Alcoa - Accelerated Portfolio Transformation Through Acquisition

Jul.11.14 | About: Alcoa, Inc. (AA)


Alcoa posted better-than-expected results in its 2nd quarter of 2014 beating the analysts’ estimates.

The company has considerably improved its operating cash flows and net margins on a year-over-year basis. Its debt profile has reached the lowest level since 2007.

Alcoa has accelerated its portfolio transformation through the acquisition of Firth Rixson which is expected to bring immense growth to the company’s aerospace sector.

The company’s management is very hopeful about the company’s performance during the next quarter based on significant growth in the aerospace and commercial transportation sectors.

The start of the earnings season brought comfort for investors, thanks to Alcoa (NYSE:AA) which posted much better than expected 2Q14 results and has set some new records. Strong earnings can be seen in all of the company's segments: downstream, midstream, and upstream.

The lower level of debt and much higher operating cash flows compared to previous operating seasons have made the earnings results even more attractive.

Results of Operations

Alcoa's year-over-year revenues fell by only 0.22% compared to the analysts' expectations of a drop of 4.1% in the top line. However, the improvement in metal pricing, the stronger volumes in the mid and downstream businesses, and the higher energy sales drove the sequential revenues to increase by 7%. The revenues in this quarter reached $5.8 billion from $5.4 billion in the first quarter of 2014.

The realized aluminum prices in this quarter reached $2,291 per metric ton compared to $2,205 per metric ton in 1Q14 and $2,237 per metric ton in 2Q13 helping Alcoa to boost its upstream revenues. Besides that, the market share gains in all sectors of the engineered products and solutions segment, higher volume from seasonal packaging, and stronger demand for industrial and commercial transportation boosted the midstream and downstream revenues as well.

The company's upstream business improved its performance for the 11th consecutive quarter whereas the Engineered Products and Solutions, the downstream business, achieved its best ever results. The midstream business continued to capture increasing demand for automotive sheet.

The company's management efficiently cut its YoY cost of goods sold by 270 basis points and selling, general and administrative expenses by 10 basis points. The restructuring and other charges were reduced by $134 million compared to the number of charges in the second quarter of 2013. Together these cost-cutting efforts improved the company's EBITDA margin to 13.3% compared to 10.53% in the previous year. The EBITDA margins of the Engineered Products and Solutions segment reached its highest ever after-tax operating figure of 23.1%, delivering an income of $204 million.

Source: Investor News Releases

Alcoa's year-over-year net earnings nearly tripled in this quarter reaching $138 million compared to a loss of $119 million in the previous year. The net income per diluted share reached 12 cents compared to a loss of 11 cents in the second quarter of 2013. Alcoa's adjusted earnings per diluted share also beat analysts' expectations. The adjusted per diluted share earnings climbed 18 cents per share against an estimate of 12 cents per share showing an immense year-over-year growth of 157%.

Alcoa has beaten analysts' earnings estimates in eight of the last ten quarters reflecting a good growth in the company's bottom line.

Lowest Level of Debt

Another positive aspect that has increased the attraction of Alcoa's stock is its low level of debt in this quarter. The company's management has successfully managed to bring down the debt to the lowest level since 2007.

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Currently its total outstanding debt totals $8.1 billion. The net debt decreased sequentially from $7.1 billion in the first quarter of 2014 to $6.9 billion in the second quarter of 2014. Its debt-to-capital stands at 35.4% while its net debt-to-capital ratio stands at 31.8%.

The lower debt will also decrease Alcoa's future interest expense which will increase the company's net earnings and will also increase its returns on invested capital.

Portfolio Transformation

To further strengthen its robust aerospace business, Alcoa signed a definitive agreement to acquire Firth Rixson, a global leader in aerospace jet engine components, for $2.85 billion in cash and stock. The acquisition will considerably expand Alcoa's market leadership and growth potential, increasing the company's earnings power which will consequently deliver sustainable value to the shareholders.

This portfolio expansion increases Alcoa's 2013 pro forma aerospace revenues by 20% while it is projected that it would double the company's aerospace portfolio's sales, compared to the global aerospace industry, through 2019. As the current revenue growth in the aerospace industry is in the 5% range, so we can expect revenue growth in the 10% range for Alcoa's aerospace sector based on the management's calculations.

The acquisition is expected to contribute incremental revenue of $1.6 billion and an EBITDA of $350 million in 2016. Approximately 70% of Firth Rixson's growth is secured by long-term agreements. The anticipated annual synergy cost savings from this transaction will be more than $100 million by year five.

Outlook for the 3rd Quarter of 2014

Alcoa's revenues are dependent on the outlook of the aerospace, automotive, packaging, building and construction, commercial transportation, consumer electronics and industrial markets. The company's management is hopeful about the considerable growth in all of these sectors, except the industrial markets sectors in which the growth is projected to decline by 8% to 12% on lower orders for new gas turbines and spare parts.

The rising truck orders and backlogs have increased the management's expectations for the North American commercial transportation market to the range of 10% to 14% from the previous range of 5% to 9% in the first quarter of 2014.

Moreover, the company reaffirmed its 7% global aluminum demand growth projection for 2014. Due to this higher demand, the prices of aluminum are also projected to grow again in the upcoming years.

Source: knoema

Final Thoughts

A bright industry outlook for the 3rd quarter of 2014, an improvement in the company's margins (especially the EBITDA margins of Engineered Products and Solutions segment), the lowest level of debts since 2007, and the acquisition of Firth Rixson ensure healthy growth in Alcoa's top and bottom lines in the next earnings season.

The company's efforts towards innovation, smart strategies for portfolio expansion and the efforts to reduce its future expenses will generate higher return on its equity and invested capital, providing more value to the shareholders. Based on this bright outlook, I would suggest investing in the company's stock.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by APEX Financial Consultants. This article was written by one of our research analysts. APEX Financial Consultants is not receiving compensation for this article (other than from Seeking Alpha). APEX Financial Consultants has no business relationship with any company whose stock is mentioned in this article.