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Anh Hoang
Anh Hoang
Articles (264)  | Author's Website |

Alcoa: Indirect Exposure to Aluminum Commodity Speculation

October 12, 2011 | About:

Alcoa (NYSE:AA), the leader in the production and management of aluminum commodity, producing 20% of the world's alumina and 10% of its aluminum, just recently announced the third-quarter results. Its net income rose on a year-on-year basis, but it fell short of Wall Street expectation mainly due to the fall of aluminum prices.

On the conference call yesterday, the company discussed its current situation. There were two significant developments overall on a global basis. The first was commodity price deflation in the Alumina and Aluminum segments. Charles McLane, the executive vice president and CFO of AA, commented that while the demand for aluminum kept growing globally and the regional premium remained strong, macroeconomic worries and commodity investors drove an 8% drop in the aluminum price. Second, the crisis in the euro zone and the volatility in the marketplace has made the consumers and businesses lose confidence. Those factors combined resulted in a dramatic reduction of orders in September and decreasing the profitability.

For the third quarter, income from continuing operations was $172 million, representing a sequential decrease of 47%, but a 182% increase on the third quarter 2010. On year-on-year basis, sales increased more than 8%. EBITDA margin was 13%, staying at $821 million. Free cash flow in the quarter was $164 million, year-to-date $250 million. The debt to capital ratio was at 33.7%, 200 basis points lower than third quarter of 2010. The net debt has been reduced by $109 million. The cash position was around $1.3 billion.

Klaus Kleinfeld, chairman and CEO, discussed that even the economy was slowing in some parts of the world; he saw the strong growth in the emerging markets to offset it. He forecasted the decline in three regions — Europe, North America and Brazil — but predicted growth of China year-on-year of 17%, up 2% forecasted from the previous quarter. There was growing demand, strong physical markets and firm support for aluminum prices. He believed that those who have chosen the speculation against aluminum were on the wrong side of the trade.

For the three segments, the Alumina and Primary segment has experienced the largest price pressure, but at the same time it ramped up productivity to compensate for the cost. The flat-rolled products got hit by normal seasonality as well as the decrease in demand caused by the euro zone crisis. The utilization of Europe has reduced by 25% to a 70% level. Nevertheless, the company continued to see strong performance on the Engineered Products and Solutions segment. Revenue remained flat, whereas EBITDA increased by $31 million compared to the third quarter of 2010.

Looking back on the 10-year history of AA, the firm has delivered quite sustainable positive cash flow over the years, despite the fluctuations in revenue and the wide swing in both operating income and net income.

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
CFO 2,411 1,839 2,430 2,199 1,676 2,567 3,111 1,234 1,365 2,261
CAPEX -1,177 -1,270 -867 -1,143 -2,138 -3,201 -3,636 -3,413 -1,622 -1,015
FCF 1,234 569 1,563 1,056 -462 -634 -525 -2,179 -257 1,246

The large capex over time has led the FCF to ride the roller coaster. Alcoa is one of the top players in the aluminum industry, a leading manufacturer of aluminum products for beverages, cars, etc. The good thing about AA is the ability to have vertical integration so that the company can lower its input costs. However, AA is in the commodity business, which is why the performance of the business pretty much relies on the commodity price, the profitability linked to cyclical demand and price movements.

With the lowest P/CF of 4.9 compared to 10-year history of 8.5, it could be attractive in terms of relative valuation on the historical basis. But AA is definitely not the stock to buy and hold as a value position, as its business fluctuates along with commodity prices. It would be indirect exposure for any investors in aluminum commodity.

About the author:

Anh Hoang
Money manager in global equities, especially in U.S. and Vietnam markets. CFA level 3 candidate. Lecturer for Stalla - CFA course in Vietnam.

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