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 one of the world’s largest integrated aluminum producers, with many operations in many countries. Alcoa’s earnings and cash flow are anchored by its competitive bauxite mining and alumina production operations (much of it held through its 60%-owned Alcoa World Alumina and Chemicals group of companies (AWAC)) and complemented by its less-competitive Primary Metals unit with over 80% of its aluminum smelting capacity in North America and Europe. Alcoa’s mid- and downstream production operations (Flat-Rolled Products and Engineered Products and Solutions) are technologically sophisticated and are currently operating at historically high profit margins, but generally feature lower and steadier margins than its upstream assets.

Alcoa’s earnings and financial metrics were seriously challenged in 2009 due to the collapse of aluminum demand and prices, leading DBRS to downgrade the Company’s ratings in December 2008 and again in April 2009. Nonetheless, Alcoa’s results were significantly improved in 2010 and further improvement has been observed in the first half of 2011, which is expected to continue for the rest of the year.

In 2009, the Company took steps to strengthen its balance sheet through the issuance of $906 million in equity and $575 million in convertible notes and to preserve liquidity by reducing costs, capex and dividends and by modifying its short-term credit facilities, issuing term debt, and selling a $1.0 billion equity investment made in 2008. Additionally, the Company launched a number of operational initiatives to reduce costs, including the curtailment of high-cost production capacity, strict inventory and administrative cost management, improved procurement initiatives and capital expenditure control.

With the rebound in economic conditions continuing during 2010, Alcoa’s earnings profile exhibited decent recovery as hesitant growth in Europe and North America supplemented much stronger growth in China and other emerging markets, driving up demand and prices for many commodities, including aluminum. Profitability was restored in the Company’s key Primary Metals unit and EBITDA margins increased across all segments.

Improved results have continued into the first half of 2011 and are expected to continue for the rest of the year. The recovery, aided by a low level of capital expenditures and dividend levels reduced in 2009, has helped to restore financial metrics to a level more in line with the assigned ratings at this point in the commodity cycle. With total debt of $9.3 billion at June 30, 2011 (reduced from $10.6 billion at the end of 2008), Alcoa’s credit metrics have continued to improve, with cash flow-to-total debt of 0.31 times, EBITDA interest coverage of 6.0 times, and debt-to-capitalization of 32.6%. Cash balances at June 30, 2011, totalled $1.3 billion.

Alcoa continues its drive to improve the competiveness of its operations, recently completing and ramping up production at the Juruti bauxite mine (60% interest) and the São Luís alumina refinery (38% interest), both in Brazil. In addition, the Company has embarked as a participant in the Ma’aden joint venture in Saudi Arabia to build a $10.8 billion integrated aluminum operation with bauxite mine, alumina refinery, smelter and rolling mill. Alcoa has a 25.1% interest in the smelter and rolling mill and AWAC has a 25.1% interest in the mine and refinery. The project is based on bauxite resources in Saudi Arabia and the availability of low-cost natural gas as a primary energy input, resulting in the expectation that the facilities will be first-quartile cost when completed. The project is expected to be financed with 60% debt and 40% equity, requiring cash of approximately $1.1 billion from Alcoa during the construction period to 2014. Alcoa will also be required to guarantee its share of the project loans until the 2017/2018 period, adding to its overall financial exposure. Ma’aden is expected to constitute a large portion of Alcoa’s expansion expenditures over the next few years and will add to the Company’s financial risk prior to completion.

Over the longer term, aluminum demand is expected to grow in step with the industrialization and urbanization of developing countries. It is a key metal in the desire to reduce weight in the transportation sector to conserve energy, it enjoys a high level of recyclability and is versatile, with a wide range of end-uses. Alcoa is expected to face competitive pressures at its European and North American operations as other, low-cost energy centres such as Saudi Arabia look to aluminum production as a means of taking advantage of their energy resources.

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

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