Stock/industry Overview

Stock/Industry Overview

Alcoa Inc. (NYSE: AA) is the leading global producer of primary and fabricated aluminum, as well as the largest miner of bauxite (the key raw material) and refiner of alumina, through its active and growing participation in all major aspects of the industry: technology, mining, refining, smelting, fabricating, and recycling . It is currently the world's third largest producer of aluminum, behind Rio Tinto Alcan and Rusal . Alcoa's products are used worldwide in aircraft, automobiles, commercial transportation, packaging, building and construction, oil and gas, defense, and industrial applications. Aluminum and alumina represent more than three-fourths of Alcoa's revenue. The company is a cost-competitive and vertically-integrated producer, with a top 30th percentile rank on the refining cost curve, and ~50th on the aluminum curve . Roughly 80% of the needed ore for the company's production come from Alcoa-controlled sources. The company also generates 20+% of the electric power used at its smelters .

From an industry perspective, integrated aluminum powerhouse Alcoa had benefited from a rebound in the price of the metal, the key profitability driver. While aluminum prices are impossible to predict, global demand for aluminum should continue to increase as population growth and economic development lead to more use in end-markets such as transportation, construction and packaging. The extent to which Alcoa benefits is likely driven by how cost-competitive it stays relative to lower-cost capacity competitors entering the market.

Alcoa management expects demand for aluminum to double by 2020 (it was up 50+% from 2000-2010), implying the need for three million tons of new annual supply . Below is a graph of projected primary aluminum consumption by region for 2011 (in millions of metric tons – mmt) and how it compares to 2010 levels :

Below is a chart referencing the key aluminum business metrics used in the aluminum industry. Although the transition from 2008-2009 was very difficult for the aluminum industry, prices, demand and production were on the upswing from 2009-2010.

Fairly Priced or Undervalued?

Although 2010 was very promising, the aluminum industry has been in quite a rut as aluminum prices have fallen significantly from their 2011 highs. The recent announcement by China of prioritizing low inflation over growth hasn't helped either. The fact that the LME Aluminum Warehouse Stocks Level are at 5 year highs, compounds the problem. This has caused aluminum producers to cut production. Alcoa expects that these factors "will result in a global aluminum industry deficit of 600,000 metric tons in 2012 ." (Note: this will just eat into the inventory at a rate of just over 10% suggesting that the inventory has a long way to go to return