4 Key Takeaways From Alcoa Inc's Earnings Report

Alcoa's report signals the worst times could be over for primary aluminum producers.

Jul 12, 2014 at 3:19PM

Alcoa's (NYSE:AA) second-quarter report was praised by the market, and the company's shares continued their impressive rally. While most of the positives have been attributed to the company's aerospace and auto businesses, the primary aluminum segment showed strength as well. Besides successful cost-cutting and continuing idling of underperforming facilities, the primary aluminum segment also benefited from industrywide trends. These developments will benefit other primary aluminum producers, such as Century Aluminum (NASDAQ:CENX) and Rio Tinto (NYSE:RIO).

Aluminum demand continues to grow
Alcoa continues to project that global aluminum demand will grow by 7% this year, fueled by continuing growth in China. The Chinese story is not that important for Century Aluminum, which derives 85% of its revenue from four customers, the biggest being Glencore Xstrata. However, it is important for Rio Tinto, for which China is a big customer.

Production curtailments create deficit
Alcoa expects a substantial deficit in the aluminum market this year. Alcoa itself has closed three smelters in 2013 and two smelters this year, while making production curtailments on many other facilities. In turn, Century Aluminum is also operating below its capacity. While the company's total annual production capacity stands just above one million tons per year, Century Aluminum produced 777,000 tons in 2013. Just like Alcoa, Century Aluminum expects to see a deficit in the aluminum market for the foreseeable future.

Aluminum inventories continue to decline
Alcoa stated that global inventories declined by 37 days from the peak reached in 2009. What's more, inventories declined by five days in the second quarter and remain at 71 days of consumption. Interestingly, when inventories were higher, aluminum prices at the London Metal Exchange (LME) were higher too. Possibly, the lower level of inventories was a source of the recent rebound in aluminum prices, although prices remain at low levels.

Better pricing would have certainly helped aluminum producers, especially for Century Aluminum, which had recently had a series of quarterly losses. However, the company is expected to return to profitability in the second quarter and is also expected to finish this year with a profit. Century Aluminum managed to grow its revenue by 31% in just one year, and this fact bodes well for the company's shares, which are up more than 60% year to date.

Premiums hit highs
Buyers who want physical delivery of aluminum pay a premium over the LME price. Back in 2013, those premiums were mostly between $250 and $300 per ton. At the end of the second quarter, premiums reached $425 per ton in Europe, $403 per ton in Japan, and $430 in the Midwest US. This fact signals improving physical demand in different parts of the world and should boost cash flows for aluminum producers.

Bottom line
The aluminum story is not only about value-add products right now. Producers can make money on primary aluminum as well, if they are positioned on the left side of the cost curve. For example, Alcoa plans to improve its aluminum cost curve position from the 43rd percentile to 38th percentile by 2016. Producers with solid costs will take advantage of the recent developments, and weaker players will be forced to leave the market.

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Vladimir Zernov 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.

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