Century Aluminum Company

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 2/5

Century Aluminum Company is a global producer of primary aluminum products, particularly focused on value-added, high-purity aluminum for industries like aerospace, automotive, and electrical.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Century Aluminum Company (CENX) operates in a cyclical industry with volatile metal prices and a high degree of economic sensitivity. Its “moat” is very fragile, and it’s primarily due to the difficulty of new entrants to the industry.

Business Overview

Century Aluminum Company (CENX) is a global producer of primary aluminum. This means they take raw materials, like alumina, and transform them into aluminum metal. This metal is then sold to various customers for use in diverse industries.

Revenue Distribution

The primary driver of Century’s revenue is the price and volume of its primary aluminum shipments.

  • Primary Aluminum: CENX primarily focuses on producing and selling primary aluminum. This accounts for the vast majority of their revenue.
  • Other: The other segment is small and consists of other aluminum-related sales, including other commodities.
  • Geographic Segments: In 2023, the majority of revenue came from sales in the United States, with the remaining coming from operations in Iceland and the Netherlands, though their production takes place in the U.S and Europe.

The aluminum market is cyclical, characterized by periods of high demand and prices followed by downturns. There are also a lot of other factors that make the industry volatile.

  • Price Volatility: Aluminum prices are highly cyclical, with prices fluctuating based on global supply and demand, global economic conditions, inflation and other macroeconomic factors. Because CENX sells a commoditized product, it’s very hard to create margin advantages.
  • Demand Fluctuations: Demand for aluminum is tied to economic growth. Industries like aerospace, automotive, and construction drive demand, so any downturn can really affect aluminum companies.
  • Rising Energy Costs: Aluminum production is very energy intensive and uses a lot of electricity. Rising power costs can hurt margins and make them volatile.
  • Government Intervention: Regulations around energy use and trade policies affect this industry. The company is dependent on the government and is susceptible to changes in global trade and domestic laws.
  • ESG Concerns: Aluminum production is very carbon intensive. The push toward decarbonization and sustainable practices has the potential to change how the business operates.
    • For example, the 2022 Inflation Reduction Act (IRA) in the U.S. might benefit companies that are adopting green technology, while potentially harming the more traditional ones.

Competitive Landscape

The aluminum industry is highly competitive, with many global players. Key competitors like Rusal, Rio Tinto, and Alcoa dominate the market.

  • Commodity Product: Primary aluminum is a commodity; meaning the product is largely undifferentiated and competition centers on price.
  • Price Takers: Companies in a commodity industry have to be price-takers. Hence, margins and profitability can be volatile and depend on the swings in market price.
  • Global Competition: Competition is strong not only in a given area, but global. The biggest companies, especially Chinese producers, dominate the industry.
  • Capital Intensive: Significant investment in plants and equipment is needed, making it difficult to grow and maintain a competitive edge.

What Makes Century Different

While Century does not offer anything special in the production process, or scale advantages due to its mid-size scale, it does focus on high-value added markets, which should in theory, allow it to command a price premium on those specialized products. However, that remains to be seen.

  • Focus on High-Purity Products: CENX focuses on high-purity and specialty aluminum products, targeting industries that demand high-performance materials with stricter standards. While the company states that these products result in higher margins, the financials have not shown that to be true in a consistent way.
  • Integrated Operations: CENX integrates some part of its operations. The company owns several bauxite mines and alumina refineries, allowing it some control over the supply chain, especially in the region they operate.
  • Strategic Locations: CENX has strategically placed its facilities, and its European facilities enjoy long-term power contracts that help to mitigate price swings.

Financial Analysis

Income Statement

CENX is a commodity-based business and that is clearly seen in its financial statements.

  • Highly Variable Revenues: The company’s revenues fluctuate wildly year-to-year, with revenues in 2022 nearly double of 2020 levels and then revenue fell by 20% YoY in 2023. This volatility comes from changes in aluminum prices.
  • Volatile Margins: Profit margins follow revenue patterns, meaning high revenue years are accompanied by high gross profit margin, and bad revenue years are unprofitable. This makes forecasting future profitability quite difficult. This volatility is a major red flag in this sector since it means that returns on capital are highly volatile and hard to maintain.
    • For example, gross profit margin went from 17% in 2021 to 2% in 2023.
  • Small Recurring Profitability: The last five years saw the company achieve a significant net income only in 2021 (with a large $316 million profit), while the rest of the years were unprofitable, with the firm losing around $100 million in 2020, 2022 and 2023.
  • Limited Free Cash Flow: While net income has fluctuated dramatically over the years, free cash flow has largely been negative. This means that for most of these years, the company has not been generating the kind of cash a shareholder would see, or at least if the company was to pay out to investors as dividends or buybacks.

Balance Sheet

Century’s balance sheet is not a pretty picture and is a huge risk to its operations.

  • High Debt: The company is highly leveraged, with almost $800 million in long-term debt. With its current level of free cash flow, it might be tough to pay it back in full, and its cash flows are also very variable.
  • Unstable Cash Position: The company’s cash position is unstable and can go from $700 million in early 2022 to just $90 million by 2023.
  • Low Book Value: The company’s book value is very low at about 370 million, especially compared to its huge debt load and liabilities.
    • Net Assets (excluding goodwill) is even lower at $228 million.

Recent Problems & Controversies

The company’s operational performance has been inconsistent, and it has struggled to achieve profitability in recent years, even if revenue seems to be on an upward trend. The company also struggles with high energy prices and high debt.

  • High Energy Prices: European plants face high energy prices and the company struggles to transfer these costs to consumers because of competition from lower-cost producers, which has been affecting profitability, especially in their European plants.
  • Low Volume Output: In Q2 of 2023, production in Iceland dropped by 10%, and the firm had an operational loss due to this and issues related to equipment failure. This hurts profitability.
  • Macroeconomic Uncertainty: The recent slowdown in aluminum prices and concerns over future demand create a risky landscape.

Management’s Commentary on Recent Performance

The management has been highlighting the importance of long-term power purchase contracts, which should reduce volatility and increase stability. Management is also focused on improving operating efficiencies to reduce costs and become more competitive.

  • Growth in Upstream: Management is focused on expanding their production of alumina, since that is one of their biggest costs. This will help them secure their supply chain and improve costs.
  • Restoring Production: Management is very focused on restoring production from previous quarters’ low and unstable levels and has shown some early success on this front.

Moat Rating: 2/5

Century Aluminum has a very weak moat, rated a 2 out of 5, primarily due to commodity nature of its product.

  • Weak Brand: The company’s brands are not strong and does not help them to command a higher price.
  • Low Switching Costs: Aluminum buyers will often choose the lowest-cost provider. Therefore, there is no real customer lock-in.
  • No Network Effects: The value of aluminum is independent of how many others use it. The more people buy aluminum, it does not mean it increases its value.
  • Fragile Intangible Assets: Though they mention having patents and technology, they are very dependent on commodities prices and have not shown a competitive edge due to those patents.
    • There is some good news however since some of these technologies are designed to reduce costs, which has a positive impact on financials.
  • Cost Advantages: CENX does not appear to have substantial cost advantages as a mid-sized producer and has not shown any unique process that reduces costs significantly.

This industry is very hard to create a sustainable moat since cost advantages are almost always imitated, and it is very hard to differentiate a basic commodity.

Understandability: 3/5

The business model is relatively straightforward. They mine materials, convert them into aluminum and sell it. The financial statements are a bit more complicated, though.

  • Simple Business Model: The steps to produce aluminum are easy to understand. It is easy to know where they generate revenues.
  • Volatile Financials: The financial statements of the firm are volatile due to the commodity industry and require some accounting experience to understand them.
  • Some Complexities: The business also has some complications in the form of different types of securities and tax regimes.

Balance Sheet Health: 2/5

The company’s balance sheet is very unhealthy. They are heavily leveraged with unstable cash and equity positions. This creates a large risk for investors.

  • High Debt Load: The company’s debt is very high relative to its assets. This makes it a riskier investment since they are more susceptible to bankruptcies and financial distress.
  • Unstable cash position: They have very low cash amounts, which are prone to swing very drastically depending on the business cycle, which does not give them any room to make mistakes.

Moat Risks and Business Resilience

While identifying the structural elements that make a moat or its absence in a company is paramount, investors should also consider things that may affect or erode this moat. Here we list the primary risks and resilience:

  • Technological Disruption: The risk of newer and more efficient technologies supplanting the current production method, which would make their current investments obsolete.
    • The business does seem to engage in R&D efforts, to which they attributed the improvement in costs, which might offer some protection against this, but they would still have to consistently innovate or be left behind.
  • Dependence on Prices: Since aluminum is a commodity and the company has little pricing power, there is a strong dependence on market price fluctuations which can destroy profit margins.
  • Energy Prices: The largest risk to this company is energy prices. They are very energy-intensive and a significant rise in the cost of electricity could make them lose their advantage.
  • Economic cycles: As discussed above, the market has cyclical demand and is tied closely to economic performance in other industries. The company has very little control over how good its business will be, and it is dependent on how well other sectors are doing.
  • Government Regulation: Changes in government policy could significantly affect the economics of the business, whether due to increased regulations, taxes or other policies around production.
  • Capital Expenditures: This business is very capital intensive, and requires significant investment in plants and equipment to maintain or improve production and can be a drag on its financials.

Despite these risks, they have shown the ability to operate and survive in this industry over a long period. That being said, management has to make sure they have enough flexibility to deal with the volatile nature of the business. Management has to be focused on improving efficiencies and costs, building brand recognition and long term contracts. These efforts would help the company survive and grow, and help it build a wider moat in its operations.