By way of a very unusual foreword, AlphaValue is unrepentant when it comes to offering a view of En+. Post the outbreak of war, only AlphaValue has continued its coverage of the name. AlphaValue is fiercely independent when it comes to equity research and has no conflict of interest whatsoever as it does not trade and does not sell to corporates. It defends its customers by never dropping any of its coverage as part of a continuing service. AlphaValue has had its fair share of issues with Rusal’s (En+’s key subsidiary) governance when it initiated coverage 12 years ago with a SELL, is deeply upset by the Ukraine war but tries to navigate an impossible path between an investment opportunity ‘only’ trading in Moscow (as its UK trading remains suspended to date) and Western pressure on Russian financial assets. En+ (/Rusal) is central to the world’s aluminium supply, besides being an efficient utility, and is likely to recover its leading position when the politically disastrous skies eventually clear up.

When we initiated coverage of En+  in early 2022, there were legacy risks associated with Russia’s political differences vs. the West. Still, the potential of its aluminium (via Rusal) and energy assets seemed to overshadow the underlying risk factors. This proposition was further fortified by the fact that (European) energy markets had begun tightening towards late 2021 – which was a boon for En+ in two aspects. Firstly, the firm was able to better manage the cash cost challenges for energy-intensive aluminium-making and, secondly, it was selling energy at increasingly-attractive spot rates – as regulated contracts were just 5% of wholesale sales.

However, with the outbreak of war, unprecedented paranoia set in and, hence, the positives of En+, like other Russian corporates, were utterly side-lined. In fact, for En+, UK trading was suspended while the Moscow ticker witnessed a free-fall before the Kremlin temporarily closed the Russian stock markets.

The Russian flag effect! 

Just after hitting its all-time high (since the 2017 IPO) in February 2022, En+ lost c.59% in market value terms vs. c.49% and c.38% losses for Rusal and Nornickel, respectively. Obviously, this value destruction was in stark contrast vs. the almost ‘FLAT’ returns for the AV Metals & Mining sector – which initially benefitted from material supply shortage fears, but the momentum reversed after ‘record’ inflation and interest rates took a toll on global growth expectations. However, what trumped the markets was the operational resilience of these firms (discussed below) as the West simply couldn’t afford to shun Russian metals (which has been our view since the outbreak of war), especially after the European gas supply shortage – now, all set to precipitate a massive global slowdown. 

Operational dynamics

En+’s H1 sales and ‘reported’ adjusted EBITDA was $8.3bn (+28% yoy) and $2.4bn (+26%), respectively. Besides a combination of a reasonable H1 for Nornickel i.e. sales and EBITDA of $9bn (flat) and $4.8bn (-16%), respectively – restrained by cost challenges and logistical disruptions, but still exceeding consensus expectations and a healthy H1 for Rusal i.e. sales and EBITDA of $7.2bn (+31%) and $1.8bn (+37%), respectively – thanks to aluminium pricing/premia excesses, En+ also benefitted from lasting promising dynamics in energy markets, with the Energy segment’s sales and EBITDA at $1.8bn (+16%) and $603m (+4%), respectively. Although ‘reported’ OCFs plummeted to minus $536m vs. plus $1.2bn in H1 21 – impacted by $1.8bn of working capital build-up in the Aluminum segment, besides higher tax payments – and ‘reported’ net debt galloped 33% (vs. end 2021) to $11.4bn, the firm has done well to avert (another) survival/credit crisis.

Aluminium market frenzy

Given that Rusal controls c.6% of global aluminium supplies, the white metal was one of the biggest beneficiaries of the outbreak of war, with prices skyrocketing from c.$2,800/t in early 2022 to c.$4,000/t in March 2022. Moreover, premia increased to as high as $870/t in Q2 22 (vs. $565/t in Q4 21) – as realised by Norsk Hydro. Although prices are back to c.$2,400/t (at present) – due to severe economic growth concerns, premia remain quite high – with Norsk having locked in c.44% of Q3 volumes at $811/t. As energy accounts for 20-30% of aluminium cash costs, sizeable global capacities, including c.50% in Europe, are battling for survival, with many being forced to curtail operations. This was a blessing in disguise for En+ as Rusal’s 9M 22 aluminium production was up 1.2% to 1.9mt. No wonder, for En+’s sales by geography, there were no ‘major’ changes vs. H1 21, with Europe and America accounting for 35% (vs. 31% in H1 21) and 6% (vs. 8%) of group sales, respectively.

Ever-valuable energy proposition

As Europe heads into the winter season, while there’s some calm as the region is believed to have built sufficient (gas) reserves to avert any power crisis, weather extremities – like the unusually warm weather in recent months – could water down the preparations. Remember, warm weather has already crippled hydro assets’ ability to contribute optimally in the near term. This means that the high-operating-margin (>20%) Energy segment could continue to be an important cashflow stream for En+. Remember that, as Rusal is c.57% owned by En+, the latter is dependent on dividend flows from the former – which have been missing for many years. On the other hand, the Energy assets are 100%-owned, with a largely domestic market focus and, hence, are a prized differentiator vs. many Russian natural resources giants (where USD-denominated sales are an impossible challenge for ‘sanctioned’ firms).

Staying put won’t be easy though

Although En+ is up c.14% over the past one month, the upside remains substantial (c.50%) – driven by both fundamental (+23-181%) and relative valuations (+21-100%), despite various discounts (associated with the Russian lineage) being taken on board. Also, the underlying volatility remains very high considering the recent re-escalation of military action in Ukraine, with the US now deliberating sanctioning Russian aluminium, and many western world aluminium majors calling on the LME to ban Russian supplies. But here again, sensing their counterparts’ operational vulnerabilities, and seeing promising 2023 order-book dynamics/supply contracts, Rusal has turned on the offensive and stated that they don’t intend to supply to the LME either.

While a conclusion on the outcome of the Ukraine war remains a difficult, multi-year process, it is increasingly clear that the Russian metal giants have been a big beneficiary – although their shares have suffered – and unfortunately, this power dynamic is unlikely to change in the foreseeable future as long as new project approvals to power EVs remain in the slow lane.

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