Alcoa Inc: AA Stock Is Still a Huge Liability

Many of the important details regarding the intended breakup of Alcoa Inc (NYSE:AA) were finally unveiled today. Whether they were compelling or disappointing for Alcoa stock is largely a matter of perspective.

Alcoa Stock: AA Is Still a Huge Liability

With Alcoa stock up more than a full percentage point on the heels of the news though (current owners of AA stock are still the ultimate future shareholders of both organizations), clearly the market has no major problem with the plans to split up the company’s debt and pension obligations.

So what exactly will the balance sheets and likely income statements look like following the Alcoa split? Based on the information provided to date, here’s the most detailed snapshot possible.

Fog Lifting on Alcoa Split

Although it was one company, the organization we know as Alcoa has largely been operating as two units for a while anyway. That is, the upstream unit — the traditional aluminum material supplier — and the downstream unit, which is often called the “value add” unit because it takes basis materials and turns them into specialty products for higher-tech uses.

The upstream division will retain the Alcoa name, while the engineered/specialty division will be dubbed Arconic and trade under the ticker “ARNC.

None of that was news to shareholders though, nor does it answer the much more pressing question most owners of Alcoa stock have been asking to themselves as well as of the company’s management: How is Alcoa’s debt going to be divvied up? Those answers finally came today.

Of the $5.6 billion worth of pension obligations on the books, Alcoa will keep $2.6 billion worth of them, while Arconic will take $3.0 billion worth with it. Of the $8.2 billion in long-term debt ($9 billion in total debt) currently sitting on the balance sheet, all of it will go with Arconic.

Don’t get the idea that the entity about to become the new Alcoa will escape debt-free though. It’s taking on $1 billion worth of new debt and giving the cash proceeds to Arconic as a parting gift.

Fair? No, but it is a logical division, in that of the two entities about to be created, Arconic is much better equipped to wield that debt load than the struggling aluminum division is.

Indeed, the company that will become Alcoa was only modestly profitable before aluminum prices imploded, and has dipped into the red ink a couple of times within the last year. The divisions that will become Arconic, on the other hand, have largely shrugged off the weakness in basic materials prices, remaining profitable even against an industry headwind.

Alcoa results by segment

For better or worse, the capital structure plans laid out today to jibe with CEO Klaus Kleinfeld’s goal of making Arconic an investment-grade organization while keeping Alcoa viable. Moody’s had previously rated a post-split Alcoa as Ba1 — “the highest junk ranking” — while Standard & Poor’s deemed it a BBB-, or its lowest-possible score that still considers AA an investment-grade outfit. Arconic, even with that debt load, should be seen as no worse than investment-grade as well.

Arconic will also retain just under 20% of the soon-to-be-issued new shares of Alcoa stock, with the rest being divvied up among current shareholders.

Bottom Line for Alcoa Stock

To the extent Kleinfeld’s goal was unlocking the value of at least one company, he’s about to do that; the Alcoa split is expected to be complete before the end of 2016. As for owners of AA stock though, the net upside remains mostly elusive if aluminum prices remain tepid.

The good news is, aluminum prices are trending higher again. The metal has improved from a price near 65 cents per pound late last year to 73 cents per pound now … the best advance seen since 2014. It’s still much closer to multi-year lows than multi-year highs though, and even if only a few of the Brexit worries come to fruition, demand — and therefore prices — for aluminum could easily slump again, pushing at least one of the two future entities back into the red.

In other words, turning a $20 bill into two $10 bills doesn’t make you any wealthier. It just gives you more flexibility in deciding which of those $10 bills is one you want to keep, and which one you don’t. Alcoa, the future Alcoa stock, remains a liability.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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