Why We Decreased Our Price Estimate For Alcoa To $33 Per Share
Trefis decreased its stock price estimate for Alcoa (NYSE: AA) from $42 per share to $33 per share in May 2019, with a change in the aluminum price trend and outlook. Aluminum prices remained strong in 2018 and saw a further uptick in Q4 2018 following expectations of aluminum supply deficit in 2019. However, a weak domestic demand environment led to continuous increase in exports of semi-fabricated products from China, which in turn led to global prices of primary aluminum witnessing a decline in the last four months. Lower price realization is expected to adversely affect Alcoa’s top line by about 14%, leading to lower margins and shareholder returns.
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Aluminum Price Trends and Revenue
- We expect aluminum revenues to decrease by over 17% in 2019 due to lower prices.
- Aluminum prices have fallen from about $1,974 per ton in December 2018 to about $1,855/ ton currently. Alcoa’s aluminum price realization is expected to decrease in 2019, led by subdued global price levels.
- Though the management forecasts a year of aluminum supply deficit, it is not reflecting in pricing due to continuous rise in Chinese aluminum exports, which have exceeded 500kmt in seven of the last eight months.
- China is a leader in semi-fabricated products and a major exporter. As increasing number of steel players are shedding capacity and demand from automobiles being modest, China has increased its exports of semi products at a lower price, which has in turn led to a decline in primary aluminum products worldwide.
- With aluminum already being a low margin business, a decrease in pricing is expected to lead to 30% to 40% of the world’s smelters losing money.
Alumina Price Trends and Revenue
- After a year of being in deficit, which led to alumina prices increasing significantly post Q1 2018, alumina has been in surplus (excess supply) from December 2018, which has, in turn, led to a drop in global price levels.
- With increasing number of aluminum players cutting down on capacity, demand for alumina is expected to further decline in 2019.
- Lower price realization and volume is expected to lead to an 11.5% drop in segment revenues.
Profitability
- Net income margin is expected to decline from 1.7% in 2018 to 1.5% in 2019, driven by lower revenue, higher smelting cost, and restructuring cost related to Spanish operations (which have been maintained on a restart condition).
- In spite of lower alumina prices (which is an input for the aluminum segment), the aluminum margins are expected to remain subdued because of the low-margin nature of business and decrease in price realization.
Too Much Cash Being Burnt
- Alcoa is highly capital intensive – with 90% of its cash from operations being used for capital spending.
- Despite generating $13.4 billion in revenues over the past year, Alcoa realized just $167 million in free cash flow which translates into a paltry conversion rate of just over 1%, that too at a time when aluminum prices were at the third highest level since 1990.
- Additionally, the company does not currently offer any dividend, so an investor’s total returns are reliant on capital appreciation alone.
- In such a scenario, in the absence of measures to enhance shareholder returns, decreasing top line and margins affect investor sentiment.
We believe that currently the company’s focus on improving its asset base and the recently announced $200 million share repurchase program are the only drivers for any stock price upside from the current level in the near term. Thus, we have reduced our price estimate from $44 per share to $33 per share for Alcoa’s stock.
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