Aluminium Is No Lightweight

It emerges as the clear winner in the game of metal substitution

Bridget Freas, CFA 23 September, 2011 | 3:56PM
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Most metals already have claimed dominance in their respective areas of popular usage. Aluminium's light weight has made it the top material for airplane bodies; steel's strength has deemed it necessary for construction; and copper's superior conductibility has given it the edge in electronics. However, continuous innovation by metal producers has widened the range of potential uses for many metal products. Further, a divergence in metal pricing in recent years has made metal substitution an important consideration for manufacturers. We examined the opportunities and trade-offs for replacement among steel, aluminium, and copper in the most likely applications to determine the winners and losers, and whether substitution even moves the needle for global consumption of each metal.

It's Not Just About the Bottom Line
The cost of the metal used is typically less than 10% of the finished product's total cost, so original-equipment manufacturers and other users of metal tend to be less sensitive to metal pricing in the short term, particularly with respect to high-end appliances, automobiles, and electronics. However, long-term price levels and price volatility make metal costs an important determinant of profitability, particularly as a wider array of materials has increased the threat that competitors might adopt cheaper methods of production. The more mission-critical the application, the greater the challenge posed by substitution to the manufacturer. Since price is generally the main driver to substitute and long-term price trends are difficult to forecast, less vital applications will see the most substitution. Other factors such as regulations, energy efficiency, risk of theft, and customer influence have been cited as drivers of metal substitution. But ultimately, we believe price levels and price volatility have the largest impact.

For the last couple of years, supply has been tighter in copper than in steel and aluminium, causing a quicker recovery in copper prices, which hit record levels while steel and aluminium still fall short of their precrisis peaks. The copper/aluminium price ratio, which was only a little higher than 2 leading up to and including the early quarters of the recession, has since risen sharply to a new high of nearly 4. While steel has exhibited the least volatility, both steel and aluminium are currently priced in line with annual averages prior to the boom and bust of 2008 and 2009. Copper, however, has had a turbulent few years. It has remained at or near all-time highs since the fall of 2010. Looking at pricing alone, copper appears to be the most vulnerable to substitution effects, but steel faces a regulatory framework that may give the more expensive aluminium an edge.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rio Tinto PLC6,250.00 GBX-0.40Rating

About Author

Bridget Freas, CFA  Bridget Freas, CFA, is a senior analyst with Morningstar covering the steel and aluminum sectors.

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