Higher Aluminum Prices And Value-added Businesses Boost Alcoa’s Q3 Results
Alcoa (NYSE:AA) released its third quarter earnings results and conducted a conference call with analysts on Wednesday, October 8. The company reported strong sequential and year-over-year growth in quarterly profits, with all business segments reporting strong results. Net income for the quarter stood at $149 million, as compared to a net income of $24 million in the corresponding period a year ago. [1] Excluding special items, net income stood at $370 million this quarter as compared to $120 million in the corresponding period last year and $216 million in Q2 2014. [2] Special items in Q3 2014 totaling $221 million after-tax, primarily comprise of restructuring charges pertaining to the closure of Alcoa’s Portovesme and Point Henry smelters, in addition to the company’s rolling mills in Australia. [3] The higher profit figures in Q3 as compared to the corresponding period a year ago are mainly due to productivity improvements and an increase in London Metal Exchange (LME) aluminum prices as compared to a year ago.
The company’s quarterly revenues stood at $6.2 billion, which represents a 7% sequential rise and an 8% year-over-year rise. All of the company’s business segments reported higher revenues on a year-over-year basis. [1]
Alcoa is focused on its portfolio transformation towards value-added products. At the same time, the company has emphasized cost reductions in order to make its upstream businesses more competitive.
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Aluminum Pricing
As expected, higher aluminum prices significantly boosted Alcoa’s Q3 results for all its business segments. LME spot aluminum prices averaged roughly $1,800 per ton in both Q3 2013 and Q2 2014. These prices averaged close to $2,000 per ton in the third quarter this year. [4]
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 contributed to the weakness in aluminum demand, and consequently prices over the last few quarters. [5]
On the supply side, production capacity was not reduced corresponding to the subdued demand conditions over the last few quarters. Persistently high aluminum inventory levels relative to demand have kept LME aluminum prices depressed. This inventory was 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 a record high, market forces failed to rationalize supply through the shutdown of smelting capacity. Though global aluminum majors like Alcoa and Rusal did make significant smelting capacity cuts, the same was not true of Chinese companies. This was 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 accounted for around 45% of the world’s aluminum production in 2013, and the expansion in production by Chinese producers more than made up for capacity cuts by global majors. [6] ((Alcoa, Rusal’s Aluminum Production Cuts Not Enough With China Smelting, Metal Miner)) This oversupply situation kept aluminum prices depressed over the last few quarters. This also prompted Alcoa to shift its product portfolio towards value-added products, in order to reduce its reliance on aluminum prices.
However, aluminum prices have rebounded recently. Global smelting capacity cuts in response to low prices have finally taken effect. LME warehouse stocks of aluminum were down around 10% in July, since the start of the year. [7] In view of the global smelting capacity cuts, as per a poll conducted by Reuters in July, the market for aluminum is expected to move from an oversupply of 235,500 tons in 2014 to a deficit of 4,444 tons in 2015. [8] However, global smelting capacity restarts in response to higher aluminum prices are expected to lower or eliminate the extent of the deficit next year. In any case, the tightening of the physical supply of aluminum has led to a recent rally in aluminum prices, which has positively impacted Alcoa’s Q3 results.
Performance of Individual Segments in Q3
Alcoa measures the operating performance of individual segments using the after-tax operating income (ATOI) metric.
ATOI for the Engineering Products and Solutions (EPS) segment stood at $209 million, up around 2.5% sequentially. [2] Favorable productivity gains were primarily responsible for this improvement. The segment reported an adjusted EBITDA margin of 23.5% in Q3, as compared to 23.1% in Q1 and 22.5% in Q3 2013. [3] The segment is expected to continue its strong performance in the next quarters driven by Alcoa’s emphasis on the aerospace segment.
ATOI for the Global Rolled Products (GRP) segment stood at $103 million, up 30% sequentially. [1] This was primarily due to higher aluminum prices and productivity gains to a lesser extent, offset by seasonal shutdowns in Europe. The segment reported record auto sheet production, driven by the ramp-up of production at the company’s plant in Davenport, Iowa.
ATOI for the Alumina segment stood at $62 million, up nearly 63% sequentially. [1] The sharp improvement in ATOI was primarily due to higher realized prices on LME-based alumina sales contracts offsetting the negative impact of lower realized prices through Alumina Price Index (API) based contracts. In addition, higher volumes and the strengthening of the U.S. Dollar also positively impacted results.
ATOI for the Primary Metals segment stood at $245 million, up sharply from $97 million reported in Q2. The third-party realized price for the segment stood at $2,538 per ton in Q3, up nearly 11% sequentially. [1] The improvement in results was due to higher LME aluminum prices and favorable regional premiums. In addition, cost savings and favorable currency movements also boosted results.
Portfolio Transformation and the Road Ahead
Alcoa has made a strategic shift in its product portfolio towards its value-added products over the past few quarters, given the uncertainty regarding aluminum pricing. The company’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 57.1% at the end of 2011, 2012, 2013 and the first nine months of 2014, respectively. [9] In calculating these figures, we have only considered third-party sales.
The aerospace segment has been at the forefront of Alcoa’s portfolio transformation. In Q3 2014 alone, several major developments in the aerospace segment have taken place. These include the signing of 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. [10] Alcoa also announced the signing of a long-term contract worth $1 billion to supply aluminum sheet and plate products to Boeing. [11] In addition to these developments in the aerospace sector, the company also announced that it will launch its lightest heavy-duty truck wheel in Europe in 2015. [12] These developments pertaining to its value-added segments will accelerate Alcoa’s portfolio transformation in the coming quarters.
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Notes:
- Alcoa Reports Strong Third Quarter 2014 Profits as Portfolio Transformation Delivers, Alcoa News Release [↩] [↩] [↩] [↩] [↩]
- Alcoa’s Q3 2014 Earnings Presentation, Alcoa Website [↩] [↩]
- Alcoa’s Q3 2014 Earnings Conference Call Transcript, Seeking Alpha [↩] [↩]
- LME Aluminum Prices, LME [↩]
- LME Aluminum Prices, LME [↩]
- U.S. Geological Survey Mineral Commodity Summary-Aluminum, 2014 [↩]
- Aluminium prices hit 17-month highs, Financial Times [↩]
- Aluminium smelter restarts seen undermining global deficit outlook, Reuters [↩]
- Alcoa’s 2013 10-K, SEC [↩]
- Alcoa Announces Jet Engine First in $1.1 Billion Supply Agreement with Pratt & Whitney, Alcoa News Release [↩]
- Alcoa Signs Multiyear Supply Contract with Boeing Valued at More Than $1 Billion, Alcoa News Release [↩]
- Alcoa to Roll out Lightest Heavy-Duty Truck Wheel in Europe, Offering Increased Fuel Efficiency, Payload, Alcoa News Release [↩]