- Alumina constitutes 57% of the Trefis price estimate for Alcoa's stock.
- Aluminum constitutes 23% of the Trefis price estimate for Alcoa's stock.
- Bauxite constitutes 21% of the Trefis price estimate for Alcoa's stock.
WHAT HAS CHANGED?
- Impact of the coronavirus outbreak
- Aluminum was one of the worst affected commodities due to the spread of coronavirus. Aluminum prices dropped from about $1,820/ton in January 2020, to below $1,500/ton in April 2020, with the spread of the virus, which affected industrial activity and demand. All aluminum miners had already faced a difficult 2019 due to a subdued pricing environment, before 2020 made it worse. However, with the package announced by the Fed and other central banks of the world to keep businesses afloat, and with lockdowns being gradually lifted, aluminum prices saw a sharp recovery on the back of expectations of increase in demand lower supply constraints. Aluminum prices have recovered to over $2,500/ton in July 2021.
- Latest Earnings Update
- In Q2 2021, Alcoa has recorded its highest profitability since inception in 2016, with a net income of $309 million on revenue of $2,833 million. Net income margin came in at 11% while EPS was $1.63 for the quarter. Aluminum price realization increased 60% y-o-y. Alcoa has sold former Eastalco site in Maryland for $100 million and finished the quarter with cash balance of $1.65 billion.
- FY 2020 Earnings Update
- Alcoa’s trend of a shrinking revenue base over the last few quarters continued in Q4 2020 as well. Alcoa reported revenues of $2.392 billion in Q4 2020, marking a decline of 2% over the previous year period. For the full year, Alcoa reported revenue of $9.286 billion in 2020, 11% lower than in 2019. Lower revenue was driven by a decrease in alumina and aluminum prices, on the back of excess supply and lower demand. The outbreak of the pandemic also hit Alcoa's top and bottom line in 2020. The company reported an adjusted loss of $1.16 per share in FY 2020, compared to adjusted loss of $0.99/share in FY 2019. Lower earnings were primarily driven by decreased price realization and higher interest cost.
- 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. It 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.
- Sale of Assets and New Operating Model
- Alcoa divested the Avilés and La Coruña facilities in Spain. The new model, which went into effect on November 1, 2019, envisaged a leaner corporate structure, with operations more closely connected to leadership, through the elimination of the Company’s business unit structure and consolidation of sales, procurement, and other commercial capabilities at an enterprise level. 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.
POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE
Below are key drivers of Alcoa's value that present opportunities for upside or downside to the current Trefis price estimate for Alcoa:
- Average Price of Aluminum Shipments: Aluminum prices have been in an uptrend since 2017. However, the price has declined since the end of 2019, only to recover sharply toward the end of 2020. We expect realized prices for Aluminum shipments to remain strong. This would be as a result of a strong demand outlook. 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 $2,045 per ton in the base case, it would represent an upside of almost 10% 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.
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 55% 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.
SOURCES OF VALUE
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.
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 in 2019, followed by the pandemic in 2020, deteriorating economic conditions led to decrease the demand for aluminum and the prices of the metal. Developments in China and the U.S. are particularly important. However, with lockdowns being lifted and economic recovery looking strong, aluminum demand is set to rise which would support strong pricing.
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 had 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.