Alcoa (NYSE:AA) will report its fourth quarter earnings results on Thursday, January 9. We expect the company to record soft earnings on revenues that are in line with the consensus estimate of $5.76 billion. Still, but most investors will watch out for any cues on its outlook into the first quarter and next year. Aluminum prices went downhill in 2013 and demand remained sluggish. The flat-rolled and engineered products divisions may partially offset the negative impact of low aluminum prices on the primary metals business.
Aluminum prices on the London Metal Exchange, which stayed above $2,000 per ton in Q4 2012, stayed between $1,700-$1,800 per ton for the major part of Q4 2013. On average, prices in 2013 have been much lower than in 2012. Alcoa uses LME aluminum prices as benchmark for its own prices. [1]
We have a Trefis price estimate of $7 for Alcoa, which represents 32% downside to the current market price.
Importance Of Aluminum Prices For Alcoa
Alcoa is organized into four business segments: Alumina, which mines bauxite and processes it into the precursor to aluminum; Primary Metals, which smelts aluminum; Flat-rolled Products, which makes sheets used in beverage cans as well as airplane wings and car parts; and Engineered Products and Solutions, which makes aerospace fasteners, turbine blades and truck wheels. While the Flat-rolled and Engineered Products and Solutions divisions produce value-added products and thus generate higher margins, a significant proportion of Alcoa’s revenues still comes from the Alumina and Primary Metals divisions. This makes its earnings highly sensitive to aluminum prices. [2]
The Aluminum Price Trend In Q4
The European debt crisis and slowing Chinese growth have contributed to the decline in aluminum demand and its prices over the last few quarters. The long-term expectations for these factors remain largely unchanged, so weakness in prices is expected to persist in the foreseeable future.
One factor that might explain falling prices is the persistently high aluminum inventory relative to demand, which may be keeping a lid on London Metal Exchange (LME) prices for aluminum. While LME prices are not the actual realized prices for Alcoa, they do indicate a broader trend in global aluminum prices. Also, despite inventories being at a record high, market forces have failed to rationalize supply through shutdown of smelting capacity. Companies like Alcoa and Rusal have announced smelting capacity cuts, but the same cannot be said of Chinese companies. This is primarily due to state intervention in the form of provision of subsidies or renegotiated power contracts to smelters, which serves as a disincentive to cut production. In fact, a few months back one Chinese company had even announced plans to add 550,000 tonnes of smelting capacity by the end of this year to take advantage of cheap power. [3]
Concentrating On Value Added Products
In the face of falling aluminum prices, Alcoa is concentrating on expanding its flat-rolled and engineered products businesses, which generate higher margins. The company is targeting the automotive and aerospace sectors in particular. These business divisions may cushion the impact of weak aluminum prices for the company’s fourth quarter results.
In the fourth quarter, Alcoa signed a co-operation agreement with Russia’s VSMPO-AVISMA to target aerospace demand for high-end titanium and aluminum products. VSMPO-AVISMA is the world’s largest manufacturer of titanium ingots and forged products, and the agreement marks the first step towards the creation of a joint venture between the two companies. Alcoa bought the Samara and Belaya Kalitva aluminum processing plants in Russia in 2005. Since then, it has invested more than $540 million in building facilities, including modern control technology for a forging press that remains the sole global source of some particularly large forging products. The titanium forgings that Alcoa and VSMPO-AVISMA aim to produce at Samara will thus be technologically difficult for any competitor to replicate in the short term. [4]
In this quarter, Alcoa also announced the signing of a deal worth about $110 million, to supply titanium and aluminum parts to aircraft manufacturer Airbus. This deal shows that traditional producers of metallic jetliner parts are fighting back against competition from sophisticated composite materials, which have gained favor among aircraft manufacturers in the recent years. (Alcoa Signs Long-Term Agreement with Airbus for Value-Add Titanium and Aluminum Aerospace Parts, Alcoa News Release)
What We Would Like To Know In The Earnings Call
In its Q3 2013 earnings conference call, Alcoa’s management had maintained 2013 growth projections of 9-10% for the aerospace segment, 2-5% for the U.S. automotive segment and 12-19% in the Chinese automotive segment. The overall growth forecast for China had been raised to 9-11% from the previous forecast of 7-10% due to strong economic growth witnessed in the third quarter. Also, the company had stuck to its 7% growth rate forecast for aluminum demand in 2013. (Alcoa Q3 2013 Earnings Conference Call, Seeking Alpha)
We would like to see if results at the end of Q4 are in tandem with expectations. While the U.S. economy seems to be picking up, we are skeptical that the performance of the Chinese automotive market and the overall demand growth are in line with projections.
Also, given that the company is releasing its annual results, we look forward to management guidance for the overall aluminum demand and that for individual segments in 2014.
Notes:
- LME Aluminum Price Graph, LME
- Alcoa 2012 10-K, SEC
- Alcoa, Rusal’s Aluminum Production Cuts Not Enough With China Smelting, Metal Miner
- Alcoa set to be heavy player in Russian titanium, Alcoa Website
Disclosure: No positions
