Alcoa (NYSE:AA) will kickoff this quarter’s earnings season when it announces its Q1 results after the market closes on Tuesday. We expect the company to record its second consecutive quarterly loss as it continues to battle with a decline in aluminum demand and the subsequent decline in prices due to global economic conditions. While aluminum prices have recovered a bit in 2012, they are still significantly down from a year ago.
Alcoa has realigned its strategy and is closing down some of its smelters in an attempt to remain profitable and to strengthen its product portfolio going forward. Alcoa’s products are used across industries including mining, refining, smelting and recycling. It competes with companies like ArcelorMittal (NYSE:MT) and US Steel (NYSE:X).
Our price estimate for Alcoa stands at $12, implying a premium of close to 20% to the current market price.
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Aluminum price recovery not enough for Q1
On average, aluminum prices are up approximately 5% in Q1 2012. Improving conditions in the U.S. economy and a modest recovery from the European debt crisis have contributed to the rise in aluminum demand and prices. However, China’s reduction in its GDP growth target has capped the price gain as demand concerns loom. Aluminum prices hit a 17-month low in December before recovering to $2,126 this year. That is still well below the 2011 high of $2,803 however. Mounting input costs and losses have forced Alcoa to announce a reduction of about 12%, or about 531,000 tons, in its smelting capacity.  The company is also scouting for a buyer for its European plant.
Long term fundamentals intact
We believe that Alcoa’s long-term fundamentals are strong even as it has lost quite a bit in 2011 and Q1 2012. Alcoa expects aluminum consumption to double by 2020 and maintains its outlook of 7% year on year growth in global aluminum consumption in 2012.  With the U.S. economy showing some encouraging signs, we believe it will bolster aluminum demand and prices going forward. Moreover, pent up demand in the automotive sector should drive growth as manufacturers eye lighter-weight vehicles in pursuit of better fuel efficiency.
Vertical integration should also help the company stay healthy even with depressed prices. Alcoa is a fully integrated producer of aluminum; it mines bauxite, refines it into alumina, makes primary aluminum and also produces midstream products like flat rolled sheets and downstream engineered products.
Further, Alcoa is pushing to ramp up its midstream and engineered products business, which offers higher margins than primary metals. However rising input costs will remain a concern for the foreseeable future and could effectively outpace and spoil the company’s cost cutting efforts.Notes:
- Alcoa Plans to Curtail Smelters in Italy and Spain as part of Global Primary Restructuring, Alcoa News Release, Jan 9 2012 [↩]
- Alcoa Announces Fourth Quarter Loss on Charges Associated with Cutting High-Cost Smelting Capacity, Market Weakness, Alcoa News Release, Jan 9 2012 [↩]