Alcoa Inc Firing on All Cylinders

Alcoa Inc  (NYSE: AA  ) , the largest U.S.-based aluminum producer, is aggressively transforming its portfolio. The company is boosting more value-added products, becoming less cyclical, less economically sensitive, and as a result more profitable.

Alcoa's latest results show that not only is the portfolio transformation well under way, but the years of cost cutting actions are also bearing fruit. The company, which is often the first in the S&P500 Index to report earnings, reported second quarter adjusted EPS of $0.18, beating Wall Street estimates of $0.12 by a whopping 50%. All of the company's business segments were profitable during the quarter. 

Primary metals business comes back a big way
Alcoa's primary metals segment has long been a drag on the company's earnings. However, in the latest quarter the commodity business came back to profit in a big way. The segment reported after-tax operating profit of $97 million, compared with a loss of $37 million in the same quarter last year.

Alcoa has been aggressively cutting costs and reducing capacity in its smelting business. Alcoa has either idled or permanently closed unprofitable smelting capacity. The company recently slashed 147,000 metric tons of smelting capacity at its São Luís (Alumar) and Poços de Caldas smelters in Brazil. 

Alcoa has also closed or announced closures of plans in Australia and the U.S. Once all announced closures and curtailments are executed, Alcoa will have reduced its operating smelting capacity by 1.2 million metric tons, or 28%, since 2007 . However, the company continues to ramp up production at its joint-venture in Saudi Arabia, which will be the world's lowest-cost smelter complex. 

Shifting focus
Aluminum producers have been struggling for years with declining aluminum prices driven by a surplus in the global capacity. However, Alcoa lately has been trying to take matters in its own hands to avoid vulnerability to swings in metals prices.

Alcoa is shifting its focus to manufacturing more high-margin aerospace and auto components. By boosting sales of specialized shapes and alloys, the company is also trying to reduce its dependence on metal prices.

I'll come to the aerospace sector later. As far as the auto sector is concerned, Alcoa continues to benefit from the increasing use of aluminum as a substitute for steel by the auto industry. The auto industry has increased its use of aluminum to reduce the weight of cars in order to meet fuel-economy standards. Alcoa increased its North America commercial transportation market growth estimates by more than 70% at the mid-point (10%-14% from 5%-9%). 

Source: Company Documents 

Increasing leverage to aerospace cycle
Alcoa is pushing deeper into the market for more profitable products. Aerospace is a particularly attractive segment as airplane backlog orders stretch out for years. The world's third largest producer of aluminum announced late last month its plan to acquire Firth Rixson, a UK-based maker of jet-engine parts. 

The company will acquire the producer of aerospace jet engine components for $2.85 billion, $2.35 billion in cash, $500 million common stock. As a result of the Rixson acquisition, Alcoa's share of aerospace revenues will increase to 20% from 17% currently. 

The acquisition, which will be accretive to earnings from year two, makes strategic sense for Alcoa. It will further diversify the company away from its low margin, volatile upstream segments and enhance its downstream businesses.

Firth generated $1 billion in revenue last year and is projected to increase its revenues by 60% to 1.6 billion by 2016. Moreover, Firth Rixson's sales through 2019 are expected to grow at more than double the rate of the global aerospace market.

Source: Company Documents 

Foolish takeaway
Alcoa has started the second quarter earnings season on a positive note. The largest U.S.-based aluminum producer is shifting its business more toward value-added downstream products. At the same time, the company is also rationalizing the upstream alumina and aluminum businesses and moving down the respective cost curves. Finally the Rixson transaction, which is expected to close by year-end, accelerates Alcoa's transformation and provides it an opportunity to become a major player in the aerospace jet engine market.

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