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Alcoa's Upstream Value Not Shaken by Economic Uncertainty
Edited by : AL CIRCLE
2 min read
Aluminum is a highly cyclical industry, and Alcoa's (AA) shipments have not yet recovered to prerecession levels; aluminum prices are still more than 35% below their 2008 peak after losing some of their gains in the past few months. We think that long-term fundamentals support aluminum demand and pricing and that Alcoa is well positioned thanks to its global scale, strength in alumina, favorable cost position, and growth projects in lower-cost assets. However, global macroeconomic concerns challenge the near term.
Earnings at Alcoa's alumina and primary metal segments--its upstream businesses--don't depend as much on end market consumption as the downstream businesses. Alumina is perpetually in short supply relative to aluminum capacity, and Alcoa always can sell any excess aluminum output to the London Metal Exchange warehouses, particularly with today's high premiums and easy financing. The key is whether the LME price of aluminum is high enough to make production attractive. While the LME price ultimately should be a function of demand, we find that in the short term it tracks global economic sentiment more closely than actual production and consumption patterns. Warehouse inventories have been declining this year, suggesting that demand is still strong. We expect global aluminum consumption growth to be in the double digits for 2011.
Alcoa's primary metal segment is the only business unit that remains below its midcycle profitability average on a margin or per-tonnage basis, and it is the segment most dependent on the LME price. About 20% of its aluminum production feeds into Alcoa's downstream segments.
Aluminum prices are at a one-year low around $2,140 per metric ton, with a majority of the pullback occurring just in the past three months. In the absence of a major downturn in aluminum consumption, we think demand levels and input costs justify a reversal in this trend with the marginal cost of production below prevailing prices even at current supply levels.
Alcoa's stock price has reacted in a similar fashion, falling more than 40% since early July. However, with the exception of the price of aluminum, all other areas of Alcoa's business model and aluminum fundamentals appear strong.
As economic clarity develops, we anticipate that a rise in aluminum prices in 2012--we forecast a 10% increase from the 2011 average--will accompany continued slow volume growth and be an important catalyst for Alcoa's shares.
Earnings at Alcoa's alumina and primary metal segments--its upstream businesses--don't depend as much on end market consumption as the downstream businesses. Alumina is perpetually in short supply relative to aluminum capacity, and Alcoa always can sell any excess aluminum output to the London Metal Exchange warehouses, particularly with today's high premiums and easy financing. The key is whether the LME price of aluminum is high enough to make production attractive. While the LME price ultimately should be a function of demand, we find that in the short term it tracks global economic sentiment more closely than actual production and consumption patterns. Warehouse inventories have been declining this year, suggesting that demand is still strong. We expect global aluminum consumption growth to be in the double digits for 2011.
Alcoa's primary metal segment is the only business unit that remains below its midcycle profitability average on a margin or per-tonnage basis, and it is the segment most dependent on the LME price. About 20% of its aluminum production feeds into Alcoa's downstream segments.
Aluminum prices are at a one-year low around $2,140 per metric ton, with a majority of the pullback occurring just in the past three months. In the absence of a major downturn in aluminum consumption, we think demand levels and input costs justify a reversal in this trend with the marginal cost of production below prevailing prices even at current supply levels.
Alcoa's stock price has reacted in a similar fashion, falling more than 40% since early July. However, with the exception of the price of aluminum, all other areas of Alcoa's business model and aluminum fundamentals appear strong.
As economic clarity develops, we anticipate that a rise in aluminum prices in 2012--we forecast a 10% increase from the 2011 average--will accompany continued slow volume growth and be an important catalyst for Alcoa's shares.
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