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Edited Transcript of AWC.AX earnings conference call or presentation 23-Aug-19 12:00am GMT

Half Year 2019 Alumina Ltd Earnings Presentation

Southbank Victoria Sep 9, 2019 (Thomson StreetEvents) -- Edited Transcript of Alumina Ltd earnings conference call or presentation Friday, August 23, 2019 at 12:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Grant A. Dempsey

Alumina Limited - CFO

* Michael Peter Ferraro

Alumina Limited - MD, CEO & Executive Director

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Conference Call Participants

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* Lyndon Fagan

JP Morgan Chase & Co, Research Division - Analyst

* Paul Young

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Paul Joseph McTaggart

Citigroup Inc, Research Division - Metal and Mining Analyst

* Peter O'Connor

Shaw and Partners Limited, Research Division - Senior Analyst of Metals and Mining

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by and welcome to the Alumina half year results conference call. (Operator Instructions) Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Mr. Mike Ferraro, CEO and Managing Director for Alumina. Thank you. Please go ahead.

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Michael Peter Ferraro, Alumina Limited - MD, CEO & Executive Director [2]

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Thank you, Vincent. Good morning, everyone. Welcome to Alumina Limited's Results Presentation for the 2019 Half Year. In this presentation, all references to currency are U.S. dollars unless otherwise indicated.

Alumina Limited has delivered a strong result for the first half. Our profit for the half year was $211 million. Net receipts of $265 million from AWAC supported a fully franked dividend of USD 0.044 per share. Our dividend reflects the impact of prior year tax payments and lower API prices. AWAC's global Tier 1 refining assets continue to generate resilient cash flows for the company. Later, I will discuss the market as we see it.

But for now, I'll hand over to our new Chief Financial Officer, Grant Dempsey, who will outline AWAC and Alumina Limited's first half 2019 results.

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Grant A. Dempsey, Alumina Limited - CFO [3]

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Thank you, Mike, and good morning. It's my pleasure to present to you all for the first time. I will start with the first half performance of AWAC and then go through the financial results of Alumina Limited.

Coming off an extraordinary 2018 performance on the back of record Alumina prices, AWAC has recorded another strong result for the first half of 2019 with EBITDA of $950 million and a net profit of $552 million. Cash from operations was $456 million despite covering a significantly higher tax payment of $338 million relating to the 2018 record profit. The fall in the average realized price in the first half was partially offset by improved operating performance which led to increased Alumina production and contributed to lower cash cost per tonne.

I will now go through AWAC's performance in a little bit more detail. Improved operating stability helped drive production to a record first half for the current portfolio of refineries. This was despite lower production at Alumar due to a major overhaul of its boilers. The overhaul is scheduled to be completed by the end of 2019 and will result in increased steam generation and improved boiler reliability. With continued production improvements at all refineries in the second half, the guidance of 12.6 million tonnes for 2019 remains unchanged. I'm also pleased to report that the Ma'aden refinery in Saudi Arabia exceeded nameplate capacity for the first half.

AWAC's average realized alumina price declined 12% to $375 per tonne which was in line with movements in the market price in the corresponding period. Coming off a record high in 2018, the API was impacted by the ramp-up of Alunorte's production after its partial curtailment in 2018 and additional supply from other refineries. While the current alumina spot price is well below the peak of 2018, it is on par with prices seen in 2017 and significantly above the lows of 2015 and 2016. Given its Tier 1 low-cost refineries, AWAC is well positioned to deliver returns through the cycle.

AWAC's cash cost of alumina production improved by 3% to $218 per tonne. Increased production and the strength of the U.S. dollar had a favorable effect, especially at our Western Australian refineries and mines, with lower energy and caustic input prices also positively impacting costs for the first half. Looking forward to the second half of the year, we expect further cost relief with a seasonal reduction in maintenance costs, continued benefits from lower caustic prices and reduced conversion costs on the back of the current low Australian dollar.

Higher demand from AWAC's refineries led to a 4% increase in bauxite production at its operated mines to 19.9 million tonnes. This, combined with a stronger U.S. dollar, led to a 10% improvement in the cash cost of mining per tonne. Given expected increases in the second half for third-party bauxite shipments, our guidance for 2019 remains unchanged at 6.2 million tonnes.

Turning to capital expenditure. Sustaining CapEx guidance for the full year remains at $155 million. The forecast's higher spend for the second half is driven by the timing of major projects, including residue storage areas, and the planning for the Willowdale crusher move. Growth projects for the year include debottlenecking and boiler upgrade at Alumar and the evaluation of expansion opportunities at our Tier 1 refineries in Western Australia. AWAC's growth CapEx guidance for 2019 has been significantly revised down from $110 million to $55 million. Approximately half of the savings are permanent, resulting from eliminating duplicated activities and optimizing resources between the projects. The other savings for the year are largely timing related, with the evaluation of the Western Australian growth projects now likely to be completed in the first half of 2020.

In terms of AWAC's full year outlook, there are no changes to the guidance for alumina production and third-party bauxite sales, all sustaining CapEx. As highlighted earlier, growth CapEx will be significantly reduced due to project savings and the delay of the evaluation of the expansion projects. Restructuring costs will also be lower than guided for 2019 due to additional time required to obtain permits and approvals for the remediation activities.

Now let's turn to Alumina Limited's results. In line with AWAC's result, the company recorded a profit of $211 million, down from our record in 2018. Alumina Limited this morning announced a strong fully franked interim dividend of USD 0.044 payable on the 12th of September 2019. As announced in July, the company redeemed its fixed rate note and related cross-currency swaps early by drawing on the existing bank facilities. Base facilities were extended and increased to $350 million, providing the company with greater flexibility to support growth opportunities as they arrive.

Whilst the Alumina market is subject to fluctuations, we believe it is a positive long-term outlook driven by demand in aluminum and a broadly balanced alumina market. We continue to invest in our capabilities to monitor and better understand the market and, along with our partner, evaluate a number of promising growth opportunities in AWAC's Tier 1 refineries. Our investment in AWAC's portfolio of low-cost assets, together with a strong balance sheet, allows us to deliver consistent returns through the cycle while investing for the long term. Thank you.

And I'll now hand back to Mike to provide you with an overview of the market.

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Michael Peter Ferraro, Alumina Limited - MD, CEO & Executive Director [4]

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Thanks, Grant. Let's talk about aluminum to start with. The economic and manufacturing slowdown and trade wars have impacted growth in aluminum demand. We expect growth in global demand of between 1% to 2% over the course of 2019 despite a reduction in demand in China in the first half. It is pleasing that forecast year-on-year growth is positive in all sectors of aluminum demand except electrical. Increasing exports of semi-finished products from China have reduced demand for primary aluminum outside China. Over the longer term, aluminum demand is expected to grow through steady economic expansion and increasing intensity of use.

Over the first half of 2019, the aluminum price ranged between $418 and $321 per tonne, and AWAC's realized price averaged $375. The alumina market was broadly balanced in the first half outside of China and has since moved into a small surplus for 2 key reasons: first, the expected level of aluminum production did not eventuate largely due to the lower aluminum prices; second, there was a higher level of alumina production due to the resumption of Alunorte, the start-up of Al Taweelah in the UAE and the ramp-up of Fria in Guinea. In China, additional alumina production, coupled with lower growth in aluminum demand, has caused Chinese alumina prices to drop significantly since June 2019.

Curtailments due to lower prices started in China in July and amounted to 2.5 million tonnes of alumina capacity per annum. Chinese prices are currently around RMB 2,500 per tonne. And if they fall further, it is expected to lead to further curtailments and bring forward maintenance to curb output. We are forecasting a modest surplus of alumina over the remainder of 2019 as alumina growth exceeds metal production both inside and outside China.

Here is our forecast of the Chinese alumina supply/demand balance over the next few years. As you can see from the chart, there are small alumina surpluses forecast, around 0.5 million tonnes or less in each of the next 3 years. This year, China will return to being a net alumina importer. There are a number of potential Chinese refining and smelting projects, as shown in the appendix. However, we believe the actual pace of completion and output will be influenced by Chinese government supply-side reforms, actual demand, environmental constraints and price movements.

The Chinese government's measures to fight pollution are likely to stay, forcing bauxite mines and alumina refineries to comply with higher environmental standards with less emissions and thus, higher costs. The production curtailments due to the red mud issues in Shanxi in May could possibly be repeated as other alumina refineries in China face similar challenges.

A total of 15 inland refineries are now using imported bauxite by converting production lines to take low-temp bauxite, blending imported one with domestic bauxite and/or installing sweetening facilities to utilize imported bauxite. Bauxite heading to inland refineries is forecast to increase by around 12 million tonnes in 2019 to 16 million tonnes. This will potentially drive up alumina production costs and provide support for Chinese alumina prices.

Starting in 2018, a range of environmental control measures have forced bauxite mines to close in Henan and Shanxi, creating a bauxite shortage in Northern China and driving domestic bauxite prices up. As a result, several inland refineries have been forced to use imported bauxite. These 2 factors have impacted the bauxite component of China's alumina cost of production. This would have led to an overall material increase in the average cost of alumina production in China were it not for lower caustic prices which have dropped 15% since the start of 2019. Henan and Shanxi has surpassed Shandong to become the marginal-producing provinces due to higher bauxite costs.

China imported 54 million tonnes of bauxite over the first half of 2019 compared with nearly 83 million tonnes over the whole of 2018. Supply from Guinea met 51% of China's import needs, and imports from Australia totaled 30%. Some projects in Guinea, which were thought to be noncompetitive, appear to be proceeding, for example, the Kimbo project. Indonesia remains our third-largest bauxite exporter to China, consistently exporting over 1 million tonnes per month, nearly 13% of China's current imports. However, Indonesia is reportedly considering bringing forward a ban on export of unprocessed ore.

IMO 2020 regulations aim to reduce sulphur emissions from shipping fuel. They are forecast to drive freight rates higher, at least in the short term, which is likely to put upside pressure on bauxite costs in China.

I'd also like to make some comments on the company's approach to ESG. We recognize that AWAC has a social license to operate which requires our operations to be conducted in accordance with community expectations. This slide shows some of the initiatives Alumina Limited and AWAC have progressed, but we recognize this is an ongoing commitment.

We are pleased to note that in July, AWAC's Brazilian mining operations at Juruti and refining operations at Alumar received certification from the Aluminum Stewardship Initiative. ASI is a global sustainability certification program for stakeholders in the aluminum industry. Alcoa of Australia has also exceeded rehabilitation targets at the Huntly and Willowdale bauxite mines in WA. The company progressively rehabilitates asset mines with strong focus on reducing the cleared footprint over time. Also available on our website is detailed information in relation to AWAC's storage facilities.

In conclusion, the first half result was a strong performance for our company. Chinese demand for imported bauxite continues at a high growth rate, which is met by ample supply but helps underpin their higher production costs. The short-term outlook is subdued at current LME prices and higher levels of alumina production, which is reflected in the current alumina price of about $300 per tonne. This is likely to continue whilst the trade wars remain unresolved, barring any supply disruptions. However, we remain positive on the long-term outlook for alumina and aluminum. As a low-cost producer in the upstream aluminum supply chain, AWAC is able to generate better margins than most of its peers. Thank you for listening to our presentation.

And I will now hand you back to the operator for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question today comes from the line of Lyndon Fagan from JPMorgan.

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Lyndon Fagan, JP Morgan Chase & Co, Research Division - Analyst [2]

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Look, the first question is just on the potential for West Australian growth projects. Now that the market has softened, do you think these projects would still be viable? Or perhaps under what conditions would you look at deferring these projects? And then the second question is just on Portland. Maybe just a quick update on the future there in the event that government subsidies don't continue.

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Grant A. Dempsey, Alumina Limited - CFO [3]

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Thanks, Lyndon, it's Grant Dempsey here. I'll take the first question, and probably Mike will take the Portland question. I think in terms of the growth projects, as you've seen, we're working through that for a decision in the first half of next year with our partner. Obviously, we take into account a number of factors in that. The long-term outlook is a really important factor. The engineering sort of process and the cost is an important factor. We make that decision through it. I think it should be noted that these are -- while they are exciting growth potential opportunities, they represent sort of less than 10% of the refining sort of network we have in Western Australia. So they're more than the creep that we've been doing, but they're not significant new lines or new refineries as it were. And they are at Tier 1 low-cost refineries. So I think all those factors will be taken into account. I think the other thing is they take 3 years to build. They last decades. So we will take a long-term view, both independent of Alcoa and then with Alcoa, in terms of view on the market and our view on the returns and make that decision at the time.

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Lyndon Fagan, JP Morgan Chase & Co, Research Division - Analyst [4]

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Can you maybe steer us to the capital intensity for some of these projects? Is it possible to give us a broad range?

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Grant A. Dempsey, Alumina Limited - CFO [5]

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I think not really at this stage because it is part of the engineering process of working through. That is -- as you will appreciate, it's sort of optimizing the capacity we're going to increase, there is an engineering process that gets you to the capital intensity. Again, it's a brownfields expansion and not a greenfields expansion, so that comes into making it fairly efficient. It's not a new line. And again, that will just be part of the process, and I think we're still a number of months away from really defining that.

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Michael Peter Ferraro, Alumina Limited - MD, CEO & Executive Director [6]

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Lyndon, on Portland, there really is no conclusion on that yet. We're still working through it and in regular discussions with the government, looking at, obviously, the energy options going forward. Right here today, it's difficult to say what that solution is, but we're still working through it. And hopefully, we can find something that works at a competitive price going forward.

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Operator [7]

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Your next question today comes from the line of Paul Young from Goldman Sachs.

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Paul Young, Goldman Sachs Group Inc., Research Division - Equity Analyst [8]

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Mike and Grant, first question is on unit cost. So putting the benefits of FX aside, just focusing on caustic soda and gas, do you still -- or do you expect to see a benefit in the second half this year from, I guess, inventory accounting and the lag in caustic soda pricing?

And then second question just on the gas. So obviously, you've got some contracts which -- new contracts which kick in, in 2020. So we obviously the cash impact. But from a P&L perspective, do you expect your unit cost to increase? And to -- maybe what magnitude in dollars per tonne in 2020 is due to the change in the gas contract mix? And I've got a few questions on the market that I'll follow up with.

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Grant A. Dempsey, Alumina Limited - CFO [9]

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Thanks, Paul. I'll answer the first part, and Mike might talk on the gas. So the answer -- short answer is yes. I think we do expect some cost benefits flowing through to the second half of '19. As you pointed out, caustic has a 6- to 9-month lag based on sort of flowing through inventories and the 3-month average pricing. So that is still flowing through. And we got part of that benefit in the first half being relatively stable, the market price, in the last 6 months. And I think we probably -- again, if the low Australian dollar continues, we'll get benefits through sort of bauxite and conversion, also noting that the maintenance is skewed towards the first half. So I think of those 3 elements, we are expecting some cap relief to continue in the second half, assuming things stay the same.

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Michael Peter Ferraro, Alumina Limited - MD, CEO & Executive Director [10]

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On the gas front, Paul, there will be an increase in price, the impact on cost per tonne in 2020. But we haven't disclosed that number. We don't regard it as material. But at this stage, we haven't disclosed it.

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Paul Young, Goldman Sachs Group Inc., Research Division - Equity Analyst [11]

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Okay. Then a question on the market and just referring to, I think, the slide in the pack showing the Chinese cost curve. I'll remind you of just how flat that cost curve is actually. But I guess the point there is I know it's a like-for-like on the net back to the port -- Chinese ports versus the seaborne market. But that indicates, just for all intents and purposes, the refinery gate that the USD 320 a tonne is the marginal cost. I guess the question I have is that do you have any view on -- or based on your view on import cost bauxite pricing, is there a way -- what that curve looks like in 2020. And then secondly to that, what your view on long-run Chinese marginal cost is because, ultimately, that must come in your thinking on looking at the refinery expansions in WA. And I guess another part to it is, is Alcoa in the same page on your long run, your view on long-run marginal cost in China?

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Michael Peter Ferraro, Alumina Limited - MD, CEO & Executive Director [12]

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To answer that last question first, we don't really compare between ourselves and Alcoa of the long-run cost going forward in China. We tend to do that independently. So I wouldn't know exactly what they view on the long run is. On the curve for 2020 of the Chinese cost curve, no, we don't -- I think we expect it to probably -- or certainly, it should increase in the context of bauxite cost. But the question is whether caustic and other costs continue to fall there. Coal costs remain -- energy costs remained flat in the first half, so expect that to continue. I think in the context of the caustic cost, I don't have a view as to where the caustic will continue to fall. It seems to have leveled out, fairly stable period over the last few months, not very long indeed. But I don't have a view on what's going to happen to the caustic market. So overall, I would be expecting that cost curve to stay at least as it is, potentially go a little bit higher.

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Paul Young, Goldman Sachs Group Inc., Research Division - Equity Analyst [13]

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Okay. Just further on that, Mike, I mean consensus long run, aluminum prices are probably sitting between USD 330 and USD 350. Do you have a view on that consensus long run?

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Michael Peter Ferraro, Alumina Limited - MD, CEO & Executive Director [14]

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We do have our long-range view, which we don't disclose, but I think you're probably in the range, Lyndon -- sorry, Paul.

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Operator [15]

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Your next question today comes from the line of Paul McTaggart from Citigroup.

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Paul Joseph McTaggart, Citigroup Inc, Research Division - Metal and Mining Analyst [16]

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Well, that gets doubly confusing with 2 Pauls. So look, guys, I just want to follow on. So in terms of restructuring costs, you've given a lower guidance for the year ahead. Is that just deferment? Is that just restructuring costs are going to roll over in the next period? Or is that sort of a firm reduction? I know you talked about delays in -- delays. So I'm going to assume they roll over. And just in terms of the growth CapEx as well, so you said that there was $50 million saving or roughly half that saving which was sort of permanent. I just want to understand how that's come about.

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Grant A. Dempsey, Alumina Limited - CFO [17]

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Sure. On the restructuring cost, yes, I think it's largely just driven by the time it takes to get the permits and approvals slight -- taking slightly longer than we planned, so that does just defer, it's a timing difference. In terms of the growth CapEx, look, the simplest way of sort of explaining it is we look at these 2 projects or budgeted these 2 projects almost independently of each other, which they are obviously independent projects in terms of the refineries in WA. But as we got into it, it made a lot of sense to look at the efficiencies between them in terms of overlap of people skills, of assessments, of engineering processes. So in that, we've sort of sequenced it, it would actually also cause some of the delay in terms of sequencing these things in a smart way between the projects, and that's just resulted in savings of sort of north of $20 million. Those project evaluations are still going ahead, slightly delayed, but they're going ahead in a more efficient way.

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Operator [18]

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Your next question today comes from the line of Peter O'Connor from Shaw.

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Peter O'Connor, Shaw and Partners Limited, Research Division - Senior Analyst of Metals and Mining [19]

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Just following up on the growth question. So in your presentation, Mike, you mentioned -- I think Grant as well, several times at least -- the positive outlook for the open market and, I guess, the company. And I would concur. But the hesitancy you've given when asked about growth in the Q&A session seems like your view that you put to us doesn't necessarily marry up with what you're seeing in terms of projects coming up. And just as an adjunct to that, if you get to a decision point next year in the first half, can you go your separate ways? Does it have to be a unanimous decision with Alcoa? Or is there something you can build separately? Or does it have to be done together?

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Michael Peter Ferraro, Alumina Limited - MD, CEO & Executive Director [20]

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Peter, I apologize if we created the view that we're more hesitant about growth longer-term in Q&A compared to what we said in the presentation. That's not the case. We do believe in the aluminum story longer term for a whole range of reasons, including replacing plastic, which just creates environmental problem; lower energy consumption; the recycling of aluminum, which will require quite a lot of significant primary aluminum to meet your future demand in a whole range of sectors. So you could easily sit back and take the short-term view as why would you expand capacity in alumina production now if there's an oversupplied market at the moment.

But a, we don't think it's significant; b, we do talk about trade wars having an impact. But that's not the long-term position. Ultimately, the market will improve. The underlying fundamentals for aluminum and alumina are there. The structural issues associated with building alumina capacity outside of China I've covered previously, the barriers to entry from a cost perspective, from access to resource, are high. So we think we're still positive on the long-term outlook. So the short-term blips in supply and price doesn't dissuade us from continuing our evaluation and what we should be doing on a go-forward basis.

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Peter O'Connor, Shaw and Partners Limited, Research Division - Senior Analyst of Metals and Mining [21]

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So Mike, given -- just given the industry, as metals and mining is typically pro-cyclical, you are proposing a view of the world which I agree with. So should you be countercyclical? And whatever the short-term blips are, this growth probably should just go because you should be investing when times are easier?

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Michael Peter Ferraro, Alumina Limited - MD, CEO & Executive Director [22]

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I think it should because certainly -- and I've been around the traps and other organizations as well in the sector. And inevitably, people kick themselves and say, why didn't I make that investment when the market was down? A, it's costing a lot more and, b, taking a lot longer to come to market now that I missed the opportunity. So it is a good tenet. The fact that it takes 2 or 3 years to build the sort of projects that we're contemplating just makes sense not to be dissuaded by short-term slowdowns.

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Peter O'Connor, Shaw and Partners Limited, Research Division - Senior Analyst of Metals and Mining [23]

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So Mike, your take on that is -- your supportive view means you would be likely to move towards a growth project. If Alcoa doesn't agree, what...

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Michael Peter Ferraro, Alumina Limited - MD, CEO & Executive Director [24]

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Provided the economics stack up, yes.

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Peter O'Connor, Shaw and Partners Limited, Research Division - Senior Analyst of Metals and Mining [25]

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But does that economics get driven by price or by the CapEx to do it?

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Michael Peter Ferraro, Alumina Limited - MD, CEO & Executive Director [26]

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Probably a combination of both.

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Grant A. Dempsey, Alumina Limited - CFO [27]

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Yes, it's the long-term returns. And I think that probably some of the hesitation you heard earlier in the Q&A was we want to respect the process of the evaluation we're going through. And as you said, Alcoa have to make their own evaluation, and we do ours independently. And it's just -- it's long-term return which is based on price and cap. And I think the other thing to remember in this is these are at our -- we are looking at them at our lowest-cost refineries. So -- and in fact, the projects I think will ultimately or potentially lower the cap at those refineries and make them even more relatively low cost to the market. So we will factor those in, and the capital intensity is a very, very important part of that process.

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Peter O'Connor, Shaw and Partners Limited, Research Division - Senior Analyst of Metals and Mining [28]

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Given this cost curve you've shown, it seems like there's a lot of margin, a lot of return. I'm just surprised it's still centralized. But can you go separately to Alcoa? Or does this have to be all in?

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Michael Peter Ferraro, Alumina Limited - MD, CEO & Executive Director [29]

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No. There are some -- this is a joint decision. So we have to decide together to proceed with any expansion in bauxite or alumina refining.

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Operator [30]

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(Operator Instructions) As we have no further question on the line today. I'll now like to hand the conference back to Mike for closing remark.

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Michael Peter Ferraro, Alumina Limited - MD, CEO & Executive Director [31]

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Thank you for making the time to listen to our presentation today, and we look forward to meeting with some of you over the next few days. Thanks very much. Thank you.

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Operator [32]

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Thank you. Ladies and gentlemen, that does conclude our call for today. We thank you all for your participation. You may now disconnect.