Alcoa Split: Will One Plus One Equal Three?

The effects of the commodities earthquake continue to reverberate around the world.
This time the company affected is Alcoa (NYSE: AA). In a long-anticipated move, on Sept. 28 Alcoa announced that it will split the company in two. Alcoa’s stock was down about 42% this year alone before the announcement.
The first part of the split company is the upstream business that has been buffeted by falling aluminum prices. It will retain the name Alcoa. The second unnamed company will consist of Alcoa’s high-margin downstream businesses, including specialty metals products for the aerospace, trucks and autos, construction and power industries.
The Alcoa split is expected to be completed sometime in the second half of 2016. It is expected to qualify as a tax-free transaction for stockholders.
It will be interesting to hear what the company says about the split in its third-quarter earnings call on Thursday, but it certainly appears as if the two companies will have drastically differing fortunes in the foreseeable future.

The Old Alcoa

The old Alcoa business will consist of the bauxite mining, alumina refining and aluminum production businesses.

Source: Alcoa presentation, May 12, 2015

It will likely continue to be battered by vast global overcapacity in aluminum, particularly in China. In fact, China’s aluminum production climbed 12% in the first seven months of 2015.
That overproduction served to push down aluminum prices more than 25% in the past year. They are now trading are near six-year lows, below $1,550 per metric ton. August saw the price sink as low as $1,506 a ton.
Even more worrisome are the premiums paid for physical delivery of aluminum, which have collapsed this year. Premiums are now at 3 ½-year lows. This drop is pushing the industry’s profits margins to levels not seen since the 2008 financial crisis.
And the future looks no brighter. Macquarie analysts went so far as to say, “We see no rationale for aluminum prices to trade anywhere near $2,000 a ton this decade.” Aluminum was above this price as recently as early 2014.
Goldman Sachs (NYSE: GS) also chimed in,  stating that aluminum producers face the “longest period of pain for a generation.”
Alcoa apparently agrees. Since 2007, it shut down about a third of its smelting capacity worldwide. More cuts from Alcoa are almost a certainty.

The New Alcoa

But the news is considerably better for the “value-add” company. Alcoa spent recent years piecing this business together by making a series of acquisitions to beef up its specialty metals and products divisions.
A major addition was RTI International Metals, a global leader in titanium and other specialty metals for the aerospace, energy and medical device markets. Alcoa also added Tital, which makes titanium and aluminum castings for aircraft, plus U.K.-based Firth Rixson, a leader in jet engine parts.

Source: Alcoa presentation, May 12, 2015

Currently, aerospace makes up about 40% of the new company’s revenues. This means it will be going head-to-head with Precision Castparts (NYSE: PCP), which is slated to be acquired by Warren Buffett’s Berkshire Hathaway (NYSE: BRK-B).
But the new Alcoa is already adding to the list of big contract wins. On Oct. 5, it signed a nearly $1 billion deal for aerospace fastening with Airbus Group (OTC: EADSY). That is the largest contract ever between the two.
Automakers will also be key to the company’s future. In the second quarter, Alcoa’s automotive sheet revenue almost tripled.
Last December, Alcoa unveiled the Micromill process. This allows the company to produce high-strength aluminum alloy to replace steel in vehicle bodies.
Last month, Alcoa announced a deal with Ford Motor Co. (NYSE: F) to supply components for the 2016 F-150 truck. The F-150 has been the best-selling U.S. vehicle since 1982.
The new “value-add” company looks to be off to a flying start. Maybe one plus one does equal three.
Alcoa shareholders should dump the old Alcoa and keep the new Alcoa when they receive both stocks next year.

Buffett’s Island Paradise

Imagine the ultimate safe haven for investors—no personal or corporate income tax, no capital gains tax—where wealth can be amassed far faster than you ever dreamed possible. This island paradise is no dream. It’s real. And it’s why Warren Buffett and many other mega-wealthy investors have parked billions of dollars here. Go here to join them today.