Alcoa Furthers Portfolio Transformation With Recent Business Developments

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Alcoa

Alcoa (NYSE:AA) has announced steps that will further its ongoing portfolio transformation. The company has announced a $190 million investment at its Davenport, Iowa facility to expand its product offerings in the aerospace and industrial markets. [1] In addition, the company recently announced that it had reached an agreement to sell its ownership stake in the Mt. Holly aluminum smelter in Goose Creek, South Carolina, to Century Aluminum Company for $67.5 million in cash, plus an additional potential earn-out. [2] These steps are a part of the company’s ongoing strategic shift towards value-added products, which are more profitable than its upstream businesses.

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Recent Developments

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The latest investment in the company’s facility at Davenport, Iowa is aimed at enhancing the performance of thick aluminum and aluminum-lithium plate in various applications, including wing ribs and fuselage frames. [1] The company is installing a new ‘very thick plate stretcher’. This investment will enable the Davenport Works facility to produce the largest high-strength monolithic wing ribs in the industry. In addition, it will enable Alcoa to serve the existing plate market while also providing airframe builders with the ability to make large wing ribs, fuselage frames and bulkheads using Alcoa thick plate. [1]

The company also recently announced the sale of its 50.3% stake in the Mt. Holly smelter to Century Aluminum Company, which holds the remaining 49.7% stake in the smelter. The transaction is expected to close by the end of 2014. This sale is consistent with the company’s policy to reduce its high-cost smelting capacity, in order to increase the competitiveness of its upstream businesses. The Mt. Holly smelter has a capacity to produce 229,000 tons of aluminum annually. The sale of its stake in the smelter will lower Alcoa’s global smelting capacity to 3.5 million tons per year. [2] The company had earlier reduced its base smelting capacity from 4.23 million tons per year at end of 2012 to 4.04 million tons per year at the end of 2013. ((Alcoa’s 2013 10-K, SEC)) As a result of the curtailment and closure of high-cost smelting capacity, Aloca’s average production cost per ton of aluminum fell from $2,287 in 2012 to $2,201 in 2013. [3]

These recent developments are a part of the company’s ongoing portfolio transformation, which will reduce its dependence on its upstream commodity businesses and consequently, fluctuations in aluminum prices.

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 weakness in aluminum demand, and consequently prices over the last few quarters. [4]

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 London Metal Exchange (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. [5] ((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.

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. [6] 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. [7] LME aluminum prices averaged roughly $1,800 per ton over the course of the third quarter in 2013. These prices have averaged close to $2,000 per ton in the third quarter this year. [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 addition, the trajectory of Chinese economic growth will influence aluminum prices to a large extent. With slowing Chinese growth, there is unlikely to be any significant upside to aluminum prices. A significant proportion of Alcoa’s alumina pricing contracts are based on LME aluminum prices. Thus, the uncertainty in aluminum prices affects Alcoa’s Alumina business segment as well. In view of the uncertainty regarding aluminum prices, Aloca has sought to reduce its dependence on its commodity businesses.

Portfolio Transformation

Alcoa’s shift towards value-added products is reflected in its revenue figures. The percentage contribution of value-added products, represented by the Global Rolled Products and Engineered Products and Solutions business segements, to the company’s total revenues has steadily increased. This figure stood at 52.1%, 54.4%, 55.7% and 57.1% in 2011, 2012, 2013 and the first nine months of 2014, respectively. ((Alcoa’s 2013 10-K, SEC)) [9] In calculating these figures, we have only considered third-party sales. Value-added businesses will drive Alcoa’s results in the near future, with cost reduction expected to keep its commodity businesses competitive.

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Notes:
  1. Alcoa Announces Investment to Further Aerospace Manufacturing Leadership, Alcoa News Release [] [] []
  2. Alcoa to Sell Ownership Stake in Mt. Holly Smelter to Century Aluminum, Alcoa News Release [] []
  3. Alcoa’s 2013 10-K, SEC []
  4. LME Aluminum Prices, LME []
  5. U.S. Geological Survey Mineral Commodity Summary-Aluminum, 2014 []
  6. Aluminium prices hit 17-month highs, Financial Times []
  7. Aluminium smelter restarts seen undermining global deficit outlook, Reuters []
  8. LME Aluminum Prices, LME []
  9. Alcoa’s Q3 2014 10-Q, SEC []