The Bull Case for Alcoa Inc Grows Stronger

Alcoa's outlook as improved further after the company reported strong second-quarter results.

Jul 16, 2014 at 10:53AM

Back in April when Alcoa (NYSE:AA) posted a quarterly loss due to a huge one-time charge following closures of high-cost plants and weak aluminum prices, the stock, in fact, moved higher. Investors' confidence in the American aluminum giant was not shaken as after excluding the one-time charge, the company's earnings beat Street estimates, driven by strong performance at its finished goods division, which caters to the aircraft and automobile industries. Moreover, the fact that Alcoa has shuttered high-cost aluminum smelters in Brazil, the U.S., and Australia to offset falling aluminum prices and has increased focus on low-cost smelting facilities, as in in Saudi Arabia, has provided further support for the stock. 

Not surprisingly, I have been bullish on the company's prospects. And following the release of yet another strong quarterly earnings report recently, the bull case has grown even stronger. Also, the increased optimism is not just because of better-than-expected results. It is also because of the rising possibility of higher raw-aluminum prices in the second half of the year.

Indeed, over the course of the year, the demand-supply fundamentals have changed dramatically. As global aluminum smelters curtailed or cut their output to make the market fundamentally balanced, supplies and inventory levels have been squeezed. Moreover, Indonesia's decision to place a ban mineral ores exports has also contributed to the shortfall.

Consequently, aluminum prices, which were close to $1,750 per ton at the beginning of the year, have been hovering near $1,900 per ton lately, having touched as high as $1,930 per ton last week on the London Metal Exchange (LME).

Strong second-quarter results
Last week, Alcoa posted better-than-expected fiscal second-quarter results. The bottom-line was boosted by solid performance from the company's aircraft and auto parts making unit and strengthening traditional aluminum smelting business.

With production cuts expected to be maintained amid accelerating pace for the global economy, the aluminum market is likely to go through a wider-than-expected demand-supply deficit. The changing scenario would help Alcoa strengthen its margin given that its smelting business is the major revenue generator.

Building further confidence on the aluminum giant is its growing revenue from value-added finished product business, which was further strengthened following a recent acquisition of UK based aerospace parts maker, Firth Rixson Ltd for $2.85 billion.

Production Cuts
Years of supply glut, massive stockpiles of the metal at the LME warehouses (more than 5 million tons), along with huge inventory levels (estimated between 10 million tons and 15 million tons) lying with secondary sources globally in the backdrop of fragile demand have forced smelters to cut output since the middle of 2013. All major aluminum smelters, including Alcoa, Rio Tinto (NYSE:RIO), and the world's No. 1 aluminum smelter, Rusal, have been curtailing production since mid-2013.

Rusal estimated that aluminum producers (ex-China) slashed production capacity by approximately 1.2 million tons last year. Alcoa itself cut aluminum production in Brazil and announced closure of smelting facilities both in Australia and New York State.

These curtailments and production cuts helped smelters to create a deficit of 726,000 tons in 2013.

Bigger-than-expected deficit
The production cuts by major aluminum smelters continued this year. Hence, it was widely expected that the aluminum market will continue to witness a deficit in 2014. The banks, however, differed over how wide the deficit could be. The most courageous forecast came from Barclays, which anticipated a deficit of 1.07 million tons. However, this forecast has turned out to be nearly accurate. Indeed, Alcoa during a conference call said that it expects a supply demand deficit of 930,000 tons up from April's forecast for 730,000 tons.

One of the key reasons why deficit will be widening this year is Indonesia's ban on mineral-ore exports. Between 2007 and 2013, Indonesia accounted for about 60% of the total bauxite supplies. As I pointed out earlier, citing CRU findings published on the Financial Times, China bought nearly two-thirds of Indonesia's bauxite exports all these years

But due to the export ban, China hasn't acquired any bauxite from Indonesia this year, which has helped widen the deficit. 

Strengthening finished goods business
In order to ward off weakness in the raw aluminum market, Alcoa has been focusing lately on strengthening its high-margin downstream business. In the latest quarter, profit from this division, which makes products used by the auto and aircraft industry, increased 5.7% to $204 million. The company expects profits from this unit to rise by about 10% in the third quarter, year on year.

Demand from the aircraft industry has been very robust in the recent past, and the trend is likely to continue. That's why Alcoa's recent acquisition of jet-engine part maker, Firth Rixson has been touted as an excellent move by industry experts. Sales from Alcoa's downstream business, which currently accounts for about 17% of the total revenue, is expected to climb to 20% of the total as a result of this acquisition. Besides, the demand from the auto industry, which is substituting aluminum for steel to meet fuel standards, is also expected to remain strong.

Take advantage of this little-known tax "loophole"
Recent tax increases have affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "The IRS Is Daring You to Make This Investment Now!," you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Varun Chandan Arora has no position in any stocks mentioned. The Motley Fool recommends General Motors. 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.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

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.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

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. The show is also heard weekly on dozens of 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. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.


Compare Brokers