Alcoa, the US-based aluminium conglomerate, has been in the spotlight for several consecutive weeks, however some may quesiton as to why it is garnering so much attention?
What is Alcoa?
The multinational company, headquartered in New York, is a global leader in lightweight metals and manufacturing techniques. A consistent part of its competitiveness is explainable by its vertical integration in the sector. Indeed, Alcoa produces both raw aluminium and semi-manufactured products and it has operations in all major steps of the value chain: mining, refining, fabricating and recycling.
The firm mainly operates through three business divisions: Global Primary Products (GPP), Engineered Products and Solutions (EPS) and Global Rolled Products (GRP). GPP deals with pure commodity operations (mining, refining and recycling) while EPS concerns primarily manufacturing operations. Finally, the GRP is itself divided in two different functions, namely global packaging (mainly involved in industrial packaging) and aerospace, transportation and industrial (providing semi-manufactured products for those industries).
“The right time to split up”
The light metals giant has been hit by the tumbling of commodity prices (aluminium is down 20% from last year), consequently the management pursued a strategy aimed at reducing the exposure of the firm to aluminium prices. Mining and smelting operations have been substantially reduced, while the downstream business has been consolidated through the recent acquisitions of RTI Metals, Firth Rixson, and TITAL. Such dealsare intended to meet the increasing demand from aerospace and automobile industries while simultaneously consolidating the revenues coming from the business less tied with raw material quotes.
However, what mostly attracted the attention of the market was the announce on the 28th of September that the company will split its upstream and downstream operations into two publicly traded companies. The former will keep the name of the original company, while the latter’s name is still to be decided. The legacy business will consist of 64 facilities, a staff of approximately 17000 employees and a yearly revenue of $13.2 billion for 2014 while the yet unnamed company will employ roughly 43000 workers, having a comparative revenue of $14.5 billion. Indeed, the latter is forecasted to be traded at a much higher multiple due to the high-profit-margin nature of the operations. CEO and Chairman Klaus Kleinfeld commented on the operation at CNBC:
“The globally competitive Upstream Company will comprise five strong business units that today make up Global Primary Products — Bauxite, Alumina, Aluminium, Casting, and Energy,” [while] “The innovation and technology-driven Value-Add Company will include Global Rolled Products, Engineered Products and Solutions, and Transportation and Construction Solutions.”
Kleinfeld will be the CEO of the downstream business while still serving as chairman of the legacy business for the transition period.
Following the release in late September, AA stocks jumped 5%. Out of the 18 analysts consulted by Bloomberg, 11 classified the stock as a buy, 6 as a hold and 1 as a sell. Consensus over the 12-month price stands at $13.40 per share, which compared to today’s (13th October) closure at $10.08, represents a 33.1% potential increase. Ultimately, the operation will create different businesses appealing different types of investors: an upstream cyclical business that is likely to generate lot of cash during upturns and a value-add business capable of delivering growth in the long term serving the automotive and aerospace industries.
Q3 Earnigs: A bad miss
Cushioning the enthusiasm tied to the split-up announce, Alcoa reported last week (on the 8th of October) third-quarter earnings per share of $0.07, missing the consensus estimate ($0.14) by half. Shares in the company fell 4% as a consequence of the release. The reasons underlying such downturn are to be fund in the large impact China’s economic downfall had on Alcoa’s business and in the numerous divestitures in the mining and smelting operations that negatively impacted revenues (down 11% from last year) coming from those. However, growing sales in the value-add business, led by heightened demand coming from the transportation industry, limited the plunge.
The biggest competitor of Alcoa, for the very nature of its business, is the global economy itself. Even though the Asian economic slowdown is likely to prevent a recovery in commodity prices, thus increasing the pressure on Alcoa’s downstream business, eventually, when the global economy strengthens, the upstream business will benefit from a rising demand in raw aluminium thus enjoying boosting revenues. In addition, Alcoa predicts a substantial aluminium deficit in 2016, if this would actually be the case demand would pick up, aluminium prices would follow and company revenues boost. Hence, for the positive outlook both upstream and downstream businesses are facing, the disappointing earnings will likely not change the consensus buy-rate attached to the stock.