Alcoa Not Out Of The Woods Yet

| About: Alcoa, Inc. (AA)

Alcoa Inc. (NYSE:AA) reported 4Q12 adjusted EPS from continuing operations of $0.06, in line with the consensus estimates of $0.06. The headline EPS of $0.21 was adjusted for several non-recurring items including gains from the sale of the Tapoco Hydroelectric Project, discrete tax items, and other special items net of restructuring charges. The adjusted EPS of $0.06 increased 100% sequentially from 3Q12 EPS of $0.03. Adjusted EBITDA of $597 million was slightly above the consensus estimates of $585 million and up from 4Q11 EBITDA of $445 million and 3Q12 EBITDA of $496 million.

Segment results

Alumina Benefits from Higher Pricing

Alumina segment reported 4Q12 after-tax operating income (ATOI) of $41 million up from 3Q12 ATOI of -$9 million. However ATOI for the segment declined by $84 million Y/Y, representing a decline of more than 67%. Production for the segment was essentially flat Q/Q at 4079kmt; however, third party shipments rose by 72kmt, a Q/Q increase of 3%. Third party sales also rose 5% sequentially. However total sales were essentially unchanged Q/Q.

ATOI margin of 3% was up from 3Q margin of -0.7%. The positive impacts of productivity gains, higher LME-based pricing and favorable currency impacts on segment earnings more than offset less favorable product pricing and mix. Adjusted EBITDA of $36 per ton increased 71% sequentially from 3Q12 EBITDA of $21 per ton.

Primary Metals' ATOI Benefits From Tapoco Sale

The primary metals segment generated quarterly ATOI of $316 million up from 3Q12 ATOI of negative $14 million. The sequential improvement was driven largely by the sale of the Tapoco Hydroelectric Project, higher realized prices, and continued productivity gains. However, excluding the Tapoco gains of $275 million, the segment still recorded sequential improvement of almost 400%. Production for the segment declined 26kmt Q/Q to 912kmt. Third party shipments were flat Q/Q. However, third party sales rose 5% Q/Q to $1890 million. Average realized prices of aluminum increased 4.6% Q/Q on higher LME pricing. Foreign currency moves had a $5 million negative impact on segment's ATOI.

ATOI margin for the segment surged to 12.5% from 3Q12 margin of -0.6%. Adjusted EBITDA of $214 per ton was up 93% from 3Q EBITDA of $111.

Seasonal Decline In Global Rolled Products' ("GRP") ATOI

The GRP segment reported 4Q12 ATOI of $69 million down from 3Q12 ATOI of $98 million, representing a 30% sequential decline, due to seasonal factors and marginal cost increases. Third party shipments declined 7% to 448kmt on seasonally lower packing demand. Third party sales were also down 4% to $1771 million. Sequential volume declines in packaging were to an extent offset by productivity improvements.

ATOI margin for the segment declined to 3.8% from 5.2% in 3Q. The segment reported quarterly adjusted EBITDA per ton of $344 and full-year EBITDA of $390, 66% higher than the 10-year average. The segment had a record 4Q ATOI and adjusted EBITDA per metric ton.

Engineered Product and Solution

ATOI for the segment was down 14% Q/Q to $137 million. Productivity gains were more than offset by sequential increases in cost, unfavorable product mix, and lower volumes. Third party shipments of 52kmt were down 1kmt from 53kmt the previous quarter. Third party sales declined $19 million to $1348 million.

ATOI margin for the segment declined 1.5 percentage points to 10.2%. Despite lower sequential ATOI, the segment reported a healthy EBITDA margin of 18%.

Financial and Credit Analysis

Alcoa reported cash flow from operations of $933 million, up from $263 million in 3Q12 but down from 4Q11 CFO of $1142 million. Capital expenditures during the quarter amounted to $398 million, up from $302 million in the previous quarter but down from $486 million in 4Q11.

The company generated free cash flow of $535 million in 4Q12, up $574 million from the previous quarter. Alcoa reported total 2012 free cash flow of $236 million down from $906 million in 2011.

The company finished the quarter with a cash balance of $1.9 billion, a sequential increase of 30%. Alcoa's quarter end debt ratio of 34.8% is in line with the target range of 30-35%. The company reported net debt-to-capital ratio of 29.7%

The company finished the quarter with record low in days working capital at 24 days, 9 days lower than the previous quarter, 3 days lower than the same period last year, and 19 days lower than 4Q08.

Over the past 4 years the company has generated over $5 billion in productivity improvements and overhead cost reduction. In addition to 3 days improvement in working capital, the company achieved $1.3 billion in productivity and overhead improvements in 2012, which is approximately $450 million more than the target. The company is projecting further improvements next year with its 2013 cash sustainability program including:

  1. $750 million in productivity gains;
  2. Managing growth capital to $550 million;
  3. Controlling sustaining capital at $1 billion;
  4. Target Saudi JV investment of $350M;
  5. Maintain 30%-35% debt-to-capital ratio.

Total debt declined to $8.8 billion from $9.5 billion in 3Q12. Net debt of $7 billion, decline to its lowest level since 2006. The credit rating agency Moody's put Alcoa on a review for a possible downgrade last month. While the company improved its credit metrics from weak 3Q12 levels on seasonal working capital declines in 4Q, leverage remains at a very high level for an investment grade credit. In a flat aluminum price environment the company is unlikely to improve EBITDA significantly from current levels and we remain concerned if the company will be able to convince Moody's to keep its Baa3 rating.


The company expects global aluminum demand growth of 7% (ex-China 4%) in 2013, up 1 percentage point from 2012 growth of 6%. At 11%, demand is expected to grow the strongest in China, followed by 9% growth in Indian consumption, 7% in Asia w/o China. The chart below lists growth expectations for other regions.

Source: Company documents

The Aerospace industry is expected to grow the fastest, with growth in sales of 9-10%, compared to 13-14% in 2012. The growth in the aerospace industry is supported by more than 8 years of commercial production (8900 large aircrafts) backlog at Boeing and Airbus. Improved airline profitability ($8.4E billion in 2013 vs. $6.7 billion in 2012), a healthier leasing situation, and regional jet growth will be further supportive of growth in the industry in 2013.

The Automotive market is expected to see production growth of 1-4% in 2013, with the strongest growth expected in China. North America is expected to grow at a modest range of 0-4% compared to 16-17% growth in 2012. However, the company expects the total production in 2013 to be close to the pre-recession levels. Production in Europe is expected to decline by 1-4%, which is better than the last year decline of 6-8%. Eastern Europe driven by Russia grew strongly. However, Western Europe declined by 8%. Production in China is expected to grow by a strong 7-10% in 2013 compared to 6-7% in 2012. Stronger SUV sales, the wealthier middle class, and uptick in the Chinese economy are all contributing to the growth.

The Heavy Truck and Trailer market is expected to see a growth in production of 2-7%, again driven strongly by growth in China, which offsets declines in North America and Europe. Production in North America is expected to decline by 15-19%. The company attributed the sequential increase in orders in 4Q12 to a temporary acceleration in purchasing due to a concern over a potential depreciation tax credit change. Production in Europe is also expected to decline by 6-10%, registrations in the region are down by 8.4% and production has already been reduced by 12%. However, China is expected to grow by 12-19%, driven strongly by infrastructure spending.

The Beverage Can Packaging market is expected to grow by 2-3% in 2013, in line with last year. Again China with 8-12% is expected to grow the strongest, followed by Europe with 2-3% growth in sales. North America is expected to remain flat with 0-1% in growth.

Commercial Building and Construction sales are expected to grow by 4-5%. Sales are expected to improve in all regions. North America is expected see a sales growth of 1-2%, which would be the first gain in 4 years. Housing starts (+27%), non-residential contracts awarded (+6%), positive architectural index since august are all contributing to the growth in sales. Moreover, the Case-Shiller home price index is also up the last 2 quarters by 7% and 2% respectively. The decline is also slowing down in Europe, from a 8% decline last year to 4-6% expected decline in sales growth in 2013. China remains the strongest; sales are expected to grow by 8-10% up from 7-8% growth last year.

Industrial Gas Turbine growth is expected to be 3-5%, in line with 2012 growth. Increased attractiveness of natural gas and higher demand of spare parts on increased utilization rates are supportive of growth in the segment.

Source: Company documents

Global Supply and Demand In 2013

The company is forecasting a global alumina deficit of 200kmt in 2013. China's deficit of 500kmt more than offsets the rest of world surplus of 300kmt. On the other hand, Alcoa is projecting a surplus of 535kmt in aluminum. China is projected to have an aluminum surplus of 350kmt in 2013, and rest of the world of 185kmt.


Despite not so bad results and a positive reaction by the market to Alcoa's results, the story remains the same, the weak underlying aluminum industry. Global market remains oversupplied (the company is forecasting another surplus in 2013), inventories continue to rise, and the case for sustainable pricing power gets pushed further into the future.

Alcoa is one of the world's largest integrated producers of alumina and aluminum. Aluminum accounts for roughly two-thirds of the company's revenue and there is little fundamentally-based upside to spot aluminum prices. We have a negative view on the aluminum fundamentals and expect the aluminum market to remain oversupplied for some time and till then we prefer to remain on the sidelines.

The company continued to make headwinds on its productivity savings goals, and we think management is doing a commendable job posting a positive cash flow despite poor aluminum prices. However, going forward results will mainly be driven by underlying metal prices rather than incremental cost saving opportunities. We think most of the company specific opportunities are behind Alcoa now but the industry specific challenges remain.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.