Alcoa Inc (AA) continues to operate in a difficult environment. We have a neutral rating on the company, as we continue to see the aluminum market remaining oversupplied in the near future. There is little upside potential for aluminum prices given the supply and demand situation. However, we believe AA is well positioned to benefit in the long term, as costs of both aluminum and alumina decrease.
Aluminum is the second-most widely used metal in the world, after steel (iron). It is also the most abundant metallic element in the earth's crust. Building and construction, beverage cans and other packaging, and transport are the three key markets for aluminum. The transport industry, driven by an expanding auto market, is the biggest consumer of aluminum in the developed world. Aluminum helps make cars that are light, energy efficient and more environmentally-friendly. Aluminum can reduce weight by as much as 55 percent as compared to steel. However, in developing countries, the construction sector is the biggest consumer of aluminum.
Alcoa Inc is one of the world's largest producers of primary aluminum, fabricated aluminum, and alumina. The company's four main reporting segments include:
- Alumina - it holds bauxite mining and alumina refining assets, and accounts for almost two-thirds of AA's revenues.
- Primary Metals - it consists of a worldwide system of smelters.
- Global rolled products - it produces sheet products.
- Engineered Products and Solutions - serves the transportation and aerospace industry.
Third Quarter Results:
AA reported third quarter adjusted EPS to be $0.03 against consensus estimates of a breakeven. Shipments were up 7.9 percent QoQ for Alumina and 2.5 percent for primary metals, while for flat rolled shipments were down 0.2 percent. Average realized prices were down 5.6 percent for alumina, 4.6 percent for primary metals, and 3.2 percent for flat rolled products QoQ. Y/y averaged realized prices were down by as much as 17 percent for both primary metals and Alumina.
Shipments ('000 tons) Avg Realized Prices ($mn)
AA's third quarter earnings surprise was driven by better than expected primary metals, and the flat rolled segment's performance and aluminum realized prices of $1.01/lb as compared to analyst estimates of $0.99, and $.015 above LME average price for Q3'12. Though the average realized price of $1.78 for flat rolled products was down 3.2 per cent for Q2, it had a spread of $.092 above the LME average price for the quarter.
AA reported after tax operating income (ATOI) of negative $9 million, down $32 million from second quarter ATOI of $23 million. Production of alumina was up 1.1 percent QoQ. Third party sales of $764 million were up almost 2 percent from $750 million in Q2.
ATOI for the primary metals was negative $14 million against negative $13 million in Q2. However, the realized price of $1.01 was better than sell side estimates of $0.99. Reported production of 938kmt was down from 942kmt of Q2. Third party aluminum shipments were up 2.5 percent, however, third-party sales were down to $1794 million from $1804 in Q2.
Flat Rolled Products:
Flat-rolled segment reported ATOI of $98 million, up 3 percent from Q2 ATOI of $95 million. Third party shipments at 483kmt were almost the same as Q2. However, third-party sales were down to $1849 million, from $1913 million for Q2.
Going forward, AA expects demand to be weaker due to the slowdown in demand in China. However, AA has raised the forecast for the aerospace industry.
ATOI for the Engineered Solutions segment was $160 million, up $1 million from Q2'12. Both third party shipments and sales were down for this segment. Shipments were down 10 percent while sales were down 4 percent.
Quarter 4 Guidance:
AA lowered its 2012 growth estimates to 6 percent, from the 7 percent estimated earlier. The biggest revision was in heavy trucks and trailers, in which AA lowered forecasts to a 7 to 8 percent decline, from a 1 percent decline reported earlier. Demand in Europe and China is the major catalyst for this downward revision. However, demand in the North American truck market is expected to grow. Truck registration in Europe fell 18 percent QoQ, however, registration in China declined by 31 per cent sequentially.
AA maintained its forecasts of 13 to 14 percent growth in aerospace, supported by significant backlogs. Alcoa maintained its forecasts for construction and packaging, and raised automotive forecasts for the North American market by 1 percent. The company expects to more than offset the continuing weak industrial demand in North America and Europe with productivity gains. The company also maintained a positive outlook for the industrial gas turbine market.
AA's shares have gone down 12 per cent in the last one year, and 2 per cent YTD. It is trading at a forward P/E of 13.2x and has a five year expected PEG ratio of 3.10. It has a forward annual dividend yield of 1.3 per cent. AA has total cash of $1.43 billion, while total debt is $9.52 billion. Levered free cash flow is $516.25 million.
Faster than expected recovery in the world economy, producers bringing supply in line with demand, declining power costs and better than expected company execution are risks to our analysis.