Amid Crashing Prices, These Aluminum Companies Are Struggling to Stay Afloat

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The price of aluminum on the London Metal Exchange is declining continuously. Aluminum fell from $2,053 per ton in February 2013 to $1,816 per ton in June 2013. Analysts expect about 782,250 tons of aluminum surplus in the global market in 2013 and around 896,000 tons in 2014. Low aluminum prices have forced the aluminum companies into unprofitable territory. Here are three aluminum companies that are planning (or have already begun) to cut down production capacities in the face of sluggish demand, in the hopes of forcing aluminum prices back up.

Low aluminum prices affecting the future

Alcoa’s (NYSE: AA) debt securities were downgraded in May by Moody’s to a junk rating of Ba1 from the previous investment grade rating of Baa3. Continuous declines in aluminum prices and there being no sign of price recovery were the primary factors in Moody’s decision. However, this downgrade won’t create a significant issue for the company, despite the downgrade's resultant higher interest payments, as its debt will mature over the next two years into $465 million in 2013 and $661 million in 2014. In the second quarter of 2013, the company focused on improving its balance sheet. It generated free cash flow of $228 million, and at the end of the quarter had a total of $1.20 billion of cash.

At present, 13% of Alcoa's total smelting capacity is idle. Aluminum production capacity and inventory in the market is exceeding demand, which is propelling the decline in aluminum prices. In the second quarter, Alcoa reported a loss of $119 million. Due to the losses sustained from low aluminum prices, it decided to close down two potlines in Quebec that had 105,000 tons of annual smelting capacity. This shutdown will complete by the end of the third quarter. The company will further review cutbacks in its production capacity of 355,000 tons of its smelting capacity in the next 13 months. This amounts to 11% of its total global capacity of 4.2 million tons. Curtailing its idle capacity will help Alcoa reduce its fixed cost, and the cut in capacity and lower cost of production will help Alcoa reduce cash losses. However, it's not a short-term fix: The benefits won't kick in until 2014 or 2015, when Alcoa aims to achieve its goal of lowering its aluminum production cost by 10%.

Asset disposal and capacity cut will not be enough for turnaround

In May 2013, Aluminum Corporation of China (NYSE: ACH) decided to sell some of the assets in its aluminum fabrication segment. The segment caused a loss of about $226.66 million in 2012. The company plans to dispose the assets of ten of its aluminum fabrication subsidiaries. It expects to complete the disposal of these assets by the third-quarter of 2013. The sale of these assets will reduce losses by $247.86 million annually. Hence, this divestment will help the company to improve its liquidity position and to optimize its asset structure in the long term. At present, its production cost is higher than aluminum prices, and it needs to liquidate more of its unprofitable assets.

Aluminum Corporation of China announced in June 2013 that it will temporarily close down 380,000 tons of its aluminum capacity. This capacity shutdown is around 9% of its total output of 4.22 million tons in 2012. The company has not decided which plants to close but will target its most expensive plants. This capacity close-down is expected to reduce cash losses by $81.53 million for this year.

Smelters under review and cash-flow in line

Alumina Ltd. (NYSE: AWC) holds a 40% share in Alcoa World Alumina and Chemicals, or AWAC, a joint venture with Alcoa, which holds the other 60% in the JV. Alcoa announced that it will review its smelting capacity over next 15 months, and it is expected that the operations of both the Point Henry and Portland smelters in Victoria, Australia, will be on the list. Both of these smelters are operating under losses; shutting them down would lower the company's cost burden. Analysts have estimated that closure of these smelters will increase the earnings of Alumina Ltd. by 10% from 2015.

Alumina Ltd. announced in 2012 that it will receive a guaranteed dividend of at least $100 million in 2013 from the AWAC joint venture. Alumina Ltd. received a $25 million dividend in the first quarter of 2013 and invested $15 million back into the joint venture. The remaining $10 million went into the company's coffers, improving its cash flow. Even though Alcoa’s rating was downgraded, Alumina Ltd. will still receive the rest of the $100 million dividend this year, which will improve its free cash flow. It is expected that the company will experience negative cash flow of $9 million in fiscal 2013, a stark improvement over its negative cash flow of $122 million in fiscal 2012.

Conclusion:

Aluminum prices will not see a significant recovery in 2013, as production will continue to exceed estimated demand. The aluminum price forecast for 2013 is $2,016 per ton, and for 2014 it's $2,419 per ton, as compared to an average price of $2,020 per ton in 2012. This implies that prices will continue to be a headwind for these companies in the near future.

Moody’s downgraded the credit rating of Alcoa, although that will not significantly increase its borrowing cost in the near future. Alcoa has decided to cut down its idle capacity, which will help it to reduce its fixed cost. The impact of the capacity cut will not be seen in 2013.

Aluminum Corporation of China has decided to dispose of some of the assets in its loss-making aluminum fabrication subsidiaries. The company has also announced it will cut down some of its aluminum capacity. This will reduce the losses of the company.

The possible closure of two smelters in Victoria will increase the earnings of Alumina Ltd. from 2015. The dividend distribution agreement from its AWAC joint venture will help the company see positive cash flow in 2013.

All of these stocks are a "hold" in the near term.

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