Analyzing Alcoa (AA) & Aluminum’s Outlook

By Yaser Anwar, CSC of Equity Investment Ideas

• Aluminum has under performed this cycle and continues to face much skepticism as a result of growing production of aluminum and alumina and the threat of accelerating growth via falling spot alumina prices. The longer term outlook will be influenced by supply moves in China and Europe.
• Alcoa provided a somewhat bullish outlook for year and a half. AA pointed to a balanced or a modest surplus market for alumina and a balanced market for aluminum in 07 and 08 using what management called conservative assumptions.
• AA also talked about an internal study that Alcoa recently completed on the supply outlook from China which remains uncertain and a key swing variable in the industry.
• Alcoa highlights that the market for aluminium is expected to operate at a 400K tonnes deficit in 06 and be balanced for 07. AA’s demand assumptions were based on 14% per year growth in China, which according to AA’s management were conservative by historical standards, and 3% per year growth through 08.
• China’s aluminum deficit is expected to remain between 800K to 900K tonnes for 07 and 08 vs net imports of 897K tonnes in 06. AA expects China’s metal production to increase 3 mill tonnes to 12.2 mill in 08 from 9.2 mill in 06 and includes the ramp up of recently started capacity , new capacity coming online which will add around 1.9 mill tonnes.
• AA points to operating costs of $250 to $300 per tonne for projects that rely of imported bauxite which accounts for 5 mill tonnes of the projects. The remaining 8 mill tonnes of supply will utilize domestic bauxite and have full operating costs of $175 to $225 per tonne according to AA.
• Alcan recently pointed to average cash costs of $180 to $250 per tonne and Brook Hunt recently published estimated cash costs of $120 to $225 per tonne for refineries in China with those using domestic bauxite at the low end and those using imported bauxite at the high end of these ranges.
• AA will benefit from ongoing consolidation (three way merger of Russian aluminum producers OAO Rusal and Sual Group with Glencore Intl.), of the aluminum industry and a slightly higher aluminum price in 2007. Consolidation will result in a better pricing environment and less volatility in sales and EPS over the course of the business cycle.
• Higher aluminum price will result from rising global consumption combined with continued tight inventories. Also, production increases in China may moderate due to higher power costs. Investors should also keep in mind that aluminum faces competition from plastics, steel, glass, and ceramics. Plastic, in the form of polyethylene terephthalate (PET), provides strong competition in the container market. Steel competes with aluminum in automotive applications.

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