Here’s Why We Have Updated our Price Estimate for Alcoa Corp. to $42

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Aluminum prices have gained approximately 26% in the first 10 months of 2017, with a sharp rise of roughly 11% in the 3rd quarter of the year. Better than expected aluminum prices are attributable to a combination of demand and supply related factors pertaining to the commodity.

LME Aluminum Prices, Source: LME Website

Chinese Curtailments Hits Global Aluminum Supply

China has been significantly working towards its goal of achieving a sustainable and clean environment by materially cutting down its heavy industrial output. Aluminum capacity downsizing by the world’s largest aluminum producer has had a material impact on global aluminum supply. Total production of the Chinese economy has been reduced roughly by 10% since the beginning of the year ((Primary Aluminum Production, International Aluminum Institute)) through forced shut down of several illegal plants operating without permits along with implementation of capacity idling to control smog in the upcoming winter months. [1] Significant supply cuts are expected starting mid-November as the winter months unfold and the country continues its fight against pollution.

Demand Condition Remains Favorable

On the other hand, demand for aluminum from the Chinese economy has remained strong. There has been a persistent growth in the Chinese construction and transportation sector as the country aims to maintain its GDP growth rate of at least 6.5%. In addition to that, with greater need for greener transportation, there has been an increase in demand for light weight and electric vehicles which are less detrimental to the environment. These vehicles are built with high aluminum content and hence puts an upward pressure on aluminum prices.

Similar supply dynamics have hit global alumina prices as well. Alumina is used as a principal raw material in aluminum production and have surged 73% since May ’17. This is attributable to the significant supply cuts in China and the consistent demand from aluminum producers ahead of the winter curtailments. [2] High alumina prices have significantly impacted the bottom line of major aluminum producers.

Alcoa, being a producer of bauxite, alumina, and aluminum; supplies 32% of its internally produced alumina to its aluminum production facility and has enabled the company to reduce the impact of rising raw material costs. [3] Third party alumina shipments of the remaining 68% of total output, has in turn, enabled the company to increase its alumina revenue.

The pricing environment is most likely to sustain over the next 4 months as the winter months last, post which normal production would resume. Given the favorable pricing environment for both alumina and aluminum, we have revised our revenue estimate for Alcoa in an expectation of higher price realization and greater shipment volume of both aluminum and alumina. This is reflected  below as per our forecast numbers.

Have more questions about Alcoa? See the links below.

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Alcoa

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Notes:
  1. Aluminum surges as winter comes early for Chinese smelters, Reuters []
  2. Alumina shortages to increase as Chinese crackdown bites, Reuters []
  3. Alcoa, Inc. 2017 Q3 – Results – Earnings Call Slides, Seeking Alpha []
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