Outlook Continues to Improve for Alcoa Inc

Alcoa's outlook continues to improve as the company accelerates its transformation.

Apr 14, 2014 at 9:04AM

Aluminum giant Alcoa (NYSE:AA) released its first quarter results this week, posting a loss. The loss was mainly due to costs related to closing of plants. In fact, the company's adjusted earnings beat Street estimates, thanks primarily to strong performance of its value-added businesses, which are benefiting from strong aerospace and auto industry demand. Indeed, these businesses will be the key growth driver going forward. Additionally, Alcoa is cutting costs and reducing capacity in its upstream business, which is also likely to benefit after the London Metal Exchange (LME) halted its plan to cut queues at its warehouse network.

Alcoa's Q1 results
Alcoa's first quarter results highlighted the strong performance of its value-added businesses. The company's value-added businesses drove 76% of segment profits in the first quarter. Still, the company posted a loss of $178 million, or $0.16 per share for the quarter. As mentioned, the loss was mainly due to costs related to the closing of plants. Excluding these costs, the company reported a profit of $0.09 per share, beating consensus forecast of $0.11 per share.

The strong performance of Alcoa's value-added businesses was driven mainly by higher demand from the aerospace and automobile industries. More importantly, both industries will continue to drive growth going forward. Automakers such as Ford (NYSE:F) and General Motors (NYSE:GM) have already announced plans to manufacture vehicles made mostly out of aluminum.

The problem for Alcoa has been the upstream business. The company is focused on cutting its capacity and lowering costs in the upstream business, however. These measures should help to improve upstream results going forward. The upstream business will also benefit from industrywide capacity cuts and the recent decision from the LME.

Supply cuts and LME's decision pushing up prices
Raw aluminum prices, which peaked at $3,114 a ton prior to the financial crisis of 2008, nosedived to under $1,800 per ton in 2013 due to a supply glut. This forced global smelting companies to cut production for the second half of last year.

While Alcoa recently closed plants in New York and Australia and slashed production in Brazil, the world's largest aluminum producer, Rusal, plans to cut its production level to an eight-year low.

In Brazil, aluminum production cuts might be even deeper than earlier anticipated. Production may hit a 12-year low since severe drought has affected hydroelectricity generation. Authorities expect power rationing could slow down the pace of manufacturing activities

Moreover, the world's biggest aluminum-producing nation, China, has decided to cut production due to higher manufacturing costs.

Apart from supply cuts, aluminum producers will also benefit from the LME's recent decision. Earlier this month, aluminum prices spiked to a five-month high after the LME said that it was forced to halt its plans to cut inventories at its registered facilities across the world.

The LME, which sits on a massive aluminum stockpile that's estimated at around 5.5 million tons, had earlier announced that it plans to cut warehouse queues following a complaint from traders that waiting periods to withdraw aluminum from warehouses exceeded more than 500 days in 2013. It is believed that warehouse owners and producers deliberately keep long waiting queues in order to boost prices.

However, the LME was forced to reverse its decision after Russian aluminum giant Rusal argued that the consultation process was unfair. A court in the UK handed a verdict in favor of Rusal on March 27 as a result. Because of this, global warehouse queues are likely to remain at least for few more months even as the LME considers holding consultations with the aluminum industry.

As I noted in a previous article, Barclays Capital expects that global aluminum producers' decisions to cut their output will result in a supply deficit of 1.1 metric tons in 2014. This, along with the LME's decision, will help to provide a floor to raw aluminum prices in the mid-term.

Transformation accelerating
Alcoa has been increasing its focus on value-added businesses. At the same time, the company is also strengthening its upstream business. Klaus Kleinfeld, Alcoa's CEO, noted that the company's transformation is accelerating as it is powering growth in value-added businesses and aggressively reshaping its commodity business. As a result, the company's outlook continues to improve.

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Varun Chandan Arora has no position in any stocks mentioned. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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