3 Big Aluminum Companies to Analyze

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The world market for basic materials is still experiencing demand contraction as a consequence of the international recession and the low growth in China. The aluminum industry is not exempted from this, and lower aluminum prices have hurt companies’ overall sales. In this context, the players in the aluminum field are being forced to trim costs in order to handle the pressure.

Let's analyze how this strategy is working for the biggest companies.

Analyzing reductions but still investing

Alcoa (NYSE: AA) has chosen two ways to face this industry dynamic. On one hand, it is executing aggressive cost-cutting actions. The company has put about 13% of its global capacity offline. We are talking about 568,000 tons of less product. In addition, Alcoa gave some hints about the possibility for further reductions to be put in place at its higher-cost plants over the next year. If it does, the company will achieve 23% of total cutoff in its global production capacity.

Despite the situation, Alcoa's balance sheet is rather healthy. In the first quarter of 2013, net income increased by 58.5% compared to the same quarter one year prior, rising from $94 million to $149 million. In the same period, earnings per share improved by 44.4%. The main drivers were higher aluminum demand for aerospace and auto markets, and cost-cutting actions.

The company has been investing in high-technology operation areas. In March 2011, Alcoa completed an acquisition of TransDigm Group’s aerospace-fastener business. Moreover, Alcoa has signed agreements for all Airbus commercial programs, to provide the company with aluminum sheet and plate, and aluminum lithium alloys for manufacturing aircraft. These are value-added initiatives that should help the company withstand market conditions.

Depending on the price of aluminia

Alumina (ADR) (NYSE: AWC) is engaged in investing in bauxite mining, alumina refining and selected aluminum smelting operations through its 40% ownership of Alcoa World Alumina and Chemicals (AWAC). The company’s partner, Alcoa, owns the remaining 60% of AWAC.

This company is highly related to Alcoa, since most of its alumina production is destined to its partner’s aluminum smelters. Hence, Alumina’s performance is very exposed to Alcoa’s primary production decisions. For this reason, recent cuts in Alcoa’s plant production, along with lower realized prices for aluminum and aluminia, have been hitting Alumina’s balance sheet. Alumina’s total production declined approximately 150,000 tons in 2011 as a result of the announced curtailments affecting the refineries in the Atlantic region.

Alumina is still adjusting to the market conditions. In 2012, full-year revenue declined $852 million, a 13% decline compared to 2011. Profit performance was bad too, as the reported loss before income tax was $61.7 million by December 2012 against profit before income tax of $127.6 million a year ago. Additionally, Alumina's net debt increased 40% compared to 2011, which represents a concern especially when the company keeps suffering from reduced cash from operations.

The Chinese issue

Just like Alcoa, Aluminum Corp. of China (ADR) (NYSE: ACH) decided to temporarily reduce its production capacity by 380,000 tons. This company, also known as Chinalco, is a vertically integrated aluminum producer leader in China that operates in four segments: alumina, primary aluminum, aluminum fabrication, and trading.

Most of Chinalco’s production is concentrated in segments with low profits within the industry. In fact, primary aluminum represents about 60% of Chinalco's revenue. This is not a good sign, since it shows how highly exposed the company is to the metal’s volatility.

Chinese aluminum companies face two main problems; one derived from a lack of raw materials, and the other related to the price of energy sources. In China, electricity prices are set by the government, and this issue requires constant negotiation between power companies with lower rates and Chinalco to keep electricity costs low.

As part of its expansion projects, Chinalco wants to reduce its reliance on third-party suppliers of bauxite. In 2010, the company bought a large stake in Rio Tinto's mineral project in Guinea, which will come into production in 2015. This initiative should reduce costs and avoid procurement variability.

However, the company’s balance sheet is not yet showing much optimism. For the first quarter of 2013, Chinalco posted a net loss of $159 million, which is an improvement compared to the prior-year’s net loss of $177 million but is still a factor of concern if demand remains stagnant.

Conclusion

Many analysts argue that the prices of aluminum and alumina will continue falling. Hence, aggressive cost-cutting action and production capacity shutdowns seem appropriate strategies to counter falling demand. These cuts could improve aluminum-industry fundamentals, pushing down the supply and increasing prices.

For some companies, integrating vertically could improve the situation. An expansion of the rolled and engineered product businesses will give the companies access to a more sophisticated and diversified market.

Considering this, I believe Alcoa possesses a more integral strategy than its peers. The company's size provides it with strategic advantages as well, such as lower input costs and access to markets with better perspectives. This gives Alcoa a solid kit to drive the crisis. Healthy demand in the aerospace market will be key to drive results moving ahead, and Alcoa is positioned to profit from it.

On the contrary, Alumina and Chinalco are strongly linked to primary segments of the aluminum industry, and lows prices in bauxite and alumina will have a direct impact on their sales and earnings with no possibility to escape from it in the medium term.

Since Chinalco is among the lower-cost players, and considering its stake in bauxite production, I would invest in the company thinking only in the very long term. For the short term, it will have to improve its balance sheet and wait for a recovery in prices; production cuts are not enough.

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