Higher Aluminum Prices And Value-Added Businesses To Boost Alcoa’s Q4 Results
Alcoa (NYSE:AA) will report its Q4 2014 results and conduct a conference call with analysts on Monday, January 12. We expect the company’s increasing emphasis on its high-margin value-added products to positively affect its results. In addition, higher average aluminum prices in Q4, as compared to the corresponding period in 2013, will also positively impact the fortunes of the company’s upstream Primary Aluminum and Alumina businesses segments.
The company has steadily shifted its product portfolio towards value-added products, in order to reduce its dependence on aluminum prices, which experienced an extended period of weakness over the past several quarters. The company’s value-added products enjoy pricing premiums and higher margins compared to its upstream businesses. The benefit of such a strategy is likely to be reflected in its results.
See our complete analysis for Alcoa
Aluminum Pricing
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. Economic weakness in Europe and slowing Chinese growth have contributed to the weakness in aluminum demand, and consequently prices, over the last few quarters. [1] China, the world’s largest consumer of aluminum, is expected to witness a slowdown in GDP growth to 7.3% and 7.1% in 2014 and 2015 respectively, from 7.7% in 2013. [2]
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. [3] 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 a 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. [4] 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 21% in December, since the start of the year. [5] In view of the global smelting capacity cuts, according to 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. [6] 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.
LME aluminum prices averaged roughly $1,800 per ton over the course of the fourth quarter in 2013. These prices averaged close to $1,950 per ton in the fourth quarter of 2014. [1] Higher aluminum prices are likely to translate into better results for the company’s Primary Aluminum and Alumina business segments.
Alcoa’s Strategic Shift Towards Value-added Products
The Global Rolled Products (GRP) and the Engineered Products and Solutions (EPS) divisions constitute Alcoa’s value-added business segments. 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. The fortunes of the upstream segment are to a large extent dependent on aluminum prices. To decouple itself from its dependence on aluminum prices, the company has shifted its focus towards value-added products.
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 57.1% in 2011, 2012, 2013, and the first nine months of 2014, respectively. [7] In calculating these figures, we have only considered third-party sales. The company’s value-added products accounted for 62% of its total segment after-tax operating income in the first nine months of 2014. [8]
Recent Developments
Alcoa has bet big on the aerospace segment in its continued portfolio transformation towards value-added products. In Q4 2014 alone, several major developments in the aerospace segment have taken place. In October, the company announced the opening of a $90 million plant producing advanced third-generation aluminum-lithium alloys for the aerospace industry in Lafayette, Indiana. [9] In November, Alcoa announced a $190 million investment at its Davenport, Iowa facility to expand its product offerings in the aerospace and industrial markets. [10] In December, Alcoa announced the signing of an agreement to acquire TITAL, a Germany-based producer of titanium and aluminum structural castings for aircraft engines and airframes. [11].
All these developments will translate into a growing share of value-added businesses in Alcoa’s revenue and profit figures in the coming years, particularly pertaining to its aerospace customers.
What We Would Like To Know From The Conference Call
In view of the company’s ongoing portfolio transformation, we would like to know from the company management, what the flurry of activity in the company’s value-added business segments would translate into in terms of revenue and margin improvement. It would help us understand how far the company is able to insulate itself from swings in aluminum prices.
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- LME Aluminum Prices, LME [↩] [↩]
- Goldman Sachs cuts China growth forecast sharply, Market Watch [↩]
- Aluminum Price Premiums: Disconnect Between LME and Reality Continues, Metal Miner [↩]
- U.S. Geological Survey Mineral Commodity Summary-Aluminum, 2014 [↩]
- Dominant holder highlights problems in aluminium market, Financial Times [↩]
- Aluminium smelter restarts seen undermining global deficit outlook, Reuters [↩]
- Alcoa’s 2013 10-K, SEC [↩]
- Alcoa’s Q3 2014 10-Q, SEC [↩]
- Alcoa Opens World’s Largest Aluminum-Lithium Aerospace Plant in Indiana, Alcoa News Release [↩]
- Alcoa Announces Investment to Further Aerospace Manufacturing Leadership, Alcoa News Release [↩]
- Alcoa to Acquire TITAL to Expand Global Growth Platform for Titanium Aerospace Components, Alcoa News Release [↩]