Alcoa’s Curtailment Of Brazilian Smelting Capacity Will Reduce Revenues
Alcoa (NYSE:AA) has announced that it will curtail 147,000 metric tonnes of aluminum smelting capacity at its Sao Luis (Alumar) and Pocos de Caldas smelters in Brazil due to rising power costs and falling aluminum prices. These include shutting down 62,000 metric tonnes of smelting capacity at Pocos and 85,000 metric tonnes at Sao Luis.The cuts are expected to be implemented by the end of May 2014. [1]
Alcoa has been periodically shutting down or idling smelting capacity due to challenging global market conditions in primary aluminum. Prices have been falling since May 2011 while costs have been increasing, which has rendered a large chunk of the smelting capacity unprofitable.
Once all the planned shutdown of smelting capacity is complete, Alcoa will have idled about 21% of its total installed capacity.
The shutdown will help Alcoa reach its stated goal of lowering its position on the global aluminum cost curve to the 38th percentile by 2016. While the shutdown will definitely impact revenues, restructuring charges associated with the same will have a further negative impact on net profits for 2014.
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. The situation has been no better in 2014 thus far. [2]
The European debt crisis, slowing Chinese growth and overcapacity in China have contributed to the decline in aluminum demand and its prices over the last few quarters. In addition, the long term expectations for these factors remain largely unchanged, so weakness in prices is expected to persist in the foreseeable future. The only silver lining is that efforts by the Chinese government to reduce overcapacity have resulted in net capacity additions reducing to a trickle. State intervention in the form of subsidies or provision of cheap power encourage smelting capacity addition in China. The country currently has an installed aluminum smelting capacity of around 30 million tonnes out of the global total capacity of 50 million tonnes.
Another 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.
Despite the smelting capacity cuts being implemented, the implications for aluminum prices are not clear. The reason is that prices can be impacted significantly only if across-the-board, large scale cuts take place globally. On a net basis, smelting capacity is still being added in countries in the Middle East where power is cheap and the cost economics works out. Alcoa itself is commissioning its new Ma’aden smelter in Saudi Arabia which will have a smelting capacity of 740,000 tonnes per year. [3]
After The Brazilian Capacity Shutdown
Once the shutdown is complete, Alcoa will have a total idle aluminum smelting capacity of 800,000 tonnes. This represents 21% of its total installed smelting capacity.
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. [4]
Alcoa will have to record restructuring charges worth $40-50 million in the first quarter after accounting for tax and non-controlling interest. Of this, approximately 30% will be non-cash. In addition, we expect further charges to be recorded in the second quarter since the shutdown will be completed only in May. The amount for this has not been specified by Alcoa thus far. We expect to obtain this information in the company’s first quarter earnings release which is due next month.
We have a Trefis price estimate for Alcoa of $9.
See More at Trefis | View Interactive Institutional Research (Powered by Trefis)
Notes:- Alcoa to Curtail 147,000 Metric Tons of Aluminum Smelting Capacity in Brazil, Alcoa Press Release [↩]
- LME Aluminum Price Graph, LME [↩]
- Alcoa to cut capacity at two aluminum smelters in Brazil, Shanghai Metals Market [↩]
- Alcoa Q4 2013 Earnings Presentation, Alcoa Website [↩]