DBRS Changes Trend on Alcoa Ratings to Negative from Stable

DBRS has today changed the trend, to Negative from Stable, on the BBB Issuer Rating and Senior Unsecured Debt rating of Alcoa Inc. (Alcoa or the Company) and its R-2 (middle) Commercial Paper rating. The change in trend reflects the weakening of alumina and aluminum prices, which have rendered Alcoa’s financial metrics poor for its current rating levels. In addition, the Company’s net indebtedness has grown in the first half of 2013. DBRS expects Alcoa will be challenged to stabilize, let alone improve its financial metrics with what we see as a general weakness in world commodity markets, including the aluminum market, and heightened price volatility in the near to medium term. A further deterioration in the outlook for the Company, or for Alcoa to stabilize/improve its financial metrics during the course of the next year, can be expected to lead to a ratings downgrade.

Alcoa is one of the world’s largest integrated aluminum producers, with significant interests in aluminum-related mining, refining, smelting, processing, fabrication, marketing and recycling facilities, as well as a producer of other light metal products. The Company is a geographically diversified and low-cost producer of alumina and an at-the-median cost producer of aluminum metal (upstream assets). Its technologically sophisticated mid- and downstream production operations (Global Rolled Products and Engineered Products and Solutions), are industry leaders and historically have provided steadier but lower profit margins than its upstream assets.

Although the Company is a leading aluminum producer, the aluminum industry has suffered from an oversupply of alumina and aluminum production, driving prices to such low levels so as to significantly reduce the profitability of even cost-competitive upstream producers.

In business for 125 years, Alcoa is a well-recognized leader in many aspects of the aluminum business, but it also has a variety of old, less-competitive facilities, particularly in its Primary Metals unit, which it has been idling to reduce aluminum production costs. The Company also has the potential of harbouring certain legacy liabilities. For more than five years now, Alcoa has been re-orienting and streamlining its operations, selling off non-core, often low-margin businesses in its downstream operations, as well as enhancing the productivity of its operations across the board. In addition, it has been improving the cost-competitiveness of its upstream operations by building some new assets and retiring older, less-efficient units, particularly in its smelting operations.

Despite these efforts, a decline in aluminum prices from above $1.20 per pound in the first half of 2011 to about $0.95 per pound at the end of 2012 reduced Alcoa’s adjusted EBITDA by almost 40% between 2011 and 2012, despite a 16% increase in EBITDA generated by its downstream operations. Reduced earnings and operating cash flow eroded the Company’s 2012 financial metrics to weak levels. Improvements are noted in EBITDA generation of Alcoa’s upstream operations in the first half of 2013 even though aluminum prices have fallen further to about $0.80 per pound at the end of the second quarter. Alcoa’s liquidity remains solid, with $1.2 billion in cash on its balance sheet at June 30, 2013, an undrawn $3.75 billion credit facility maturing in 2017, as well as $1 billion in undrawn credit facilities with shorter-term maturity dates.

Concerns over the strength of growth in the all-important (for commodities) Chinese economy and disharmony in that country’s short-term credit markets, combined with lacklustre growth in the United States and a growing concern over the potential end of quantitative easing and the end of the downward trend in interest rates, as well as the still-shaky semi-avoidance of large-scale financial disaster in Europe have culminated in a sharp reversal in sentiment and in the trend of commodity prices in the spring of 2013. The growth in production capacity brought on by accelerated capital expenditures supported by the strong commodity prices of 2010 and 2011 and high cost inflation throughout the industry have exacerbated the price weakness and margin squeeze being experienced in the first half of 2013.

Although Alcoa has fared better than most, its flexibility from a financial and ratings perspective is poor compared with other larger and more diversified miners. Accordingly, a further deterioration of aluminum and alumina prices, without offsetting cost reductions by Alcoa, can be expected to lead to a renewed deterioration of the Company’s financial metrics and the likelihood of a downgrade of its ratings. The Company also remains vulnerable to any unexpected financial shocks that might arise with respect to its downstream businesses or in dealing with any of its legacy issues.

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

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The applicable methodologies are Rating Companies in the Mining Industry (primary) and Rating Companies in the Industrial Products Industry (secondary), which can be found on our website under Methodologies.