Aluminum manufacturer Alcoa (NYSE:AA) is going through a rough patch as its profitability has taken a beating lately due to falling alumina prices arising from oversupply of the commodity. Alcoa is a major global producer of aluminum and related products and could play a vital role in bringing prices back to previous levels if it continues to cut capacity. In April, Alcoa announced that it would cut or curtail nearly 390K tons in refining capacity and might have to cut more assessing the market, going forward.
Our price estimate for Alcoa stands at $12, implying a premium of close to 20% to the current market price.
Cut in capacity
In April, Alcoa announced that it would curtail 390K ton of refining capacity in the Atlantic region, which represents almost 50% of its annual global capacity of 18 million ton.  This trend of capacity cuts is expected to continue in the near future until the aluminum prices recover. The revival of alumina prices will be critical for Alcoa as it derives nearly 25% value from the Alumina segment.
Automotives, China to drive growth
Alcoa sold about 12% of its flat-rolled products to the automotive industry in 2010, according to Morgan Stanley estimates.  The automotive industry has been looking for new materials that can replace steel to increase fuel efficiency of the vehicles.  Aluminum fits the deal quite nicely as it is a lighter metal and has comparable strength to steel. Increased usage in the automotive industry could see aluminum demand rise in the future.
Emerging markets such as China hold the key to growth as demand for midstream products like flat-rolled aluminum will increase, going forward. Hence the company has planned to restructure its midstream flat-rolled products’ business into a more market-driven structure by dividing the division into 5 recognizable segments: Aerospace, Ground Transportation, Packaging, Consumer Electronics and Defense. This will help the emerging markets closely associate with the distribution facilities of Alcoa. If Alcoa is able to capitalize its exposure to China, it will be a major driving factor in the future.Notes:
- UPDATE 2-Alcoa cuts alumina output as oversupply dents prices, reuters.com, April 5, 2012 [↩]
- Goodyear replaces Steel core with lighter Aluminum in aviation tyres, commodityonline.com, May 24, 2012 [↩]