Alcoa Continues Aerospace Push With Announcement Of Virginia Facility Expansion
Alcoa (NYSE:AA) recently announced that it is expanding the Alcoa Power and Propulsion facility, located in Hampton, Virginia. The company will invest $25 million to scale-up a process technology that will reduce the weight of its jet engine blades by 20%, and significantly improve their aerodynamic performance. The company will add equipment for a new production line and modify existing machinery at the Hampton facility to produce the blades. [1]
The expansion of its Hampton facility is consistent with the company’s strategy of focusing on its value-added products, in view of a subdued pricing environment for aluminum affecting its upstream businesses. The aerospace segment is amongst the most promising segments for the company, and a major consumer of the company’s value-added products.
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Hampton Facility Expansion
The lightweight jet engine blades will be made primarily using nickel-based superalloys, and will be produced using the Enhanced Equiax (EEQ) casting technology, which was developed by Alcoa itself. These blades can be used to retrofit existing engines or build next-generation aircraft engines, such as the latest engines for large commercial aircraft, including narrow and wide body airplanes. The expansion will start this month and is expected to be completed by Q4 2015. ((Alcoa Boosting Aerospace Capabilities in Virginia to Meet Demand for Next-Gen Aircraft Engine Parts, Alcoa News Release))
With low aluminum prices negatively impacting its Primary Metals and Alumina businesses, Alcoa is shifting its focus towards value-added products.
Aluminum Prices
Aluminum has diverse applications in industry. It is an important input in the packaging, aerospace, automotive, construction, commercial transportation, power generation, capital goods and consumer durables industries. Thus, demand for aluminum is broadly correlated with industrial growth. The European debt crisis and slowing Chinese growth have contributed to the decline in aluminum demand, and consequently prices over the last few quarters. [2]
On the supply side, production capacity has not been reduced corresponding to the fall in demand. Persistently high aluminum inventory levels relative to demand are keeping London Metal Exchange (LME) aluminum prices depressed. While LME prices are not the actual realized prices for Alcoa, they do indicate a broader trend in global aluminum prices. Despite inventories being at a record high, market forces have failed to rationalize supply through the shutdown of smelting capacity. Though global aluminum majors like Alcoa and Rusal have announced smelting capacity cuts, 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 serve as a disincentive to cut production. China accounts for around 43% of the world’s aluminum production and the expansion in production by Chinese producers has more than made up for capacity cuts by global majors. Thus, this oversupply situation is set to continue and is likely to keep prices depressed. [3]
The average realized price per ton of aluminum for Alcoa has fallen consistently over the last three years. It has fallen from $2,636 in 2011 to $2,243 in 2013. ((Alcoa’s 2013 10-K, SEC))
Shift To Value-Added Products
Low aluminum prices have put pressure on margins in the company’s Alumina and Primary Metals segments, which represent Alcoa’s upstream businesses. In order to compete effectively in such an environment, the company has made concerted efforts to rebalance its portfolio towards its value-added products. The value added products, represented by the Global Rolled Products (GRP) and the Engineered Products Services (EPS) divisions, have pricing premiums over the upstream businesses and command higher margins.
The GRP segment is mainly involved in the production and sale of aluminum plate, sheet and specialty foil. This segment’s products are sold to customers in packaging and consumer goods, aerospace, automotive, brazing, building and construction industries. The EPS segment’s products include titanium, aluminum and superalloy investment castings, fasteners, aluminum wheels, integrated aluminum structural systems, architectural extrusions, forgings and hard alloy extrusions. These products are sold to customers in the aerospace, automotive, building and construction, commercial transportation and power generation industries. ((Alcoa’s 2013 10-K, SEC))
Alcoa’s shift towards value-added products is reflected in its revenue figures. The percentage contribution of the GRP and the EPS segments sales to the total revenues has steadily increased. This figure stood at 52.1%, 54.4%, 55.7% and 57.2% at the end of 2011, 2012, 2013 and Q1 2014 respectively. [4] In calculating these figures, we have only considered third party sales. The company’s value-added products accounted for 76% of its total segment after-tax operating income. ((Alcoa Boosting Aerospace Capabilities in Virginia to Meet Demand for Next-Gen Aircraft Engine Parts, Alcoa News Release))
Aerospace Segment
Alcoa is betting big on its aerospace customers to drive sales of its value-added products. In the aerospace segment, Alcoa has raised its forecast for growth in production from 8% to 9% for 2014. The company expects strong performance from its large commercial aircraft and regional aircraft segments. The combined backlog of 10,675 aircraft units for Boeing and Airbus represents eight years worth of production. For Alcoa, this represents sustained demand for its aerospace products for the medium term. Further, the company expects strong aviation demand from Asia and the Gulf region. [5]
The expansion at its Hampton facility is the third major development in the aerospace segment for Alcoa in 2014. The company had earlier announced the setting up of a $100 million facility in La Porte, Indiana for the production of nickel-based superalloy jet engine parts. ((Alcoa Expands in Indiana to Capture Growing Aerospace Demand for Advanced Jet Engine Parts, Alcoa News Release)) Alcoa also recently signed a long-term agreement worth $290 million to supply aluminum sheet to Spirit AeroSystems over five years. Spirit is one of the largest designers and manufacturers of aerostructures for commercial, military, business and regional jets in the world. [6]
These investments are growing Alcoa’s aerospace business, which had revenues totaling $4 billion in 2013. This represents around 17% of Alcoa’s revenues of $23 billion in 2013. ((Alcoa’s 2013 10-K, SEC))
The Road Ahead
We expect the company to continue to focus on its value-added products in the near and medium term. We expect the supply glut to persist for aluminum, keeping prices subdued. In such an environment, the fortunes of the company’s upstream business will be more dependent on productivity gains rather than top line growth. Revenue growth for the company will be driven by the company’s GRP and EPS divisions, especially by aerospace and automotive sales.
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Notes:- Alcoa Boosting Aerospace Capabilities in Virginia to Meet Demand for Next-Gen Aircraft Engine Parts, Alcoa News Release [↩]
- LME Aluminum Prices, LME [↩]
- Alcoa, Rusal’s Aluminum Production Cuts Not Enough With China Smelting, Metal Miner [↩]
- Alcoa’s 2013 10-K, SEC [↩]
- Alcoa’s Q1 2014 Earning Conference Call Transcript, Seeking Alpha [↩]
- Alcoa Signs Long-Term Supply Agreement With Spirit AeroSystems For Aluminum Sheet, Alcoa News Release [↩]