Arco Aluminum Sale is a Good Move for BP

BP (NYSE:BP) seems to be piling up its cash reserves to make good on the costs incurred in relation to the Gulf of Mexico oil spill. BP, the third largest of the six oil & gas ‘supermajors’, recently announced that it will sell Arco Aluminum to a consortium of Japanese firms in a deal worth $680 million. ^[1] BP competes with oil & gas heavy-weights including Exxon Mobil (NYSE:XOM), Royal Dutch Shell (NYSE:RDS.B), Chesapeake (NYSE:CHK), Anadarko (NYSE:APC) and Chevron (NYSE:CVX).

We have a price estimate of $53.41 for BP stock, a premium of about 15% to market price.

BP and Arco Aluminum

Arco Aluminum is a wholly-owned subsidiary of BP. It produces and markets rolled aluminum products in North America through its 45% stake in a joint production venture with Novelis. The joint venture operates as a production co-operative, in which both partners supply their own input materials and own their share of the output.

The operations based out of Louisville, Kentucky manufactures aluminum coils from recycled aluminum and sells it to beverage can businesses across North America. The operations hold the distinction of being the largest and lowest cost producer of aluminum can sheet in North America. Arco Aluminum’s sale of  can sheet products exceeded 650 million pounds in 2010.

The Deal in Detail

BP entered into the agreement to divest Arco Aluminum with a consortium of 5 Japanese companies. A special purpose vehicle (SPV) by the 5 Japanese companies (Sumitomo Light Metal Industries, Furukawa Sky Aluminum, Sumitomo Corporation, Itochu Metals  and Itochu Corporation) is expected to receive all the assets from Arco by the third quarter of 2011. BP, which will be paid $680 million in cash, was advised by RBS (NYSE:RBS) Securities on the deal.

BP Equity Affiliates Revenue –

What Does the Deal Mean to BP?

BP targets $30 billion in divestments in 2011 to cover the cleanup and compensation costs in excess of $40 billion that it incurred in 2010 due to the oil spill at the Deepwater Horizon drilling rig. The divestments target BP’s non-strategic assets – the aluminum business clearly being a part of it for the oil & gas giant.

We assume that BP’s share of the aluminum produced by Arco in 2010 was 50%. Using this, and the fact that Alcoa (NYSE:AA), the leading producer of aluminum in the world earned about $3,800 per tonne of flat-rolled aluminum, BP’s revenues from Arco in 2010 would be approximately $1.2 billion. With profit margins in the business being in the 5-8% range, and with the low costs for Arco, this would signify earnings of just less than $100 million for BP.

This would affect BP’s revenue from equity affiliates in the years to come, dropping our base case number below $4 billion in 2011, after which it might settle around $4.2 billion by the end of our forecast period. This represents a loss of about $600 million in value for BP, which is more than made up for by the $680 million cash offering. Looks like a good deal for BP.

See our full analysis and $53.41 price estimate for BP

1. BP Agrees Sale of Arco Aluminum, BP Press Releases, April 4 2011 [↩]