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Mounting Challenges for Aluminium Firms

The STAR - Monday, September 29, 2008

With the present difficult market conditions, local aluminium product companies will need to enhance their manufacturing capability. This is the key to building sustainable competitive advantage and maximising value for shareholders.

By Hanim Adnan and Eugene Mahalingam

IT will be an uphill task ahead for the local aluminium products sector although industry players are still optimistic of their future prospects.

Companies which have registered reasonable returns and given good dividends in the past three to five years, are now bracing for further challenges.

This is given the softening global demand, escalating energy costs and increasing influx of cheap imports from China.

An interior of Alcom's factory in Bukit Raja Industrial Estate, Klang
The two main segments of the local aluminium sector are the rolled products and extrusion industry players.

Due to the capital and technology intensive nature of their operations, there are only two players in local rolled products (sheet and foil) - Aluminium Company of Malaysia Bhd (Alcom) and Hydro Aluminium Malaysia Sdn Bhd.

The extrusion industry, however, is more fragmented with many players including big listed groups like LB Aluminium Bhd, Press Metal Bhd and Metech Group Bhd.

Tan See Ping

Reasonable revenue but healthy dividends

Over the past five years, analysts said most aluminium players were estimated to have grown on average by about 20% to 25% per annum in terms of revenue, thanks to the increase in global aluminium price.

Total dividend payout among major listed players over the past three years was also good averaging about 2% to 10% per annum despite tough market conditions.

In terms of production tonnage, some players have expanded their production tonnage by an average of about 4% per annum in the past few years.

Malaysia’s largest rolled products producer Alcom has been paying out dividends in the range of 10% to 15% per annum over the past five years.

Managing director Tan See Ping told StarBiz: “I believe shareholders have come to view Alcom as a company with consistent track record for paying healthy dividends.

“We hope we can continue to meet that expectation.”

A recent publication by the Minority Shareholder Watchdog Group reported Alcom as the 14th best performer among the top 500 companies on Bursa Malaysia in terms of dividend yield over a three-year period.

For the 15-month financial year ended March 31, Alcom paid a gross dividend of 12.5% amounting to a total net payout of RM12.2mil.

Alcom, which produces about 35,000 tonnes per annum, accounts for over 60% of total sheet and foil production in Malaysia, while the remaining production is by Hydro Aluminium Malaysia in Johor.

A ship loaded with alumina about to head for the worldmarket

Challenges ahead

Tan said the major challenge for local players would be in the increase of low-priced imports from China.

He said aluminium millers in China were able to procure raw aluminium ingots at prices traded on the Shanghai Futures Exchange, which are typically lower than London Metal Exchange (LME) prices.

In addition, Chinese millers enjoy export tax rebates on some of their products, which also gave them sizeable cost advantage.

In recent years, Tan said the Chinese government had eliminated or reduced rebates on aluminium extrusions, but this had yet to happen for aluminium rolled products.

“When that materialises, it will be a major upside for local rolled products manufacturers like Alcom,” he added.

Tan pointed out that raw materials (aluminium ingots) accounted for a high percentage of local aluminium companies’ operating costs - between 60% to 80% depending on the price of aluminium, which fluctuates with the prices on the LME.

He said inventory and receivables management was important for cash flow management especially when aluminium ingots were usually purchased on cash terms based on international practice.

“It is quite typical for a manufacturer to have two months of inventory and two months of receivables, but this really varies from company to company, depending on their discipline in working capital management,” he added.

Tan said the rolled product segment, which caters to the manufacturing industry, has a higher export orientation of close to 60% of its revenues.

The current decline in commodity prices, he said, is partly driven by weaker market sentiment and may affect capacity utilisation. Major industry players are selling on a “pass-through” basis, meaning that selling prices comprise a metal cost component that floats with prices on the LME, and a manufacturing value-added component which is effectively what the manufacturer earns for converting the raw ingots into fabricated products.

As such, the drop in metal commodity prices may not directly translate into better margins.

“In the longer term, lower metal prices are, of course, better for the local industry as it has a direct influence on market demand and also the cost of working capital required to sustain the business.”

Extrusion Woes

Similar to rolled product producers, extrusion players are also likely to be affected by the slowing global economy and higher energy costs.

This could weigh down on the cost structure of most players, analysts said.

In fact, the slowing economy could affect sales of aluminium products in the mid-term and also makes it difficult for industry players to pass on the higher costs on to consumers.

LB Aluminium, the country’s largest manufacturer of aluminium extrusion, is optimistic about the sector despite the current high crude oil and raw material prices.

General manager Yap Chee Woon said: “Demand for aluminium is still good and our production capacity has not declined.’’

LB Aluminium is also one of the largest aluminium extrusion manufacturers in South-East Asia with an annual production capacity of up to 35,000 tonnes per year.

About 60% of the group’s extrusions are used in the construction industry. It also supplies extrusions to the engineering, transportation, electrical, electronics, furniture, household and agricultural tools industries.

About 30% of its annual turnover is derived from overseas, with exports to Australia, the USA, Canada, Europe and South East Asia.

Going forward, Yap expects demand for aluminium-based products to increase.

“The usage of timber, steel and PVC products is declining. Aluminium has become one of the substitutes for these materials as it is recycleable and environmentally friendly.

In the engineering and electronic sectors, aluminium is replacing copper as raw material. “Therefore, we believe there will be positive growth in these sectors as well,” he said.

A spokesperson from another top aluminium extrusion group said the domestic market still looked promising, especially for the construction sector.

“The local market remains good. We have an order book that will take us well into the next 12 months.”

On whether lower oil prices would help boost the industry, he said: “It may help, but aluminium has always has its own demand and supply dynamics.”

On the global front, the spokesperson said demand for aluminium extrusion was expected to grow, albeit at a slower pace.

“We export to many developed countries. We do notice that the market is softer but growth is still positive except in the US because of its sub-prime housing problem.”  


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