DBRS Confirms Alcoa Inc. at BBB with a Stable Trend

DBRS has today confirmed the Senior Unsecured Debt rating of Alcoa Inc. (Alcoa or the Company) at BBB and its Commercial Paper rating at R-2 (middle). The trend for both ratings is Stable. Alcoa is emerging from a period of serious challenges brought on by the recent economic recession. The Company’s credit metrics have been impaired throughout the downturn, but Alcoa has been able to weather the storm by taking actions to reduce its costs, complete important capital projects and re-establish a sound liquidity profile. With economic recovery underway, the Company’s credit metrics are expected to improve to a level more commensurate with its assigned ratings.

The Company faced a real-life “stress test” when the financial crisis that unfolded in the fourth quarter of 2008 led to a serious economic recession in late 2008 and early 2009, resulting in downgrades of the Company’s ratings in December 2008 and again in April 2009. It became evident that Alcoa was not the lowest-cost producer in the aluminum industry and the Company was hard hit by the collapse in aluminum demand and prices. The market downturn highlighted the volatility of the Company’s earnings and its dependence on aluminum, which was among the poorest performers in the commodity sector.

Despite these issues, Alcoa has been able to bring its debt under control, reduce its costs and complete important expansion projects.

Alcoa’s liquidity was enhanced in early 2009 by the issuance of $905 million in equity and $575 million in convertible notes. As of December 31, 2009, liquidity levels remained sound, with $1.5 billion in cash on hand and $3.5 billion in unutilized credit facilities. The Company’s long-term debt maturities in 2010 and 2011 total approximately $1.1 billion, which DBRS believes will be easily funded. Alcoa’s net debt at the end of 2009 was $8.3 billion, down from a year-end peak of $9.8 billion in 2008. Gross leverage of 39% remains high (net leverage was 35%). Coverage metrics for 2009 were very poor as a result of the economic downturn, including cash flow-to-total debt at 0.03 times and EBITDA interest coverage at only 0.6 times. These metrics do not support the current rating, but DBRS views them as cyclically low numbers.

The near-term outlook for Alcoa’s markets is much more positive than in the 2008–2009 downturn. Current aluminum prices are about 25% above the 2009 average and the outlook for aluminum use in the European and North American ground-transportation sectors is improving. China is expected to continue to show strong demand growth for a full range of aluminum products. Alcoa’s procurement initiative, cost-reduction programs and the bringing on stream of new, lower-cost operations are expected to improve its competitiveness. Capital expenditures, estimated at $1.3 billion in 2010 ($850 million sustaining), are expected to be funded from internal cash flows.

DBRS expects that Alcoa will further reduce its leverage to less than 35% in 2010 and will show large improvements in its coverage metrics, with cash flow-to-total debt above 0.2 times and EBITDA interest coverage between 5.0 and 10.0 times. If metrics fail to improve as expected, negative rating actions may be taken.

Alcoa’s capital investments will improve competitiveness and cash flow by lowering production costs of alumina and aluminum, in addition to increasing output capacity. The sale of low-margin businesses will improve the overall profitability of the Company. Alcoa is also expected to benefit from its recent commitment to participate in a massive integrated aluminum facility in Saudi Arabia, which is expected to be one of the lowest-cost aluminum producers in the world when completed in 2014.

Over the long term, DBRS believes that the benefits of new, lower-cost production capacity and the ongoing appeal of aluminum as a material that is both lightweight (enhancing energy efficiency) and cost-effective should bode well for growing profitability and restoration of the Company’s credit metrics to a level commensurate with its BBB rating.

Notes:
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 (Natural Resources) rating.