Alcoa Q4 2015 Earnings Review: Weakness in Aluminum Prices Weighs On Results

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Alcoa (NYSE:AA) released its fourth quarter results and conducted a conference call with analysts on January 11. [1] The company’s results were negatively impacted by the weakness in aluminum and alumina prices, with productivity improvements partially offsetting the negative impact of weak pricing on results. Alcoa’s adjusted net income, which excludes the impact of one-off items, fell to $65 million in Q4 2015, as compared to $432 million in the corresponding period of last year. [2] The company reported an 18% year-over-year decline in revenues to $5.25 billion in Q4 2015, with a combination of lower aluminum and alumina prices, divestitures, and closures in upstream capacity translating into lower revenues. [1] The most important takeaway from the earnings call was that Alcoa remains on track to complete the separation of its upstream and value-added business segments into two companies in the second half of 2016, with cost reduction expected to remain the mantra for boosting profitability of the upstream side, whereas profitable growth opportunities in the aerospace and automotive end markets are expected to boost the prospects of the value-added segments.

Weak Pricing Negatively Impacts Results

LME Aluminum Prices, Source: LME

Alcoa uses London Metal Exchange (LME) aluminum prices as a reference for its own sales. The decline in LME aluminum prices over the last twelve months, as illustrated by the chart shown above, weighed down Alcoa’s Q4 results, with the company reporting a 30% year-over-year decline in its average realized price for aluminum sales in Q4. [2]

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Aluminum prices have weakened considerably over the past year due to the prevailing oversupply of the metal. Aluminum is extensively used in industrial applications and the demand for the metal is largely correlated with economic growth. Weakening economic growth in China, the world’s largest consumer of aluminum, has raised concerns about Chinese demand for the metal, negatively impacting aluminum prices. [3] Despite the weakness in demand, high aluminum production levels in China, enabled by state support in the form of tax breaks and the provision of subsidized power, have resulted in a global oversupply situation. [4] The oversupply of aluminum will put pressure on aluminum prices in the near term.

The weakness in demand for aluminum has also translated into weakness in demand for alumina, since alumina is primarily used in the production of aluminum. Weakness in demand for alumina has negatively impacted pricing, with the company reporting a 24% year-over-year decline in prices. ((Alcoa Q4 2015 Earnings Release, Alcoa Website)) In addition to the weakness in pricing, both the Primary Metals and Alumina business segments reported lower production and shipment levels in Q4, due to the closure of high cost production capacity. As a result of a combination of weaker pricing and shipments, the Alumina business segment’s after tax operating income (ATOI) fell to $98 million in Q4 2015, around 45% lower than in the corresponding period of last year. ((Alcoa Q4 2015 Earnings Release, Alcoa Website)) Similarly, the Primary Metals segment reported a loss of $40 million in Q4 2015, as compared to an ATOI of $267 million in Q4 2014. ((Alcoa Q4 2015 Earnings Release, Alcoa Website))

Company-wide productivity improvements boosted Alcoa’s bottom line by $350 million year-over-year in Q4 2015, which partially offset the impact of weak pricing on the company’s results. [5]

Value-Added Businesses

A combination of organic growth and acquisitions have boosted the share of value-added businesses in Alcoa’s revenues. Alcoa’s value-added businesses 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 company announced in Q3 2015 that it intends to split up its upstream and value-added businesses into separate publicly traded companies in the second half of 2016. This split would separate the high-growth potential value-added businesses from its upstream segments, in which the company is shutting down high-cost capacity. Alcoa’s value-added segments reported a combined ATOI of $215 million, flat as compared to the corresponding period of 2014. [2] Higher production volumes in the Engineered Products and Solutions segment offset the impact of lower shipments from the Global Rolled Products segment (as a result of divestitures). In addition, 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.

Alcoa’s management is extremely bullish about the prospects of its value-added business, considering the high growth prospects in the company’s aerospace and automotive end markets. Alcoa’s aerospace and automotive revenues rose 24% and 60% year-over-year respectively in 2015, through a combination of organic and inorganic growth. [2] With several long-term deals translating into a firm order book for Alcoa’s value-added businesses, future prospects look quite bright for the value-added segments post the planned split in 2016. On the other hand, the upstream segments will have to continue to focus on managing costs, given that the pricing environment is unlikely to improve significantly any time soon.

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Notes:
  1. Alcoa Q4 2015 Earnings Release, Alcoa Website [] []
  2. Alcoa Q4 2015 Earnings Presentation, Alcoa Website [] [] [] []
  3. Copper and Aluminum Sag to Six-Year Lows on China Demand Concern, Bloomberg []
  4. China measures set to boost aluminium supply, Financial Times []
  5. Alcoa’s Q4 2015 Earnings Call Transcript, Seeking Alpha []