Alcoa (AA) is the second largest player in the global aluminum market, producing almost 7% of the world’s aluminum output. Alcoa is vertically integrated producing alumina, primary aluminum and a variety of other aluminum products. Alcoa breaks its business into three primary business groups:
- Downstream — Engineered Products and Solutions — produces end market products for the aerospace, industrial gas turbines, building and construction and commercial transportation industries.
- Midstream — Global Rolled Products — Includes the production of rolled, rigid container sheets used for beverage and food cans and aluminum plate and sheets for the aerospace, transportation and industrial markets.
- Upstream — Global Primary Products — The mining, refining, smelting and energy to produce aluminum.
Historically, the Upstream business segment has produced the majority of profits, but with depressed aluminum prices, the Downstream business segment has turned into a larger contributor to operating income. Although aluminum prices dictate revenue for the Upstream business segment, they also serve as an input cost for the Midstream and Downstream segments, decreasing costs and increasing profits.
Alcoa – 50% Gains Year-to-Date … and Rising!
With such great YTD stock price performance, investors may think that they missed the boat for Alcoa stock, but I think there is room left to run on a solid business platform.
Alcoa’s Upstream business segment will benefit from the recovery of aluminum prices as large producers have worked to whittle down capacity, which has driven up aluminum prices to over $2,000 a tonne since the beginning of the year.
Aluminum prices will most likely rise further if Indonesia continues its ban on mineral ore exports, which includes bauxite, a mined mixture of minerals that used to make aluminum.
Alcoa Deals
A higher aluminum price is not the only catalyst that will spark additional stock price growth. Alcoa recently purchased
Firth Rixson, a maker of jet engine components. Aerospace has been a highly profitable business for Alcoa and is looking to grow it by 8%-9% this year. A $1 billion contract to supply aluminum sheet to Boeing (BA) finalized earlier this month will certainly help aid further growth.
The growth in the use of aluminum in auto manufacturing has increased, driving additional aluminum demand. Aluminum is lighter than steel but three times more expensive. Up until recently, aluminum has only been used to produce premium luxury cars as the weight reduction allows for smaller power trains, increasing fuel efficiency while not compromising power. This changed when Ford announced that its new F-150 will be made with an aluminum body. The F-150 is Ford’s highest volume and highest profit vehicle. If the vehicle proves successful, look for other manufacturers to adopt aluminum as an alternative to steel in short order.
Alcoa’s Recent Business Performance
Alcoa posted a first quarter loss of $178 million with a $255 million restructuring charge related to cutting production in Brazil and closing plants in Australia and New York. Excluding special items, net income was $98 million on 6.5% lower sales of $5.5 billion. Lower sales were primarily due to 8% lower aluminum prices on a year-over-year basis.
Capacity cuts helped Alcoa’s second quarter, which posted a $138 million profit compared to a $119 million loss the previous year and beating analysts’ forecasts. Revenues of $5.8 billion were flat year over year.
With a strong fundamental business platform to take advantage of increasing aluminum prices, plan for Alcoa’s stock to provide market-beating returns through next year.
As of this writing, Kenneth Fick did not hold a position in any of the aforementioned securities. Write him at kfick@piercethefog.com or follow him on his blog at www.piercethefog.com.
