Alcoa Maintains Its Aerospace Focus With $1 Billion Boeing Deal
Alcoa (NYSE:AA) has announced its signing of a long-term contract worth $1 billion to supply aluminum sheet and plate products to Boeing, the world’s largest aerospace company. The agreement makes Alcoa the sole supplier to Boeing for wing skins on all of its metallic structure aircraft. Alcoa plate products, which are used in applications such as wing ribs, wing skins or other structural parts of the aircraft, will also be used on every Boeing platform. [1]
The deal is the latest in a series of developments for Alcoa in the aerospace sector. Aerospace remains at the center of Alcoa’s shift towards value-added products, as it looks to reduce its dependence on its commodity businesses.
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Focus on Aerospace Segment
Alcoa is betting big on its aerospace customers to drive sales of its value-added products. The company maintained its outlook of 8-9% global sales growth in 2014 for the aerospace segment, during its second quarter earnings conference call. [2] The large commercial jet segment is expected to grow at 12.1%, driven by a strong commercial jet order book, which represents nine years of production. The strong order book is also reflected on the jet engines side with 23,000 engines on firm order. Demand for regional jets is expected to grow at 13.2%. For Alcoa, this represents sustained demand for its aerospace products for the medium term. Hence, it has increased its exposure to the aerospace segment.((Alcoa’s Q2 2014 Earnings Presentation, Alcoa Website))
In 2014 alone, several major developments in the aerospace segment have taken place for Alcoa. In July, the company announced the signing of a a 10-year agreement worth $1.1 billion to supply jet engine components to jet engine manufacturer Pratt & Whitney, a division of United Technologies Corporation (UTC). [3] In June, the company announced the $2.85 billion acquisition of jet engine components maker Firth Rixson. ((Alcoa’s Transformation Accelerates, Will Acquire Firth Rixson To Grow Global Aerospace Portfolio, Alcoa News Release)) Prior to that, it had announced a $25 million expansion of the Alcoa Power and Propulsion facility in Hampton, Virginia. ((Alcoa Boosting Aerospace Capabilities in Virginia to Meet Demand for Next-Gen Aircraft Engine Parts, Alcoa News Release)) The company had also 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 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. [4]
Alcoa’s aerospace revenue of $4 billion in 2013 accounted for around 17% of its total revenue for the year. ((Alcoa’s 2013 10-K, SEC)) With several recent developments in the aerospace segment, its share of the company’s revenue is set to grow.
Strategic Shift Towards Value-added Products
Alcoa’s aerospace push is central to its shift towards its value-added products, as it looks to reduce its dependence on its commodity businesses. The sale of aluminum and alumina constitutes Alcoa’s upstream commodity businesses. Demand for these commodities is broadly correlated with economic growth. These commodities suffered a steep decline in prices as the European debt crisis and slowing Chinese growth contributed to weakness in aluminum demand over the last few years.
On the supply side, production capacity was not reduced corresponding to the fall in demand over the last few quarters. Persistently high aluminum inventory levels relative to demand have kept London Metal Exchange (LME) aluminum prices depressed. [5] This inventory has been built up partially as a result of aluminum being tied up in financing deals, which were made possible due to low interest rates. ((Aluminum Price Premiums: Disconnect Between LME and Reality Continues, Metal Miner)) Despite inventories being at fairly high levels, market forces failed to rationalize supply through the shutdown of smelting capacity. Though global aluminum majors like Alcoa and Rusal announced smelting capacity cuts, the same cannot be said of Chinese aluminum producers. 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 is the world’s largest aluminum producer and the expansion in production by Chinese producers more than made up for capacity cuts by global majors. [6]
In view of uncertainty regarding aluminum prices, the company has shifted its focus towards value-added products, which command greater pricing premiums and higher margins as compared to the upstream businesses. Alcoa’s shift towards value-added products is reflected in its revenue figures. The percentage contribution of the Global Rolled Products and the Engineered Products and Solutions segments, which represent Alcoa’s value-added businesses, to the company’s total revenues has steadily increased. This figure stood at 52.1%, 54.4%, 55.7% and 58% at the end of 2011, 2012, 2013 and first half of 2014, respectively. [7] In calculating these figures, we have only considered third-party sales. The company’s value-added products accounted for 72% of its total segment after-tax operating income in the first half of 2014. (( Alcoa’s Q2 2014 10-Q, SEC))
Thus, Alcoa’s business strategy seems to be quite clear – a shift towards value-added products driven by the aerospace segment.
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Notes:
- Alcoa Signs Multiyear Supply Contract with Boeing Valued at More Than $1 Billion, Alcoa News Release [↩]
- Alcoa’s Q2 2014 Earnings Conference call Transcript, Seeking Alpha [↩]
- Alcoa Announces Jet Engine First in $1.1 Billion Supply Agreement with Pratt & Whitney, Alcoa News Release [↩]
- Alcoa Signs Long-Term Supply Agreement With Spirit AeroSystems For Aluminum Sheet, 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 [↩]