After the London Metal Exchange announced new rules designed to have its global network of warehouses more quickly deliver aluminum to customers, shares of the metal's producers like Alcoa (NYSE:AA), Century Aluminum (NASDAQ:CENX), and global giant Rusal fell as it signaled there would be renewed pressure on prices.
Heavy aluminum users like soda bottlers and brewers have long complained about rising costs incurred as a result of delayed metal deliveries, sometimes running as long as 100 days or more. So for those warehouses with the longest wait times, the LME's new rules would cut that delivery time in half, causing them to deliver more aluminum than they take in and likely pushing metal prices down. With aluminum trading just north of $1,800 per ton after hitting a four-year low of $1,752 per ton in June, renewed downward pressure could be a problem.
Other signs that aluminum may be losing its luster include miners trying to extract themselves from the market. Last week, Vale (NYSE:VALE) announced it sold its 22% stake in aluminum producer Norsk Hydro for $1.8 billion while Rio Tinto (NYSE:RIO) was selling down its position in aluminum products company Constellium for $330 million. There are other factors involved in miners dumping their holdings, such as Vale's looming tax bill in Brazil, for which it needs to raise cash, and an industrywide "flight to the core" by miners reining in costs by focusing only on core assets, but with aluminum prices still down 5% from the year ago period and below the breakeven point for production, there remains a softness in the market that can't be ignored.
For all that, I still see macro trends in the aluminum market's favor, and I find Alcoa as the largest aluminum producer in the U.S. to be particularly attractive.
Rusal, for example, was able to slash its losses by two-thirds in the third quarter from where it stood in the prior period through a program of cost containment. Although there's been a global economic slowdown that's impinged on demand, it's also created a production deficit that should widen over the next two years by 1.3 million metric tons. Rusal says global aluminum usage should hit 51.2 million tons this year, but production is estimated to be 50.9 million tons. It's cutting its own production levels by 324,733 tons this year and will slash it another 647,504 tons in 2014.
Output is down 5.8% over the first three quarters of 2013 to 2.95 million tons even as demand is expected to rise 10% this year.
Alcoa confirms the production deficit, but because it's branching out into niche specialty markets that will drive its profits going forward, it's less worried about the impact forces such as the new LME rules will play on its own performance. When it reported its own earnings last month, Alcoa was able to keep revenues flat despite lower market prices for aluminum.
It's looking to opportunities like Airbus' new A330-300 aircraft that will be used for short, high-density routes primarily in Asia, but will require advanced alloys to achieve the reduced weight and increased passenger capacity the plane maker is looking for in body design and engine components.
The aluminum producer is also looking at the housing industry and seeing the need for greater energy efficiency as playing to its strengths. It points out new window products as an example of how it can take a large slice of what it estimates to be a $58 billion opportunity. From hurricane resistance to thermal performance, Alcoa sees the homebuilding market as particularly lucrative opportunity, even if it's small at the moment.
Indeed, Alcoa's value-add businesses now account for 57% of total revenues and 79% of after-tax operating profits. It's looking to add more than $2 billion in new revenues to its business, and though a good part of the plan comes from firming prices in the marketplace, it's also the growth of these value-add businesses that will drive its momentum forward.
Trading at just a fraction of its sales and book value, I find Alcoa a shining example of an undervalued play ready to reap the windfall that's soon coming to the aluminum industry.