Alcoa (AA) released its first-quarter earnings on Monday, April 8. The company's reported revenues of $5.83 billion were slightly lower than Q4 2012 revenues of $5.89 billion due to two fewer production days compared to the previous quarter. On a year-over-year basis, revenue was lower than the Q1 2012 figure of $6 billion due to 8% lower aluminum prices. However, due to strong productivity growth across business divisions, lower overhead costs, and higher regional price premiums, sequential adjusted net income improved by almost 90% to $121 million.
The global rolled products as well as the engineered products and solutions segments reported higher sequential after tax operating income (ATOI) figures due to higher productivity and volumes. The alumina segment showed a 41% sequential rise in ATOI primarily due to positive trends in the Alumina Price Index (API) and spot prices. Interestingly, sequential ATOI in the primary metals segment (adjusted for the Tapoco sale) declined primarily due to lower aluminum prices. This shows that the traditional correlation between alumina and aluminum prices is no longer valid. Earlier, alumina used to be priced as a percentage of market aluminum prices.
The company's management maintained its demand and growth projections made at the end of 2012.
Comments on Aluminum Price Trends
Aluminum prices on the London Metal Exchange, which are used as a benchmark by the company to determine its own prices, have been dropping sharply since the end of February. Prices have dropped from $2,100/tonne to below $1,850/tonne and are still trending lower.
Alcoa stuck to its earlier stand that aluminum prices on the LME are not being driven by demand/supply fundamentals. It asserted that the steep decline being witnessed in prices is due to money flowing into equity and out of commodities in general. The management said that the negative pricing trend in aluminum is in sync with that being observed in copper, zinc, and lead. According to Alcoa, the curtailment in smelting capacity in China has in fact tightened the demand/supply dynamics and the global inventory position is now stable.
Performance of Individual Business Segments
In the engineered products and solutions (EPS) division, ATOI rose sequentially from $140 million to $173 million due to productivity gains and higher sales volumes. The division reported a record adjusted EBITDA margin of 20.9%. Alcoa is upbeat about the aerospace market and maintained its 9%-10% growth projection for 2013. The company touts a large backlog of orders for planes with Boeing and Airbus, which might take up to eight years to clear.
The company sounded equally sanguine about its global rolled products (GRP) division. Here, ATOI climbed sequentially to $81 million from $77 million due to higher productivity and volumes, although gains from these were offset partially by higher energy, maintenance and labor costs.
In the upstream part of the business, Alcoa's alumina division gained handsomely due to higher API and spot prices and marginally due to productivity related improvements. ATOI increased sequentially from $41 million to $58 million. On the other hand, adjusted ATOI in the primary metals division declined marginally to $39 million from $41 million. This was primarily due to lower LME prices and higher costs, partially offset by lower energy costs and higher productivity.
Alcoa has maintained its 2013 global aluminum demand growth figure at 7%. In the automotive segment, it expects a global growth rate of 1%-4% and a Chinese demand growth rate of 7%-10%. Growth in the North American market will be driven heavily by increasing aluminum intensity i.e. higher aluminum content per vehicle. This is due to new U.S. Corporate Average Fuel Economy (CAFE) standards, which demand better fuel economy in vehicles from manufacturers. This can be achieved by replacing steel with aluminum to make vehicles lighter.
In the heavy truck and trailer segment, Alcoa has narrowed its 2013 growth rate projection for China from 12%-19% to 12%-16%, no doubt keeping in mind the slow Chinese growth in the first quarter. The growth rate in the industrial gas turbine segment is expected to be 3%-5%. Power plants in the U.S. are switching to natural gas from coal owing to cheap prices of natural gas thanks to the shale gas revolution. Further encouragement is being provided by environmental regulations, which mandate cuts in carbon emissions. The potential can be gauged from the fact that the market share of gas-fired electricity generation has moved up from 24.6% in 2011 to a new record of 30.4% in 2012.
Overall, Alcoa has been shifting its business mix focus to value-added products over the last few years. ATOI from the EPS and GRP divisions in 2012 constituted 71% of the total as compared to 25% in 2003. If this trend continues in future, it will boost margins and reduce earnings volatility due to aluminum price fluctuations.
We have a Trefis price estimate for Alcoa of $8, which we will revise shortly now that the first-quarter results are out.
Disclosure: No positions.