VALUATION HIGHLIGHTS

1. Alumina constitutes 56% of the Trefis price estimate for Alcoa's stock.
2. Aluminum constitutes 31% of the Trefis price estimate for Alcoa's stock.
3. Bauxite constitutes 13% of the Trefis price estimate for Alcoa's stock.

WHAT HAS CHANGED?

1. Alcoa's Recent Earnings
   • Alcoa posted a stronger-than-expected set of Q2 2022 earnings, with revenue rising 29% year-over-year to $3.64 billion, driven by stronger pricing for alumina and aluminum. Net income came in at $549 million, up from $469 million in Q1 and $309 million in the same quarter a year ago.
   • In 2021, Alcoa reported a 30% (y-o-y) growth in total revenues assisted by rising prices of Alumina and Aluminium from pent-up demand and uncertainties surrounding the Russia-Ukraine war.

     The company’s Bauxite, Alumina, and Aluminium segments account for 2%, 26%, and 72% of total sales, respectively. Geographically, the U.S., Netherlands, Australia, Spain, Brazil, and Other regions account for 43%, 22%, 17%, 12%, 5%, and 1% of total sales, respectively. However, around 65% of the company’s long-lived assets, including plant and machinery, are located in Australia, Brazil, and Iceland.

     With $920 million of cash from operations and $565 million of net proceeds from investment activities, the company repaid $800 million of long-term debt and distributed dividends for the first time since its inception in 2016. Per recent filings, the company expects the transportation, construction, and packaging industries to be key demand hubs for aluminum.

     Thus, there is a strong likelihood of demand exceeding supply and assisting cash generation capabilities of Alcoa in the coming years.

2. 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:

Aluminum Division

• 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 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.

BUSINESS SUMMARY

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 in 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.

KEY TRENDS

Deteriorating demand conditions for aluminum:

Aluminum has diverse applications in the 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 a decrease in 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 aluminum commodity as well as aluminum stock prices, making the market extremely uncertain.

The Indonesian export ban could raise 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. Although Indonesia relaxed this ban in 2017, it intends to reintroduce the ban at the end of 2022 - an event that can reduce global supply and raise prices.