Alcoa Q3 Earnings Review: Productivity Improvements Partially Offset Impact Of Weak Aluminum Prices
Alcoa (NYSE:AA) released its third quarter results and conducted a conference call with analysts on October 8. [1] As expected, the ongoing weakness in aluminum prices negatively impacted the company’s results, with productivity improvements partially offsetting the negative impact of weak pricing. Alcoa’s adjusted net income, which excludes the impact of one-off items, fell to $109 million in Q3 2015, as compared to $149 million in the corresponding period of last year. [1] The company reported an 11% year-over-year decline in revenues to $5.57 billion, due to a combination of divestments, smelting capacity closures and weak aluminum pricing, partially offset by rising revenues from the companies value-added segments, as a result of a combination of acquisitions and organic growth. [1] The most important takeaway from the earnings call was the management’s confidence in the prospects of the company’s value-added businesses, after the company’s recent announcement to split its upstream and value-added businesses in the second half of 2016.
Weak Aluminum Prices and Productivity Improvements
LME Aluminun Prices, Source: LME
Alcoa uses London Metal Exchange (LME) aluminum prices as a reference for its own aluminum sales. The sharp decline in LME aluminum prices over the last twelve months has negatively impacted Alcoa’s results, with the company’s average realized price for primary aluminum sales declining 25% year-over-year to $1,901 per ton. [2] Weak LME aluminum prices negatively impacted Alcoa’s results to the tune of $219 million on a year-over-year basis in Q3. [2]
Aluminum is a metal that has extensive industrial applications and the demand for the metal is largely correlated with economic growth. Slowing economic growth in China, the world’s largest consumer of aluminum, has raised concerns over Chinese demand for the metal, negatively impacting aluminum prices. [3] On the supply side, robust Chinese aluminum production, facilitated by state support in the form of tax breaks and subsidized power, has resulted in a global oversupply situation. [4] This oversupply of aluminum is expected to keep prices of the metal subdued in the near term.
The weakness in pricing negatively impacted the results of the Primary Metals business segment, with the segment reporting a loss of $59 million as its after tax operating income (ATOI) for Q3 2015, as compared to a profit of $245 million in the corresponding period last year. [1] In contrast to the Primary Metals segment, the Alumina business segment reported an ATOI of $212 million in Q3 2015, as compared to $62 million in the corresponding period last year. [1] Despite weak alumina prices, the closure of high-cost refining capacity, the commencement of production from lower cost facilities, and productivity improvements propped up this segment’s profits.
Company-wide productivity improvements boosted Alcoa’s bottom line by $186 million after tax, which partially offset the negative impact of weak aluminum pricing and higher maintenance and labor related costs. [5]
Value-Added Businesses
Alcoa has been strategically realigning its operations towards its value-added businesses over the past several quarters. These business segments produce a variety of lightweight metal engineered products, with the aerospace and automotive end markets constituting the most important customer base for these businesses. The share of the value-added businesses in the company’s revenues (considering only third party sales) stood at nearly 59% in the first nine months of 2015, as compared to around 54% in 2012. [1]
Alcoa recently announced that it intends to split up its upstream and value-added businesses into separate publicly traded companies in the second half of 2016. The company’s value-added business are less impacted by fluctuations in aluminum prices, as compared to the upstream segments, and the end markets for these businesses have strong growth prospects. Alcoa’s value-added segments reported a combined ATOI of $257 million, as compared to $274 million in the corresponding period last year. [1] Higher production volumes and productivity improvements offset the impact of weakness in aluminum pricing and costs associated with the ramp-up of new facilities on the results of the value-added segments. The company management is very bullish about the prospects of its value-added business, considering the robust growth prospects in the aerospace and automotive end markets. Alcoa’s aerospace and automotive revenues rose 25% and 44% year-over-year respectively in the first nine months of 2015, through a combination of organic and inorganic growth. [2] In addition, the company recently announced the signing of long-term supply agreements with Airbus and Lockheed Martin, adding to the robust prospects of its value-added businesses. [5] Given the flurry of activity in terms of acquisitions, organic capacity expansions, and the signing of new deals, the future looks bright for Alcoa’s value-added businesses and the standalone company that would comprise these businesses in 2016.
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Notes:
- Alcoa Q3 2015 Earnings Release, Alcoa Website [↩] [↩] [↩] [↩] [↩] [↩] [↩]
- Alcoa Q3 2015 Earnings Presentation, Alcoa Website [↩] [↩] [↩]
- Copper and Aluminum Sag to Six-Year Lows on China Demand Concern, Bloomberg [↩]
- China measures set to boost aluminium supply, Financial Times [↩]
- Alcoa’s Q3 2015 Earnings Call Transcript, Seeking Alpha [↩] [↩]