Trends Driving Our $12 Price Estimate For Alcoa

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Aluminum prices have fallen sharply over the past couple of months. London Metal Exchange (LME) aluminum prices are currently trading close to $1,700 per ton, as compared to $1,900 per ton around two months ago. [1] The recent fall in prices has primarily been due to a global aluminum supply glut, driven by rising Chinese aluminum exports. [2]

LME Aluminum Prices

(Source: London Metal Exchange)

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. [3]

On the supply side, production capacity has not been reduced corresponding to the weakness in demand over the past couple of years. Persistently high aluminum inventory levels relative to demand have kept LME aluminum prices depressed. This inventory was built up partly due to excess supply, and partly as a result of aluminum being tied up in financing deals, which were made possible due to low interest rates. [4] 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 accounts for around half of the world’s aluminum production, and the expansion in production by Chinese producers has more than made up for capacity cuts by global majors. [5] This oversupply situation is expected to keep aluminum prices depressed.

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Earlier this year, Chinese aluminum producers were boosted by a decision of the Chinese government to provide tax breaks and subsidized power to domestic aluminum smelters. [6] This has encouraged Chinese aluminum producers to maintain high production levels despite the weakness in aluminum pricing. In addition, a recent decision of the Chinese government to do away with taxes on exports of aluminum will boost the country’s aluminum exports. [7] As a result of a combination of weakness in domestic demand and rising domestic production, China’s aluminum exports rose 43% year-over-year in Q1. [7] The rising tide of exports from China has worsened the global oversupply situation, which has negatively impacted aluminum prices.

Trefis Estimate

As a result of the decline in aluminum prices, we have revised downward pricing forecasts in our stock price model for Alcoa. As a result, our new price estimate for Alcoa stands at $12.59, which is around 12% lower than our previous estimate.

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Notes:
  1. LME Aluminum Prices, LME [] []
  2. Supply glut puts pressure on aluminium, Financial Times []
  3. World Economic Outlook January Update, IMF []
  4. Aluminum Price Premiums: Disconnect Between LME and Reality Continues, Metal Miner []
  5. Global aluminum production; the sound of one hand clapping, Reuters []
  6. China measures set to boost aluminium supply, Financial Times []
  7. China’s Aluminum Set to Worsen Glut as Export Taxes Removed, Bloomberg [] []