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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers