Alcoa Corporation (AA) Earnings Call Transcript & Summary

[ Good day ], everyone. Thanks for attending our conference. We're pleased to have here today with us, Bill Oplinger, EVP and CFO of Alcoa. Like our other panels, we'll begin with some opening remarks from Bill before getting into some prepared Q&A and questions from the audience. As a reminder, you can submit questions via the webcast or you can e-mail me at emily.chieng@gs.com. And so with that, I'll hand it over to Bill for some opening remarks.

Thanks, Emily. Just some thoughts to start out. Hopefully, most of you are familiar with our company, but we're a large vertically integrated aluminum company that has operations around the world, are really 3 segments of business. We have a bauxite business. It's one of the largest bauxite miners in the world. It's a very low-cost bauxite mining operation that's geographically diverse. We have an alumina refining business. It generates around -- produces around 13.5 million metric tons of alumina a year, very low-cost system. That is, again, geographically dispersed between 3 continents and we have 3 of the lowest-cost alumina refineries in the world. And then we have an Aluminum segment that is a second-quartile aluminum smelting operation with aluminum smelters, geographically dispersed and close to the end markets. We've also got a rolling mill that we run in the U.S. As we think about the strategic priorities of the company. Last year, we launched 3 key strategic actions coming into 2021. Those 3 strategic actions -- and it almost seems like a lifetime ago because they were launched in October of 2019 -- 3 things: We redesigned the organization to have a new operating model that eliminated our business unit structure and went to global operations and global commercial operations under our Chief Officer -- Chief Commercial Officer. That's important because we've seen a lot of the benefits of that flowing through in 2020. That was executed at the end of last year. Results have been significant overhead savings, but probably more importantly, resulted in better operating structure and better management of working capital. Secondly, we launched the sale of noncore assets. We're targeting $500 million to $1 billion of net proceeds we gave ourselves to the first quarter of 2021. We executed on a sale of our Gum Springs facility, which ended up with an enterprise value of $250 million, $200 million of that was upfront cash proceeds. So we're making progress on our noncore asset sales. And then thirdly, probably most importantly, we put a number of assets under review. We have put 4 million metric tons of alumina assets under review, 1.5 million metric tons of smelting assets and we will take -- at the time, we said we'd take 5 years to get that done, we're 1 year into it. We've already curtailed our smelter in the Pacific Northwest, the Intalco smelter. We have launched a collective dismissal process that's working its way through the system in Spain for the San Ciprián smelter. We've permanently closed the Point Comfort refinery that we've made good progress 12 months in, 13 months in to our strategic review that's been going. Then COVID occurred. And because of COVID, we took a number of actions and I can tell you, we were very well-positioned to run through COVID. We've not had any significant operational issues. I'm very proud of the fact that our operations, we're ahead of that and immediately set up action plans to try to mitigate the actions of -- mitigate the impact of COVID. And we launched a couple of additional actions, some additional savings, but probably most importantly, the deferral of our U.S. pension contribution under the CARES Act. So with that in mind, when I think about the future of the company, I think we have a really strong pathway to significantly improve our company. We've shown this year that we're lowering operating costs. We're managing capital, both capital expenditures and working capital, very effectively. We're repositioning the portfolio over the next 4 years. We've taken significant actions this year and that's just an indication of the actions that we will continue to take over the next 4 years. And we're focused on strengthening the balance sheet over time. Once we get through our portfolio review over the next number of years, we will have a first-quartile large bauxite business like we do today. We will have a first-quartile cost position in refining similar to what we have today. And we will have a first quartile smelting portfolio that's probably smaller than the portfolio that we have today. In addition to that, we will be the lowest greenhouse gas emitter from an intensity perspective of any of the major aluminum companies. And we'll continue to have exposure to all 3 parts of the value chain within the primary upstream aluminum value chain: bauxite, alumina and aluminum. And then on top of that, we will continue to have best-in-class governance and we see today that's probably even more important than it has been in the past. So I think, over the next few years, we are positioned to make the company extremely successful. And with that, Emily, I'll turn it back over to you.

Great. Thanks, Bill, that was really a comprehensive overview. Maybe let's start bigger picture and start this thing here and talk a little bit about the macro. So what exactly are you seeing around the supply-demand picture for each of your 3 segments, bauxite, alumina and aluminum? And maybe share what Alcoa's views are around each of these for 2021?

We -- in 2020, we're seeing an excess of bauxite and the surplus of bauxite we believe in 2020 was around -- will be around 11 million metric tons and that essentially is adding to the stockpile growth that we see in China. That has resulted in some lower pricing on bauxite into China. And so we continue to see stockpile growth on the bauxite side and that is coming out of Guinea and to some extent, Indonesia and Australia. On the alumina side, we're seeing that the alumina market is largely in balance and we -- and 2020 is expecting that China has returned as a net importer of alumina. So we're projecting that alumina imports into China for the year are about 3.5 million metric tons. And then on the aluminum side, aluminum has been the one that -- the product that's been most impacted from COVID during the course of the year. Global surplus of aluminum in the 3 million to 4 million metric ton size for aluminum. That has resulted in some higher inventories during the course of the year. We're seeing third quarter inventories up to around 14.7 million metric tons and around 90 days of consumption, which results in about the same levels of consumptions that we saw back in '20 -- or same level of inventories that we saw in 2015. However, with that said, we are starting to see strength in our markets. We have -- gave a view at the beginning of the fourth quarter that was somewhat uncertain around the value-add products markets globally. We are starting to see the value-added products markets strengthen globally and so our view is more favorable today going into the fourth quarter around value-added products, specifically on the slab side than what we had been projecting just a month ago; very strong recovery out of China, and you see that in many of the overall indicators of the Chinese economy; and some strength in the rest of the world also as we come through this first wave. With that said, it's hard to say what the impact of a second wave of COVID will be but at this point, we are seeing stronger at least value-add product volumes than what we had been projecting in the third quarter.

Great. That makes a lot of sense. And then maybe just touching on the supply side of the equation. Is there anything that you're seeing there in the market that could potentially concern you? Or do you think perhaps China is acting a little more rationally? And also from the bauxite and aluminum markets as well.

The Chinese story around supply side, I guess, on a couple of -- on each one of our products, the Chinese bauxite supply is deteriorating. And as we have been projecting over the years, both quality is deteriorating and the volumes are starting to get less, and we're seeing strength in bauxite pricing within China or for inter-China bauxite and it's being -- continue to be imported from the rest of the world. On the alumina side, many of the large-scale coal store refineries were either delayed or deferred or canceled. So that has resulted in the balance that we're seeing on alumina. And then on Chinese aluminum supply, we're seeing the transition from the western and the northern part of the country down to the south, trying to take advantage of some of the hydro energy down in the south. With that has come some higher prices for trading of aluminum expansion capacity and so that's added some cost, but that transition is ongoing.

Great. And then maybe pivoting to the U.S., there's been a lot of moving pieces with the Section 232 tariffs over the last couple of months. What's the latest update here? And how do these impact Alcoa? And maybe any early thoughts on what the change in the administration could mean for these tariffs?

Yes. Let me address the first one -- the last one first and that is it's probably too early to say what an impact of change of the administration will be. And I think we believe that as far as changes to 232 may not come quickly because it won't be one of the first things that the administration is focused on. The administration will be focused on other major priorities before that. Just to be clear on where we stand on 232. The tariff from Canada coming into the U.S. has been rescinded at this point. That is a difference, again, from what we were signaling in our third quarter update, in our third quarter earnings results. We, at the time, we're projecting that there would be tariffs coming in from Canada into the U.S., and we had projected that part of the deterioration in the fourth quarter versus the third quarter in our aluminum business was associated with those tariffs. Now that those tariffs are off, we will reverse the tariff accrual that we took in the third quarter for the September month, which is about $4 million. We had built into our guidance $18 million of tariffs coming into -- from metal coming in from Canada, so we will not -- at least at this moment, we will not be recognizing that $18 million. So it's about a $22 million benefit to our outlook from the third quarter. So at this point -- and you don't know whether this will change over time, but at this point, we're not seeing tariffs from the Canadian metal coming over the quarter.

Great. That's clear. Maybe moving on each of the segments then. Let's start with aluminum. As part of your portfolio review process, you're talking about -- you're looking at options for around about 1.5 million metric tons of capacity here. But we've seen a little bit of movement from the back-end core stuff, the curtailment of Intalco and San Ciprián, can you frame out the puts and takes here in terms of financial benefits or any cost considerations we need to think about? And any sort of time lines around the San Ciprián curtailment there as well?

Yes. So the -- let's start with the big picture. We put 1.5 million metric tons under review of smelting capacity in October. Out of that 1.5 million metric tons, I believe around 900,000 metric tons was currently operating, 600,000 metric tons was already curtailed. Out of the currently operating metric tons at our capacity, we have curtailed the top of smelter. That curtailment occurred in the third quarter of 2020. We typically don't provide the plant-level details around earnings either on a go-forward basis or a backward basis, but to put it in perspective, Intalco was losing about $25 million on a pretax and post-tax basis in the first quarter of 2020. That's why we needed to take action at that facility. We then transition to ABI. We were coming out of a lockout in ABI. We now have a 6-year agreement for labor stability in ABI, which really puts the company in a better position. ABI should be one of our premier facilities and if we have labor stability in ABI, we can invest in it and really make it a premier facility. We were losing significant money during the lockout. We said that we would spend money on the restart. We have completed that restart in the third quarter of the year. And we also went out and said we expected ABI to be EBITDA-positive in the third quarter of the year, and it did. It turned EBITDA-positive both in the third and projected to be in the fourth quarter. So offsetting significant losses there. If we then go to Spain, we initiated the collective dismissal process earlier in this year. There is a very formal process for executing a collective dismissal. We're following that formal process and we will give further updates as we have better information around when that curtailment will take place. But we're following that to make sure that we follow all the laws of Spain and try to effectively get that collective dismissal done. So we gave ourselves 5 years. We've made considerable progress over the course of the first year and we'll continue to execute on that restructuring program.

Right. And maybe while on you're on the topic of aluminum, maybe also touch on Portland as well, I think the power contract with AGL there. And early next year, we're seeing some headlines that renewable energy may be a part of the solution here. What's the latest update you can provide on any of that?

The power contract ends -- if you recall, and just to give a little bit of a history, Portland was curtailed by a power supply interruption at the very, very end of 2016. We made the decision to restart Portland at the very beginning of 2017. We're committed to running it for 4 years. We got significant governmental support to continue to operate that facility. All of that comes to an end in the middle part of 2021. And so we have to renegotiate a power supply that can make that facility successful over the midterm. To put it in perspective, Portland is a great facility. It's good technology, it's one of our newer facilities, has a tremendous labor force, creative, hard-working and -- but the issue there is getting a power contract. So we are in the process of having discussions with the power generators. We have an idea of what we need to get to be able to continue to operate that facility. We want to put that facility in a position of success over the midterm, not just breaking even. We want to be able to invest in that facility and make it a facility that is there for the mid- to long term. So that's the -- we're going through those discussions now with the power suppliers and we should know something over the next few months.

Right. Moving on to alumina. I think you're also looking at options for around 4 million metric tons of refining capacity there. Your alumina assets are top-quartile, but maybe what's the latest update on that business? And where could you potentially see some movement in terms of capacity?

So we have put 4 million metric tons under review. We immediately took action on permanently closing the Point Comfort refinery. Point Comfort refinery historically was a complex refinery that used imported bauxite. And at the height of some of the alumina prices that we saw in 2018 where alumina prices went as high as $800 a ton, we did not restart that facility. So we've decided to permanently close it. We're in the process of working through demolition of that facility now. That leaves around 1.5 million metric tons of capacity under review within our refining system. We haven't said which refinery that is. We continue to work through the analysis of that. So at this point, as you said and just to kind of bring it back to where we stand, we are first-quartile on the cost curve. We've got 3 facilities that are -- bounced in and out of the first decile of the cost curve, that's Wagerup, Pinjarra and São Luis. And so we have 3 great refineries and we're well-positioned to serve the smelting market around the world. So I think we have an extremely strong refining system that -- and you can't forget that it's got in-situ bauxite that is really valuable in today's world.

Right. Let's pivot -- let's move to capital allocation. When you think about the full priorities, call it, balance sheet, existing portfolio, growth spend and capital returns, what do you expect the time frame is for achieving a capital allocation strategy that better resonates with the vision you have for the company? And I think you've also got $1.7 billion of cash on the balance sheet at the end of the third quarter, where do you think the next use of your cash will be?

Yes. So we -- you alluded to the fact that we've got $1.7 billion of cash on the balance sheet. We have come through this first wave of COVID with a very strong liquidity position. We went out and borrowed at the beginning of the third quarter, $750 million. We got the lowest coupon rate that we've ever had as an independent company and that gave us some flexibility around the capital structure as we were going through the COVID pandemic. As we progress into 2021, we will follow our capital allocation structure. You highlighted there's 4 excess uses of free cash flow. But let me start at the very top of the capital allocation structure model. We'd like to keep $1 billion of cash on the balance sheet. The reason why we keep $1 billion of cash on the balance sheet is we're in a cyclical industry. We saw that in the middle part of this year where metal prices and alumina prices declined dramatically, having $1 billion of cash on the balance sheet allows the company to weather the storm. Secondly, we invest in our businesses, in our plants. So we spend around $300 -- between $300 million and $400 million of sustaining capital a year and we will sustain the operations. As far as we look out, there will be some higher sustaining capital in the near term because of some of the mine moves that we have going on in our bauxite business and some of the residue deposit areas that we're building in the refining business, but that is really just maintaining, sustaining and strengthening a first-quartile set of assets. Beyond that, as you said, we have 4 potential uses for free cash flow: strengthening the balance sheet, shareholder returns, moderate growth of projects and repositioning the portfolio. Repositioning the portfolio is a new use of cash flow that we announced back in October because it will cost us money to curtail some of these sites. You see that it costs us a little bit of money in Intalco, will cost us some more money in Spain when we rebuild. But to come back to your question, near term, I think the greatest value creation for our company is to continue to pay down debt and continue to work on the pension that we have. Our pension is large in relation to the size of our company. I think it's complex. And it's not -- I don't say it's more complex than other pensions, but having a pension obligation that's large in relation to the size -- and people have to understand pension accounting -- we will actively go after both the pension and the debt side in the near term because we think that's the thing that creates the greatest equity value. We target a lowest WACC and we have a net debt target. We are higher than our net debt target today. We're sitting at around $3.3 billion of proportional net debt. We would like to get that down to $2.5 billion over the next few years. So that's what we believe unlocks the greatest equity value, it's actually by addressing the balance sheet.

Great. Maybe digging to a couple of the comments you made there. First, on the CapEx front, do you have any early views on 2021 CapEx? I know you mentioned sustaining was about $300 million to $400 million over the sort of the long term, but how do you think about the return-seeking CapEx and where that could shake out?

Yes. So we haven't put our 2021 estimates yet. We will do that in January 2021. As we've alluded to over the last year or so, we do have some large mine moves that are ongoing in Australia, one in Brazil. So those are fairly expensive and will be a big part of the investment that we make on the sustaining side. On top of that, we're spending some money around residue deposit areas, building new residue deposit areas. And then thirdly, we are spending more capital around impoundment management. Impoundments is a huge issue for our industry, but we believe we have a world-class impoundment management process and are continuing to invest in our impoundments to make sure that we have minimal risk there. If I then transition to return-seeking, we put all return-seeking capital on hold in 2020 due to the pandemic. That resulted in a total return-seeking spend of around $35 million because we had already spent some at the beginning of the year and there were some projects that had trailing costs. We are evaluating small return-seeking projects going into 2021 and we will follow our capital allocation model. But I'm talking tens of millions of dollars, not hundreds of millions of dollars. These are not the midsized return-seeking projects that we have, for instance, in Australia. Those are currently on hold. So the expansions for Wagerup and Pinjarra at this point are on hold but the return on seeking may be in the tens of millions in 2021. And I should say it's important to note that when we talk about return-seeking, it's a combination of cost savings and growth. So a lot of focus around spending money to save costs.

That makes sense. I know you touched on this early on in your opening remarks, but I want to come back to the pension payments. And you mentioned with the CARES Act, you were able to defer about $200 million of payments until 2021. Maybe walk us through when you have to pay that amount. How are you thinking about utilizing the $380 million of prefunded pension that you have available? And Any early indications of what total required pension funding might be in 2021 as well?