Massena East Shutdown Will Further Reduce Alcoa’s Smelting Capacity And Revenues

Alcoa‘s (NYSE:AA) has announced that it is permanently closing down the remaining two potlines at its Massena East aluminum smelter in New York because they are not competitive anymore. This facility has three potlines, one of which has already been permanently shuttered in August last year. ^[1]

The latest shutdown will reduce Alcoa’s smelting capacity by 84,000 tonnes, in addition to the huge capacity already lying idle due to lack of demand and an unfavorable pricing environment. The company had announced a review of 460,000 tonnes of smelting capacity last year and the East Massena shutdown is a part of that.

The shutdown will also help Alcoa reach its stated goal of lowering its position on the global aluminum cost curve to the 38th percentile by 2016. While there will be an impact on the company’s sales figures, the net profit may get a slight boost due to a greater reduction in expenses relative to the decrease in revenues.

See Full Analysis for Alcoa Here

Importance Of Aluminum Prices For Alcoa

Alcoa is organized into four business segments: Alumina, which mines bauxite and processes it into the precursor to aluminum; Primary Metals, which smelts aluminum; Flat-rolled Products, which makes sheets used in beverage cans as well as airplane wings and car parts; and Engineered Products and Solutions, which makes aerospace fasteners, turbine blades and truck wheels. While the Flat-rolled and Engineered Products and Solutions divisions produce value-added products and thus generate higher margins, a significant proportion of Alcoa’s revenues still comes from the Alumina and Primary Metals divisions. This makes its earnings highly sensitive to aluminum prices. While the company is trying to reshape its business towards the downstream value-added segments, the structural shift is likely to take time. Till then, its earnings and business strategy will continue to remain sensitive to global aluminum prices.

Unfavorable Aluminum Prices And Reduced Demand

Aluminum prices were on a constant decline in 2013. The price per tonne dropped steadily from $2,100 at the beginning of 2013 to $1,700 towards the end of the year. ((LME Aluminum Price Graph, LME))

The European debt crisis and slowing Chinese growth have contributed to the decline in aluminum demand and its prices over the last few quarters. The long term expectations for these factors remain largely unchanged, so weakness in prices is expected to persist in the foreseeable future.

One factor that might explain 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. While LME prices are not the actual realized prices for Alcoa, they do indicate a broader trend in global aluminum prices. Efforts by companies like Alcoa and Rusal to provide a cushion to prices by cutting down smelting capacity have been undermined by Chinese smelters which kept adding capacity. Chinese smelters were encouraged to add capacity due to state intervention in the form of provision of subsidies or renegotiated power contracts. ((Alcoa, Rusal’s Aluminum Production Cuts Not Enough With China Smelting, Metal Miner))

After The East Massena Shutdown

Once the shutdown is complete, Alcoa will have a total aluminum smelting capacity of 3,950,000 tonnes. Of this 655,000 will be idle. The idle capacity is expected to increase further because of the 460,000 tonnes which were put under review last year, closure or curtailment of 361,000 tonnes has been announced so far.

Alcoa is expected to make further progress towards its target of lowering its position on the global aluminum production cost curve to 38th percentile by 2016. By the end of 2013, the company had reached 43th percentile which represents an 8 point reduction since 2010. ((Alcoa Q4 2013 Earnings Presentation, Alcoa Website))

Alcoa will have to record restructuring charges worth $60-70 million for the first quarter of 2014, of which around 40% will be non-cash.

We have a Trefis price estimate for Alcoa of $7.

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1. Alcoa to Permanently Close Remaining Potlines at Massena East Smelter, Alcoa News Release [↩]