Image Shown: It has been rough for Alcoa Corporation over the past couple of years as the company faces a slowing global industrial economy while trying to optimize its asset base and overall operations in a bid to save on costs.
By Callum Turcan
After the market close on January 15, alumina, aluminum, and bauxite product leader Alcoa Corporation (AA) reported earnings covering the fourth quarter of 2019. The company’s top- and bottom-line results missed consensus expectations, sending shares of AA lower initially during after-hours trading.
Financial Updates
For the full-year, Alcoa recorded $10.3 billion in GAAP sales, a GAAP operating loss of $0.4 billion, and GAAP diluted EPS of -$6.07 (negative $6.07). On a non-GAAP adjusted basis, Alcoa’s diluted EPS came in at -$0.99 (negative $0.99) in 2019. However, please note $1.0 billion in restructuring charges (in part due to the divestment of two facilities in Spain, which we will cover later on in this piece) are responsible for some of this weakness, as Alcoa seeks to completely shake up its asset base to better deal with the slowing industrial economy world-wide.
In 2019, Alcoa’s cash from operations climbed higher by over 53% versus 2018 levels to ~$0.7 billion, while its capital expenditures dropped modestly lower to ~$0.4 billion. The firm doesn’t pay out a dividend and did not repurchase a meaningful amount of its stock in 2019, as Alcoa is desperately trying to get a handle on its large net debt/liability load (keeping pension-related liabilities in mind). Before including long-term pension obligations, which we caution are very material, Alcoa exited 2019 with a net debt load of ~$0.9 billion according to its press release.
When the company publishes its 10-K filing for 2019, we will get a much better look at its balance sheet and overall financial status. Another key consideration mentioned within its earnings press release, Alcoa noted that “net pension and other postretirement employee benefits liability of $2.4 billion at December 31, 2019, up $40 million from year-end 2018” which is simply daunting given its existing net debt position. This is largely why Alcoa is pursuing major structural changes at the company.
Divestment and Asset Base Optimization Update
On January 2, 2020, Alcoa announced a deal to sell off its waste treatment facility in Gum Springs, Arkansas, for up to $250 million in cash. Upon closing the sale of Elemental Environmental Solutions, a wholly-owned subsidiary, Alcoa will receive $200 million in cash and the potential to receive an additional $50 million if certain post-closing milestones are met. As part of the arrangement, Alcoa will sign a multi-year deal with the new owner to continue using those facilities. Privately-held Veolia ES Technical Solutions is the acquirer of these assets.
Historically, Elemental Environmental Solutions processed spent pot lining for the smelting industry. Please note that pot lining is utilized when extracting aluminum metal from aluminum oxide (pot lining is located within the steel shells and acts as a cathode during this process) and is highly hazardous. In 1988, the US Environmental Protection Agency classified spent pot lining as a hazardous waste material that needs to be disposed of properly (creating a set of rules that needs to be followed when disposing of spent pot lining).
This transaction is part of Alcoa’s divestment program, announced in October 2019 during its third quarter earnings report, that seeks to raise $0.5-$1.0 billion in cash by selling off non-core assets over the next 12 to 18 months. Furthermore, Alcoa launched a related program late last year to streamline its operations on the back-end as well. That involves cutting down on the size of Alcoa’s management team, consolidating certain operations (sales, procurement, and other activities) when possible, and reducing its headcount by ~260 employees company-wide (this program is expected to be completed by the end of the first quarter of 2020).
Alcoa announced plans to sell off its Avilés and La Coruña aluminum facilities in Spain in the middle of 2019 after announcing in October 2018 that operations at the plants would be curtailed until/if Alcoa could find a third-party interested in taking those facilities off its hands. The buyer is private-equity firm PARTNER Capital Group AG, however, it doesn’t appear Alcoa is receiving any money from this deal on a net basis and is instead incurring modest but meaningful cash outlays in order to remove these operations (and the related liabilities) from its balance sheet. Here’s a slightly edited excerpt from Alcoa’s 10-Q filing covering the third quarter of 2019 providing more details on this arrangement:
In January 2019, Alcoa Corporation reached an agreement with the workers’ representatives at the Avilés and La Coruña (Spain) aluminum facilities as part of the collective dismissal process announced in October 2018 and curtailed the smelters at these two locations… in February 2019. As part of the agreement, the Company agreed to conduct a sale process to identify third parties with interest in acquiring the facilities and to maintain the smelters in restart condition up to June 30, 2019. Through the sale process, PARTER Capital Group AG (‘PARTER’), a private equity investment firm, was identified as a potential buyer for both of the Spanish facilities, inclusive of the smelters and casthouses at both facilities and the paste plant at La Coruña…
…On July 5, 2019, Alcoa Corporation signed a conditional share purchase agreement with PARTER for the purchase of these two facilities, which was subject to PARTER meeting certain financial conditions prior to July 31, 2019 to support the facilities future operations…
…As of July 31, 2019, PARTER met the financial conditions and the transaction has closed. Alcoa Corporation recorded Restructuring and other charges, net, of $134 (millions of USD) in the third quarter of 2019 resulting from financial contributions of up to $95 (millions of USD) to PARTER per the agreement and a charge of $39 (millions of USD) to meet a working capital commitment and write-off the remaining net book value of the plants’ assets. Cash outflows at the close of the transaction were $37 (millions of USD) with the remaining financial contributions of $80 (millions of USD) to be paid in quarterly installments through the second quarter of 2021…
Alcoa is making real progress on improving its operations and asset base, but it’s a tough space to operate in. Here’s why we view the aluminum industry negatively as it relates to the ability to generate meaningful shareholder value in the space, from our 16-page Stock Report covering Alcoa (can be accessed here):
The aluminum industry, a subset of the industrial metals group, remains highly cyclical. The threat of production overcapacity, the level of global metal inventories, and changes in economic growth expectations (especially China) can cause significant volatility in the prices of aluminum and other industrial metals. Sustained weak prices coupled with rising costs for energy, which is used heavily in metal production, could have disastrous implications on the group’s financial condition. Competition remains fierce, and recent industry consolidation has done little to change this dynamic. We don’t like the group.
Concluding Thoughts
As of this writing, Alcoa is trading at the lower bound of our fair value estimate range and shares appear fairly valued. With global industrial activity slowing down considerably, we aren’t optimistic on Alcoa’s outlook. Material asset base and operational changes will help, but there’s only so much that can be done given the firm’s looming liabilities. Even with the US-China semi-trade truce now in effect, Alcoa still has plenty of work to do to turn this ship in the right direction. We continue to stay away from Alcoa, but appreciate management attempting to bring down the firm’s net debt/liability burden via divestments and free cash flow.
Metals and Mining (Aluminum) Industry – AA ATI ACH CENX KALU
Diversified Mining Industry – BHP FCX NEM RIO SCCO VALE WPM
Related: IYM, JJU, FOIL
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Callum Turcan does not own shares in any of the securities mentioned above. Newmont Corporation (NEM) is included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.