Alcoa: Inflation Plus Market Growth

May 09, 2022 12:16 PM ETAlcoa Corporation (AA)2 Comments
Edward Ambrose profile picture
Edward Ambrose
1.83K Followers

Summary

  • Alcoa’s price for aluminum in the first quarter of 2022 per metric ton was $3,861. This is compared to the average price in 2020 of $1,915. It doubled.
  • Prices began to decline in March. Alcoa stock fell 30% from April 18, until now. On May 5th, 2022, prices recovered, and Alcoa stock went up 4.5%.
  • Alcoa took a $1.1 billion charge for restructuring involving cutting back some troubled operations and selling interest in a Brazilian mine. So, that will lower restructuring expenses.
  • Electric vehicles use much more aluminum to increase their range. However, automakers are hampered by the lack of semiconductors which causes auto production to be well below demand.
  • First quarter EPS is $2.49. The analysts who still have price target over $100 per share, argue that annualizing the $2.50 cents gives $10 in earnings for a $61 stock. I do not believe that this stock will achieve this, but it is a buy.

ALCOA Plant, Chaguaramas, Trinidad

Nandani Bridglal/iStock Editorial via Getty Images

The Aluminum Production Process

Aluminum starts off as bauxite ore. Alcoa (NYSE:AA) uses 93% ore internally and sells the other 7%. Alcoa uses refineries co-located with the mines to process bauxite into alumina, an interim product. Alcoa uses 30% of Alumina internally and sells the rest to third parties. The Alumina is smelted down into aluminum. The smelters are closer to the primary market. Alumina requires large amounts of natural gas and caustic soda along with other chemicals. The aluminum smelter power average 27% of production costs with other minerals and carbon adding another 27%.

Alcoa believes its mines and Alumina refineries are among the top quarter of producers. Alumina prices should go up from $375 to $420 based on the closing of European plants and the disruptions caused by the war in Ukraine. Higher alumina prices increase Alcoa’s profitability while raising its competitors’ costs.

Alcoa Restructuring

With the restructuring reserve of $1.1 billion taken in the fourth quarter, 2021, two operations have been curtailed in Spain and the company will sell its ownership share of MRN in Brazil. Aluminum plants in Portland, Australia, and Alomar, Brazil are being reopened which will increase aluminum capacity by 10% in the latter part of 2022. These moves will reduce costs and increase financial results and increase production volume.

Process Upgrades

ELYSIS is a zero-carbon aluminum smelting process that should also lower costs. Aluminum from this process has been selected by Apple for use in one of its iPhones. The process is in low-level R&D activity which they anticipate will be put into a production process. Alcoa has also produced a process for recycling aluminum cans into high-quality aluminum.

Electric Vehicles

Lower weight means a vehicle has a longer range. Aluminum weight is 1/3 that of steel. Steel companies have responded with their third-generation advanced high strength steel so there is a fight between steel and aluminum. The Drucker Worldwide Research Study predicted that aluminum would get 11% to 16% of automotive structures by 2025. They also expected that high-strength steel would get 7 to 10%. This kind of volume would require a significantly higher demand for aluminum.

Financial Results

The aluminum price in the first quarter of 2022 is 67% higher than in the previous quarter. Year to year the alumina prices were up 22%. The earnings per share were up 168%. However, the sales were down by 8% so revenue was only up by 15%.

Alcoa First Quarter Comparison

($MIL)

2021

2022Q1

change

%

Aluminum Price $/MT

2308

3861

1553

67%

Alumina Price $/MT

308

375

67

22%

Revenue

2870

3293

423

15%

Cost Goods Sold

2292

2182

-110

-5%

G&A Plus R&D

59

53

-6

-10%

Adjusted EBITDA

519

1059

540

104%

Net Income ALOCA

175

468

293

167%

Diluted EPS

0.93

2.49

1.56

168%

Volume (000) MT

2472

2277

-195

-8%

Table by Author

Volume Sensitivity

Metals manufacturers have a limited market growth opportunity. The concerns about the Chinese lockdowns and the European problems after the Ukrainian invasion, have caused turmoil in the metals market with steel being hit the hardest but copper and other metals have also declined in price.

Aluminum worldwide production

Metric Tons (000)

Volume

% Change

2021

72,939

3.1%

2020

70,764

2.3%

2019

69,142

Alcoa Competitive Advantage

Alcoa believes that its network of co-located mines is a cost advantage. The fact that 70% of alumina is bought by competitors indicates the value of these facilities. The mines and alma refineries are in the top quartile of plants. Alcoa has closed aluminum smelters which cannot get into the second quartile.

Thirty percent of Alcoa's power is generated by hydroelectricity or facilities that they own. Another 60% have contracts that are linked to the price of aluminum. If the price of aluminum goes up Alcoa will pay more but not drastically more. On the downside, lower aluminum prices were resolved. Lower power cost the Spanish facilities that were closed to live off of the spot market. This made them high-cost facilities.

Risks And Opportunities

The risk of falling aluminum prices is the situation that Alcoa is currently in. The Chinese lockdown and the problems in Europe highlighted the slowdown in worldwide manufacturing. Small changes in demand generate quick changes in price.

Alcoa’s restructuring will make the company more profitable compared to 2021.

Aluminum does have the advantage in new applications in electric vehicles. But for these advantages to happen, the automotive industry must get enough semiconductors and that will probably not happen before 2025.

Valuations

The current weakness in the market will reduce Alcoa’s profitability this year. The advantage they have is the steps they have taken to lower costs. This gives them the ability to take short-term hits and still prosper. As much as I like the $2.50 quarter concept perhaps a $6 earnings projection is more realistic. That would mean $6 of earnings or a $61.00 stock with a PE of 10. While there is no guarantee, I think the current stock price takes much of the risk out of the valuation.

Conclusions

The last month has demonstrated the risk of purchasing commodities that can do well in inflationary environments but can collapse quickly. What makes Alcoa an attractive stock is the potential for automotive industry growth as the number of electrical vehicles continues to grow rapidly. So, this is an attractive option, but its decision-making is under uncertainty. The automotive potential minimizes downside risk. Alcoa is a buy.

This article was written by

Edward Ambrose profile picture
1.83K Followers
I am not the typical analyst. I have unique skills, honed by years of successful Mergers and Acquisition accomplishments, to find beaten down stocks that have the potential for recovery and growth. These companies are helpful in balancing a portfolio as well as beating the market. This experience left with strong appreciation for fundamental analysis of a company’s businesses rather than the whole corporation, to find what will drive the results. ed.ambrose9@gmail.com 609 685 2290

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

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