Aluminum producer Alcoa (NYSE:AA) has already been grappling with a weak aluminum market. Now adding to the list of worries for the company, is falling copper prices. This is because aluminum is generally accepted as a cheaper substitute to copper in many applications and many manufacturers were seriously considering switching to aluminum with copper reaching all-time high prices last year. However, the euro zone crisis fiasco is taking a toll on copper prices, which could again attract demand lost to aluminum. Below we take a detailed look at how copper prices could affect the company’s value.
Alcoa is a world leader in the production and management of primary aluminum, fabricated aluminum and alumina, and competes globally with alumina producer Rio Tinto (NYSE:RIO) and steelmakers like ArcelorMittal (NYSE:MT) and US Steel (NYSE:X).
We have a price estimate for Alcoa at $12, implying a premium of close to 35% to the current market price.
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Aluminum vs. Copper
Copper, a barometer of economic growth, is primarily used in electrical appliances and construction. It is used widely in electrical appliances because it is an excellent conductor of electricity. Notably, about 65% of copper usage is attributable to electrical appliances. In addition, the metal is often used for roofing and plumbing in addition to its use in automobile and ship manufacturing. Therefore, copper prices are highly correlated with economy activities around the globe.
With concerns around Europe mounting again, copper prices have slumped to about $3.50 per pound from an all-time high of $4.50 per pound last year.  In comparison, aluminum is priced at about $0.90 per pound.  Given the costs of retooling the manufacturing processes and the extra aluminum it takes to conduct the same amount of electricity as copper, it becomes more economical to use copper instead of aluminum if copper prices fall below $3.50 per pound.
Further, many aluminum manufacturers have either cut or plans to cut capacities across the globe, which could limit the supply. However, with new additional supply coming up, copper prices may remain under pressure after 2013. This could hurt shipments for the company.
Over the past 5 years, aluminum has substituted about 2% of the copper market on average. If copper prices remain below at $3.50 levels, then copper could snatch some of this market share.
However if copper continues its bull run following an eventual economic recovery, it will be a dream come true situation for the beleaguered company.Notes: