Alcoa: A Virtual Washout Of Profitability?

Alcoa (NYSE: AA) is currently facing a double whammy of decreasing revenues and lower margins. The company’s profitability is expected to decline by a whopping 88% in a year, with Trefis projecting its net income to drop from $227 million in 2018 to $27 million in 2019, translating into net income margin of 0.3% in 2019, barely breaking-even. Deterioration in its financials is expected to be driven by a decrease in aluminum and alumina prices, along with an increase in cost of sales and restructuring charges, due to the company’s operational and production issues. However, margins are expected to rebound in 2020, on the back of higher revenue and absence of non-recurring major restructuring charges.

You can view the Trefis interactive dashboard – Alcoa: Cost And Profitability Analysis – to better understand the factors that are causing a sharp decline in margins, and alter the assumptions to arrive at your own estimates of revenues, expenses, and profits for the company. In addition, here is more Materials data.

Revenue Performance

• For the full year, Trefis expects Alcoa’s revenues to decrease by 18.4%, from $13.4 billion in 2018 to $10.9 billion in 2019.
• Lower revenue is to be driven by lower alumina and aluminum volume sales (mainly due to expiration of the Tennessee tolling agreement) and price realization, on the back of a number of aluminum players cutting back on capacity and price realization declining due to higher supply.
• However, with a projected recovery in volume and global price levels, revenue is expected to increase to over $11 billion by 2020

Alumina

• 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 an 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 segment revenues dropping from $5.2 billion in 2018 to $4.1 billion in 2019.

Aluminum

• Lower shipments and prices are expected to lead to a decrease in aluminum revenues from $7.2 billion in 2018 to $5.9 billion in 2019.
• Continuous rise in Chinese aluminum exports have led to a decline in global price levels.
• 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 demand for primary aluminum products worldwide.

Bauxite

• Revenues to decline in 2019, as global prices are expected to remain under pressure with the seaborne bauxite market likely to see excess supply, as higher production in Guinea and Southeast Asia, will only partially be offset by higher demand in China.

Expenses and Profitability

Though total expenses are likely to decline in 2019, a rise in cost of sales, SG&A, and restructuring cost is expected to restrict the fall in total expenses to a lower rate than revenue decline, thus decreasing profitability.

• Cost of Goods Sold (COGS): Though COGS as % of revenues has decreased over recent years, it is expected to increase from 75.2% in 2018 to ~77.7% in 2019, driven by lower sales of alumina and aluminum products along with higher costs for carbon materials, energy, and maintenance related expenses.
• SG&A Expense: SG&A expense as a % of revenue is expected to increase from 1.9% in 2018 to 2.3% in 2019, led by higher consulting and information technology costs, combined with costs to support the Spanish collective dismissal process, and unfavorable impact of the recording of a bad debt reserve against a Canadian customer receivable due to bankruptcy in early 2019.
• R&D Expense: Company has decreased R&D spending over recent years to cut back on cost. The metric is expected to remain stable in the near term.
• Depreciation: Depreciation expense has declined over the years and is expected to reduce further in 2019, as a group of assets related to the acquisition of Alumax is reaching the end of their depreciable lives.
• Restructuring Charges: Restructuring charges as % of revenue is expected to be a major drag on margins, as the metric is expected to go up significantly from 3.9% in 2018 to 6.2% in 2019, due to higher cost related to two aluminum plants in Spain with combined operating capacity of 124,000 metric tons per year, that have been maintained in restart condition, as a part of a Collective Dismissal Process with the workers.
• Interest Expense: Interest expense as % of revenue has remained stable over the last two years and is expected to remain around the current level in the near term, in the absence of major changes in debt levels.
• Income Tax: Income tax expense as a % of revenue has seen a lot of volatility due to different international tax rates and fluctuation in alumina and aluminum prices which results in changes to the distribution of the (Loss) income before income taxes in the Company’s various tax jurisdictions.
• Other Expenses: Other expenses are expected to witness a decline in 2019 due to better mark-to-market impacts on derivative instruments.

Thus, net income is projected to drop from $227 million in 2018 to $27 million in 2019, which marks a decline of about 88% in profitability, driven by a larger drop in revenues (18.4%) compared to decrease in total expenses (17.2%). However, as revenues expected to rebound in 2020 and with rising production and shipments, along with almost all of the restructuring charges already incurred, margins are expected to move up to 3% in 2020, higher than its 2017 level. Therefore, we believe that though 2019 could be one of the worst years for Alcoa, the year 2020 could be a turning point for the company and its shareholders.

According to Alcoa Valuation by Trefis, we have a price estimate of $30 per share for Alcoa’s stock. Despite a significant deterioration in margins during 2019, our price estimate is higher than the current market price, as we believe that the company’s focus on improving its asset base, expectations of improving margins in 2020, along with the recently announced $200 million share repurchase program, would continue to support the growth in its stock price.

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