Alcoa’s Portfolio Transformation Process To Culminate In Separation Of Upstream And Value-Added Businesses
Alcoa (NYSE:AA) has announced that it will split into two publicly traded companies in the second half of 2016, a step that is the culmination of the company’s ongoing product portfolio transformation. [1] This move will separate the company’s upstream commodity businesses from its value-added business segments. The split will decouple the high-growth value-added segments from the upstream commodity businesses, which have suffered from weakness in aluminum pricing.
Aluminum Pricing
Aluminum Price Graph, Source: LME
Aluminum prices have been trending downward over the course of the last several years, and have weakened considerably over the past twelve months. Aluminum is a metal with extensive industrial applications and the demand for the commodity is largely correlated with economic growth. Weak economic conditions in Europe and a slowing Chinese economy have tempered the demand for aluminum over the past few years. However, global aluminum supply was not scaled back in response to weakness in demand over the last few years. The effect of smelting capacity reductions, in response to falling prices, by global aluminum majors like Alcoa and Rusal was offset by additions to smelting capacity by Chinese companies. China accounts for nearly half of the world’s aluminum production and the expansion in production by Chinese producers more than made up for capacity cuts by global majors. [2] State support for Chinese aluminum producers, in the form of provision of tax breaks and subsidized power, allowed Chinese producers to boost production despite weakness in demand and pricing. Thus, oversupplied global markets have kept a lid on aluminum prices over the past few years, which was part of the reason for Alcoa’s strategic realignment of its business.
Portfolio Transformation
Alcoa’s Global Rolled Products (GRP) and the Engineered Products and Solutions (EPS) divisions constitute its value-added business segments, which produce value-added light metal products with a focus on the automotive and the aerospace markets. Given the robust growth prospects in the end markets served by Alcoa’s value-added segments, and weakness in aluminum pricing, the company has expanded the scale and scope of its value-added segments over the past few years. This is reflected in the share of value-added products in Alcoa’s revenues (considering only sales to third parties), which has risen from 54.4% in 2012 to 57.7% in the first half of 2015. [3]
Alcoa has made a series of acquisitions and investments in 2015 to bolster its capabilities to cater to the aerospace and automotive end markets. The company sees a firm nine-year order book in the aerospace segment. [4] In addition, demand for aluminum from the automotive sector is set to rise at a fast pace, given stringent emissions regulation which are forcing automakers to increase the content of lighter materials, such as aluminum, in their vehicles. As per projections by Ducker Worldwide, average aluminum content in cars in North America is set to increase to 19% of a car’s curb weight by 2025, which is almost double from current levels. [5] Given the opportunity presented by the aerospace and automotive sectors, Alcoa has been focusing on its value-added businesses as the growth drivers for the company.
What Lies Ahead
Given the weak business conditions impacting Alcoa’s upstream business and the relatively robust prospects of the value-added segments, the company’s value-added businesses would certainly benefit if they were separated from the upstream segments. Alcoa’s management remains confident that the company’s value-added segments would achieve an investment grade credit rating, when they constitute a separate company. [1] The same is not true for the upstream businesses as a standalone entity. [1] Alcoa’s planned split into two companies would provide investors access to two investment avenues with different business drivers and prospects. With Alcoa’s increasing emphasis on its value-added products, the announcement to split the upstream businesses and the value-added segments is perhaps the logical culmination of its ongoing portfolio transformation process. Given the superior prospects of the value-added segments, a split from the upstream business is likely to unlock greater value for investors focused on these value-added segments.
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- Alcoa to Separate into Two Industry-Leading Public Companies, Completing Successful Multi-Year Transformation, Alcoa News Release [↩] [↩] [↩]
- Global aluminum production; the sound of one hand clapping, Reuters [↩]
- Alcoa’s Q2 2015 Earnings Release, Alcoa Website [↩]
- Alcoa’s Q2 2015 Earnings Call Transcript, Seeking Alpha [↩]
- 2015 North American Light Vehicle Aluminum Content Study, Ducker Worldwide [↩]