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Investment Overview for Alcoa (NYSE:AA)
- Alcoa has split its business into two successor companies with effect from November 1, 2016, separating its upstream business segments from its value-added business segments. We are awaiting the release of detailed financial data from the two companies, before restructuring our models for the same.
Aluminum prices have weakened considerably over the last year or so as a result of weak global demand and oversupply, negatively impacting Alcoa's Primary Aluminum and Alumina businesses. In order to lessen its dependence on its commodity businesses, the company has been transforming its product portfolio towards its value-added business segments, which have more favorable demand prospects. The company also has just split its upstream and value-added businesses into two publicly traded companies.
- Acquisitions have boosted value-added businesses
- Alcoa has boosted its value-added businesses through the acquisition route. The company's acquisitions over the course of 2014 have largely been focused on boosting the company's revenues from its aerospace and automotive markets. This was reflected in Alcoa's results for the full year 2015, in which the company's revenues from its aerospace and automotive end markets rose 24% and 60% respectively, on a year-over-year basis.
- Reductions in aluminum smelting capacity have accelerated portfolio transformation
- The company has permanently closed down a significant proportion of its aluminum smelting capacity over the course of last year. The company's smelting capacity stood at roughly 3.4 million tons per year (mtpy) at the end of 2015, as compared to 4.04 mtpy at the end of 2013. The closure of smelting capacity has accelerated the company's portfolio transformation.
Below are key drivers of Alcoa's value that present opportunities for upside or downside to the current Trefis price estimate for Alcoa:
Primary Metals Division
- Average Price of Primary Metals: We expect realized prices for Primary Metals shipments to decline in 2016 as a result of weak demand conditions. We expect realized prices to increase gradually and grow at a higher rate towards the end of the forecast period, as economic growth (and consequently demand) in large markets, such as China, recovers. However, if economic conditions improve faster than expected, prices may increase faster than expected. In this scenario, if realized prices and margins for the division reach $2,600 per ton and 12.6% respectively, instead of $2,300 per ton and 10.6% in the base case, it would represent an upside of 5% to our price estimate.
- Primary Metals EBITDA Margin: EBITDA margins for the Primary Metals division are expected to rise to 10.6% by the end of the forecast period, driven by the company's efforts to increase the productivity of its operations. However, if the company is unable to realize these improvements in productivity, the expected margin improvements will not be realized. If margins rise to only 9.6% by the end of the forecast period, it would represent a 2% downside to our price estimate.
Alcoa is the leader in the production of aluminum products such as primary aluminum, fabricated aluminum, and alumina. The company is involved in every aspect of the industry including mining, refining, smelting, and recycling.
Aluminum products and alumina represent more than three-fourths of Alcoa’s revenues; accordingly the company is heavily impacted by aluminum prices. The company's non-aluminum products include fasteners for aerospace and industrial customers.
Alcoa operates in more than 30 countries worldwide, in addition to investments in Australia, Brazil, China, Russia, Guinea, and Saudi Arabia.
Bauxite, the primary ore used in aluminum production, along with alumina and power, make up most of the company's operating costs. Other raw materials used include petroleum coke, aluminum fluoride, fuel oil, steam, and coal.
Engineered Products division is most valuable for Alcoa
The Engineered Products segment includes titanium, aluminum, and super alloy investment castings, forgings and fasteners, aluminum wheels, integrated aluminum structural systems, and architectural extrusions.
Products are sold directly to industrial and retail customers and through distributors. Hard alloy extrusions products serve the aerospace, automotive, and commercial transportation markets.
Macroeconomic conditions limit upside to aluminum prices in near term:
Aluminum has diverse applications in industry. Thus the sales of aluminum are largely dependent on global economic growth. China, the world's largest consumer of aluminum, is expected to witness a slowdown in GDP growth to 6% in 2017, from 6.9% and 6.3% in 2015 and 2016 respectively. Weakness in Chinese economic growth will result in weakness in demand for aluminum. This would limit the growth in aluminum prices in the near term.
Indonesian export ban to provide support to prices
As per the provisions of a law passed by its Parliament, the Indonesian government halted the exports of bauxite ore from the country in January 2014. The country intends to boost its domestic mineral processing capacity at the cost of exporting unprocessed mineral exports. Bauxite is the key mineral ingredient for the production of alumina. Indonesia used to account for 10-15% of global bauxite supply and was a major exporter to China, the world’s largest aluminum producer. A constriction of supply due to the Indonesian export ban would put upward pressure on the prices of bauxite, which is used to produce alumina, the precursor for aluminum. More expensive input prices will provide support to the prices of both aluminum and alumina.
Strong growth in aerospace end markets
Alcoa expects strong long-term demand from its aerospace end markets. Current order books for commercial jets represent nine years of production at 2015 delivery rates. The strength in demand is also represented in demand for jet engines and other aircraft components.
Strong growth in automotive end markets
Robust growth in the sales of commercial vehicles will drive overall auto sales in the U.S. over the forecast period, bolstering the demand for aluminum-based automotive parts. Further, the average age of vehicles in the U.S. has risen steadily, which could be indicative of pent up demand for automobiles. In addition, there is increasing demand for aluminum components from the automobile industry as manufacturers aim to reduce the weight of their automobiles in order to meet increasingly stringent emissions regulations.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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