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Alcoa's business during the crisis years (2008-2010)
Posted by: Chandan Dubey (IP Logged)
Date: March 5, 2012 01:27PM
This is part two of my recent commentary on Alcoa. The first part was Alcoa and its CEO. In this part, I will concentrate on the conference calls from 2009 to 2010 and see what direction the business has been taking since the financial crisis.
To better understand the situation, let me put here the chart for Alcoa and Aluminum prices.
Fig 1. Price of Aluminum
Fig 2. Alcoa, stock chart.
Something which immediately jumps from these pictures is the similarity of the graphs above. It is not very far-fetching to assume that this similarity is not going to go away at the moment. But for now, let us not get side-tracked by tangential discussion.
The year 2008
Looking at the 2008 shareholder letter by the then chairman and retired CEO Alain JP Belda we see how the precipitous drops in the Aluminum prices effected Alcoa during 2008. The Aluminum market soared to an all time high in Jul 2008, followed by the fastest drop in price and customer demand in history.
The smelting process for Aluminum is very power intensive. To put it in perspective, one tonne of aluminum requires the same amount of electricity as an average family uses in 20 years. It is very important to have cheap electricity and the best way to do it is to produce it yourself. Hence, the immediate action for Alcoa was to secure power and that too cheaply. Alcoa succeeded in doing this and 80% of the smelting power was either self generated or covered by contracts that lasted at least through 2028.
Alcoa exited the packaging and the consumer business (one of the trademarks of the new CEO of getting out of low margin ventures). It acquired two high growth fastener businesses and got out of one of its non-core soft alloy extrusion business by swapping it with two smelters in Norway, making it the largest aluminum producer in the world (once again).
The CEO letter additionally gives us a clear vision of Alcoa from his own eyes. Kleinfeld thinks that producing Aluminium is a great business with high growth (nearly 6%) and he supports it by several statistics. In particular, the population growth, need of lightweight transportation, and infrastructure development.
We also see that the CEO wants to concentrate on generating cash from Alcoa. As we saw in the first article, Alcoa’s cap spending was out of sync with its operating cash flow and Kleinfeld recognized that Alcoa cannot do this for long. It must use the money it generated to fuel its expansion. We will start seeing the results in 2009 and later.
The year 2009
In the year 2008 Alcoa had an OCF of $1.2 billion and cap-ex of $3.4 billion. This leads to a negative FCF of around $2.1 billion. Comparing it to 2009 we have a OCF of $1.36 billion and cap-ex of $1.6 billion. The FCF is only a negative $257 million. The improvements were achieved by cutting down on several fronts at once.
The first target was to reduce the procurement costs (in obtaining raw materials, equipment and supplies to the site) by $2 billion until 2010. Out of this, $1.5 billion was to be reduced in 2009. Alcoa saved $1.998 billion in 2009 itself.
The second obvious place is to reduce the cap-ex and bring it to something which is more in line with the OCF. The management looked at the CapEx into two parts. The sustaining CapEx is the expenditure in managing and upgrading the currently owned facilities, while the growth CapEx is for acquisition or building of new facilities. The target was to bring the sustaining CapEx to $850 million. In 2009 the sustaining CapEx for Alcoa was $1.25 billion. Which compared to 2008 is a great achievement. The effect on the balance sheet of Alcoa can be seen in the figure below.
Fig 3. Alcoa’s debt and equity
The year 2010
From Q1-2010 conference call.
In 2010, we also hear the management talk about China a lot more. In Q1, China was producing more aluminium than it was consuming. The management expects that this is only temporary. With the growing urbanization in China the electricity is a scarce resource and Chinese will try to not have too many smelters running.
What we’ve seen here with China in the worse of all downturns, they have been very, very good in managing their supply and demand balance and they’ve been very agile and very, very fast in responding here. So, I would be very sure that this surplus is really only temporary.
We also hear about how the management thinks of the Aluminium business and the growth in it.
In Q2 the prediction of the management about China is already coming to fruition. China’s surplus has been reduced from 400,000 tons to 200,000 tons. The company acquired Traco which is a manufacturer of windows for commercial buildings and fitted nicely with Alcoa’s construction portfolio.
Alcoa’s Russia segment is now having positive after-tax operating income for the first time and China facilities are increasing production.
In Q3, the CEO talks about the value driver.
Alcoa in this quarter changed the pricing structure. A small discussion from the conference call is below. The end result being that Alcoa stopped hedging its Aluminium contracts for better transparency. This will further drive the stock price to closely follows the price of Aluminium.
From the CEO letter of 2010, Alcoa met all cash sustainability targets (Fig 4). The liquidity positions continue to strengthen and for the first time since 2004, Alcoa is FCF positive again (Fig 5).
Fig 4: Cash targets
Fig 5: Improvement abound
At the same time, Alcoa did not compromise on values and safety. I will let the CEO have the final summary.
In the next article I will look at the year 2011 and the current plunge in the price. I will also have more details on the profitability of the company, its balance sheet at the moment and the shareholder returns.
Additional disclosure: The data and some of the quotes are taken from the conference call and the annual reports of Alcoa.
Re Alcoa s business during the crisis years 2008-2010
Posted by: nicosolo (IP Logged)
Date: March 5, 2012 05:08PM
Is alcoa a buy at its current level
Re Alcoa s business during the crisis years 2008-2010
Posted by: cdubey (IP Logged)
Date: March 6, 2012 02:05AM
The amount of research I have done so far, I would say yes. There is a 80% upside from here. With cyclicals though you should be prepared for a bumpy ride. Do not make a full position at once.
I still have to look at other aspects of Alcoa before making a buy decision. You will read about it in the next few days.