Argonaut Algorithm: David Franklyn’s pick to play bullish bauxite demand drivers

Argonaut Funds Management’s David Franklyn joins Stockhead to share investing secrets from the high-conviction resource sector investing fund, including his junior stock pick of the month.

Aluminium smelters are in dire straits, with over capacity led from a commodity hungry China keeping a lid on prices and treatment charges at the same time as power prices elsewhere hobble the power munching processing plants.

In recent days South32 (ASX:S32) has flagged plans to close its Mozal smelter in Mozambique by March 2026 after failing to come to terms with the southern African government on a new power supply deal.

And back home, the majority Rio Tinto (ASX:RIO) owned Tomago smelter near Newcastle is communicating a doomsday scenario to its workforce with a power supply deal with AGL to run up in December 2028.

Plans to supply the Tomago plant with renewables will not be viable without government subsidies, Tomago’s CEO has previously warned.

Yet demand for aluminium remains strong, mirroring the inflection of other commodities linked to decarbonisation and electrification like copper – for which it is often a lower cost alternative – and tin.

With smelting on the nose, the best place to look for value could be at the very start of the alumina and aluminium production process.

The key raw material used in the supply chain, bauxite, is having a renaissance, having seen prices in key market China run to record highs late last year.

“China are the big buyer of of bauxite, but their production has been declining for some time, so they now import something like 70% of their bauxite requirements,” Argonaut Funds Management’s David Franklyn says.

Around 74% of that now comes from Guinea in West Africa, the dominant supplier of high grade, low silica bauxite, with between 22-23% from Australia.

Rising demand, uncertain supply

Demand continues to increase. The International Aluminium Institute predicted in 2022 that usage will lift from 86.2Mt pre-Covid to 119.5Mt by 2030, around 40% higher.

That’s already playing out in China’s hunger for bauxite imports.

“In the first half of this calendar year, China imports increased by 33%. Right. So the dynamic is pretty good as far as emerging increasing demand from China,” Franklyn said.

At the same time, the status of key supplier Guinea is uncertain.

There’s around 220MT of producing capacity for bauxite in the country.

But around 27Mt is sensitive to weather in a locale that gets close to 4000mm of rain a year, half of it in just two months in July and August.

Close to 60Mt comes from licences that have been revoked by the country’s ruling military junta in a crackdown on foreign producers.

“There’s the normal political gyrations that you see, which is causing some nervousness and buyers wanting alternative supplies,” Franklyn noted.

“But more recently, what they’ve done is they’ve been revoking a number of the mining licences and that’s getting up to significant volume, we’re talking about somewhere between 40 and 60 million tonnes.“

Prices in China climbed as high as US$125/t for Guinean bauxite, which typically grades over 45% Al2O3 and has ~3% silica.

They’ve slipped to US$74/t with Guinea’s bauxite exports hitting a first half record of 99.8Mt to June 30. But with the wet season upon us supplies could get ropy heading into September.

The premium for Guinean over Australian bauxite has slipped, with high grade but also high silica Australian bauxite trading at US$69.50/t.

“I just think that the demand-supply dynamics are looking pretty interesting, and you’d suggest that prices are likely to be supported around current levels.”

Argonaut’s stock of the month

Aluminium, alumina and bauxite options on the ASX include Rio Tinto (ASX:RIO) and South32 (ASX:S32), who capture the full value chain but as diversified producers are largely not priced on their aluminium business units.

American-headquartered Alcoa Corporation (ASX:AAI) is a major alumina and aluminium producer in Australia and North America, but doesn’t ship raw bauxite.

At the smaller end of the market, there are a handful of junior explorers and developers such as Western Yilgarn (ASX:WYX) and the recently listed VBX (ASX:VBX).

But it’s the Queensland producer Metro Mining (ASX:MMI) that makes the grade as Argonaut’s August stock pick.

A recent purchase for the Argonaut natural resources fund, Franklyn says the business’ rising production profile and reducing cost base make the Cape York producer an attractive proposition.

“Simon Wensley is the MD. He came in three or four years ago when the business was in a bit of trouble, largely because of a lack of scale and its costs were too high,” Franklyn said.

“It was producing 3-4Mt per annum. Its, shipping was relatively small scale and expensive and its operating costs reasonably high.

“And so when prices came down, basically, I think it was squeezed.”

More recently, the Bauxite Hills operation has been expanded to a target production rate of 6.5-7Mtpa, with improved barge and trans shipping infrastructure cutting logistics costs.

MMI is aiming to chase further improvements by shipping with capesize vessels, chasing a status as the ‘lowest cost operator’ in the seaborne market.

It generated about $16m in cash during the June quarter, when shipments rose 19% YoY to 1.7Mt. Between 4.8-5.3Mt of the Weipa style bauxite is expected to be shipped in the second half of the year before the traditional December-March shutdown.

“So you’d expect there’s going to be an acceleration in free cash generation. They’ve still got a lot to do, they’ve still got some debt (which has) been coming down,” Franklyn said.

“But when things were very tough they had to get high cost debt. Ideally in the next 12 months, they should be able to pay that all off.

“Their net debt is about $60m, market cap’s about $420m.“So I just think the business is turning around and I think on those kinds of numbers, it’s looking attractive.

“But there’s always that scope where you get a spike in the bauxite price and then they’ll do exceptionally well.“

Argonaut Funds Management is a high conviction resource sector investor managing the Argonaut Natural Resources Fund and the Argonaut Global Gold Fund. David Franklyn is the Fund Manager for the Argonaut Natural Resources Fund.

The views, information, or opinions expressed in  this article are solely those of the interviewee and do not represent the views of Stockhead. Stockhead does not provide, endorse or otherwise assume responsibility for any financial product advice contained in this article.