the pressure on margins for producers that depend on purchased raw materials.

Tariffs don't improve a tough position for primary U.S. aluminum assets

The commodity nature of aluminum necessitates a competitive cost profile, the key driver of which is a steady, inexpensive supply of electricity, some of which is subsidized or benefits from preferential rates to support local investment and employment. Power for the electrolytic reduction of alumina powder to aluminum metal can account for 20%-40% of the cash cost of primary aluminum production--more than the alumina raw material in many cases. Europe, the U.S., and China have elevated or rising power rates from shifting fuels and environmental considerations, which compares to abundant low-cost baseload hydro in Canada, Scandinavia, and Russia and natural gas in the Middle East. Aluminum prices have moved for reasons unrelated to trade and tariffs, such as primary aluminum inventories, global demand, and capacity cuts.

Alcoa's credit improvement has come from debt reduction and asset pruning that structurally improved profitability, not better smelting margins because of tariffs or high U.S. Midwest premiums. We estimate Alcoa is generating only about one-third of its EBITDA from primary aluminum smelting, with most of its earnings from world-class bauxite mining and alumina refining assets in Australia. The spike in alumina prices in mid-2018 helped push adjusted debt/EBITDA to an attractive 2x and return on capital to about 15%, while the company uses excess cash flow to reduce pension obligations and return cash to shareholders. In contrast, Century Aluminum Co.’s narrow operating profile and unstable profitability are currently on display, as a margin squeeze from higher input costs for alumina pushed EBITDA into negative territory in the fourth quarter of 2018. Moreover, the company's most reliable earnings are generated from its assets in Iceland, which have attractive power arrangements, while U.S. assets operated at 60%-65% capacity utilization in 2018.

Chart 3

image

Tariffs aren't boosting U.S. aluminum capacity much.

A 10% tariff is unlikely to stimulate much incremental primary aluminum output in the U.S., and a greenfield smelter in the U.S. remains highly improbable: If the 25% surge in LME prices since 2016 hasn't sparked more investment, a 10% tariff probably won't. In fact, only a few primary aluminum restarts in the U.S. have even been proposed. Increasingly stringent scrap import restrictions in China are causing a glut of recycled material in the U.S., which could be an opportunity for this less power-intensive mid-market to flourish, although demand for domestic recycled material in the U.S. has weakened in favor of primary metal, most of which is imported. Recycled aluminum requires as much as 95% less electricity to produce than primary, and the metal can be recycled countless times. On the other hand, secondary aluminum trades at a discount to LME primary because residual alloys or other factors weaken its market acceptance for high value added aluminum products.

Even with a 10% tariff, most mothballed primary smelters in the U.S. remain globally uncompetitive, because of capital requirements for technological catch-up as well as high operating costs. For instance, since tariffs were announced, only Century Aluminum has proposed a meaningful primary aluminum investment for restart. The company proposes to spend $116 million to restart all three of its previously curtailed potlines at its Hawesville, Ky. facility, which should yield 150,000 tonnes of incremental capacity, or about 3% of U.S. demand. Alcoa announced the restart of the Warrick, Ind. smelter in mid-2017, well before tariffs were announced, aiming for three of five potlines to resume production by mid-2018 to support internal consumption at its rolling mill. The company only hit target run-rate production of 161,000 tonnes 18 months after some disruption, highlighting the long lead time required to restart an aluminum smelter. In this case, the smelter had only been idled since March 2016, and the restart cost $18 million through the third quarter of 2018. Most other smelters in the U.S. have been out of commission for longer, and would be that much more difficult and costly to restart. For example, Alcoa recently paid $62 million to terminate an electricity supply agreement for its Wenatchee, Wash. smelter and permanently close one of four potlines at the fully curtailed facility. The other three lines at Wenatchee have been curtailed since 2015. In contrast, Norsk Hydro announced its decision last year to upgrade and restart its second production line at Hydro Husnes in Norway, spending NOK1.4 billion (about $165 million) to add 100,000 tonnes of hydroelectricity-sparked capacity.

Tariffs haven't done much to change U.S. aluminum imports.

Tariffs appear to be having only a small effect on U.S. aluminum import reliance, mostly because domestic marginal production cannot economically fill the 75%-80% of consumption that is imported. Primary aluminum production in the U.S. is up about 10% year-over-year, indicating some support from tariffs. But this 100,000 tonne jump is tiny in a market that imports more than 5 million tonnes, almost half of which came from Canada in 2017. The U.S. reliance on imports has meant tariffs are mostly being passed through to domestic customers, with no discernible effect on the profitability or credit quality of U.S. or foreign aluminum producers.

Aluminum is probably the most electricity-intensive commodity in the world--so much so that it's colloquially called "congealed electricity," and aluminum exports are sometimes viewed as akin to exporting power. Better economics for U.S. primary aluminum could mean diverting scarce electricity from high value-added manufacturing to a volatile, globally oversupplied commodity that is not very labor-intensive, so it supports fewer and less technically advanced jobs than the many downstream industries it supplies. The U.S. Aluminum Association on Nov. 5, 2018, combined with the industry associations in Canada and Mexico to request full exemptions in North America, noting pointedly that "The USMCA cannot work for the aluminum industry or our many downstream customers without exempting Canada and Mexico from the 232 tariffs or quotas."

Swings in aluminum prices in the last 12-18 months, meanwhile, have far outstripped the effects of tariffs for profits and cash flow, because of unrelated factors like restrained output from China, a spike in alumina input costs, and the history of sanctions on Russian producer Rusal. Higher prices and tariff protection have improved profitability for some of the U.S. industry's marginal production, supporting the credit quality of some of the least competitive producers, but increasing output at a higher cost to domestic customers. Regional premiums also remain elevated, especially in the U.S., due to a combination of the Section 232 tariffs and elevated freight costs. The average premium for physical delivery in the U.S. is currently about $400 per metric ton (mt), more than double the $175/mt about a year ago. This compares to premiums of $60-$100/mt in Asia and Europe, which are about steady year-over-year. These premiums contribute to producers' realized (all-in) prices, as well as the input costs for downstream consumers.

Aluminum buyers build cutting-edge plants despite tariff headwinds.

Paradoxically, most recent investment proposals in the U.S. aluminum industry are downstream, the higher value-added segment that should be hindered by higher costs from tariffs. Novelis and Aleris have recently opened aluminum rolling capacity to supply the North American automotive industry's shifting demand to lightweight aluminum from steel, but these decisions were made several years before tariffs amid fairly tight capacity for aluminum rolled products like can sheet in North America. The pace of investment announcements indicates that several companies expect the ultimate buyers of automobiles and other goods produced in the U.S. will absorb higher costs if tariffs are sustained. Table 2 lists some significant downstream projects in the U.S., which appear to be advancing even with the implementation of tariffs.

Notwithstanding the optimism for strong demand, we believe sustained tariffs would weaken cash flow during a period of elevated capital expenditure (capex) for a few manufacturers of downstream aluminum products. Aluminum rolling mills are capital-intensive with long lead times, and often require 12-18 months of potentially unsteady ramp-up after 12-18 months of construction. In many cases, the debt financing to fund these projects can contribute to elevated financial risk, as was the case with Aleris through the construction of its Lewisport, Ky. facility.

Table 2

Completed And Announced Capacity Additions In U.S. Aluminum Rolled Products
Company Project Estimated Capex LTM EBITDA (in mil. $) Status

Novelis Inc.

Oswego, N.Y. automotive finishing line $120 million 1,378.5 Complete and commissioned in 2016.

Aleris International Inc.

Lewisport, Ky. rolling mill to serve auto sector $400 million 204.5 Complete and opened at the end of 2017.

Kaiser Aluminum Corp.

Upgrade Trentwood facility in Spokane, Wash. $150 million 204.2 Projects nearing completion, with some planned downtime in 2019 for completion.
Braidy Industries Inc. (unrated) 300,000 tonne aluminum rolling mill in Kentucky $1.68 billion Startup No construction financing and no EPC contract in place.
Tariffs announced in Jan. 2018 and implemented March 2018.

Novelis Inc.

200,000 tonnes of automotive sheet in Guthrie, Ky. $300 million 1,378.5 Broken ground in Kentucky, and expects first production in 2020.

Novelis Inc.

100,000 tonnes of automotive sheet in China $180 million 1,378.5 Broken ground in China with completion expected in 2020.

JW Aluminum Continuous Cast Co.

175 million pounds of capacity for construction, automotive, and general distribution at Mount Holly, S.C. N.A. N.A. Construction is underway and is expected to be complete in early 2020.

Arconic Inc.

Hot mill expansion in Alcoa, Tenn. $100 million 2,052.0 Industrial and automotive sheet.
N.A.--Not applicable.

Aluminum is integral to China's economic and environmental policy.

The U.S. Aluminum Association believes "China's subsidies to producers of both primary aluminum and semi-fabricated aluminum products have resulted in significant overcapacity in the market, hurting the plants and people of the U.S. industry." Chinese producers have indeed cut production and capacity in recent years, ostensibly doing so to support the shift to a more domestic demand orientation, as well as to lower emissions, particularly during winter months. Our ratings incorporate meaningful government support for aluminum producers in China, including market leader Aluminum Corp. of China Ltd. (Chalco), as well as Qinghai Provincial Investment Group Co. Ltd. (QPIG), but none for China Hongqiao Group Ltd..

Our rating on Chalco is three notches higher than its stand-alone credit profile because we see a high likelihood that the Chinese government would extend timely and sufficient extraordinary support to the company in case of financial distress. The government owns 35.8% of Chalco through its 100%-owned Chinalco, and in our view the company plays a role in helping the government to secure China's access to natural resources globally, which is particularly important given the country's rapid industrialization.

We continue to assess QPIG as having a high likelihood of receiving extraordinary support from the Qinghai provincial government. The government, as a controlling shareholder, directly and indirectly controls about 86% of the company, and the Xining city government, which operates under the Qinghai provincial government, controls the remaining stake. QPIG is the largest aluminum producer in Qinghai province. Its credit standing is important for the government as a default could reverberate throughout the value chain, including the power and coal industries. However, we see a gradual transition for QPIG toward a less strong link with or a less important role to the Qinghai provincial government and therefore a weakening of the likelihood of extraordinary government support over time. While the local government has a track record of providing timely support to QPIG, the recent missed coupon payment may reflect less effective governance and monitoring of QPIG and potentially weakened willingness to support the company, in our view.

Hongqiao is a private company that doesn't benefit from extraordinary government support in our credit rating. Hongqiao is larger, has lower production costs, and is more vertically integrated than its Chinese peers, but it is less geographically diversified than Chalco and Alcoa. Hongqiao has high debt leverage because it spent heavily to fund capacity expansion and has accumulated a heavy debt. Lower capex over the next few years will be important in demonstrating a track record of prudent spending before we can build confidence in its financial discipline. We continue to view the company's corporate governance as weak, and a key credit consideration will be its timely and transparent financial reporting and market communication.

This report does not constitute a rating action.

Primary Credit Analyst:Donald Marleau, CFA, Toronto (1) 416-507-2526;
donald.marleau@spglobal.com
Secondary Contacts:William R Ferara, New York (1) 212-438-1776;
bill.ferara@spglobal.com
Sergei Gorin, Moscow (7) 495-783-4132;
sergei.gorin@spglobal.com

No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.

Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.

To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.

S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.

S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.

Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: research_request@spglobal.com.


Register with S&P Global Ratings

Register now to access exclusive content, events, tools, and more.

Go Back