Alcoa (NYSE:AA), the largest U.S. based aluminum producer, kicked off the earnings season with better than expected quarterly results. Alcoa, which is considered by investors as an economic barometer, expects global aluminum demand to outpace supply this year. If AA's forecast turns out to be true, it will end a decade-long surplus in the aluminum market.
Better than expected results
Excluding one-time items, Alcoa reported adjusted 1Q14 EPS of $0.09, beating sell-side estimates of $0.05 by 80%. A rebound in the company's rolling business largely drove the beat. The headline loss of $0.16 per share was adjusted for restructuring charges related to the primary metal and GRP segments and other special items totaling $276 million, or $0.25 per share.
Due to restructuring and closure costs and a seasonal working capital build, the company generated negative free cash flow of $760 million in 1Q14. However, supported by growth in its downstream business, Alcoa is still expected to generate positive free cash flow for the year.
Auto and aerospace driving demand
2014 is expected to be a strong year for aluminum demand. Alcoa's management expects global aluminum demand growth of 7% and is projecting a deficit of 730,000 tons in 2014. Among the company's end markets, aerospace is expected to register the strongest growth, with Alcoa increasing its 2014 growth estimates to 8-9% from 7-8% previously. Robust demand for both large commercial aircraft and regional jets and continued growth in the business jet market is driving strong aluminum demand in the aerospace sector.
Similarly, automotive aluminum demand is expected to register strong growth over the next several years, as automotive original equipment manufacturers (OEMs) increase their use of aluminum to improve fuel efficiency and meet industry standards. Alcoa shares, similar to other players in the industry, have benefited from the news of increasing aluminum usage in light vehicles. Although aluminum is much more expensive than steel, automotive OEMs have increased aluminum usage recently as consumers are becoming more sensitive about fuel efficiency, and standards require a significant improvement in fuel efficiency. At the Detroit Auto Show, Ford (NYSE:F) recently unveiled its first high-volume vehicle, the F-150 pickup, to be built with full aluminum body. The new F-150 is expected to improve fuel efficiency by 30%.
AA is well positioned to significantly benefit from this new trend. The company expects to grow its auto sheet revenues by $350 million from 2013-15 and a further $720 million from 2015-18. Automotive sector demand is expected to grow by 1%-4% in 2014. Moreover, U.S. demand should particularly remain strong. The 2%-5% U.S. demand growth should translate into pre-recession production levels of 16 million vehicles per year. Furthermore, as the European outlook continues to improve, Alcoa has also increase its European demand growth to a midpoint of 2% growth from a midpoint of 1% previously.
Constellium (NYSE:CSTM) is another company that has positioned itself well to benefit from this growing demand automotive aluminum sheet. The Dutch company is already a leader in the global aerospace aluminum market and should benefit further from its exposure to the aluminum auto-sheet market.
As the Goldman Sachs analyst also wrote in his report, 2014 is a year of transition for Alcoa. The company is taking aggressive actions to lower the cost base of its commodity business and announced a number of smelting capacity reduction decisions recently, which should improve its margins in Primary Metals segment. The aluminum producer plans to curtail 147,000 ton of aluminum smelting capacity in Brazil by the end of May 2014. Furthermore, the company will permanently close the 190,000 ton Point Henry aluminum smelter in Australia by August 2014 and two remaining potlines at the Massena East, New York smelter, totaling 84,000 metric tons of smelting capacity . These actions are consistent with the company's stated goal of lowering its position on the world aluminum production cost curve to the 38th percentile, and the alumina cost curve to the 21st percentile.
The largest U.S. based aluminum producer is aggressively cutting costs and is well positioned to benefit in the long term from moving down the cost curve in aluminum and alumina. Moreover, the company is also well positioned to benefit from emerging trends in global aerospace and automotive markets, which are looking at a multi-year growth.