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Why Isn’t Alcoa Rising on Higher Aluminum Prices?

How Do Markets See Alcoa before Its Impending Split?

(Continued from Prior Part)

Higher aluminum prices

In the previous part of this series, we noted that Alcoa’s (AA) earnings are sensitive to aluminum prices like other primary producers including Century Aluminum (CENX), Rio Tinto (RIO), and Norsk Hydro (NHYDY). However, despite aluminum prices trading near nine-month highs after the big spike last week, Alcoa has not seen any substantial price action.

There has been a divergence between aluminum prices and Alcoa, which you can see in the graph above. The divergence can be attributed to two factors.

Concerns about how long the rally will last

There are genuine concerns over the longevity of the aluminum price rally. Previously, higher aluminum prices have led to more Chinese aluminum exports, which negatively impacted prices. China’s March aluminum exports are a testimony to this fact. China exported 420,000 metric tons of unwrought aluminum in March, a year-over-year (or YoY) increase of 17.1%. Prior to this, Chinese aluminum exports dipped sharply in January and February, falling 12.2% and 33.8% YoY, respectively. As aluminum prices rose in March, more Chinese producers found it profitable to sell metal overseas.

Split

Over the last couple of years, Alcoa has grown its value-added business substantially, driven by organic growth as well as acquisitions. Falling commodity prices and Alcoa’s capacity cutting actions have also reduced the revenue share of the commodity business in Alcoa’s consolidated revenues. In 1Q16, the commodity business accounted for only 33% of Alcoa’s revenues. However, the commodity business’s contribution to the company’s adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) was ~25%.

As markets start valuing Alcoa more as an engineering company as compared to a commodity play (RJI) (DJP), the divergence should not be a big surprise. Having said that, Alcoa’s earnings are still sensitive to aluminum prices. So, though Alcoa can diverge somewhat from aluminum, it can’t be totally divorced from aluminum price volatility.

Meanwhile, there seems to be some divergence on how investors and traders see Alcoa before its split. We’ll explore this in the next part of this series.

Continue to Next Part

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