Alcoa Earnings Preview: Low Aluminum Prices Will Weigh On Results

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Alcoa (NYSE:AA) will report its first quarter earnings result after close of markets Tuesday, April 8 and hold its earnings conference call on April 9. We expect the company to report lower year-over-year revenues and profits. This is on account of lower aluminum prices as well as restructuring charges associated with shutdown of smelting capacity. The flat-rolled and engineered products divisions may partially offset the negative impact of low aluminum prices on the primary metals business.

Aluminum prices on the London Metal Exchange (LME), which stayed above $1,800 per ton in Q1 2013, stayed between $1,700-$1,800 per ton for the major part of Q1 2014. On average, prices in Q1 2014 have been much lower than in the comparable period last year. Alcoa uses LME aluminum prices as benchmark for its own prices. [1]

While prices have surged in the first week of April on the London Metal Exchange, this is largely due to the impact of a court ruling in the favor of Rusal. The ruling has blocked the implementation of new LME warehouse rules which would have otherwise depressed the spot premiums manufacturers like Alcoa depend on. The upsurge, however, is likely to be temporary as structural factors remain largely unchanged. [2]

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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.

The Aluminum Price Trend In Q1

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. This inventory has accumulated as a result of aluminum being tied up in financing deals which were made possible due to low interest rates. While LME prices are not the actual realized prices for Alcoa, they do indicate a broader trend in global aluminum prices. Also, despite inventories being at a record high, market forces have failed to rationalize supply through the shutdown of smelting capacity. Companies like Alcoa and Rusal have announced smelting capacity cuts, but the same cannot be said of Chinese companies. This is primarily due to state intervention in the form of provision of subsidies or renegotiated power contracts to smelters, which serves as a disincentive to cut production. 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]

Smelting Capacity Shutdowns

Alcoa announced the shutdown of smelting capacities at three facilities in Q1. These include shutdown of the Massena East aluminum smelting capacity of 84,000 tonnes, the Point Henry smelting capacity of 190,000 tonnes and the Sao Luis (Alumar) and Pocos de Caldas cumulative smelting capacity of 147,000 tonnes. Alcoa now has a total idle aluminum smelting capacity of 800,000 tonnes. This represents 21% of its total installed smelting capacity.

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

For Point Henry, Alcoa will have to record restructuring charges worth $250-270 million after accounting for tax and non-controlling interest. Of this, approximately 60% will be recorded in the first quarter of 2014. In addition, cash costs worth $160 million will be recorded throughout 2014.

For the shutdowns at Sao Luis (Alumar) and Pocos de Caldas, 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.

What We Would Like To Know In The Earnings Call

In its Q4 2013 earnings conference call, Alcoa’s management had maintained 2014 growth projections of 7-8% for the aerospace segment, 2-5% for the U.S. automotive segment and 6-10% in the Chinese automotive segment. In the truck and trailers segment in North America, Alcoa expected production to increase by 1-5% in 2014. Demand in the commercial building and construction segment was expected to grow by 3-4% in 2014 in North America.((Alcoa Q4 2013 Earnings Conference Call, Seeking Alpha))

We would like to see if results at the end of Q1 are in tandem with expectations.

The next big growth opportunity for Alcoa is expected to be the increased adoption of aluminum for automobiles. We would like to know if there have been further deals on this front after the one for Ford’s F-150 pick-up truck.

We have a Trefis price estimate for Alcoa of $9 which will be updated after the Q1 results.

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Notes:
  1. LME Aluminum Price Graph, LME []
  2. Aluminum Price Premiums: Disconnect Between LME and Reality Continues, Metal Miner []
  3. Alcoa to cut capacity at two aluminum smelters in Brazil, Shanghai Metals Market []