This Stock is Reducing its Reliance on Aluminum Pricing

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

Earnings season kicked off last Tuesday, as Alcoa (NYSE: AA) reported EPS ex-items of $0.03. Underlying the figure is a divergence in performance between upstream and downstream segments:

<table> <thead> <tr> <td><span><strong>Segment</strong></span></td> <td><strong>After-Tax Operating Income (ATOI)</strong></td> </tr> </thead> <tbody> <tr> <td>Alumina </td> <td>($9 million)</td> </tr> <tr> <td>Primary Metals </td> <td>($14 million)</td> </tr> <tr> <td>Global Rolled Products  </td> <td>$98 million</td> </tr> <tr> <td>Engineered Products & Solutions</td> <td>$160 million</td> </tr> </tbody> </table>


Lower LME-based pricing hurt both upstream segments. Year-on-year, Alumina ATOI dropped $163 million, while Primary Metals ATOI fell $124 million. Third-party realized aluminum prices were down 5% sequentially and 17% year-on-year.

However, improved pricing for value-added products such as aluminum plate, sheet and foil helped drive up Global Rolled Products ATOI $38 million year-on-year, while Engineered Products & Solutions ATOI rose $22 million over the same quarter last year. These increases represent impressive year-on-year gains of 63 and 16 percent, respectively.

Alcoa also downwardly revised its 2012 world aluminum demand forecast from 7% to 6%. This signals further weakness for aluminum prices, particularly when combined with bloated warehouse stocks. As shown below, aluminum warehouse stocks have yet to regress to their pre-recessionary levels:

<img src="/media/images/user_13962/lme_alum_large.png" />


Aluminum prices may remain abated as long as warehouse stocks stay elevated. But these lower prices can be fortuitous for companies that process purchased aluminum into intermediate goods, as lower input costs could result in higher profits through margin expansion.

Kaiser Aluminum (NASDAQ: KALU) provides rolled, extruded, and drawn aluminum products for industries such as aerospace and automotive. Outlook supplied in the last quarterly earnings release states the company "continue[s] to expect robust long-term demand growth for [its] aerospace and high strength products driven by increasing build rates, larger airframes, and monolithic design [and] anticipate[s] automotive growth opportunities will continue for the next several years as a result of increasing aluminum extrusion content and higher build rates."

In the case of Kaiser, lower aluminum prices are unlikely to boost margins significantly, since many of its customers pay spot-based or index-based pricing rather than paying a firm price. Still, higher build rates should result in higher sales volumes, which bodes well for the firm. Kaiser reports earnings Wednesday.

Like Alcoa, Reliance Steel and Aluminum (NYSE: RS) is having to navigate a commodity-based business through falling commodity prices. In addition to the weakness in aluminum, same-store selling prices were down last quarter by 4.7% for carbon steel and 12.9% for stainless steel relative to the same quarter of 2011.

Reliance, which reports Thursday, has made several acquisitions this year in an attempt to boost its exposure to various value-added areas.

In February, Reliance purchased McKey Perforating, a metal perforator and fabricator. Next, in April, it purchased National Specialty Alloys, a processor and distributor of premium stainless steel and nickel alloy; and Worthington Steel's plant in Vonore, Tennessee, which processes customers' carbon steel, aluminum and stainless steel for a fee, without actually providing the metal.

Then, in July, Reliance bought Airport Metals, an Australian aircraft materials distributor. And so far this month, it has completed the purchase of GH Metal Solutions, a steel processor and fabricator; and Sunbelt, which provides the oil and gas industry with special alloy steel bar and heavy-wall tubing.

These types of acquisitions can help Reliance and others mitigate their dependence on metals pricing. In an environment characterized by falling base metals prices, developing higher value-added offerings may be necessary in order to remain profitable for years to come.

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