Higher Aluminum Prices And Value-Added Businesses To Boost Alcoa’s Q1 Results
Alcoa (NYSE:AA) will report its Q1 2015 results and conduct a conference call with analysts on Wednesday, April 8. 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 Q1 2015, as compared to the corresponding period in 2014, will also positively impact the fortunes of the company’s upstream Primary Aluminum and Alumina business segments.
The company has steadily shifted its product portfolio towards value-added products, in order to reduce its dependence on aluminum prices, which have 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.
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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 6.8% and 6.3% in 2015 and 2016 respectively, from 7.4% in 2014. [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 accounts for around 45% of the world’s aluminum production, 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 2014. [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 this year. In any case, the tightening of the physical supply of aluminum has provided a boost to aluminum prices.
LME aluminum prices averaged roughly $1,700 per ton over the course of the first quarter in 2014. These prices averaged close to $1,800 per ton in Q1 2015. [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 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 56.4% in 2011, 2012, 2013, and 2014, respectively. [7] [8] In calculating these figures, we have only considered third-party sales.
Recent Developments
Alcoa has bet big on the aerospace segment in its continued portfolio transformation towards value-added products. In Q1 2015 alone, several major developments in the aerospace segment have taken place. In March, the company announced the completion of the acquisition of TITAL, a Germany-based producer of titanium and aluminum structural castings for aircraft engines and airframes. [9] The company also announced the $1.5 billion acquisition of RTI International Metals, Inc. a global supplier of titanium and specialty metal products and services for the commercial aerospace, defense, energy, and medical device markets. [10] In addition, the company announced the opening of an expanded aluminum wheel manufacturing capacity in Europe, earlier on in the quarter. [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 shed some light on the road ahead for Alcoa.
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Notes:
- LME Aluminum Prices, LME [↩] [↩]
- World Economic Outlook January Update, IMF [↩]
- 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 Q4 2014 Earnings Presentation, Alcoa Website [↩]
- Alcoa Completes Acquisition of TITAL, Alcoa News Release [↩]
- Alcoa to Acquire RTI International Metals, Boosting Value-Add, Multi-Material Aerospace Portfolio, Alcoa News Release [↩]
- Alcoa Opens Expanded Wheels Manufacturing Plant in Hungary, Alcoa News Release [↩]