Alcoa: Higher Aluminum Prices And Productivity Improvements Boost Q4 Results

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Alcoa (NYSE:AA) released its fourth-quarter earnings results and conducted a conference call with analysts on Monday, January 12. The company reported strong year-over-year growth in quarterly profits, with all business segments reporting strong results. Excluding one-time costs, net income stood at $432 million in Q4 2014, as compared to $40 million in the corresponding period last year. [1] One-time charges, totaling $273 million in Q4 2014, primarily consist of non-cash charges pertaining to  restructuring activities undertaken by the company during the quarter. [1] These include the sale of three rolling mills in Europe, the sale of Alcoa’s stake in the Jamalco mine and alumina refinery, and the completion of closure activities at the company’s rolling mills in Australia. Quarterly revenues stood at $6.38 billion in Q4 2014, around 2% higher compared to the corresponding period a year ago. [1]

The increase in the company’s profit figures in Q4, as compared to the corresponding period a year ago, are mainly due to company-wide productivity improvements and improvements in realized prices, which sharply boosted the results of the company’s upstream Alumina and Primary Metals business segments.

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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Better Pricing and Productivity Improvements

Alcoa’s average realized price per ton ton of aluminum sold stood at $2,578 in Q4 2014. This is almost 19% higher compared to the corresponding period in 2013. [1] This was partly due to higher London Metal Exchange (LME) aluminum prices. The company uses LME prices as a reference for the prices of its own primary metal sales. 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. [2]

Aluminum has diverse applications in industry. The demand for aluminum is broadly correlated with industrial growth. Economic weakness in Europe and slowing Chinese growth contributed to the weakness in aluminum demand, and consequently prices, over the last few quarters. Global smelting capacity cuts, in response to low prices, have led to a tightening of supply. This has positively impacted aluminum prices. LME warehouse stocks of aluminum were down around 21% in December, since the start of the year. [3] 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. [4] 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 led to the increase in aluminum prices. [5]

In addition, the  results of the company’s Alumina and Primary Metals business segments benefited from the company’s ongoing efforts to reduce operating costs and enhance the productivity of its operations. The closure of some of the company’s high-cost smelting and refining capacity in previous quarters has contributed to this. Company-wide productivity improvements boosted the company’s year-over-year quarterly profits to the tune of $210 million. [1] As for the company’s upstream businesses, a combination of higher prices and productivity improvements boosted the after-tax operating income of the Primary Metals business segment to $267 million in Q4 2014, from a loss of $35 million in Q4 2013. [1] The after-tax operating income of the Alumina business segment rose to $178 million in Q4 2014, from $70 million in Q4 2013. [1]

Portfolio Transformation and Performance of Value-Added Segments

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 the 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 lessen its dependence on aluminum prices, the company has shifted its focus towards value-added products. The company is focusing on the aerospace and automotive segments and has made several investments and acquisitions over the past year to cater to customers in these segments.

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 56.4% in 2011, 2012, 2013, and 2014 respectively. [6] [1] In calculating these figures, we have only considered third-party sales.

The results of the GRP segment in Q4 2014 were boosted by robust demand for aluminum sheet from the automotive sector, which boosted volumes. In addition, higher aluminum prices provided a better pricing environment for the segment. Lastly, Alcoa’s company-wide efforts to boost productivity also helped boost the segment’s results. After-tax operating income for the GRP segment rose to $71 million in Q4 2014, as compared to $ 21 million in Q4 2013. [7] The after-tax operating income for the EPS segment, excluding the impact of the integration of Firth Rixson, a manufacturer of jet-engine components that Alcoa acquired in 2014, rose from $168 million in Q4 2013 to $177 million in Q4 2014, driven by robust demand from the aerospace and commercial transportation segments, which boosted shipment volumes. [1]

The Road Ahead

The company expects to continue its ongoing strategic shift towards value-added products in 2015. The investments made by the company in boosting its production capacity and enhancing the breadth of its product offerings, should result in an increased share of value-added products in the company’s overall revenues. In addition, the company expects to continue improving the productivity of its operations. Alcoa expects to realize benefits totaling $900 million from productivity improvements. [7] A combination of an increasing share of value-added products and productivity improvements bodes well for Alcoa’s results in Q1 2015 and beyond.

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Notes:
  1. Alcoa’s Q4 2014 Earnings Presentation, Alcoa Website [] [] [] [] [] [] [] [] []
  2. LME Aluminum Prices, LME []
  3. Dominant holder highlights problems in aluminium market, Financial Times []
  4. Aluminium smelter restarts seen undermining global deficit outlook, Reuters []
  5. LME Aluminum Prices, LME []
  6. Alcoa’s 2013 10-K, SEC []
  7. Alcoa’s Q4 2014 Earnings Call Transcript, Seeking Alpha [] []