Alcoa: 2013 In Review
Alcoa (NYSE:AA) suffered due to low aluminum prices in 2013, but has performed better than 2012 in the first three quarters due to cost-cutting efforts and the contribution from the value-added product divisions. In the first nine months of 2013, Alcoa recorded revenues of $17.4 billion compared to $17.8 billion in the comparable period of 2012. Despite lower revenues, net income stood at $54 million compared to a net loss of $95 million last year due to cost related savings. [1]
Low aluminum prices and a global inventory glut forced Alcoa to announce massive cuts in smelting capacity. The company instead decided to focus on its value-added businesses. It signed major deals with Airbus, China’s Commercial Aircraft of China Ltd. (COMAC), and Russia’s VSMPO-AVISMA, to supply aerospace products and parts. It also conducted a ground breaking ceremony in Tennessee to expand production of aluminum products for the automotive segment.
Among other notable events, Alcoa was replaced in the Dow Jones Industrial Average (DJIA) index in 2013 by Nike, due to its low share price and market cap.
We have a Trefis price estimate of $7 for Alcoa , which represents 32% downside to the current market price.
See Full Analysis for Alcoa Here
Smelting Capacity Cuts
In May, Alcoa announced that it would consider cutting about 11% of its smelting capacity, or 460,000 tons, over the next 15 months as it battles low prices for aluminum. According to a company news release, this step was being taken in response to a 33% drop in aluminum prices since 2011. At the time of making this announcement, it already had an idle smelting capacity of 568,000 tonnes, or 13% of the total.
Aluminum prices on the London Metal Exchange, which are used as a benchmark by the company to determine its own prices, have been dropping sharply since the end of February. Prices have dropped from $2,100/ton at the beginning of the year to below $1,800/ton. [2]
One factor bearing on the falling prices is the persistently high aluminum inventory relative to demand, which may be keeping a lid on London Metal Exchange (LME) prices for aluminum. Also, despite falling aluminum prices, Chinese production is expected to have risen by 10% from 2012. This represents an absolute increase of 2.2 million tons. Thus, despite inventories being at a record high, market forces have failed to rationalize supply through the shutdown of smelting capacity in China. This is primarily due to state intervention, through both the provision of subsidies or the renegotiation of power contracts to smelters. ((Alcoa to Consider Cutting 11% of Capacity, WSJ))
Deals With Aircraft Manufacturers
Alcoa announced a new agreement for strategic technology and commercial cooperation with Commercial Aircraft of China Ltd. (COMAC). COMAC is a manufacturer of large passenger aircraft in China and has ambitions of competing with Boeing and Airbus. The deal will help Alcoa gain a stronger foothold in the Chinese aerospace market, which is one of the world’s fastest growing markets. ((Alcoa Fastening Systems Enters Strategic Partnership with COMAC, Alcoa Press Release))
Alcoa also signed a co-operation agreement with Russia’s VSMPO-AVISMA to target aerospace demand for high-end titanium and aluminum products. VSMPO-AVISMA is the world’s largest manufacturer of titanium ingots and forged products, and the agreement marks the first step towards the creation of a joint venture between the two companies. Alcoa bought the Samara and Belaya Kalitva aluminium processing plants in Russia in 2005. Since then, it has invested more than $540 million in building facilities, including modern control technology for a forging press that remains the sole global source of some particularly large forging products. The titanium forgings that Alcoa and VSMPO-AVISMA aim to produce at Samara will thus be technologically difficult for any competitor to replicate in the short term. [3]
Alcoa’s total revenues for 2012 were $23.7 billion, of which $5.5 billion were contributed by the Engineering Products and Solutions division. Although total revenues declined in 2012 from the previous year’s figure of $24.9 billion, revenues of the Engineered Products division rose 3.8% from $5.3 billion in 2011. ((Q4 2012 Earnings Presentation, Alcoa Website))
The division reported a record adjusted EBITDA margin of 22.5% in Q3 2013. Alcoa is upbeat about the aerospace market and maintained its 9-10% growth projection for 2013. The company touts a large backlog of 9,900 orders for planes with Boeing and Airbus, which might take up to 8 years to clear. It signed orders worth $135 billion with these companies at the Paris Air Show in the second quarter. ((Alcoa Q3 2013 Earnings Presentation, Alcoa Website))
Reasons For Alcoa’s Exclusion From Dow Jones
The DJIA is a price-weighted index, which means that the stocks with the highest share price have the greatest weight. The three companies which were removed from the index (Alcoa, HP, Bank of America) in the latest shake-up had single-digit or low double-digit stock prices. Thus, movements in their prices didn’t impact the index as much as higher prices members like IBM and 3M. With a price of $7-8 per share at the time of removal, Alcoa was easily the cheapest stock in the DJIA. ((Alcoa, H-P, Bank of America kicked off Dow, The Christian Science Monitor))
According to the chairman of the index committee that decides the DJIA’s composition, Alcoa, BofA and HP constituted just 3% of the index’s value. For an index that has just 30 companies, the committee felt that it couldn’t justify allocating three positions on the index in return for just 3% of the value.
The owners of the DJIA also wanted to diversify the make-up of the index to reflect the real economy. The economy has gradually shifted from heavy manufacturing to other areas like finance, healthcare and technology. The mining and materials sector, to which Alcoa belongs, constitutes just 3-3.5% of the overall U.S. stock market today. Also, aluminum consumption in the U.S., as a percentage of the overall Gross Domestic Product (GDP), has declined over the last five decades. While it represented 0.2% of the U.S. GDP in 1959 when Alcoa joined the DJIA, today it constitutes just 0.02%. This trend was mirrored in Alcoa’s steadily declining share of the Dow, from 2% 10 years ago to 0.4% today. ((Alcoa Junk Downgrade Is Rare Trauma for Dow Stocks: Commodities, Bloomberg))
Although eventually there was little financial impact due to Alcoa’s removal from the DJIA, it signified a loss of prestige for the company over time. The company’s share price had fallen from peak levels of $48 in 2008 to $7 in 2013 when the DJIA removed it.
Understand How a Company’s Products Impact its Stock at Trefis
Notes:- Alcoa Q3 2013 10-Q, SEC [↩]
- LME Aluminum Price Graph, LME [↩]
- Alcoa set to be heavy player in Russian titanium, Alcoa Website [↩]