Alcoa Corporation (AA) Earnings Call Transcript & Summary

All right. Well, good morning, everyone. I'm Curt Woodworth, Crédit Suisse metals and mining analyst. And we're very pleased to have Alcoa with us today for our virtual NDR fireside chat. From Alcoa today is CFO, Bill Oplinger. Bill, I think it'd be helpful to maybe just start the discussion, if you could provide a general update sort of operationally, how you've kind of been managing through this COVID crisis and how you see the business kind of performing going forward into the back half of the year.

Yes. Thanks, Curt, for having me. Certainly has been a tumultuous year with COVID hitting in the early part of the year. I would, however, step back to the latter part of 2019, and to some extent, I feel some of the actions that we took got us ahead of some of the tumult that's occurred this year. Going back to October of 2019, we launched 3 -- the key strategic actions. The first was a new operating model, where we said that we eliminated our business unit structure and went to a global chief operating officer, chief marketing officer structure that allowed us to take out significant overhead costs, but also allowed us to really run the business in a more optimized way. And I would tell you, that set us up for a good performance through the COVID pandemic. We also announced noncore asset sales of $500 million to $1 billion. We executed on the first of those in the first part of the year when we sold our Gum Springs site. We announced a portfolio review of putting smelting portfolio of 1.5 million metric tons and refining portfolio of 4 million metric tons under review. We subsequently acted on the curtailment of Intalco, which was completed in the third quarter of this year. And we're in the process of a collective dismissal discussion with workers in sand-separating smelter. In addition to that, we announced in the early part of 2020 as we saw some of the key markets that were struggling before COVID, that we were going after working capital and lower production costs, each of about $100 million of financial benefit in 2020, and those are progressing well. We believe, in aggregate, we will achieve the $200 million in 2020. And then lastly, when COVID clearly hit, we took further actions. And so a number of COVID-response actions. First, we reduced our overall capital spending by an incremental $100 million, put our growth programs on hold, and then reduced environmental ARO and some hiring and travel reductions. And then the large one is a reduction in our deferral of pension contributions from 2020 to 2021. But I think all those actions put us in a good position to make it through the pandemic, both from an operational perspective and from a financial perspective. If I just briefly touch on how we've managed through the -- or have, through the state, managed through the crisis. We've had approximately 600 employees that have been impacted by COVID. 97% of those have returned to work at this point. And so we're seeing that haven't had significant impact there. All of our operations have continued to run. And this is really a testament to the work that our operations team put together early on, on having response programs and looking at staffing and some of the work that they've done to make sure that all the sites are continuing to operate. So from my perspective, I think we were able to get ahead of this. And have, again, at least until now, managed through things successfully and plan to manage through in the coming months.

Yes. I know the performance has been great. I think, last quarter, alumina and bauxite set records in production. That's pretty remarkable in this type of climate. In terms of the portfolio review, I believe you had identified -- or some of the productivity targets you outlined this year for $10 million to $75 million of benefits from now, which I assume would be maybe some benefit from the Intalco or Bécancour coming back up. Can you kind of just walk through operationally kind of how you see the portfolio sort of shifting in the next 1 to 2 years? There's been some discussion on the power situation in Australia. And to your point, you have other assets under operational review. Can you help us kind of frame sort of the opportunity set productivity-wise in the next couple of years in the business, different things you're looking at?

Sure. So we -- in October, we announced on the smelting side, 1.5 million metric tons under review. Out of that, there was a certain piece of that, that was already curtailed. So there are a number of sites that are curtailed, the iron ore smelter or what anti-smelter parts of Intalco were already curtailed. So we essentially said that over a 5-year time period, we'll be looking to fix, close or sell those sites. And it's important to understand that fix is included in that list of options. So it's not necessarily that we're looking at curtailing or closing 1.5 million metric tons. We would also consider better power contracts or better agreements to try to make those more competitive. If you were to get -- as we get to the end of that 1.5 million metric ton review, one of the things that's important to note is that it will -- assuming that many of those are either curtailed or sold, we will be much better positioned from a carbon footprint perspective than what we are positioned today. We're in good shape from carbon footprint, but we'll be, we believe, the lowest carbon producer after that review is done. So if we come back to today, we took action early on Intalco. And Intalco is just not competitive at current pricing in the current situation. So we were able to get Intalco curtailed in the third quarter. We've announced the collective dismissal process on the smelter in Spain. We announced that back in June. We've extended it out a little bit to go through look a potential sale process. Later in September, we have a date that we have to meet with the worker councils or the unions and the government to see where we stand on that sale process. So we're executing systematically on that review. And we'll continue -- we've given ourselves 5 years to do it. And I think it made good progress through the process of it.

And in terms of the carbon strategy for Alcoa. You've also been somewhat at the forefront on looking and developing carbon-free aluminum with Elysis. And then there's been a lot more discussion on green alumina. And then, I think, potentially an LME contract for lower carbon aluminum, which I would think would position you very, very well, certainly relative to the Chinese aluminum produced or so. Can you talk to that and the level of importance within the organization and maybe any timing on some of those efforts?

Sure. So carbon is one part of our sustainability strategy. And so we'll focus on carbon in this discussion, but sustainability is broader than that for us than just the carbon footprint. We believe that it is very important for the market to go towards a green carbon standard for the market to continue to increase for bringing alumina products that are low carbon. We think that's a positive for the industry. It's a positive for the impact on the environment. We have been on the forefront of this. We launched a couple of products, one called ECOLUM and ECODURA. The ECOLUM is a low-carbon product that we've been able to develop that's based on hydropower. And it builds on the fact that our refineries and bauxite to mines are the lowest carbon footprint, the lowest carbon intensity refineries in the world. So I think we're well positioned there. As you mentioned, we are partners with Rio Tinto in the Elysis project. Elysis made good progress in 2019. It was slowed a little bit in 2020 because of COVID on the building of the research facility in Québec, but we continue to make progress there. Elysis will be a tremendous breakthrough in the industry. It will provide for 0 carbon in the smelting process, and will really position us and Rio Tinto as the leaders on low carbon. Again, I would say the greenhouse gas emissions are only a part of the ESG strategy that we have. ESG strategy, it includes things like the community work that we do in each of our communities, leveraging the Alcoa Foundation to make sure that we're investing in the communities that we're in. So I think from an ESG perspective, we are in pretty good shape.

Okay. Great. And maybe shifting gears a little bit to more sort of the macro environment. Clearly, China has had a pretty strong demand recovery and metal prices have responded. It's been a little bit more uneven in the rest of the world. But can you just give us some updated thoughts on kind of what you're seeing supply/demand-wise in aluminum? And then given with the interest rates so low, it does seem like we're seeing more activity in terms of the warehouse finance trade being going on. So even though you did see some inventory build in aluminum, probably some of that metal is really not even available to consumer. So just kind of give us an update on kind of what you're seeing or any recent developments in the aluminum market would be great.

Sure. So we are seeing some signs of recovery outside of China. We're starting to see an improvement in transportation and construction industries in the rest of the world. There's still uncertainty in the rest of the world. But as you say, the Chinese demand has rebounded in 2020. And so the picture, in our view, is bright, brighter in China than what it had been. We're seeing rebounding manufacturing activity, continued supportive policies, and so a strong V-shaped recovery in China that we believe will drive aluminum demand to be equal or better than what we saw in 2019. As far as the inventories go, we have seen a little bit of a decline of inventories in -- between June and August. As you said, the aluminum future spur is in contango. So there is a cash and carry trade that contango is pretty strong. And with the low interest rates, we do see a strong demand from inventory financing like we've seen at times in the past. Ultimately, supply and demand will dictate the premium in each of the regions. We've seen premiums increase with the elimination of the Canadian exemption in the North America. And so we believe that we're starting to see a recovery in the rest of the world, strong recovery in China. And the -- as you've said, the aluminum inventories are supported by the cash and carry trade.

And then within China, there's always this ever-present kind of fear that they're going to continue to build more capacity and look to export that. But the net trade balance has been relatively neutral. Even more countries like India recently came out and is evaluating putting tariffs on Chinese materials. So -- and China, in general, is a high-cost producer. So I mean, do you feel like the China supply/demand balance is actually pretty tight just given the demand? And any update on the supply side in terms of what you're hearing in China and also ex China?

Yes. So the -- we would expect that full year 2020 supply-demand balance in China is relatively balanced. And the reason that is, is we saw some curtailments earlier in the year and some capacity growth later in the year. But for 2020, we're anticipating that China is balanced. We have seen an increase in both alumina and aluminum prices with the recovery in China and the rest of the world. And at this point, we would typically talk about how much capacity in the world is cash negative. And today, in the alumina side, we would say that probably less than 5% of the Chinese production is cash-negative. That's a little bit lower than what it was reported in the second quarter of last -- I'm sorry, second quarter of 2020. And on the aluminum side, there's very little production, if any, that is cash negative in China. So the rebound in pricing has resulted in the Chinese facilities to be at least cash neutral.

Okay. And then in terms of the balance sheet and capital structure and the pension, it seems like you identified the $900 million of cash levers pull, which should set you up to be in a pretty strong position next year, given if aluminum and alumina prices hold. So can you discuss kind of capital allocation strategy coming out of COVID? It seems like you'll be in a pretty healthy position with over $1 billion of cash on the balance sheet. What are kind of the strategic uses for cash going forward? And any updates on the pension liability right now as well would be great.

Yes. So let me address the pension liability first. You know that since we launched as an independent company back in 2016, we've been extremely focused in trying to reduce the pension and OPEB liability and have made consistent progress over the years. We did 2 large new organizations out of the pension, back in, I believe it was 2018, and have continued to focus on that. We borrowed $500 million to set up a prefunding balance in the pension. That prefunding balance gives us flexibility on being able to make contributions into the pension plan. And then we deferred under the CARES Act, we deferred approximately $200 million of contributions into the U.S. pension plans from 2020 to 2021. What that means is that going into 2021 -- before I go into 2021, let me give you an estimate of what the ending the balance of 2020 will look like. We started the year of pension and OPEB balance of around $2.3 billion. Even at these substantially declining discount rates, interest rates and discount rates, even with having deferred $200 million of contributions in 2020, we would anticipate the end of the year, assuming today's discount rates and today's asset returns, we would predict to be at around $2.6 billion of pension and OPEB liability. So while it's a $300 million increase, it's a significantly better position than what we would have been in given if we had not taken the actions that we've taken. Now let's fast forward to 2021. In our K, we talk about contributing approximately $380 million of cash contributions in 2021 between pension and OPEB. We will -- because of the deferral, that will increase to $580 million in 2021. However, like I said, we have a large pre-funding balance set up in the pension that we can take advantage of. The prefunding balance is projected to be approximately $380 million. So as we go into 2021, we will launch cash flows, and we will use that prefunding balance if we don't feel the cash flows are substantial enough to cover the pension contributions and do all the things we want. Now let me kind of take you to capital allocation, and this all ties into the pension. Capital allocation, we'll start with trying to maintain $1 billion of cash on the balance sheet. We've not been able to do that the last few quarters because of the COVID situation. We'd like to rebuild cash on the balance sheet. We will sustain the operations. We've historically sent between $300 million and $400 million of CapEx, and we'll be updating that number January 2021. And beyond that, there's 4 uses of cash, and these are not necessarily in rank order. Those 4 uses of cash are further deleveraging. You know we have a leverage target. It's a proportional net debt target. So it would be further deleveraging. Second would be returning cash to shareholders. The third would be repositioning the portfolio. It costs money to reposition the portfolio. You see that when we curtail a site, it costs us money. And then the last is midterm growth projects. As I said, our growth projects were put on hold in 2020. We do have some growth projects in, specifically in Australia and Brazil on the refining side that we could spend money on. At this point, Curt, if I were to give you an indication of where my thinking is, is a real priority for the company coming out of 2020 is do further deleveraging. And I believe, and we've done some work on this, that deleveraging the company is the best way to unlock equity value. And so you know, and we've had this discussion before, we target an optimal WACC. We believe that the optimal WACC drives the greatest value of future cash flows. And in my belief today, we want to get to our net debt target, our proportional net debt target. So I could see us doing further deleveraging over time.

And I guess, to some degree, the cadence of that will be somewhat dependent on the timing of the asset sales. You mentioned $0.5 billion to $1 billion. I think you've completed roughly $200 million thus far. So still potentially a significant amount of cash that could come in. Could you talk to any update on timing of that? Are there any material tax consequences of some of the assets you're looking to sell? And just give us an update.

Sure. We announced back in October, $500 million to $1 billion of proceeds from asset sales. We executed on Gum Springs. Gum Springs generated $200 million. It had very little to negative EBITDA. So it was a really good sale. We had a contingent payment that we're looking to be able to get approximately $50 million on Gum Springs. Beyond that, the only asset that we've publicly stated that's for sale is the land down in Texas, and we continue to work through that land sale. And we have committed that we will have our asset sales completed by the end of the first quarter of 2021. I would tell you, things have gone a little bit slower on the asset sales, simply because of the -- it's very difficult to get people into sites. It's very difficult to do due diligence with some of the restrictions that we've had. We're still committed. We'll give you an update at the end of the third quarter, and we're still working towards those assets. You asked about tax, and I would make a couple of comments around tax. First of all, depending on where the asset sales are, we have large net operating losses in the U.S. that are trailing. And -- so we would be able to take advantage of any sales in the U.S. that would largely be tax-free. And if I can have a little bit of a tangent around tax, we, as you know, and I'm sure, as you know, clearly, we have a fairly complex tax situation. We make money in certain places around world, for instance, in Australia, and therefore, we pay taxes in Australia. How we lose money in certain places around the world, for instance, in the U.S., and therefore, we don't pay taxes in the U.S. And that leads us to have a fairly strange effective tax rate from time to time. And so we -- as we look out into the third quarter, we estimated the tax expense -- the income statement and tax expense to be about $150 million in the third quarter. I think that's going to increase to $225 million in the third quarter, simply because we're changing our projection of full year taxes -- sorry, I should say full year profitability. Full year profitability has -- our view of full year profitability has increased since when we ran the tax calculation for the second quarter, and that will result in slightly higher taxes in the third quarter which should normalize out in the fourth. So a lot of complexity there, but with an improving market environment, slightly higher full year taxes with a piece of that getting recognized in the fourth.

So the $225 million for the third quarter, would that include like a catch-up tax payment or that's kind of where it...

It does. Absolutely, it does. It includes a large catch-up tax payment for the year. If you recall, in the second quarter, we had a negative tax rate. And as we're projecting out into the full year, we get to a profitability, a pretax profitability level, and therefore drive the catch-up tax in the third quarter, which will, to some extent, reverse out.