Alcoa (AA) is an iconic name in the aluminum industry, with a history dating back to the very start of the sector. It's been through some big changes recently, including a string of acquisitions in the metal fabricating space that eventually led to a corporate split a few years ago (the other unit is called Arconic). However, after struggling through a difficult aluminum market recently, Alcoa is again looking to shake things up. Here's what's going on, and why it matters for investors in this bellwether business.
Alcoa is known as an aluminum company, but that really shortchanges the breadth and depth of the company's business. Making aluminum, or products from aluminum, is the end of a process, not the start. The value chain begins with bauxite. Alcoa is the second-largest bauxite miner on planet Earth. And, in addition to that, its bauxite production costs are in the lowest 25% of the industry.
Bauxite is then processed to make alumina. Up to 90% or so of Alcoa's bauxite is used internally at the company. Excluding China, it is the largest producer of alumina in the world. And, as with Bauxite, it is one of the lowest-cost players, with expenses in the bottom quartile.
Making aluminum is the final step of the process. Only about a third of Alcoa's alumina gets used internally to make aluminum, largely commodity aluminum. Basically all of the aluminum it makes gets sold to third parties that turn it into usable products (like Arconic). Here's where things start to diverge in a material way, however: Alcoa is only a top-10 aluminum producer and its costs are in the third quartile, meaning there are a lot of larger and more efficient players in the space.
Time for some change
Now add to this puzzle that aluminum prices have been relatively weak lately, leading to losses of $4.43 per share through the first nine months of 2019. While that number includes one-time costs, the general trend is still the same. When times get tough in aluminum, Alcoa feels the pain pretty quickly.
As a company selling commodity products, there's only so much Alcoa can do about this. However, one key path to stability in volatile markets like those in which it competes is to be large and low-cost. That's exactly the position Alcoa maintains in bauxite and alumina. But it's not where the company sits in the aluminum space.
That's the background for the big announcement Alcoa made when it released third-quarter 2019 earnings. CEO Roy Harvey announced during the company's earnings call a "multiyear review" of its aluminum and alumina operations, with the goal of driving "costs lower" and producing "sustainable profitability." Investors cheered the announcement, sending shares sharply higher following the earnings release. This news comes on top of the company's ongoing efforts to streamline its operating structure and cut costs (which already included selling assets).
Looking at the big-picture plan that management provided, the direction here is clear. None of its bauxite production is being reviewed in this process. Around 25% of its alumina production is being looked at for potential changes. And nearly 50% of its aluminum production could end up on the chopping block. Alcoa is clearly going to be refocusing on the areas where it has the best industry positions (bauxite and alumina), while effectively resetting its position in aluminum.
From a business perspective, that seems like a solid move. Although the aluminum business will likely end up being smaller, the goal of improving the company's cost structure is laudable. Once that reset has been completed, it can start to grow the business from a position of industry strength. Or it can simply choose to remain smaller than it has been historically in this piece of the aluminum value chain.
A different look
The big takeaway for investors here is that Alcoa's business could be changing dramatically. And while it may remain an important player in the aluminum space, broadly speaking, it won't be quite as much of an aluminum company going forward. In fact, it appears that it could increasingly look like a bauxite miner. That's not inherently good or bad, though the direction in which the company is moving (focusing on low-cost operations) does appear to be a solid one.
However, if you are a long-term investor looking for exposure to aluminum, you might want to consider other alternatives at this point, or at least sit on the sidelines until Alcoa's overhaul plans start to take shape.