Rating Action Overview

• Alumina Ltd. faces a challenging outlook for at least the next 12 months. For 2024, we expect the company to continue to report negative free operating cash flow (FOCF) because of restructuring costs at operating joint venture (JV) Alcoa World Alumina and Chemicals (AWAC). This includes the curtailment of the Kwinana refinery and an elevated capital expenditure (capex) program. Alumina owns 40% of AWAC; Alcoa Corp. (BB/Stable/--) owns 60% and is the operator of AWAC. Importantly also, Alumina is under takeover offer from Alcoa Corp.
• Alumina's dependence on structurally subordinated dividends from AWAC means the company may have to meet its share of the AWAC JV obligations with debt. This could squeeze liquidity. As at Dec. 31, 2023 approximately US$200 million headroom was available in the company's US$500 million syndicated credit facility. The AWAC JV continues to face operating headwinds from mining lower quality bauxite, likely until 2027, which may lead to lower alumina output and higher operating costs.
• Consequently, we are lowering the issuer credit ratings on Alumina and its debt program rating to 'BB' from 'BBB-'. At the same time, we removed the ratings from CreditWatch, where we had placed them with negative implications on Sept. 5, 2023.
• The negative outlook reflects a one-in-three possibility that we could lower the ratings on Alumina given the ongoing risks to liquidity and uncertainty regarding the recovery in AWAC cash flow generation and subsequent distributions to Alumina. AWAC's free cash flow is highly sensitive to the alumina price and for AWAC to generate meaningful free cash flow, the alumina price needs to be at about its current level of about $US360 per metric ton (mt). If Alcoa succeeds in taking over Alumina, we will likely revise the outlook on Alumina to stable.

Rating Action Rationale

The operating AWAC JV's elevated capex and restructuring spending will pressure Alumina's 2024 cash flow and liquidity over the next two years, in our view. Alumina's reliance on distributions out of AWAC exposes the company to weak profitability and cash flow at AWAC. The 60% owner and operator of AWAC, Alcoa Corp, is taking action to improve long-term profitability through a restructuring plan that for 2024 is likely to curtail operating cash flow and require investment from the JV partners. Restructuring costs of US$130 million related to the Kwinana refinery shutdown in the first quarter of 2024, coupled with an elevated rehabilitation spend over the next 12 months. In addition, the San Ciprian refinery, which continues to operate at a loss, faces an uncertain future. Any action to shut down this operation could expose the JV to further restructuring costs. These restructuring costs mean Alumina will likely have to fund a substantial proportion of its US$144 million share of AWAC's 2024 capex plan of US$360 million. Consequently, Alumina's debt is likely to increase, and its liquidity position is likely to tighten. Alumina had about US$200 million of undrawn capacity under its US$500 million syndicated bank facility as of Dec. 31, 2023.

While the outlook for the aluminum value chain has improved in recent months, the AWAC JV's profitability and cash flow are highly sensitive to alumina price swings and elevated mining costs at a time when Alumina's credit cushion has weakened. We project Alumina's 40% pro rata EBITDA could recover to above US$300 million for fiscal 2024 (year ending December 2024) based on our expectation of aluminum prices of $2,300 per ton and alumina prices of about $360/ton (assuming the Alumina Price Index (API) reflects about 15.5% of the London Metal Exchange benchmark). That said, we note earnings will continue to be highly sensitive to alumina prices. A +/- $10 per metric ton (mt) change in API could affect the AWAC JV's EBITDA by +/- US$90 million while a +/- 1c move in the AUD/USD exchange rate could swing EBITDA -/+ US$25 million.

Alumina expects the curtailment of Kwinana to realize about US$70 million of cost savings. However, this benefit is somewhat offset by likely higher operating costs associated with the lower bauxite grades at its two Western Australian refineries, which the company expects to continue until 2027. These refineries are set to produce more than 75% of the company's 2024 guidance of 9.4 million metric tons (MMt) of alumina output. The curtailment of Kwinana also means AWAC needs to source about 3 MMt from third parties to fulfill customer contracts. We expect this to be cash flow neutral at best.

Since Alumina relies on structurally subordinated cash flow from the AWAC JV, its ability to access capital may tighten when AWAC faces weak profitability, restructuring costs, or elevated capex. Weak cash flow generation at AWAC means Alumina is unlikely to receive material dividends from AWAC, thereby weakening its ability to meet its operating and debt service obligations. Debt restrictions at AWAC mean that the JV effectively uses internal cash flow to fund capex. So, when the JV requires capital, as is currently the case, Alumina relies on its debt facilities to meet these capital calls. This structural weakness means Alumina is reliant on a timely recovery in AWAC's cash flow generation to support credit quality. The current high sensitivity to alumina prices of AWAC's cash flows, exacerbated by higher costs from mining bauxite of lower quality, heightens risks regarding the amount and timeliness of Alumina's dividend receipts from the JV and therefore, Alumina's debt-servicing capacity.

Outlook

The negative outlook reflects a one-in-three possibility that we could lower the ratings on Alumina because of the ongoing risks to cash flow, liquidity, and profitability. AWAC's ability to generate meaningful cash flow, fund its capex program, and make material distributions to Alumina is highly sensitive to changes in the alumina price.

Downside scenario

A downgrade could occur if cash flow from the AWAC JV does not materially improve to support an improvement in Alumina's financial profile. This could occur if:

• Weaker alumina prices or higher costs limit AWAC's cash flow generation and constrain its ability to make material distributions to Alumina;
• Alumina's liquidity transitions to less than adequate such that its liquidity sources relative to uses in the next 12 months falls below 1.2x, or headroom in the company's bank facility materially decreases;
• Unanticipated outcomes in relation to the ongoing mine approval process results in a material delay in mining higher-grade bauxite at its Western Australian mines.

These scenarios would likely include Alumina's ratio of debt to EBITDA remaining above 3x or negative free operating cash flow persisting.

Although less likely, a significant deterioration in the ratings on Alcoa Corp. could also place downward pressure on the ratings on Alumina because of counterparty risks.

Upside scenario

We may revise the outlook on Alumina to stable if the AWAC JV successfully executes its restructuring initiatives, thereby lowering operating costs and stabilizing the financial profile of Alumina. This would include AWAC achieving free cash flow generation such that Alumina's pro rata free operating cash flow to debt remains above 15%. In addition, a sustained increase in the alumina price could also materially improve cash flows at AWAC, leading to a revision of the outlook to stable.

If Alcoa Corp. succeeds in its takeover of Alumina, and the Alumina business becomes a wholly owned operating entity of Alcoa, we are likely to revise the outlook on Alumina to stable from negative in line with the outlook on the rating on Alcoa.

Company Description

Alumina, through its 40% interest in AWAC, engages in bauxite mining, alumina refining, and aluminum smelting. AWAC is one of the world's largest alumina businesses, with production of up about 9.4 MMt a year. AWAC owns bauxite mines in Australia, and alumina refineries in Australia, Brazil, and Spain. AWAC also has shareholdings in bauxite mines and alumina refineries in Guinea, Brazil, and Saudi Arabia. AWAC also owns 55% of the Portland Aluminium Smelter in Australia. Alcoa Corp. is the operator and owns the remaining 60% in AWAC. Alumina was founded in 1970 and is headquartered in Victoria, Australia.

Our Base-Case Scenario

Assumptions

• Alumina production of about 9.4 MMt in 2024 with lower production to be offset by third party shipments.
• Aluminum prices averaging $2,300/mt in 2024 and $2,400/mt in 2025 based on S&P Global Ratings' metals price assumptions.
• Alumina prices of $355/mt to $365/mt based on our expectation of API reflecting 15.5%-16% of the London Metal Exchange's aluminum price.
• Restructuring costs of $130 million in relation to the Kwinana curtailment.
• Share of AWAC Capital expenditure of $144 million for 2024 and about the same amount for 2025.
• Negligible dividends to shareholders in 2024.
• Based on the above we expect free operating cash flow for 2024 to be marginally negative before recovering to above US$100 million in 2025.

Liquidity

We consider Alumina's liquidity to be adequate, based on the following observations and estimates:

• Sources of cash, including availability under its US$500 million syndicated bank facility, will be at least 1.2x its uses over the next 12 months;
• Our view that the company will likely maintain sufficient covenant headroom under its syndicated bank facility; and
• Our view the company has sound relationships with its banks and a generally satisfactory standing in the credit markets.

Principal liquidity sources include:

• Undrawn amount of US$204 million as of Dec.31, 2023, from Alumina's US$500 million senior secured revolving syndicated bank facility;
• Funds from operations from distributions from AWAC of about US$100-US$150 million.

Principal liquidity uses include:

• Share of capex undertaken by AWAC of about US$140-US$150 million.
• Negligible distributions to shareholders.

Ratings Score Snapshot

Issuer Credit Rating: BB/Negative/--

• Business risk: Fair
• Country risk: Low
• Industry risk: Moderately high
• Competitive position: Fair

Financial risk: Significant

• Cash flow/leverage: Significant

Anchor: bb

Modifiers

• Diversification/portfolio effect: Neutral (no impact)
• Capital structure: Neutral (no impact)
• Financial policy: Neutral (no impact)
• Liquidity: Adequate (no impact)
• Management and governance: Neutral (no impact)
• Comparable rating analysis: Neutral (no impact)

Related Criteria

• Criteria | Corporates | General: Sector-Specific Corporate Methodology, April 4, 2024
• Criteria | Corporates | General: Corporate Methodology, Jan. 7, 2024
• Criteria | Corporates | General: Methodology: Management And Governance Credit Factors For Corporate Entities, Jan. 7, 2024
• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• General Criteria: Group Rating Methodology, July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
• General Criteria: Methodology: Industry Risk, Nov. 19, 2013
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011

Ratings List