Alcoa (NYSE:AA), the largest aluminum producer in the United States, has yet again decided to postpone expansion of an alumina refinery in Australia as aluminum prices continue to remain under pressure. The move followed its earlier announcement to curtail capacity at some of its smelters and refinery in the wake of falling aluminum prices and rising costs. Alcoa is a fully integrated producer of aluminum; it mines bauxite, refines it into alumina, makes primary aluminum and also produces midstream products such as flat-rolled sheets and downstream engineered products. It competes with companies like Rio Tinto (NYSE:RIO), ArcelorMittal (NYSE:MT) and US Steel (NYSE:X).
Our price estimate for Alcoa stands at $12, implying a premium of close to 35% to the current market price.
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To cut alumina refining capacity
In 2008, the company had postponed plans to expand the Wagerup refinery in Australia. However, the company has secured another five-year extension of the permit, which expired last October. The refinery currently has a production capacity of about 2.6 million tons per annum of alumina. Expansion will take the capacity to as high as 4.7 million tons per annum, subject to approvals. Such expansion would enable the company to ride the emerging market growth.
But, alumina prices have also declined to a level at which the company would find it difficult to justify the expansion of its refinery. Alcoa has already announced that it will cut its alumina refining capacity in the Atlantic region – which contributes to almost half of the company’s alumina production 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 it 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 for Alcoa’s stock.