Alcoa Inc (AA): Free Cash Flow Concerns Escalate

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Alcoa Inc (NYSE:AA) reported a Q1 adj EPS of USD 0.11, which was above consensus of USD 0.08 and up from Q4 of USD 0.06 supported by productivity improvements and higher volumes downstream. For the aluminium market, Alcoa Inc (NYSE:AA) reiterated its 7% global demand growth forecast for 2013 and continues to see a fairly balanced market.

Alcoa Inc (AA): Free Cash Flow Concerns Escalate

According to a recent report from Nomura equity research, Alcoa Inc (NYSE:AA) would likely face a potential debt rating downgrade if aluminum prices persist at current low levels, given FCF metrics would degrade significantly. Analysts at the firm believe Alcoa Inc (NYSE:AA) would generate adjusted FCF (including Ma’aden JV investment not categorized as capex) of negative $805 million at LME prices of $0.88/lb for the remainder of 2013.

However, analysts believe the bigger issue for equity investors is the long term structural earnings potential of Alcoa Inc (NYSE:AA) under a weak aluminum price environment given earnings growth from the downstream businesses is becoming more difficult to come by with margins near peak levels and end-market growth rates compressing outside of aerospace. They believe the prospect of further significant downstream margin expansion at this point is low given much of the easily achievable productivity improvements / cost savings have been captured.

Another component of the industry running to stand still theme deals with three factors: Chinese aluminum self sufficiency despite high cost status, the correlation of aluminum prices to resource currencies to which Alcoa Inc (NYSE:AA)’s costs are exposed, and worsening structural oversupply conditions leading to unprecedented levels of inventory, which ultimately will have to be absorbed.

Nomura reduce its 2013 EPS estimates to $0.30 from $0.40 to reflect weaker LME spot prices. The firm also lower its aluminum price estimate to $0.88/lb for the remainder of 2013 from $1.00/lb for the full year previously. The research firm have also reduced its target price to $8 from $9, reflecting 6.5x firm’s estimated 2014E, which is near the mid-point of Alcoa Inc (NYSE:AA)’s historical forward EV/EBITDA range.

Nomura reiterate its ‘Neutral’ rating.

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