The election of Donald Trump to the United States presidency continues to send shock waves around the world, moving markets in sometimes unexpected ways as investors look to profit from Trump's "America First" platform and a likelihood of reduced regulation.
And while on the surface, American metals and mining companies seem high on the list of companies to profit from aggressive actions to reduce imports and support more manufacturing at home, it's not always so simple. This is particularly true for a company such as Alcoa Corporation (AA), the recently spun-out pure-play bauxite, alumina, and aluminum producer, which has mining and production sites on five continents.
Here's a closer look at Alcoa's business, and the things that investors really need to understand going forward.
Where Alcoa's business comes from
Alcoa is inextricably tied to the mining of bauxite and refining it into alumina, which is almost entirely done outside the United States today. Through the first half of 2016, the bauxite and alumina segments generated 48% of Alcoa's before-corporate expense adjusted EBITDA and produced 73% of its after-tax operating income last year.
Here's a look at where Alcoa's bauxite mining and alumina refining assets are located:
All of Alcoa's bauxite mining happens outside the U.S., and only one of its alumina refineries -- worth about 13% of Alcoa's total refining capacity -- is a domestic asset. But with the vast majority of the world's bauxite located outside North America, it only makes sense that Alcoa's raw-materials operations would happen in proximity to where the raw materials are found.
Let's move on to aluminum smelting and casting:
Alcoa has a significant aluminum production presence in the U.S., with about 31% of its aluminum smelting in the U.S., and another 25% in Canada. But it's worth noting that Alcoa has been cutting its domestic aluminum smelting, having closed its smelting operation near Evanston, Ind., earlier this year, with management bluntly saying that "Despite the hard work of employees, these assets are not competitive." The company also closed its Port Comfort, Texas, alumina refining operation in 2016.
Aluminum casting, however, is heavily dependent on North America and Europe and typically best suited to be located close to customers. Alcoa says 96% of its casting segment's revenue comes from North America and the EU. Further, Alcoa is the No. 1 aluminum billet producer and the second-largest aluminum slab producer in North America. These two products are important for transportation, industrial, and packaging manufacturers. The company is North America's largest food-can producer and second largest drink can sheet producer, and it's aiming to have more than 13% of the North American automotive sector by 2020.
In terms of revenue and profits, aluminum smelting and casting generated $111 million in after-tax operating income for Alcoa in 2015, roughly 11% of the total, and 37% of adjusted EBITDA, excluding corporate expenses, in the first six months of 2016.
What Donald Trump aims to do
In many ways, the president-elect's trade platform leaves a lot open for interpretation, though he has been adamant that he will take aggressive actions to protect American jobs and work hard to bring manufacturing back to the United States. His actions are likely to include duties and tariffs on imports, particularly from countries known to manipulate their currency to benefit domestic manufacturing, or even provide direct subsidies, such as China. However, Trump has also threatened tariffs against other countries, simply because they have more competitive labor costs, such as Mexico.
Here are potential best-case and worst-case scenarios:
Aggressive actions to protect American manufacturing lead to a stronger domestic manufacturing base. The Trump administration levels the playing field against foreign producers that benefit from their own government's intervention in pricing, such as through subsidies or currency manipulation. And low-wage manufacturing such as textiles don't come back, while high-skilled manufacturing grows at home and is competitive globally.
A Trump administration's isolationist "America-first" actions lead to a trade war that harms the prospects of American manufacturers to sell their products into growing overseas markets. Weak global sales drag on the economy, leading to a recession. This recession hurts domestic manufacturing the worst, leading to layoffs and plant closures.
The reality is that it's likely to take years for the effects of Trump's trade policy actions to have an impact, and a number of other variables, including the overall state of the domestic and global economy, will have a bigger impact in the near term.
What it means for Alcoa
While aggressive trade policy could have some meaningful benefit for steelmakers (as was discussed here), it's not as clear-cut for Alcoa and other upstream aluminum producers, simply because the raw material is found far from the United States, and it's just more cost-effective to process and refine it near the mines.
That means Alcoa is more affected by global commodity prices than domestic trade policy. And over the past half-decade, Alcoa management has taken steps to reduce its production costs -- including closing American raw-material processing facilities, while it's focusing its domestic capital investments on growing its finished product manufacturing.
The upshot is this: Alcoa wins if Trump's trade policy boosts American manufacturing, because American manufacturers are Alcoa customers. If the American economy suffers as a result of overly aggressive actions by the Trump administration, that's bad for Alcoa. Either way, bauxite and aluminum prices, and Alcoa's ability to manage its costs, are far more important to the company's prospects than who's in the White House.