Long-term investors in metals specialist Alcoa (NYSE:AA) have dealt with a number of setbacks in recent years, ranging from the company's deletion from the Dow Jones Industrials to Alcoa's difficulties in maintaining upward momentum in its stock price after a precipitous decline. Yet in the company's eyes, much of what Alcoa has had to endure has stemmed from unfair trade practices among Chinese aluminum manufacturers.
Recently, the Aluminum Association, a trade association that includes both Alcoa and a number of other manufacturers both in the U.S. and around the world, asked trade officials in the U.S. to take a closer look at allegations that Chinese producers are putting unfair pressure on the industry. The move echoes the sentiments that Alcoa CEO Klaus Kleinfeld has stated on numerous occasions, but do the allegations have merit? Let's take a closer look at what the trade association is saying and whether it indicates that Alcoa is losing a Chinese trade war.
Why aluminum producers are angry
The letter from the Aluminum Association to the U.S. Trade Representative asked for a closer look at alleged practices that Chinese producers are using questionable tactics to get around export taxes. Currently, the Chinese government imposes a 15% export tax when domestic producers ship primary aluminum metal out of the country. That tax makes sense because China has to important a large amount of bauxite, which is a raw material that goes into aluminum production, and so the government at some level wants to discourage the producers from making more metal than is necessary for the domestic Chinese aluminum market.
However, Alcoa and other producers have said that Chinese manufacturers often engage in a practice that Kleinfeld has called "fake semis." Essentially, what this entails is having manufacturers make something that will qualify as a semi-fabricated product, thereby avoiding the export tax on raw materials. However, industry officials believe that the intent of purchases of those products is to melt them down and reuse the raw material for other purposes. As CFO Bill Oplinger described in Alcoa's latest quarterly conference call, "Fake semis compete directly with primary metal by avoiding China's 15% export duty tax and capturing a 13% VAT rebate. At current metal pricing and premium levels, the economics of exports have deteriorated." Yet exports of Chinese semis are up 40% year-to-date, showing how important it is for producers to avoid the added costs of exporting raw material directly.
Officials at the Aluminum Association argue that Chinese producers are creating "distortions in the marketplace that have ripple effects across the entire [aluminum] industry." With U.S. manufacturers making moves to idle smelters and refinery operations, these practices are hurting the industry overall in the eyes of those making the allegations.
Why Alcoa is still moving forward
Despite these challenges, Alcoa has continued with its broad-based turnaround strategy. Surprisingly, the aluminum producer hasn't abandoned the primary metal market, but it has chosen some tactical moves that blunt the impact of unfair competition.
First, Alcoa has worked hard to cut the average cost of its aluminum production. By idling high-cost facilities in favor of cheaper alternatives, Alcoa has dramatically reduced its operating expenses, allowing it to maintain margins even as aluminum prices have remained weak.
Yet more importantly, Alcoa has increasingly focused on its opportunities to make value-add products rather than simply supplying raw materials. By working closely with major partners in the aerospace and automobile industries in particular, Alcoa has unearthed new ways to work directly with manufacturers to give them the products they need already pre-fabricated. This has the dual benefit of freeing up Alcoa's customers to concentrate on manufacturing their own products, while also giving Alcoa a greater profit and demonstrating its expertise in meeting expectations across sectors and industry groups.
Nevertheless, Alcoa and its peers all have to deal with financial pressure from the actions of Chinese manufacturers. Past attempts to enforce trade sanctions have proven ineffective, and now, China is hearing lobbying efforts from the Chinese Non-Ferrous Metals Industry Association to drop the export tax entirely. With thousands of jobs at stake, the Aluminum Association's complaints will definitely be heard, but it's far from certain whether any potential action from trade officials will result in real change. That makes Alcoa's decision to move forward with other initiatives that much smarter in the long run to avoid any chance of losing a trade war with China.