Alcoa Struggles While Chalco Expands in Indonesia

Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Alcoa’s (NYSE: AA) stock fell by almost 3% on Wednesday 19th December after Moody’s started a review of Alcoa’s downgrade after a year over year 22% slump in aluminum prices in the third quarter. The company’s current rating is Baa3, i.e., one step away from "junk." Alcoa has cut its smelting capacity by 12% and expects to incur restructuring charges of ~$160 million in Q4. On the other hand, Alcoa has recently opened a wheel manufacturing facility in China which is a part of its strategy to expand in the world’s biggest aluminum market.

In its third quarter, Alcoa reported a net loss of $143 million or $0.13 per share but excluding the one-off extraordinary items, the loss climbs to a profit of $0.03 per share which is ahead of a breakeven estimate by analysts. As it now turns out, Alcoa might still face a downgrade despite posting better than expected results. Standard & Poor’s have also given Alcoa their lowest investment grade, BBB-, albeit with a stable outlook.

Meanwhile, the Aluminum Corp of China (NYSE: ACH), also known as Chalco, the country’s leading aluminum firm and the second biggest global player in this industry, is planning to build a plant in Indonesia with an annual production capacity of one million tons. The first phase of this facility is likely to become operational as early as 2014. Indonesia is already the biggest supplier of bauxite to China, the main ingredient required to produce aluminum. Earlier this year, Chalco also started a joint venture with Indonusa Dwitama to construct Indonesia’s biggest bauxite mining facility in East Kalimantan province.  This plant will alone will grow global capacity of Aluminum metal production by ~10% as 4 tons of bauxite will, at best, produce 1 ton of Aluminum metal. 

Similarly, China’s privately held Bosai Minerals Group, the country’s biggest bauxite producer, is also thinking about developing a $1 billion Indonesian site. The Indonesian government currently permits only licensed producers that have processing plants inside Indonesia to produce and send mineral ores out of the country. Moreover, the exporters have to pay a 20% duty.  That said China is undeterred as it looks to secure as many bauxite sites as possible for its future growth. The country currently produces (42.5%, 18 month average) and consumes more refined aluminum than anyone else.

The Chinese companies are running contrary to the current industrial trend in which falling aluminum prices and the global oversupply have forced Alcoa and the Russian Rusal PLC, which has significant representation in SPDR S&P Russia ETF (NYSEMKT: RBL), to scale back their production. This is mainly because aluminum demand from China’s government remains high and the Chinese firms supply the commodity directly to the local governments. Moreover, there are indications that Indonesia might implement an outright ban on exports of some minerals by 2014.

However, there is oversupply in China as well due to the slowdown in the country’s economy. As a result, prices in China have fallen by 9% in H1-2012 which caused Chalco to report a half-yearly net loss of $520 million. However, the situation is more severe in the West where LME spot price for aluminum fell by more than 12% in the corresponding period.

As I indicated nearly two months ago, I felt that aluminum prices have bottomed and should start to stabilize and even rise from here, now that all of the major central banks have committed themselves to massive quantitative easing, which will both stimulate demand and create more dollars chasing stable supply.  Inventories are near 6 year lows and demand has been flat since May.

However, the rise in price will be modest in the near term with small fluctuations, as always, based on month-to-month inventory changes.  Structurally, however, all fundamental commodities will see a long term bid not just from China but the rest of the emerging markets – notably Southeast Asia who will emerge over time as China’s biggest trading partner. So far this year, the prices have averaged $2017/MT and this is projected to improve slightly to $2,200/MT in 2013, which is still considerably lower than $3,012/MT before the world was hit by financial crisis. A turnaround is expected to happen slowly in the next eight years as Alcoa is expecting the market to double by 2020 from 2010 levels.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>Alcoa</p> </td> <td> <p>Chalco</p> </td> </tr> <tr> <td> <p>Stock YTD</p> </td> <td> <p>0.21%</p> </td> <td> <p>4.80%</p> </td> </tr> <tr> <td> <p>P/E</p> </td> <td> <p>N/A</p> </td> <td> <p>N/A</p> </td> </tr> <tr> <td> <p>EPS</p> </td> <td> <p>-0.23</p> </td> <td> <p>-1.53</p> </td> </tr> <tr> <td> <p>Yield</p> </td> <td> <p>1.30%</p> </td> <td> <p>N/A</p> </td> </tr> <tr> <td> <p>ROA</p> </td> <td> <p>0.77%</p> </td> <td> <p>-0.98%</p> </td> </tr> <tr> <td> <p>ROE</p> </td> <td> <p>-1.48%</p> </td> <td> <p>-9.06%</p> </td> </tr> </tbody> </table>

Even with that expected rise in demand, the oversupply of capacity from regions like North America and Europe means that even as mine supply improves throughput will follow in line with it and prices should remain flat until new capacity cannot compete with supply.  The problem with this analysis is China.  The International Aluminum Institute – where I obtained this data – has reliable data for Chinese Aluminum and Alumina production capacity. 

<table> <tbody> <tr> <td colspan="7"> <p><strong><em>Alumina Production Capacity Ratio</em></strong></p> </td> </tr> <tr> <td> <p><strong>Year</strong></p> </td> <td> <p><strong>Afr. & Asia</strong></p> </td> <td> <p><strong>N. America</strong></p> </td> <td> <p><strong>S. America</strong></p> </td> <td> <p><strong>W. Europe</strong></p> </td> <td> <p><strong>E. & Cent. Europe</strong></p> </td> <td> <p><strong>Oceania</strong></p> </td> </tr> <tr> <td> <p><strong><em>2012</em></strong></p> </td> <td> <p><strong><em>60%</em></strong></p> </td> <td> <p><strong><em>63%</em></strong></p> </td> <td> <p><strong><em>64%</em></strong></p> </td> <td> <p><strong><em>61%</em></strong></p> </td> <td> <p><strong><em>60%</em></strong></p> </td> <td> <p><strong><em>65%</em></strong></p> </td> </tr> <tr> <td> <p><strong>2011</strong></p> </td> <td> <p>84%</p> </td> <td> <p>80%</p> </td> <td> <p>95%</p> </td> <td> <p>83%</p> </td> <td> <p>92%</p> </td> <td> <p>95%</p> </td> </tr> <tr> <td> <p><strong>2010</strong></p> </td> <td> <p>87%</p> </td> <td> <p>75%</p> </td> <td> <p>90%</p> </td> <td> <p>80%</p> </td> <td> <p>91%</p> </td> <td> <p>97%</p> </td> </tr> <tr> <td> <p><strong>2009</strong></p> </td> <td> <p>83%</p> </td> <td> <p>61%</p> </td> <td> <p>91%</p> </td> <td> <p>69%</p> </td> <td> <p>94%</p> </td> <td> <p>100%</p> </td> </tr> <tr> <td> <p><strong>2008</strong></p> </td> <td> <p>93%</p> </td> <td> <p>87%</p> </td> <td> <p>93%</p> </td> <td> <p>99%</p> </td> <td> <p>102%</p> </td> <td> <p>96%</p> </td> </tr> <tr> <td> <p><strong>2007</strong></p> </td> <td> <p>88%</p> </td> <td> <p>85%</p> </td> <td> <p>95%</p> </td> <td> <p>99%</p> </td> <td> <p>99%</p> </td> <td> <p>95%</p> </td> </tr> <tr> <td> <p><strong>2006</strong></p> </td> <td> <p>86%</p> </td> <td> <p>96%</p> </td> <td> <p>95%</p> </td> <td> <p>99%</p> </td> <td> <p>99%</p> </td> <td> <p>95%</p> </td> </tr> <tr> <td> <p><strong>2005</strong></p> </td> <td> <p>88%</p> </td> <td> <p>98%</p> </td> <td> <p>87%</p> </td> <td> <p>100%</p> </td> <td> <p>98%</p> </td> <td> <p>99%</p> </td> </tr> <tr> <td> <p><strong>2004</strong></p> </td> <td> <p>88%</p> </td> <td> <p>99%</p> </td> <td> <p>97%</p> </td> <td> <p>101%</p> </td> <td> <p>99%</p> </td> <td> <p>96%</p> </td> </tr> </tbody> </table>

At this point I would look at the global aluminum market as simply a leading indicator for global economic activity but not as a strategic portion of one’s portfolio, preferring to put my investment capital in sectors which will benefit from the current over supply and low prices. Like the crash in iron and coal prices, the drop in aluminum prices is a boon for Southeast Asia as emerging markets now can build their infrastructure at two-thirds of the price they could at the beginning of 2012.  I like the Global X ASEAN ETF (NYSEMKT: ASEA) for a broad overview of the region’s biggest companies for that idea. 

PeterPham8 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus