Alcoa (
AA
) will kick off this quarter's earnings season when it announces
its Q4 results after the market closes on Tuesday, January 8.
Alcoa's results are closely eyed as it usually is the first Dow
company to post earnings. We expect the company to record soft
earnings, but most investors will watch for any cues on its
outlook. Aluminum prices and demand remain sluggish due to global
economic conditions. Also, aluminum inventory continues to remain
high relative to demand, keeping a further lid on London Metal
Exchange (LME) prices for aluminum.
In December, the rating agency Moody's put Alcoa's debt rating
on review for a possible downgrade citing a challenging operating
environment and a fall in aluminum prices this year. According to
Moody's, aluminum prices are not expected to show significant
recovery over the next several quarters.
Aluminum prices on the London Metal Exchange, which are used as
a benchmark by the company to determine its own prices, have
averaged $2,051 this year. This is 15% lower than last year. Prices
touched a 34-month low in August as global supply exceeded
demand.
Alcoa's management has taken certain steps to meet challenges.
It is making efforts to reduce its debt from present levels of $8.3
billion, shifting its focus to value added products used in the
aerospace industry and cutting capacity in smelters to streamline
operations.
See Full Analysis for Alcoa Here
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 earnings still
come from the Alumina and Primary Metals divisions. This makes
its earnings highly sensitive to aluminum prices.
Aluminum Price Trend In Q4
The continuing European debt crisis, slowing Chinese growth, and
the U.S. fiscal cliff situation have contributed to the decline in
aluminum demand and prices over the last few quarters. The price
trend chart on the London Metal Exchange (LME) shows aluminum
prices falling steeply from nearly $2,100 at the beginning of Q4 to
breach $1,900 before rallying back steadily to about $2,100 as of
today. However, prices failed to breach the $2,200 mark throughout
the quarter. As mentioned before, we think that high inventory
levels are keeping a lid on prices. While LME prices are not
the actual realized prices for Alcoa, they do indicate a broader
trend in global aluminum prices.
What Does The Fiscal Cliff Deal Mean For Alcoa?
A fiscal cliff deal was reached and ratified at the beginning of
2013 and Alcoa stock prices received some boost. However, at this
point it would too early to claim a positive long term gain.
Manufacturers and the rest of the U.S. economy still face
uncertainty on the debt ceiling, in addition to the delayed budget
cuts. At best, it seems like the can has been kicked down the
road.
What Is Alcoa's Management Doing To Meet
Challenges?
Alcoa's management claims to be working to increase Alcoa's
profitability in divisions that produce engineered products and
supply aerospace customers while cutting costs in its mining and
smelting segments. In October, Alcoa cut its 2012 global
aluminum demand forecast to 6% from 7%, but maintained its
long-term outlook that aluminum demand will double in 2020
from 2010 levels.
Alcoa reported an operating loss figure of $143 million in Q3
2012. We think that the company should pare down its debt
(currently $8.3 billion) in line with its lower earnings
rate. Alcoa claimed on its Investor Day in November that it
has cut $5 billion in costs since 2008 through productivity
improvements such as increasing yields out of its refineries and
streamlining operations by cutting capacity in smelters.
Alcoa says that it has cut its near-term maturities to roughly
$400 million over the next four years (excluding 2014 convertible
bonds), and expects net debt to be down 30% from 2008 to between
$6.8 billion and $7.1 billion by end of 2012.
The company's recent strategy realignment and capacity cuts for
smelters and alumina refining should continue to drive productivity
improvement. Further, its Saudi Arabian project is on track
and is expected to start full-fledged operations in early
2013. This will help the company's efforts to
geographically diversify its operations. Additionally,
vertical integration should help the company maintain healthy
margins even with depressed prices.
We believe that Alcoa's long-term fundamentals are strong while
it continues to face near term headwinds. What Alcoa can and
must do is to focus more on engineered products to improve margins
and earnings. In an environment of slow economic growth, it would
be a stretch to expect aluminum prices to trend upwards because it
is primarily an industrial metal.
We have a
Trefis price estimate for Alcoa of $10
which will be revised after the fourth quarter earnings
results.
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