Alcoa Maintains Aerospace Push With Opening Of New Aluminum-Lithium Alloy Manufacturing Facility
Alcoa (NYSE:AA) recently announced the opening of a plant producing advanced third-generation aluminum-lithium alloys for the aerospace industry in Lafayette, Indiana. With the opening of the $90 million manufacturing facility, Alcoa hopes to capitalize upon increasing aerospace demand for aluminum-lithium alloys. These alloys are less expensive than titanium and composites and their application translates into better fuel efficiency and lower maintenance costs. [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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Alcoa’s Increasing Focus on Aerospace
Alcoa offers a wide portfolio of aluminum-lithium products including extruded, forged and rolled parts. The company holds the market-leading position in aluminum-lithium extrusions, supplying these products for aircraft’s such as the Airbus A380, Airbus A350, Boeing 787, and Gulfstream G650. The company has $100 million in aluminum-lithium revenues contracted for 2017. (( Alcoa Opens World’s Largest Aluminum-Lithium Aerospace Plant in Indiana, Alcoa News Release))
Alcoa is extremely bullish on the aerospace segment. It is banking upon aerospace to drive sales of its value-added products. The company forecasts 8-9% growth for its aerospace end markets this year. [2] The large commercial jet segment is expected to grow at 12.1% this year, 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% this year. For Alcoa, this represents sustained demand for its aerospace products for the medium term. Hence, it has significantly 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. The company recently announced the signing of a long-term contract worth $1 billion to supply aluminum sheet and plate products to Boeing. ((Alcoa Signs Multiyear Supply Contract with Boeing Valued at More Than $1 Billion, Alcoa News Release)) 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). (( Alcoa Announces Jet Engine First in $1.1 Billion Supply Agreement with Pratt & Whitney, Alcoa News Release)) 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. [3]
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 at a rapid pace.
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. ((LME Aluminum Prices, LME))
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. [4] 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. [5] LME aluminum spot prices currently stand at around $1,900 per ton, as compared to peak levels of over $2,700 per ton in 2011. ((LME Aluminum Prices, LME))
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. [6] 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)) With its increasing emphasis on its value-added products, driven by the aerospace segment, the company is taking rapid strides towards mitigating the impact of primary aluminum prices on its business prospects.
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Notes:
- Alcoa Opens World’s Largest Aluminum-Lithium Aerospace Plant in Indiana, Alcoa News Release [↩]
- Alcoa’s Q2 2014 Earnings Conference call Transcript, Seeking Alpha [↩]
- 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 [↩]