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Investment Overview for Alcoa (NYSE:AA)

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1. Latest Earnings Update
   • Alcoa’s trend of a shrinking revenue base over the last few quarters continued in Q3 2019 as well. Alcoa reported revenues of $2.6 billion in Q3 2019, marking a decline of 24.2% over the previous year period. Lower revenue was driven by a decrease in aluminum shipments, along with a drop in global price levels of alumina and aluminum, on the back of excess supply and lower demand. The company reported an adjusted loss of $0.44 per share in Q3 2019, compared to adjusted earnings of $0.82/share in Q3 2018. Lower earnings were primarily driven by decreased price realization, restructuring charges and expenses related to divestiture of the Avilés and La Coruña facilities in Spain.

2. Portfolio Review
   • Over the next 12 to 18 months, Alcoa intends to pursue non-core asset sales expected to generate an estimated $500 million to $1 billion in net proceeds. Based on annualized 2019 year-to-date results, the Company estimates approximately $50 million to $100 million in reduced adjusted EBITDA due to such asset sales. Over the next five years, Alcoa plans to realign its operating portfolio, and has placed under review 1.5 million metric tons of smelting capacity and 4 million metric tons of alumina refining capacity. The review will consider opportunities for significant improvement, potential curtailments, closures or divestitures

3. Sale of Assets and New Operating Model
   • Alcoa divested the Avilés and La Coruña facilities in Spain, for which it recorded $137 million in charges for Q3 2019. Additionally, $37 million restructuring charge for severance costs related to implementing a new operating model was also recorded. The new model, which goes into effect on November 1, 2019, will result in a leaner corporate structure, with operations more closely connected to leadership, through elimination of the Company’s business unit structure and consolidation of sales, procurement and other commercial capabilities at an enterprise level. The Company anticipates the majority of the restructuring costs associated with the new operating model will be paid in cash in the fourth quarter 2019 with the remainder in the first quarter 2020. The new operating model is expected to result in annual savings of approximately $60 million in operating costs beginning in the second quarter of 2020.

4. $200 million Stock Repurchase Program
   • On October 17, 2018, Alcoa announced a $200 million stock repurchase program that would be executed depending on cash availability, market conditions and other factors. This repurchase program does not have a predetermined expiration date. In Q4 2018, management repurchased shares worth $50 million.

5. Spin-off of value-added businesses
   • Alcoa spun off its light metals engineering businesses (the value-added businesses of the undivided Alcoa Inc.) towards the end of 2016. The value-added businesses now constitute an independent company named Arconic. The undivided Alcoa's commodity businesses, primarily the manufacture and sale of aluminum, alumina, and bauxite, now constitute the business of the successor company, which carries the Alcoa name.

6. After being in deficit in 2018, Alumina to turn surplus in 2019. Bauxite surplus to continue through the year
   • Global alumina deficit in 2018 was primarily driven by third-party supply disruptions with a 50% supply cut expected from the world's largest alumina refinery, Alunorte, to comply with judicial orders. This was expected to be further exacerbated by the re-establishment of China's refinery curtailments during winter cuts. Alumina supply was also affected due to strikes at Alcoa's 3 mines - Wagerup, Pinjarra, and Kwinana. In 2019, we expect alumina surplus in China, due to refinery expansions and lower than previously expected smelting production due to economic and environmental reasons. Bauxite is expected to continue remaining in surplus in 2019 due to rising year-on-year exports from Guinea, Australia, and Indonesia. Additionally, Chinese customers stockpile bauxite due to uncertain sourcing within and outside China. Surplus in 2019 will help them grow stockpile this year as well.

7. Aluminum to remain in deficit in 2019
   • The global aluminum deficit in 2018 was aggravated by the global alumina supply deficits and similar aluminum production curtailments. Additionally, the 10% tariff imposition in the U.S. amplified the impact of the deficit in the U.S., in particular. Also, US sanctions on Rusal, which accounts for 14% of world aluminum production outside China, affected supply. Though Alcoa has been able to achieve some success with striking employees, other global factors would continue to affect supply in 2019. Lower margins have led to many economic curtailments of smelting plants. Continued strong consumption growth in developing and developed markets would lead to robust demand for aluminum, which will not be completely met due to rising curtailments. Though the management forecasts a year of aluminum supply deficit, it is not reflecting in pricing due to continuous rise in Chinese aluminum exports, which have exceeded 500kmt in seven of the last eight months. China is a leader in semi-fabricated products and a major exporter. As increasing number of steel players are shedding capacity and demand from automobiles being modest, China has increased its exports of semi products at a lower price, which has in turn led to a decline in primary aluminum products worldwide. Aluminum prices have fallen from about $1,974 per ton in December 2018 to about $1,855/ ton currently. Alcoa’s aluminum price realization is expected to decrease in 2019, led by subdued global price levels.

8. Curtailment of additional capacity at smelter in Canada
   • In December 2018, Alcoa curtailed half of one operating potline at the Becancour smelter in Quebec, as the curtailment was necessary to ensure continued safety and maintenance in light of recent retirements and departures. This will enable the salaried employees to continue to run this portion of the line safely with a smaller workforce, while the company would continue to work on reaching a new labor contract with the unionized workforce.

9. RCF Amended and Restated
   • In November 2018, Alcoa entered into an amended and restated $1.5 billion revolving credit agreement. As per the new terms, the maturity date has been extended by a year to 2023. Also, a few favorable terms have been included, such as, lower interest rate and release of collateral in case Alcoa achieves an investment grade rating with stable or better outlook. This reflects Alcoa's improving financial profile and a better debt maturity schedule for the company.

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Below are key drivers of Alcoa's value that present opportunities for upside or downside to the current Trefis price estimate for Alcoa:

Aluminum Division

• Average Price of Aluminum Shipments: Aluminum prices have been in an uptrend since 2017. However, price has declined in the last few months and we expect realized prices for Aluminum shipments to decline further. This would be as a result of a poor demand outlook. However, if there is a truce in the US-China trade war and global economic conditions improve, particularly in the manufacturing and infrastructure sectors in China and the U.S., it would drive the demand for aluminum and the prices of the commodity, coupled with the global supply deficit prediction. If demand conditions improve faster than expected, prices may increase faster than currently factored into our estimates. In this scenario, if realized prices for the division reach $2,600 per ton by the end of the forecast period, instead of $2,392 per ton in the base case, it would represent an upside of 5% to our price estimate.
• Aluminum EBITDA Margin: EBITDA margins for the Aluminum division are expected to rise to 10% by the end of the forecast period, driven by expectations of improved pricing environment in the medium term and the company's efforts to boost the productivity of its operations. However, if the company is unable to realize these improvements in productivity, margin growth for the division will be lower than currently factored into our model. In this scenario, if margins rise to only 8% by the end of the forecast period, it would represent a 5% downside to our price estimate.

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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 represent around 54% of Alcoa’s revenues; accordingly, the company is heavily impacted by aluminum prices.

Alcoa operates in around 10 countries worldwide, including Australia, Brazil, the U.S., and European countries.

Bauxite is the primary ore used in alumina production whereas alumina is the primary ore used in aluminum production. The company also sells bauxite and alumina to third parties.

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Alumina division is most valuable for Alcoa

In spite of the Aluminum segment contributing maximum revenue to Alcoa, the alumina division has become the most valuable division for the company is 2018. This was mainly due to higher margins in the segment, favorable price and product mix and higher prices due to supply constraints. However, we expect aluminum to come back as the most valued segment for the company in the near future.

The Alumina segment represents the company's worldwide refining system, which processes bauxite into alumina. About two-thirds of the alumina produced is sold under supply contracts to third parties worldwide, while the remainder is used internally by Alcoa's aluminum segment

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Deteriorating demand conditions for aluminum:

Aluminum has diverse applications in industry. Thus the sales of aluminum are largely dependent on global economic growth. With the US-China trade war taking a toll on global trade and growth, deteriorating economic conditions are expected to decrease the demand for aluminum and the prices of the metal. Developments in China and the U.S. are particularly important. Additionally, contracting manufacturing activity, especially in the global automotive sector is also expected to lead to a drop in demand for aluminum. This could be partially offset by the U.S. government's infrastructure revamp plan. Thus, concerns about global manufacturing, industrial and economic growth is expected to keep aluminum prices subdued in the near term.

Imposition of punitive tariffs against aluminum imports in the U.S.

The U.S. government's tariffs on imported aluminum in the country. are expected to boost domestic aluminum demand and remain a beneficial move for Alcoa as it is a prominent U.S. aluminum player.

Effects of Rusal sanctions

The U.S. government recently announced sanctions against the Russian giant, Rusal, barring them from international business. However, these sanctions were consequently eased with a possible hint of withdrawal given that Rusal's majority owner, Deripaska, ceded control from the company. These major developments had led to excessive growth and consequent decline in both, aluminum commodity and aluminum stock prices, making the market extremely uncertain.

Relaxation of Indonesian export ban could dampen bauxite 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 has supported bauxite prices. However, Indonesia relaxed this ban in 2017. Further relaxation of export regulations in the country could boost global supply and dampen prices.

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?

1. We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
2. 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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