Aluminum producer Alcoa (NYSE:AA) has announced that it plans to curtail its alumina refining capacity, an expected move following a slump in alumina prices and in line with the company’s plans to cut smelter capacity. 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. In the wake of falling aluminum prices and rising costs, Alcoa announced plans to cut capacity at some of its smelters in an attempt to remain profitable. 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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To cut alumina refining capacity
In an expected move, the company announced on Thursday a reduction in its alumina refining capacity to align production with the smelter curtailments announced in January. Alumina prices have also declined to a level at which the company was finding it difficult to justify continuing production at higher cost plants. This move will reduce the company’s alumina refining capacity by approximately 390,000 tons in the Atlantic region. The Atlantic region encompasses about half of the company’s total annual alumina refining capacity of 18 million tons. 
The company expects these steps to curb the oversupply of alumina while enhancing the efficiency of its refining system. Should this not succeed in doing so, the company may have to opt for further capacity cuts which could significantly impact our price estimate given that alumina constitutes about 27% of our valuation.
Another fact to note is that Alcoa’s January prediction that China’s aluminum industry would cut 1.1 million tons of capacity hasn’t been realized.  Should that occur, however, it would likely provide a healthy boost to aluminum prices by eliminating excess supply.Notes:
- Alcoa cuts alumina output as oversupply dents prices, Reuters, April 5 2012 [↩]
- Alcoa Sees Aluminum Cuts as Production Gains: Commodities, Bloomberg, April 10 2012 [↩]