DBRS Changes Trend on Alcoa Inc. Ratings to Stable from Negative

DBRS Limited (DBRS) has today confirmed and changed the trend on the Issuer Rating as well as on the Senior Unsecured Debt, Commercial Paper and Preferred Shares ratings of Alcoa Inc. (Alcoa or the Company) to Stable from Negative following ongoing strengthening of the Company’s business profile and ongoing improvements in the Company’s weak credit metrics. DBRS has subsequently discontinued and withdrawn the Commercial Paper and Preferred Shares ratings of the Company with Alcoa’s concurrence.

Alcoa 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 Primary Metals unit and steady profit growth for its EPS unit. Furthermore, Alcoa closed the acquisition of RTI International Metals (RTI) in July 2015 and is close to completing construction at the Saudi Arabian Mining Company (Ma’aden) integrated aluminum project in Saudi Arabia, which will add to equity earnings and reduce Ma’aden construction/investment outflows.

Improvements in Alcoa’s Upstream businesses have been overshadowed by very competitive alumina and aluminum markets. This has meant that, despite a $2.5 billion reduction in net debt from the end of 2008 to December 2014, credit metrics have been weak; however, while remaining weak, metrics have steadily improved since 2009 and will be somewhat further improved by the equity issuance associated with the RTI acquisition.

Alcoa’s net income, before items DBRS considered to be non-recurring, has been volatile over the last decade, ranging from a peak of $2.5 billion in 2006 to a loss of $899 million in 2009. Currently, earnings have improved sharply to a more robust $1.1 billion in 2014 and $1.2 billion in H1 2015 (annualized) from a weak $47 million in 2013. The Company’s Upstream units, which drove record earnings in 2006 as well as the subsequent declines, provided volatility during the period. Its Downstream units have been steadier contributors to earnings (except for a dip in 2009) and, as a result of acquisitions, restructuring and other improvements, are now generating earnings at near-record levels.

Alcoa was net free cash flow positive each year from 2010 to 2014 with solid operating cash flows despite generally weak aluminum prices and with restrained capital expenditures and dividends, resulting in a steady decrease in net debt until 2014 when the Firth Rixson acquisition led to a $389 million increase in net debt. In H1 2015, working capital needs and $171 million in net acquisitions caused a further $429 million increase in net debt. Nonetheless, Alcoa’s financial metrics have largely continued to strengthen through the period.

Alcoa’s earnings before non-recurring items in H2 2015 are expected to be challenged by a significant drop in realized aluminum prices, partially offset by added income from Downstream acquisitions. As a result, income is expected to remain well ahead of 2014 levels, but may dip from H1 2015 levels. Over the longer term, industry cutbacks in metal capacity and ongoing consumption growth are expected to lead to higher aluminum prices which, combined with improving cost competitiveness caused by curtailments and additions of low-cost capacity in Primary Metals and Alumina as well as acquisitions in Downstream and organic growth initiatives, should lead to stronger overall earnings.

Accordingly, DBRS expects that Alcoa’s earnings and key financial metrics will improve in 2015 with the equity issuance and added earnings related to the RTI acquisition as well as ongoing growth in its Downstream units, partially offset by reduced earnings from Upstream units as aluminum prices and regional premiums continue to deteriorate. Release of some of the H1 2015 investment in working capital should bring the Company’s 2015 net free cash flow closer to neutral from the $397 million use of funds in H1 2015. Acquisitions, the realization of synergy, organic growth, cost improvements in its Upstream operations and other efficiencies are expected to help Alcoa to continue to improve its financial 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 and Rating Companies in the Industrial Products Industry, DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers and Preferred Share and Hybrid Criteria for Corporate Issuers, which can be found on our website under Methodologies.

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