Arconic Is A Strong Buy; Alcoa Depends On Success Of Productivity Improvements

| About: Alcoa, Inc. (AA)

Summary

Q2 performance (annualized) for Arconic when compared to 2015, shows marked improvement in revenues as well as after tax income. Arconic is a strong buy.

Arconic gains from the improvement in aerospace and automotive market growth; the portfolio transformation program is well on track to gain from the margin improvement as well.

Q2 annualized for Alcoa when compared to 2015, or as given in Form 10, shows improvement areas. If the projected productivity benefits are realized, it would make the gap smaller.

Alcoa's (NYSE:AA) split is now cast in stone and the time table is well set to create two companies that will create investor value going forward. The Form 10 released in June'16 gave the outlines of a 'remain company', which is Arconic and a 'going company', Alcoa. In Form 10, the details of Alcoa as a separate entity had been juxtaposed in the 2015 results. Now the Second Quarter results need to be re-constructed to examine how both the companies are on track to create investor value.

First of all there is evidence to believe that Arconic has gained in Aerospace and automotive to retain market share and margins on the back of good portfolio management. These segments remain the most potent segments where much of the future potential exists.

Let me start with the Arconic analysis first:

  1. Revenue +0.5 Billion Annualized: Q2 Revenue of $3.5 Billion on an annualized basis looks to be $14 Billion, better than the annualized 2015 results of $13.5 Billion as given in 2015 Annual Report (Page-6)
  2. After Tax Operating Income +$176 Million Annualized: After tax operating income of $294 Million for Q2 or $1.176 Billion annualized compares with 2015 number of $1 Billion (Page-6)
  3. Global Rolled Products Adjusted EBIDTA/T of $380 is higher than 2015 level. However the impact of alternate metal supply at Warrick needs a permanent solution.
  4. EPS ATOI+$125 Million Annualized: EPS is the star of the quarter with $180 Million of ATOI and an EBIDTA margin of 22%, this compares on an annualized basis of $720 Million against 2015 performance of $595 Million (page-6)

On the market and portfolio analysis Arconic stands out in the segments Automotive (+17% growth), which is slated to touch 50% when Tennessee automotive ramp up is complete. The Aerospace segment is holding against some headwinds like pricing pressure, supply chain inventory de-stocking and model transition (weaker demand legacy platforms).

The automotive segment projections going forward do take into account U.S. auto growth of 1-4%, EU growth of 2-4% and China growth of 3-5%.

For aerospace the projections for H2 is solid going into 10% growth projected for 2017 on the back of:

-New engine launches with multiple new technology and product introductions

- Supply chain ramp-up challenges

- Legacy engine spares and replacements remain strong

- Demand leading to new orders

Analysis of legacy Alcoa (Upstream):

The upstream analysis cannot ignore the impact of prices, both in Alumina & Aluminum. Alumina has fortunately moved up from the earlier quarter but still somewhat down from last year.

Alumina Prices Realized

Year 2015 in $/T

Q1 2016 in $/T

Q2 2016 in $/T

340

249

304

Click to enlarge

Whereas for Aluminum prices we see a positive movement from the average prices of last year.

Aluminum Prices Realized

Year 2015 in $/T

Q1 2016 in $/T

Q2 2016 in $/T

1815

1793

1849

Click to enlarge

The key highlights of Alcoa include:

  1. Revenue: $2.3 Billion for the quarter, annualized at $9.2 Billion is down from $11.2 annualized in 2015, largely due to closure of Warrick, which has taken out 60kt of capacity. However the impact in terms of EBIDTA is positive.
  2. After Tax Operating Income of $150 million annualized at $600 Million is quite lower than the annualized $901 Million in 2015 (page-7 of annual report). This is to be tallied against the total production of 2.8 Million tons in 2015 against Q2 production of 595,000T. This loss in volume does not appear to be fully compensated by the improvements in productivity. However the total annualized productivity benefits of $550 Million (as given in the Q2 presentation on page-5), if achieved, would get us close to the annualized number for 2015. Page-34 of the presentation gives $739 Million of productivity ideas, which remains a strong wish-list for success.
  3. Future projection of deficit of 775 Kt for the world as shown on page-18 of Q2 presentation bodes well with the recent movements of LME. Global inventories are down by 50% from the 2009 levels also is a strong pointer to the hardening of prices going forward.
  4. Alumina global markets have been projected to be in deficit of 1.5 Million ton. This also compares well with the positive movement of Alumina prices given on page-20.

I go back to the Form 10 released by Alcoa in June2016 and reconstruct the 2015 numbers as given in that report for Alcoa:

2015 Data

Bauxite

Alumina

Aluminum

Cast products

Energy

Rolled

Production (Million T)

45.3

15.7

2.81

2.957

0.266

$ Million

Third Party Sales

71

3343

14

6186

426

993

Total Sales

1231

5030

5106

6232

723

1011

ATOI

258

476

1

110

145

20

Click to enlarge

If I take the numbers from the Q2 presentation, many of the details are missing. However it is still possible to construct how this would look like for 2016, based on the assumption that large part of the productivity benefits would flow in.

2016 Q2 Annualized

Bauxite

Alumina

Aluminum

Cast products

Energy

Rolled

Production (Million T)

45.3

13.3

2.4

2.56

0.266

$ Million

Third Party Sales

71

2876

12

5686

390

905

Total Sales

1231

4527

4377

5342

690

970

ATOI

210

390

120

70

110

30

Click to enlarge

This still leaves a lot to be done in terms of productivity improvements as capacity of 400,000T is short in Aluminum from the levels of 2015.

Overall Summary

The performance numbers in Q2 for Arconic when compared to the numbers as given in 2015 Annual report shows marked improvement in revenues as well as after tax income. Arconic is a strong buy.

Arconic gains from the improvement in aerospace and automotive market growth; the portfolio transformation program is well on track to gain from the margin improvement.

Q2 for Alcoa when compared with the numbers as given in 2015 Annual report, as well as the Form 10, shows some improvement areas. If the projected productivity benefits are realized, the gap between the two will be smaller.

Disclosure: I/we 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.