More Pain Ahead for Aluminum Stocks

With aluminum prices having fallen nearly 20% in 2015, consensus expectations indicate that a recovery is in store. However, we're far less optimistic, and we see more pain ahead for aluminum smelters. Our long-term aluminum price forecast of $1,440 per ton in today's dollars, or real terms, sits roughly 15% below consensus and 10% below current spot prices.

We forecast that Chinese aluminum consumption growth will decelerate from a 15% annual rate over the last decade to only a 2% annual rate through 2020. Largely due to weak demand from the construction end market--China's largest end market for aluminum--this deceleration will have a material impact on prices. China accounts for roughly half of global aluminum consumption and has been responsible for over 90% of incremental consumption over the last 10 years.

Additionally, we expect structural overcapacity to remain in place as supply from China's state-owned smelting facilities proves sticky and the country continues to add capacity through the end of the decade.

With these factors in mind, all six of the aluminum companies we cover are trading above fair value.

The Aluminum Company of China, or Chalco, a high-cost Chinese aluminum producer, is trading more than three times above our fair value. We also see roughly 30% downside for Alumina Ltd., South32, Rio Tinto, and Norsk Hydro.

Alcoa is trading at a more modest premium relative to our fair value estimate, as the iconic aluminum smelter has rapidly diversified away from commodity-grade aluminum toward high-value alloys with a wide range of applications in the automotive and aerospace end markets.

Although aluminum stocks may look cheap by any number of quantitative or technical measures, we urge investors to exercise caution and seek out greener pastures.