DBRS Confirms Alcoa Ratings at BBB, Negative Trends

DBRS has today confirmed the BBB Issuer Rating and Senior Unsecured Debt rating, the R-2 (middle) Commercial Paper rating and the Pfd-3 Preferred Shares ratings of Alcoa Inc. (Alcoa or the Company) and has maintained the trends as Negative due to the Company’s weak credit metrics in an environment where the outlook for aluminum markets is clouded given the uncertain course of global economic expansion.

Further improvements in the Company’s credit metrics and added evidence of the success of its new operations can be expected to lead to a return in trend to Stable.

Although Alcoa’s ratings remain under Negative trend, the Company has enhanced its business profile over the last several years through investing in new production capacity in its Alumina business unit and in its Primary Metals unit (together, Upstream businesses), adding new low-cost capacity but, more importantly, closing old high-cost capacity. The Company has followed a similar course in its Global Rolled Products (GRP) unit (Midstream business), rationalizing capacity and it has expanded its Engineered Products and Solutions business (EPS) through organic growth and acquisitions (Downstream businesses on its own or with GRP). The result has been Alcoa’s more competitive position on industry cost curves for its Upstream units, and margin growth for its EPS unit, but a number of new facilities and operations, including Firth Rixson, have not been as yet been fully put in place nor fully ramped-up.

Alcoa’s operating cash flow has been volatile ranging from $3.6 billion in 2006 to $515 million in 2009 during the great recession and at about a $2.3 billion annual rate to date in 2014, primarily due to volatile price for products in its Upstream businesses despite rising contributions from its EPS unit and stable contributions from its GRP unit. Nonetheless, restrained capital expenditures and dividends have kept Alcoa net free cash flow positive each year from 2010 to 2013. Combined with dispositions and equity issues, the Company’s net debt decreased by $2.9 billion from the end of 2008 to the end of 2013. That said, reduced earnings and cash flow, driven by lower aluminum and alumina prices, plus erosion of the Company’s equity base due to large writedowns, have caused its credit metrics to be weak for its ratings, albeit generally improving since 2009.

DBRS expects Alcoa to have strong operating cash flow and reduced investment in working capital in the fourth quarter of 2014, to bring the Company’s 2014 net free cash flow closer to neutral from the $670 million deficit to September 30, 2014. The closing of the Firth Rixson transaction is expected to reduce currently high cash balances by at least $2.3 billion. If expected Firth Rixson operating results are achieved in 2015, Alcoa’s credit metrics can be expected to return to their generally improving path.

Over the longer term, aluminum industry cutbacks in metal capacity and ongoing consumption growth are expected to lead to higher Upstream prices. In addition, Alcoa can expect improving cost competitiveness from curtailments and if additions of low-cost capacity in Primary Metals and Alumina meet design expectations leading to overall improvement in earnings, operating cash flow and credit metrics.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.