Alcoa Inc (AA), BHP Billiton Limited (ADR) (BHP): This Aluminum Producer Is Worth Considering

When odds continue to stack up, only the toughest can survive. The world’s leading aluminum producer, Alcoa Inc (NYSE:AA), is proving this every day. As the company combats a huge glut in world aluminum production, the falling aluminum prices continue to weigh heavy on performance.

So, is it all over for this aluminum maker? Should investors just abandon it? I think the answer is no. The first-quarter results were a pleasant surprise for analysts and Alcoa Inc (NYSE:AA) still has lots to offer.

A quick recap of the last quarter

Alcoa Inc (NYSE:AA) reported adjusted earnings of $0.11 per share, topping the $0.08 per share estimated by Wall Street analysts. Adjusted EBITDA of $690 million was $66 million higher than the first quarter of 2012. Revenue of $5.83 billion fell a little short of analysts’ expectations of $5.88 billion, on account of lower aluminum prices.

This was a noteworthy performance as it shows the company’s resilience in the face of tough operating conditions. These numbers were on account of some great cost cutting efforts and good profitability in Alcoa Inc (NYSE:AA)’s downstream business. The company ended the quarter with $1.6 billion cash in hand.

The market glut

Alcoa Inc (NYSE:AA)’s woes stem from overcapacity in the aluminum markets. According to Barclay’s, 2013 will be the ninth consecutive year that supply will exceed demand. Analysts are expecting surplus capacity in excess of 1 million tons this year.

The excess will come from China, which is expected to increase its production 10%, or 2.2 million tons this year. Chinese producers are also suffering from the global oversupply, but they have some buffer from the government subsidies and incentives.

China has already doubled its capacity from 9.3 million tons in 2006 to 19.7 million tons last year. This increase pushed up global raw aluminum production to 45.2 million tons in 2012 from 33.9 million tons in 2006.

The excess supply is taking a toll on LME aluminum prices, which stand at $1,864 per ton, down approximately 45% from their 2008 peak. The falling prices are weighing on Alcoa Inc (NYSE:AA)’s raw aluminum sales.

Restructuring

Where problem arises from over capacity the cure can only come from reducing capacity. That is exactly what Alcoa is doing. It is striving to strike a demand-supply balance.

Last year, the company cut 12% production by shutting down its Tennessee facility and rationalizing capacity elsewhere. This year it has closed two production lines at its Baie-Comeau smelter in Canada and postponed the construction of a new line. This will take off another 105,000 metric tons. This year’s closure is part of the 11% or 460,000 tons of capacity reduction goals that the company has set for itself by the end of next year.