Alcoa Corporation (AA) Earnings Call Transcript & Summary

Good morning, everyone. Good afternoon, good evening, depending where you are joining us. Thank you for being present in this webcast or fireside with William Oplinger, who is Executive Vice President and CFO of Alcoa. Thank you, Bill, for joining us. Before we start, I need to read some disclosures. So it's not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website, www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. So with that out of the way, Bill, again, thank you very much for joining us. As always, it's good to have you and the company participate in this conference. Unfortunately, it is virtual and with me being live in Laguna, but nonetheless, things are going well and we thank you for being here. So Bill, maybe before we start. Do you want to give us a little bit of an update on what you are seeing regarding COVID situation in your operations? Any potential impact above and beyond what you have already mentioned in the past and maybe translating or doing a bridge into how you see the aluminum and alumina markets amid the pandemic and everything that we are going through this crazy year?

Sure. Thanks for having us, Carlos. It's always good to do this conference. I can tell you, though, it's a lot better to do it from Laguna than it is from the third floor in Pittsburgh. It's been a tumultuous year, and I'll give you an update on how COVID-19 has affected our operations. I'm especially proud of the fact that our operations have been able to manage through COVID-19 successfully. We've not had any production impacts across the system. Our mines, refineries, smelters, casthouses, rolling mill, all continue to operate and have strong protocols in place for managing through COVID-19. Through the early part of this month that we've had a total of about 600 employees infected with COVID-19, 97% of those have recovered. And we've been able -- as I said to be able to manage through without any significant impact. Early on, we put together a crisis response team and developed response programs in every one of our operations. And I think that just has really allowed us to manage through successfully. If we transition to the markets, we are starting to see a rebound in the aluminum markets, led by China, a very strong V-shaped recovery in China, broad-based in all of our major market segments: construction, transportation, packaging. The rest of the world, we're starting to see some strength in the rebound. And that, combined with the Chinese V-shaped recovery, has driven aluminum and alumina prices higher. And so that's been favorable. It feels like we've seen the bottom of some of the pricing that we saw at the beginning of the COVID pandemic. So overall, a good, strong recovery in many of the regions of the world. And as far as how much of the global supply is cash negative at these levels, we see globally that in alumina, we've got about 10% of the world ex China that's cash negative at these price levels, probably 5% in China. And then in aluminum, less than 5% world ex China and really very little cash negative production in China. So overall, we're seeing the recovery hit and prices being...

Okay. And Bill, maybe a subset of the market focusing on North America, this Section 232 has been on and off, on and off, yesterday, you just had another update. What can you tell us as to how do you see the situation? And the latest measures announced yesterday, what are the implications as far as you can say for Alcoa, in particular?

Well, exactly like you said, Carlos, the tariffs have been on and off again over the last few years. I think that -- and I guess our view is that the U.S. has made the right decision in removing the tariffs at this point on the Canadian smelters. We have a presence in both the U.S. and Canada. All along, we have said that tariffs are disruptive. And so given the fact that Canada is a vital trading partner, we believe that taking the tariffs off is favorable. And we've said all along that having tariffs or quotas is essentially disruptive to the market. And runs counter to some of the principles that we believe in, which is free trade. With that said, we are studying the announcement from yesterday. We need to understand it better. We will be seeking some clarifications on it. I can tell you that retroactive tariffs can be even more disruptive than regular tariffs. And so we need to understand it better, and we'll be reviewing the details of the order when it's released to seek further clarity on it. But more to come on that certainly.

Understood. In -- one of the, I guess, negative impact of tariffs is on the downstream aluminum supply chain. So on that, what are the latest views on the company's exposure to the rolling business in the U.S., particularly with the Arconic noncompete expiring in, I guess, a month or so from now? How do you see the company strategy or how does the company want to position on the rolling business going forward?

Yes. So the packaging business is one of the stronger markets that we've seen. It's been resilient through COVID-19. It appears to have good growth opportunities over the next few years. So at this point, we are pleased with our position in the packaging industry. You know that Warrick produces largely end and tab, some body stock, some food stock. So it's a position that allows us to continue to grow with the packaging business. So at this point, we're pleased with our Warrick rolling facility. Always opportunities for improvement, and they have plans to improve the profitability of the facility in the second half of this year. But at this point strategically Warrick is a good asset.

All right. Fair enough. And just, I mean, talking about the portfolio, the company had been very proactive on addressing the difficult situation that the aluminum sector, in particular, has experienced. And it has put in place a streaming portfolio or a portfolio review with the focus on streaming it. And also, there are different actions that the company announced earlier in the year to reduce cost. Could you give us an update on both the portfolio review as well as the successful implementation of the cost reduction initiatives?

Yes. I will take you back to October of 2019. We've -- over the last -- within the last year, we've announced 3 sets of that activities, and that started back in October of '19. We came out with a strategic direction in October '19 that had a number of activities that we are initiating for 2020. Those were repositioning of the portfolio. And so we announced a review of our portfolio of 1.5 million metric tons smelting capacity, 4 million metric tons refining capacity. So we'd execute -- we've begun to execute on that strategic portfolio review. We've curtailed the Intalco smelter. We've permanently closed the Point Comfort refinery, and we've begun discussions on a collective dismissal process for the smelter in Spain. So good strong progress on the repositioning of the portfolio. Secondly, we announced asset sales. We are anticipating proceeds of $500 million to $1 billion. We had completed the first asset sale in the first quarter, recognized $200 million of cash proceeds from the Gum Springs sale with a $50 million contingent payment that could come over the next couple of years. We continue to work on our asset sales. The only announced asset that we have for sale is the Rockdale land and continue to work on that. However, we are in various stages of other asset sales at this point. And then thirdly, we announced the -- a new organizational design where we eliminated the business unit structure. I think that new organizational design positioned us really well for going into COVID. At that point, we had reduced overhead by approximately 300 positions, took out on a run rate basis $60 million of overhead costs and, but more importantly, streamlined the operations, streamlined the reporting relationships and have an end-to-end commercial activity that looks at the commercial activities from -- all the way from raw materials and to products going out the door. And that positioned us well for the downturn that we saw coming out of COVID. However, before COVID, in February, we saw that some of our markets were being negatively impacted. And so we announced 2 more initiatives, $100 million productivity challenge and a $75 million to $100 million working capital challenge. In aggregate, we feel that we will be able to deliver on those challenges for 2020. So good, strong progress on both of those. Especially on the working capital side, we'd already achieved over $100 million of working capital improvement through the first half. Second half, for working capital, it's really going to be trying to offset some of the price increases that we're seeing. And one last thing. And then in COVID, we announced a series of COVID-related actions, travel restrictions, hiring restrictions, pension deferral. And so the aggregation of all those 3 active -- the 3 sets of activities is about a $900 million savings that we're looking to generate. And through the first half, we are on target to be able to generate that $900 million.

All right. Thank you for the update on that. And just on the portfolio or asset sales, you have given yourself a few years to complete those. But maybe because of the pandemic, should we expect that maybe you push out a little bit the time frame and the time that you have given yourselves to complete these deals? I don't know how much can you -- are you able to really pursue these asset sales under the current situation?

Yes, I should have put some timing around some of those programs. On the portfolio review, we gave ourselves 5 years, on the portfolio review. On the asset sales, we only gave ourselves 18 months. And the 18 months is up at the end of the first quarter of 2021. We are pushing for the asset sales. But to your point, it has been harder to get progress on the asset sales than what we had anticipated, largely because of COVID. It's hard to do due diligence on a site if you can't get anybody to the site. And as you know, in your industry, it's just harder to get people together, given where we're at in the pandemic. So things are going a little bit slower.

All right. And then talking about the working capital reduction challenge, I know very well that Alcoa is always focusing on that. I experienced that back in the day. But can you give us a little bit more details as to what are the -- some of the specific initiatives that you guys are pursuing there? I received questions from investors asking how much factoring or transactions like that is the company doing at this time. So if you can explain a little bit what is behind this, that would be great.

I can. Yes. Let me just start with the organizational design. This was a massive -- and you remember your days at Alcoa, this is a massive change of organization. We used to have 3 different business units. Those 3 different business units would be tasked with working on their working capital. And we'd review how they're doing against their working capital target. Very different mindset change for our company. We have now put the entire commercial organization, procurement, sales, marketing and supply chain management altogether in one organization led by one leader. That one leader oversees everything from raw material procurement, all the way to rolling mill sales. And he has an organization that is trying to optimize working capital across the entirety of the process. So instead of having silos of working capital, you're seeing an optimization. How does that impact? Can you optimize alumina shipments from the alumina business into the smelting business and run that differently based on having all of this put together? Probably one of the best examples of what we're working on is some of the work that we have done around transportation optimization. Really trying to minimize demurrage, making sure that shipments come in just in time, hit their slot, come into a port and be able to minimize inventory levels down. As far as the factoring question goes, the other nice thing about having this organization is there's a very, very tight linkage between the commercial team and the treasury team. So we know of any type of payment deals that are current, and we make sure that anything that's done is done at a cheaper rate than our borrowing cost, right? So there are no embedded terms deals within the organization that may be more expensive than the marginal borrowing cost. So really, really have tight control over working capital at this point.

All right. And Bill, continuing on the line of cash generation or cash outflows and cash management, can you give us an update or review of the pension and OPEB situation for the company? A lot of moving pieces. CARES Act definitely help. You were proactive in prepayment -- making some prepayments in the last few years that really helped -- came handy this year and may come handy for the next year as well. So could you give us an update because this is also clearly an important focus of investors?

Yes. One of the things that I think was one of our priorities coming out of Alcoa Inc. was really trying to understand that there would be cycles in our business and that we needed to future-proof our balance sheet. We needed to make significant improvements on the resiliency of the company. As part of that, in 2018, as you mentioned, we went out and borrowed money and established a prefunding balance in the pension. What that allowed us to do, and we knew it at the time that if there was a down cycle and we wanted to skip pension contributions, we were able to do that through this prefunding balance. In a cash flow situation like where we saw in the first half of the year, we are very much in a cash conservation mode. It turns out that the CARES Act came out in advance of us using our prefunding balance, and the CARES Act said that we could defer our pension contributions from 2020 into 2021. That's great for 2020. It just means that in 2021, we were going to be making higher pension contributions. So let me put that into perspective. Our projection for 2021 was that we would need to make $380 million of cash contributions between pension and OPEB. Of course, these will vary depending on what discount rates end up and asset returns, but a close enough approximation. If we defer $200 million contributions this year, that means that $380 million becomes $580 million for next year. $580 million is a large number. So we do have the prefunding balance set up. The prefunding balance is currently worth around $380 million. And as we go into 2021, we will determine based on how cash flow looks, will we make the contributions or will we use the pre-funding balance. To just to wrap up this conversation, when you look at the balance sheet, and we came into the year with around $2.3 billion of pension and OPEB liability on the balance sheet, discount rates have declined sharply. Asset returns have been okay. They've not been bad. But as we look forward, if the discount rates stay where they are at today and asset returns are the expected return on assets that we have, we would project that balance to be at $2.6 billion at the end of the year. Now that's a -- you have to keep in perspective, we didn't make our $200 million contribution. So to go from $2.3 billion to $2.6 billion is not a bad outcome in the environment that we're in. So I feel good that we've managed our balance sheet conservatively over the last few years and it positioned us for a situation like where we saw in the first half.