Alcoa Earnings Preview: Productivity Improvements To Partially Offset Impact Of Weak Aluminum Prices On Q3 Results

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Alcoa (NYSE:AA) will release its third quarter results and conduct a conference call with analysts on Thursday, October 8. [1] The prevailing weakness in aluminum prices is expected to negatively impact the company’s results. However, the company’s efforts to boost the productivity of its operations, including the closure of high cost smelting capacity, will at least partially offset the impact of weak aluminum prices on the results. In addition, a string of acquisitions pertaining to Alcoa’s value-added businesses over the past year should boost the volumes of the company’s Engineered Products and Solutions (EPS) business segment. Alcoa announced its decision to split its upstream and value-added businesses towards the end of last month, a step which is a culmination of its portfolio transformation process. In this article, we will take a look at what to expect from Alcoa’s Q3 results.

Aluminum Prices

Aluminum Prices, Source: LME

Aluminum prices have weakened considerably over the past twelve months, as indicated by the graph shown above. Aluminum is a metal with extensive industrial applications and the demand for the commodity is largely correlated with economic growth. A slowdown in economic growth in China, the world’s largest consumer of aluminum, has raised concerns over Chinese demand for the metal, negatively impacting aluminum prices. [2] On the supply side, booming Chinese aluminum production, facilitated by state support in the form of tax breaks and subsidized power, has resulted in a global oversupply situation. [3] The prevailing oversupply of aluminum is expected to keep prices of the metal subdued in the near term.

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LME aluminum prices averaged roughly $2,000 per ton over the course of the third quarter in 2014. ((LME Aluminum Prices, LME)) These prices averaged close to $1,600 per ton in Q3 2015. [4] Lower aluminum prices will negatively impact Alcoa’s Q3 results, particularly those of the upstream Primary Aluminum and Alumina business segments.

Productivity Improvements

In order to counteract the impact of weakening aluminum prices on its results, Alcoa has been trying to boost the productivity of its operations through a variety of measures, including the closure of high cost smelting capacity. Alcoa’s smelting capacity currently stands at 3.4 million tons per year (MTPY), as compared to 4.04 MTPY at the end of 2013. [5] Company-wide productivity improvements boosted Alcoa’s year-over-year quarterly profits to the tune of $209 million post tax in Q2, allowing the company to report a higher year-over-year adjusted net income figure in the second quarter, despite weaker aluminum prices. [6] These productivity improvements should at least partially offset the negative impact of weak aluminum prices on Alcoa’s Q3 results.

Recent Developments

Given the weakness in aluminum prices and strong demand for the company’s value-added products, Alcoa has been increasingly focusing on its value-added segments to drive the company’s growth. This is reflected in the share of value-added products in Alcoa’s revenues (considering only sales to third parties), which has risen from 54.4% in 2012 to 57.7% in the first half of 2015. [6] Alcoa has boosted production capacity pertaining to its value-added businesses as well as made several acquisitions in this space, focusing on the aerospace and automotive end markets. As a result of these actions, the shipments of the EPS segment and the share of Alcoa’s value-added businesses in the company’s overall revenues are set to rise in Q3 and beyond.

Alcoa’s portfolio transformation process culminated in a recent announcement to split up the value-added and the upstream businesses into distinct publicly traded companies in the second half of 2016. [7] This move should benefit the value-added businesses, since these have superior prospects as compared to the upstream business segments. We look forward to hearing more details on this latest development from the company management in the Q3 earnings conference call.

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Notes:
  1. Alcoa to Host Webcast of Third Quarter 2015 Results, Alcoa News Release []
  2. Copper and Aluminum Sag to Six-Year Lows on China Demand Concern, Bloomberg []
  3. China measures set to boost aluminium supply, Financial Times []
  4. LME Aluminum Prices, LME []
  5. Alcoa to Close Poços Smelter in Brazil, Alcoa News Release []
  6. Alcoa’s Q2 2015 Earnings Release, Alcoa Website [] []
  7. Alcoa to Separate into Two Industry-Leading Public Companies, Completing Successful Multi-Year Transformation, Alcoa News Release []