Alcoa Inc. Raises Its Aerospace Stakes

Aerospace growth is soaring, and backlogs at aircraft original equipment manufacturers (OEMs) such as Boeing Co (NYSE: BA  ) and Airbus Group NV (NASDAQOTH: EADSY  ) are at record highs. The two aircraft manufacturing giants are stepping up production as airlines order new, more fuel-efficient planes.

Alcoa (NYSE: AA  ) , the biggest U.S. aluminum producer, is also taking steps to cash in on the boom in commercial aircraft orders. The company recently announced that it will expand its downstream aerospace reach into the large commercial jet engine market by building a new $100 million facility in La Porte, Indiana. 

Alcoa already produces structural engine components for business and regional jets; however, the new facility will expand the company's reach to large commercial aircrafts. The new plant will increase Alcoa's capacity to supply engines for narrow-body aircraft, which are among the top-selling jet engines in the world. Construction of the plant is already under way and is expected to be complete by the end of 2015.

Long-term contracts secured
While the company has not disclosed its customers, Alcoa says that it has enough long-term contracts to support the facility. I believe the company's new plant is likely to serve big engine manufacturers, such as General Electric (NYSE: GE  ) and Rolls Royce, since the new Indiana plant will make parts that form the rib cage around a jet engine's vital parts.

Commenting on the news Alcoa Chairman and CEO Kaus Kleinfeld said, "Aerospace growth is soaring and Alcoa is ramping up our downstream capabilities to capture that demand." He further said, "Applying our industry-leading expertise, this facility will deliver highly engineered parts our customers need to build some of the best-selling engines and at high volumes." 

At it again
This is the second major aerospace investment by Alcoa in Indiana in two years. The previously announced $90 million green-field aluminum lithium facility is expected to come online by the end of 2014. Adjacent to its existing Lafayette plant, this new facility will be capable of producing more than 20,000 tons of Alcoa's patented aluminum lithium alloys used for lighter, more fuel-efficient aircraft and will compete with carbon fiber. 

Aerospace demand
Following significant aerospace market growth over the last decade, large aerospace build rates are at historical highs. The surge in air travel in developing countries in particular is driving demand for new aircrafts. Goldman Sachs expects the large commercial build rates to grow at a CAGR of 3.9% in the next three years. More importantly, Goldman expects wide-body build rates to significantly outpace narrow-body build rates, growing at an 8.9% CAGR compared to a 2% CAGR for narrow-bodies. 

This is particularly good news for producers like Alcoa and Constellium (NYSE: CSTM  ) , as wide-body aircraft are naturally larger and require more materials. Alcoa also expects 2014 to be a strong year for aerospace demand. The company has increased its global aerospace market growth forecast to 8%-9% from a previous forecast of 7%-9%.

Alcoa shares have outperformed the market by a significant margin in 2014. Year to date Alcoa is up by more than 30%, compared to -1.5% for Kaiser Aluminum Corp and 4.5% for the S&P 500. Despite this strong performance, I believe Alcoa has further upside potential as aluminum demand continues to improve.

Bottom line
Alcoa is focused on creating value through growth in high-margin downstream businesses, particularly in the aerospace market, and the company's new facility is another reminder of it. Within the company's $4.0 billion aerospace portfolio (year-end 2013 figures), Alcoa generates about $1.5 billion of revenue from nickel alloy products. This is a very high-margin business for the company, with a stronger EBITDA margin compared to Alcoa's engineered products and solutions segment.

The new Indiana plant will not only help Alcoa meet increasing demand from customers and increase its presence in the aerospace nickel alloy market, but will also improve the company's overall margins. This is a second major investment in the aerospace sector by Alcoa in the last couple of years, underpinning the rising aerospace demand cycle. Its state-of-the-art aluminum lithium facility in Lafayette is also expected to come online later this year. While the expansion provides Alcoa with additional capacity to supply narrow-body engines, more importantly, it provides an opportunity to capture share in the higher-growth wide-body aircraft engine market.

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