DBRS Comments on Alcoa’s Initiatives to Improve Liquidity

DBRS notes that Alcoa Inc. (Alcoa or the Company) has announced that it is undertaking a series of operational and financial actions to improve its cost structure and liquidity. DBRS views the announcements made March 16, 2009, as positive, but given the challenges that Alcoa faces in the near term, its credit metrics may continue to further deteriorate to the point where negative rating action may be taken.

Measures announced include a $1.1 billion offering of shares and convertible notes and a plan to reduce working capital in 2009 by $800 million. Combined with asset sales of $1.1 billion in 2009, these measures will help repair Alcoa’s deteriorated credit metrics in the face of heavy capital requirements in the first half of 2009 and severely depressed aluminum markets expected for much of 2009. If carried out as planned, the $3 billion addition to liquidity would, on a pro forma 2008 basis, reduce Alcoa’s gross leverage from a year-end level of 43% to approximately 34%, which is still at the higher end of the range for the Company’s A (low) rating.

Alcoa has also announced a reduction of the quarterly dividend to $0.03 per share, saving $400 million annually. Alcoa will institute a series of operational cost reduction measures geared to enhance its 2009-2010 performance and improve its cost structure by $2.0 billion annually by 2010 through procurement efficiencies and through overhead rationalization ($400 million). As well, capital spending will be reduced to a sustaining level by the second half of 2009, saving $850 million annually. During the first half of 2009, DBRS expects that Alcoa’s capital spending will include sustaining capital plus an approximate $500 million needed to complete expansion projects underway.

Alcoa experienced significantly reduced earnings and cash flow in the fourth quarter of 2008, when realized aluminum prices fell to $0.96 per pound (compared with $1.33 per pound for the first nine months of the year). Currently, aluminum prices are approximately $0.60 per pound and shipments in the first half of 2009 are expected to be weak, negatively affecting expected operating cash flows. The savings measures announced will be necessary to keep free cash flow in positive territory.

DBRS will continue to monitor Alcoa’s 2009 results to determine whether the deterioration in its credit metrics can be halted. Aluminum market conditions have weakened significantly since DRBS downgraded Alcoa in December 2008, and it is expected that the Company’s cash flows will be much weaker than expected at that time, while capital expenditures remain relatively high. Alcoa has indicated that the actions it has announced are intended to resolve liquidity concerns and to ensure the firm is in a position to be able to exploit opportunities over the long term. The measures announced should help slow the deterioration in the Company’s credit metrics, although Alcoa’s inability to reverse the weakening trend could lead to negative rating action.

Notes:
The ratings of Alcoa are based on public information.

All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Mining, which can be found on our website under Methodologies.

This is a Corporate rating.