A brief look at the stock chart tells you things haven't gone well for Alcoa (AA) in the last year. Shares of the vertically integrated aluminum manufacturer were mired in a slide that started in April 2018 and lasted through the year.
While the stock has steadied somewhat in January so far, management's outlook for 2019 didn't inspire optimism, indicating difficult market fundamentals will continue. Investors will watch management try to navigate persistent headwinds, with the looming threat of slowing economic growth bearing down on the commodity-linked business. For a tough year ahead, we'll offer three glimmers of hope that investors would do well to keep their eyes on.
1. Developments in China's economy and industrial sector
Alcoa provides market updates for each product in the aluminum value chain. That includes bauxite (the ore from which aluminum is obtained), alumina (the processed form of bauxite), and aluminum (the metal) -- and each is important to the overall business. In fact, last year the company generated adjusted EBITDA of $426 million from bauxite, $2.4 billion from alumina and only $404 million from aluminum.
For 2019, the company expects the bauxite market to boast a surplus between 7 million and 11 million metric tons. The overall market glut only exists because China stockpiles bauxite to account for its own supply insecurity, and explains why Alcoa's bauxite segment -- a key supplier to China -- enjoys the highest EBITDA margins of the bunch.
Meanwhile, the alumina market is expected to move from its 2018 deficit to a surplus in 2019. That will also be driven by China, only this time owing to new refinery start-ups outpacing smelter capacity additions. The changing market dynamics could sting Alcoa's main profit generator from last year, especially when coupled with expectations for global aluminum demand to grow by the slowest rate since the Great Recession. Not surprisingly, China will play a role in determining global growth for aluminum, too, it struggles to limit air pollution (potentially limiting industrial output) and prop up its slowing economy (slowing growth impacts domestic demand for industrial products).
Simply put, investors should keep an eye on developments out of China. Even if tariffs that helped Alcoa in 2018 remain in place for the year, the country could make or break the company's 2019 simply by pressing its thumb on the scale of global markets.
2. Portfolio reshuffling
Alcoa drastically overhauled its portfolio in the aftermath of the Great Recession, but it is still retooling operations to boost efficiency. Although recent moves have promised to lift long-term profits, investors have had to swallow up-front costs ranging from asset impairments to untimely pension payouts (which, to be fair, the company got too far behind on).
The latest blow will come from Spain. Alcoa reached a tentative agreement with a local union to curtail the output of two smelters in the country, preserve some jobs, and provide retirement packages. While the move would remove 124,000 metric tons of aluminum supply from the market each year, the company expects to record about $102.5 million in restructuring costs. On top of that, the business may incur additional expenses of around $130 million, although only 25% of the total is expected to be paid in cash.
The transactions would increase annual net income by approximately $75 million based on market conditions from 2018 (Alcoa reported $871 million in net income in 2018) beginning in the third quarter of 2019, but Wall Street analysts might squirm in the nine months leading up to that date. Investors will need to watch that the charges stick within the estimated ranges.
3. Canadian dairy
It sounds strange, but Canadian dairy is holding up a potentially huge windfall for Alcoa's business, thanks to recently renegotiated North American Free Trade Agreement (NAFTA). The old agreement was a sweet deal for inefficient dairy farmers in Quebec by giving them nearly unencumbered access to the U.S. market, which came at the expense of American dairy farmers -- and now the Trump administration is demanding change. To exert maximum leverage, Uncle Sam won't lift tariffs on Canadian aluminum imports until Canada ratifies the new NAFTA, complete with concessions from the dairy industry.
While Alcoa has noted that American tariffs placed on aluminum imports from all countries actually provided a benefit to its business in 2018 by increasing market share for products manufactured in the United States, the windfall could be even greater if the United States and Canada worked things out. After all, 28% of the company's aluminum production originates in Canada, which means it racks up a hefty tariff bill bringing products over the border when supplying its American facilities.
That puts a lot of focus on Canadian dairy. Quebecois farmers are putting up a fight, helping lead a nationalist political party to achieve a majority in recent provincial elections, marking the first time since 1966 that one of the province's top two parties didn't emerge victorious. It may not matter in the end because Quebec is also home to Canada's aluminum industry, and aluminum is more valuable (both in terms of jobs and gross domestic product) than dairy. Nonetheless, the pace of developments will be something for investors to keep an eye on.
Is another rough year ahead?
Alcoa actually had a solid year of operations in 2018. The caveat is that the bar was already pretty low thanks to years of sluggish performance. That said, the business is leaner and financially healthier than at any other point in recent memory, which should help it to navigate headwinds with more ease going forward. However, it might be easier to turn an ocean liner than a globe-spanning, commodity-based business in a sliding aluminum market. Aluminum investors can expect another volatile year ahead.