DBRS Downgrades Alcoa Inc. to BBB, Stable Trend

DBRS has today downgraded the ratings on Alcoa Inc.’s (Alcoa or the Company) Senior Unsecured Debt to BBB and its Commercial Paper to R-2 (middle), both with a Stable trend, due to a worse-than-expected deterioration of the Company’s credit metrics during 2008 and a poorer outlook for aluminum than DBRS had previously expected. Alcoa is not the lowest cost producer in the aluminum industry and the Company has been severely hit by the collapse of aluminum demand and prices. Today’s rating action removes Alcoa from Under Review with Negative Implications, where it was placed on April 8, 2009.

Alcoa had high net leverage at the end of the first quarter (38%), despite the receipt of proceeds from a first quarter equity issue ($876 million) and sale of investments ($506 million) due to very weak operating results in light of difficult aluminum markets. Although leverage improved somewhat over year-end 2008 levels (41%), operating earnings and cash flow for the quarter were very weak resulting in poor coverage metrics (rolling 12-month EBITDA gross interest coverage at 3.4 times and cash flow-to-total debt at 0.12 times). Realized primary aluminum prices for the first quarter were $0.71 per pound, down 26% from the fourth quarter 2008 and 44% from the first quarter of 2008. Alcoa’s third-party alumina, primary aluminum, flat-rolled product and engineered products shipment volumes fell 18%, 15 %, 12 % and 30 %, respectively, from fourth quarter 2008 sales levels, reflecting the impact of the economic downturn on the automotive, transportation, building and construction and aerospace markets, all of which are important to Alcoa. Both aluminum prices and the across-the-board reduction in shipment levels where much worse than DBRS had previously anticipated and are indicative of the challenges Alcoa and the industry face.

Aluminum markets remain very weak and DBRS expects reduced shipments to continue into the fall of 2009, reflecting ongoing slowdowns in the automotive, aircraft, construction and other sectors. Alcoa will continue to face capital expenditures at above sustaining levels for the second quarter of this year as it completes expansion projects in Brazil. Following mid-year, the Company’s capital expenditures are expected to decline to an annualized rate of $850 million. DBRS believes that at current spot aluminum prices ($0.66 per pound), much of the industry is unable to generate cash from operations and that further capacity shutdowns, combined with any economic recovery, will lead to somewhat higher aluminum prices in the second half of 2009. Despite this, DBRS does not expect Alcoa to generate sufficient cash to materially improve its financial metrics in the near term, even though the Company has introduced a wide range of cost-cutting measures.

DBRS expects that after the second quarter, Alcoa should be able to keep debt levels in check until rising aluminum prices brought on by economic recovery and reduced costs brought on by new production capacity and efficiency initiatives provide sufficient excess cash flow to reduce leverage. As such, DBRS expects coverage metrics to remain weak throughout 2009 and possibly further.

Alcoa’s liquidity was enhanced by the issuance of $905 million in equity and $575 million in convertible notes during the first quarter and remains sound with $1.1 billion cash on hand and $4.8 billion (net of $0.3 billion commercial paper outstanding) in unutilized revolving credit facilities at the end of the quarter. The Company has only $56 million long-term debt maturities in 2009. DBRS believes the Company has the resources to complete its expansion projects by mid-year and to weather the current downturn in aluminum prices. DBRS also expects Alcoa will be able to successfully renew $1.9 billion in revolving credit facilities maturing October 12, 2009 (these were undrawn at the end of the first quarter), if they are required.

The demand for aluminum will continue to focus on the need for lightweight metals to meet energy efficiency targets as well as the utility of aluminum in the construction industry. Alcoa is expected to remain focused on aluminum, where it is an important, but not the lowest cost producer. DBRS expects that Alcoa’s financial profile will improve as the current economic downturn comes to an end leading to higher prices for aluminum and alumina, hence the Stable trend designation.

Notes:
All figures are in U.S. dollars unless otherwise noted.
The ratings of Alcoa are based on public information.

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

This is a Corporate rating.