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Caustic Costs Curtail Alcan

By Stephen D. Simpson, Simpson, – Updated Nov 16, 2016 at 12:16PM

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Market fundamentals for aluminum are positive, but Alcan's operating costs are getting in the way.

Hard to believe that aluminum was once more highly valued than gold, but it was. These days, though, aluminum producers have yet to get the same sort of love that has been lavished on steel, gold, and copper companies. But could solid industry fundamentals still mean a run-up in aluminum prices is possible?

Canadian aluminum giant Alcan's (NYSE:AL) third-quarter report points to some of the challenges and opportunities that are afoot in the aluminum market. Revenue dropped 21% from the year-ago period and about 6% from the second quarter as total volumes declined because of the spinout of Novelis (NYSE:NVL). Margins also declined, and that led operating earnings per share to fall about 27% from last year and 31% from the second quarter.

Demand and pricing don't seem to be Alcan's major problems. If you strip out the product shipments produced by Novelis last year, production was up about one-third (though a fair chunk of that has come from increased ingot sales to Novelis that had been considered intercompany). On the pricing side, although the company is seeing some lower premiums, per-ton pricing on the London Metal Exchange has risen almost 8% from last year.

The issue, though, is costs. The production of aluminum requires copious amounts of electricity and power, and energy prices are quite a bit higher now than they were last year. Making matters worse, raw materials such as caustic soda and maritime freight costs aren't helping. To be fair, though, this is not a problem unique to Alcan; Alcoa (NYSE:AA) has the same troubles.

If these two companies can get a hold of their operating costs, there could be better times ahead. Although supply growth is increasing faster than demand, there is still a net shortfall of aluminum, and inventories have been declining for some time now. Assuming that the revivals in commercial aerospace and commercial construction continue, and assuming that China continues to consume more and more aluminum internally, the demand picture looks pretty healthy.

Alcan would seem to be the cheaper of the two today, but both stocks should do better if cost pressures ease up a bit. It's hard for me to get excited about stocks whose estimates have been falling, but I won't rule out the possibility that these two large companies have shinier days ahead.

For more metal missives:

Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).

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