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Investment Overview for Alcoa (NYSE:AA)
WHAT HAS CHANGED
Aluminum prices have weakened considerably over the last year, with weak global demand and oversupply, aluminum prices are negatively impacting Alcoa's Primary Aluminum and Alumina businesses. In order to lessen its dependence on volatile aluminum prices, the company has been transforming its product portfolio towards its value-added business segments. The company has further announced that it intends to split its upstream and value-added businesses into two publicly traded companies in the second half of 2016.
- Acquisitions have boosted value-added businesses
- Alcoa has boosted its value-added businesses through the acquisition route. The company's acquisitions over the course of 2014 have largely been focused on boosting the company's revenues from its aerospace and automotive markets. This was reflected in Alcoa's results in the first nine months of 2015, in which the company's revenues from its aerospace and automotive end markets rose 25% and 44% respectively, on a year-over-year basis.
- Reductions in aluminum smelting capacity have accelerated portfolio transformation
- The company has permanently closed down a significant proportion of its aluminum smelting capacity over the course of last year. The company's smelting capacity stood at roughly 3.4 million tons per year (mtpy) at the end of Q3 2015, as compared to 4.04 mtpy at the end of 2013. The closure of smelting capacity has accelerated the company's portfolio transformation.
- Announcement to split upstream and value-added businesses in second half of 2016
- Alcoa's portfolio transformation will culminate in the break up of the company's upstream and value-added businesses into two publicly traded companies, in the second half of 2016. The split is likely to benefit the company comprising the value-added businesses, which are also likely to receive a favorable share of Alcoa's debt, in order to achieve a better credit rating.
Below are key drivers of Alcoa's value that present opportunities for upside or downside to the current Trefis price estimate for Alcoa:
Primary Metals Division
- Average Price of Primary Metals: We expect realized prices for Primary Metals shipments to decline in 2015 as a result of the global oversupply of aluminum. We expect realized prices to increase gradually and grow at a higher rate towards the end of the forecast period, as economic growth (and consequently demand) in large markets, such as China, recovers. However, if economic conditions improve faster than expected, prices may increase faster than expected. This scenario represents a 4% upside to our price estimate.
- Primary Metals EBITDA Margin: EBITDA margins for the Primary Metals division are expected to rise in 2015 and 2016 as a result of the company's efforts to increase the productivity of its operations. However, if the company is unable to realize these improvements in productivity, the expected margin improvements will not be realized. This scenario represents a 5% downside to our price estimate.
Alcoa is the leader in the production of aluminum products such as primary aluminum, fabricated aluminum, and alumina. The company is involved in every aspect of the industry including mining, refining, smelting, and recycling.
Aluminum products and alumina represent more than three-fourths of Alcoa’s revenues; accordingly the company is heavily impacted by aluminum prices. The company's non-aluminum products include fasteners for aerospace and industrial customers.
Alcoa operates in more than 30 countries worldwide, in addition to investments in Australia, Brazil, China, Russia, Guinea, and Saudi Arabia.
Bauxite, the primary ore used in aluminum production, along with alumina and power, make up most of the company's operating costs. Other raw materials used include petroleum coke, aluminum fluoride, fuel oil, steam, and coal.
Engineered Products division is most valuable for Alcoa
The Engineered Products segment includes titanium, aluminum, and super alloy investment castings, forgings and fasteners, aluminum wheels, integrated aluminum structural systems, and architectural extrusions.
Products are sold directly to industrial and retail customers and through distributors. Hard alloy extrusions products serve the aerospace, automotive, and commercial transportation markets.
Macroeconomic conditions limit upside to aluminum prices in near term:
Aluminum has diverse applications in industry. Thus the sales of aluminum are largely dependent on global economic growth. China, the world's largest consumer of aluminum, is expected to witness a slowdown in GDP growth to 6.8% in 2015, from 7.8% in 2013, and 7.4% in 2014. Weakness in Chinese economic growth will result in weakness in demand for aluminum. This would limit the growth in aluminum prices in the near term.
Indonesian export ban to provide support to prices
As per the provisions of a law passed by its Parliament, the Indonesian government halted the exports of bauxite ore from the country in January 2014. The country intends to boost its domestic mineral processing capacity at the cost of exporting unprocessed mineral exports. Bauxite is the key mineral ingredient for the production of alumina. Indonesia accounts for 10-15% of global bauxite supply, and about 50% of shipments to China, the world’s largest aluminum producer. China may be forced to import more expensive bauxite in order to meet its requirements, once it runs down its bauxite inventories. More expensive input prices will provide support to the prices of both aluminum and alumina, provided demand for these commodities recovers sufficiently.
Strong growth in aerospace end markets
Alcoa expects strong long-term demand from its aerospace end markets. Current order books for commercial jets represent nine years of production at 2014 delivery rates. The strength in demand is also represented in demand for jet engines with around 23,000 engines on firm order.
Strong growth in automotive end markets
The company expects robust demand from its automobile end markets, particularly in North America. The average age of a vehicle in the U.S. stands at around 11.5 years in 2015, as compared to a historical average of 9.7 years, indicating pent up demand for automobiles. In addition, there is increasing demand for aluminum components from the automobile industry as manufacturers aim to reduce the weight of their automobiles in order to meet increasingly stringent emissions regulations.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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