Alcoa: the Comeback Will Continue
Over the past three months, Alcoa (AA) shares have been in turnaround mode, gaining almost 30% on the stock market. In fact, despite mixed first-quarter results around a month ago, Alcoa shares have continued rising. The rally in Alcoa shares of late can be attributed to the rally in aluminum prices, which have risen over the past three months, although in a volatile manner.
Aluminum prices have increased in 2016, though there was a slight dip back in March when prices crashed.
Where’s the aluminum market headed?
The rise in aluminum prices is good news for Alcoa since the company has struggled so far on account of weak pricing. In fact, as a result of weak prices, Alcoa’s earnings in the first quarter had dropped 92%, which is not surprising if we consider that aluminum prices have dropped in excess of 40% in the past five years.
As such, it is understandable why the recent improvement in aluminum prices has been a tailwind for Alcoa as the stock has struggled for the better part of the five years due to weak financials. The good thing is that the rally in aluminum prices will continue going forward on account of increasing demand and lower production.
For instance, weak aluminum prices have made a majority of smelters in China unprofitable. In fact, according to a survey, it is estimated that the overall cost of the smelting industry in China stands at 12,000 yuan/ton (or around $1,850/ton), while the average cash cost stands at 10,300 yuan/ton (around $1,580/ton).
Currently, aluminum trades at $1,617 per ton, which means that most smelters in China are not profitable even after the aluminum price rally this year. This is because the overall cost of the smelting industry is higher at $1,850 per ton. This is the reason why a number of aluminum smelters in China have been shutting shop.
Last year, it is estimated that China shut down 5 million tons of smelter capacity, which is 12% of the country’s overall capacity of 42 million tons. What’s more, in 2016, it is estimated that no new aluminum smelter capacity will be added in China. More importantly, last year’s smelter cuts are already taking a toll on Chinese production of aluminum.
In the first three months of 2016, China’s total aluminum production stood at 7,170 thousand metric tons as compared to 7,556 thousand metric tons in the prior-year period, indicating a drop of over 5%. Since China accounts for almost 54% of global aluminum production, a decline in production over here is good news for aluminum pricing and Alcoa. In fact, as a result of lower production, China’s aluminum exports have started dropping of late.
In April, China’s aluminum exports fell 7.8% year-over-year and it is likely that the trend will continue as the country’s production capacity goes down. On the other hand, an increase in demand for aluminum across the globe, in association with lower supply from China, will lead to better pricing conditions due to demand-supply forces. Let’s take a look.
Better aluminum demand will push the market into deficit
The overall demand for aluminum is expected to grow by 5% this year, while supply is expected to grow by just 2%. In fact, as demand is expected to outpace supply this year, Alcoa expects a global aluminum deficit of approximately 1.1 million metric tons and global alumina deficit of 1.4 million metric tons.
The growth in global aluminum consumption will be driven by several key markets. For instance, Alcoa expects global aerospace sales to grow 6% to 8% for 2016 even though the market is in a transition right now. A number of key original equipment manufacturers are making a move from old platforms to new platforms in a simultaneous manner. CEO Klaus Kleinfeld has rightly pin-pointed that Alcoa is “seeing lower orders due to that for legacy models and a careful ramp up of the new models.” So, investors can expect more orders in the aerospace segment going forward.
Alcoa has been able to make a comeback this year due to the resurgence in aluminum prices. Looking ahead, it is likely that aluminum prices will continue to improve due to higher demand and lower production. So, I think that it makes sense to remain invested in Alcoa for the long run as its finances will improve on the back of stronger pricing.