Alcoa Inc. Moving Down the Cost Curve

Alcoa further rationalizes its upstream business and remains committed to transforming the company.

Jun 12, 2014 at 11:38AM

Alcoa Inc (NYSE:AA), the largest U.S. aluminum producer, expects aluminum demand to outpace supply in 2014. If this happens, it would end a seven-year surplus in the aluminum market. The aluminum market has been in surplus since 2007, mainly because of large capacity increases in China and the Middle East. However, analysts expect Chinese production to grow at almost the same rate as demand in 2014. CRU Group, a market analysis firm, forecasts Chinese output to grow by 10% to slightly more than 26 million tons compared with demand of 25.8 million tons in 2014. 

While improving demand should help Alcoa post strong results, the company has also been taking self-help actions to create value for shareholders. Alcoa, which is often considered an economic barometer by investors, has been transforming itself into a value-added, technologically advanced manufacturing company providing innovative solutions for its customers and commanding a leading position in many of its key end markets.

While Alcoa, similar to its peer Constellium (NYSE:CSTM), continues to spend most of its growth capex on high-margin automotive and aerospace markets (downstream), in this article, I will focus on the company's upstream assets and the steps Alcoa is taking to drive down costs in the upstream Alumina and Primary Metals segments.

Adding low-cost capacity
Alcoa is cutting costs by restructuring its upstream segments through the rationalization of capacity by shutting down high-cost smelters and adding new low-cost capacity. Alcoa entered into a joint venture with the Saudi Arabian Mining Company, Ma'aden, in 2009 to build the largest and the lowest cost integrated facility in the in Middle East. The joint venture will be one of the lowest-cost facilities in the world, producing 1.8 million tons of alumina, 740,000 tons of aluminum, and 380,000 tons of rolled aluminum products. 

Shutting down high-cost facilities
Alcoa is not only adding new low-cost capacity; at the same time, it's also shutting down high-cost facilities. Over the past five years, the aluminum producer has permanently closed about 30% of its global aluminum (smelting) capacity. In addition, by the end of 2014, the company will take down its can sheet rolling capacity by 200,000 tons at its Point Henry rolling mills in Australia. 

Alcoa is not the only company cutting output. United Company Rusal, the world's largest aluminum producer, saw its output drop by 8% in 2013 and is planning to cut back by a similar amount this year. Other companies that have announced capacity cutbacks include Rio Tinto (NYSE:RIO) and Norsk Hydro (NASDAQOTH:NHYDY). These capacity shutdowns/curtailments combined with increasing demand should further provide support to prices.

Improving productivity
In addition to adding new low-cost capacity and shutting down high-cost facilities, Alcoa is also focused on improving productivity to drive down costs in the company's upstream business. After the 2008 financial crisis, the aluminum producer has implemented rigorous productivity enhancement measures and has achieved more than $6 billion of savings between 2009 and 2013. The company is planning additional cost savings of $850 million in 2014, of which $250 million was already achieved in the first quarter. 

Strong aluminum demand
Aluminum usage ex-China is expected to outpace production by 1.3 million-1.4 million tons this year. Aluminum producers outside China, including Alcoa, Rusal, Rio Tinto, Norsk Hydro, etc., have cut production by 3 million tons since 2012 and are expected to cut production further by 1.6 million tons in 2012. As the global aluminum demand continues to improve, and capacity cutbacks finally begin to bite, aluminum prices should improve later this year. Moreover, a strong demand outlook should further lend support to prices in 2015.

The supply and demand situation in China should also improve going forward, as producers in Asia's biggest economy are losing money at current prices, and output is set to decline as banks cut credit to companies making losses.

Record premiums
Aluminum premiums are also at record highs. According to United Company Rusal, the largest producer of aluminum, premiums paid to secure aluminum are expected to exceed $500 per ton as soon as the next quarter, as demand continues to improve and supply remains tight.

Buyers across the world are paying record premiums for supplies of aluminum, as stockpiles tracked by the London Metal Exchange (LME) remain low. "At least 75% of stockpiles in London Metal Exchange warehouses are tied into financing transactions and unavailable for immediate withdrawal," said Oleg Mukhamedshin, Deputy CEO of Rusal. 

Bottom line
While the improving demand for aluminum should help Alcoa post strong results, the company has also been taking self-help measures to create value for shareholders. The company has been transforming itself into a value-added technologically advanced manufacturing company providing innovative solutions for its customers and commanding a leading position in many of its key end markets. Alcoa is also cutting costs in its upstream operations and rationalizing capacity by shutting down high-cost smelters, which should further help the company improve its EBITDA margins.

Say goodbye to "Made-in-China"
"Made in China" -- an all too familiar phrase. But not for much longer: There's a radical new technology out there, one that's already being employed by the U.S. Air Force, BMW and even Nike. Respected publications like The Economist have compared this disruptive invention to the steam engine and the printing press; Business Insider calls it "the next trillion dollar industry." Watch The Motley Fool's shocking video presentation to learn about the next great wave of technological innovation, one that will bring an end to "Made In China" for good. Click here!


Jan-e- Alam has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information