Alcoa Corporation (AA) Earnings Call Transcript & Summary

Hey everyone, this is Matt Fields. I cover High Yield Metals and Mining for Bank of America. It's my pleasure to welcome you all to our 2020 Leverage Finance Conference. And it's my additional pleasure to have Bill Oplinger, the Chief Financial Officer from Alcoa here joining us. Bill, I think, has some prepared remarks. And I think if you're ready, Bill, take it away.

Thanks, Matt. I do just have a few comments to start out with, and then we can open it up for Q&A. Just briefly to introduce you to Alcoa, if you don't know us, you should get to know us. We're vertically integrated aluminum -- primary aluminum company. We're one of the world's largest bauxite miners. We have a first quartile cost position in bauxite. One of the world's largest alumina producers, a first quartile cost position in alumina with a number of plants down in the first decile. And then we're an aluminum producer that is around the second quartile aluminum producer. We're listed on New York Stock Exchange. We have western governance, and we launched as an independent company back in November of 2016 and then have made a lot of strides and progress since then. Our transition to what we've been up to over the last year, there's a lot that we've been up to, and I just want to make sure we hit on a few of these things. Back in October of '19 a year ago -- a little over a year ago, we announced 3 strategic initiatives that we had ongoing. We announced a brand-new organization model. That model switched from a BU-centric model to much flatter organization that has the operations under a single leader and commercial under a single leader. That's a new model, not only from – that has not only allowed us to take out some overhead, really has been the groundwork for some of the better operational performance that you've seen out of the company this year. And it also allows us to manage working capital and the commercial activities from end to end. So it has been a very favorable change in the organization that was enacted a year ago. We also announced repositioning our portfolio of assets. We put 4 million metric tons of refining capacity under review. And subsequently, as soon as we -- essentially, as soon as we made that announcement, we announced the permanent closure of our Point Comfort refinery, that eliminates 2.5 million metric tons out of that 4 million metric ton review. We also put 1.5 million metric tons of smelting capacity under review. We took action during the course of the year. We curtailed the Intalco facility, which was a high-cost facility. We have also announced the initiation of the collective dismissal process in Spain, and we continue to work through that collective dismissal process in Spain. Once we get through that asset repositioning, not only will we be first quartile in our 3 segments of businesses, but we will also be the most sustainable aluminum -- primary upstream aluminum business out there. We'll have the lowest carbon emissions footprint on the smelting side from an intensity basis, and we'll continue to have the lowest carbon footprint on the refining side continuing where we stand today. Thirdly, we announced asset sales. So we announced that we are projecting $500 million to $1 billion of non-core asset sales, and those were expected proceeds to occur by the end of the first quarter of 2021. I'll hit on that a little bit later, but we've made very good progress. And you probably saw an announcement last night that we're -- we have an agreement to sell our Warrick rolling mill. In addition to that, we announced 2 near-term activities that will be completed in 2020, a productivity target, that is both volume increases and cost savings, and a working capital target between the 2 of those. We are anticipating about $200 million of benefit, and we feel, in combination of those 2, are on target to deliver in 2020. And then lastly, when COVID hit, we were well positioned to manage through the COVID pandemic. We did announce a number of cash sustainability actions, specifically that we would defer our pension contribution that was required to be made in 2020 to 2021. We did that, that was approximately $200 million to preserve cash on the balance sheet. We then transition to what we're seeing in the fourth quarter. We are seeing better aluminum prices, better alumina prices. And if you look at our sensitivities, that should drive better EBITDA in the fourth quarter versus the third quarter. In addition to that, we had assumed in our fourth quarter outlook that we would still have to accrue for tariffs into the U.S. from our Canadian plant, that has subsequently changed. So that's about a $22 million swing versus what we had projected for the fourth quarter, back in October, a $22 million benefit versus what we were projecting. However, all that adds up to higher profitability. So our projection for the tax expense goes from $25 million to $45 million in the fourth quarter. So the higher profitability, which is great, will result in a little bit higher taxes that will be booked in the fourth quarter. So then lastly, we announced last night, the divestiture of the Warrick rolling mill. Total consideration for the Warrick rolling mill is $670 million. $583 million will be -- I'm sorry, $587 million will be in the form of cash, $83 million will be in the form of the assumption of OPEB liability. We expect that to close in the first quarter. We're excited about that because it essentially puts us at the top end of our range for expected proceeds from our non-core asset sales. We feel it's at a fair price for both us and Kaiser. I should have said, Kaiser is the buyer. And we're happy that we think Kaiser is the right owner for that facility. It puts our plant and our employees in a company that is strategically focused on rolling. And it was our last rolling mill that we had coming out of the process of separating from Alcoa, Inc. And so we're pleased to see that go for a fair price and go to an owner who, we believe, has great opportunities to make that plan successful. So Matt, that's all I had to cover.

I think that's a great summary, Bill. I'm going to jump in to Q&A here, and then if we see some from the audience, we'll go ahead there. So I think we're seeing it like you mentioned, an interesting move on prices in the fourth quarter. We're seeing a sort of a big rally in aluminum, a little bit less of a rally in alumina. It's kind of -- what are your thoughts on the recent aluminum price move? And why isn't sort of alumina getting invited to the party?

Well, they are 2 very different markets. The aluminum market is traded on the LME. And so there's much more trading of a ton of aluminum than there is a ton of alumina. Since alumina is sold between a customer and a supplier via contracts. And so in the case of aluminum, what we're really seeing is related to the sentiment in the marketplace as a couple of things are driving that positive sentiment. First of all, the overall market sentiment with a potential vaccine on the horizon coming out of the COVID pandemic seems to be driving many assets up and it’s also having a positive impact on aluminum. Secondly, we have sort of seen a very strong V-shaped recovery out of China. And so that has had -- that has led the way in driving aluminum prices up. We're starting to see some positive news in the rest of world. I probably should have mentioned in my fourth quarter view, we've done a lot of talking about value-add products and -- at least versus the outlook that we gave in October, we're seeing stronger value-added products demand. That is not resulting yet in higher premiums, but we are seeing stronger demand. If you then transition to the alumina side. Alumina prices have also gone up, but not at the rate of aluminum. We believe that the aluminum market is fairly well balanced and is creeping up in sentiment with the aluminum prices as we see some customers try to lock in some of the prices that we're at, but not to the same extent as alumina.

That's very helpful. What do you think can help get prices stronger from here? Does Chinese demand matter? Does Chinese smelter refinery profitability matter? What are the sort of key metrics that we're looking for to see sort of foreshadow this type of -- sort of a global rise in aluminum prices?

Yes. So Chinese demand certainly matters, and that has been part of the driver of the recovery that we've seen. We do see reduction in visible inventories in both China and in the Rest of the World. And so that's a positive sign. So the Chinese demand is important. As far as the Rest of the World goes, we're really taking a view that we'll wait to see how strong the rebound will be coming out of COVID. But at this point, as I mentioned, the value-add products markets are recovering, and we're seeing that in a number of our end-user markets.

Are there any measures you can envision to counter China's sort of continued heavy exports of aluminum?

Well, there are some measures in place today, and those are specifically the U.S. Section 232 tariffs and some various antidumping, countervailing duties against Chinese aluminum exports from a number of countries, and we expect those to continue. There's potentially more tariff measures that wraps up its investigation into Chinese aluminum extrusions and decides whether to levy long-term duties there. There are potential opportunities under a new Biden Administration to work with like-minded countries to pressure China's trade-distorting policies and take some steps together to end a Chinese circumvention efforts like a chance to transshipment through other markets. The other forum could potentially be the WTO taking a more active role. So we do believe that there's an opportunity to try to get more of a level playing field. When you look at the OECD report that has been out now for a while, a big piece of the subsidies in the aluminum industry have been granted to just a small number of the Chinese aluminum companies. So there's still opportunities to level the playing field. I would say, though, that we do see China itself is shifting a little bit. There's more stringent environmental measures. A new long-term domestic carbon neutrality pledge, which should be a positive for supply growth and really a focus on domestic consumption on trying to make sure that they increase domestic consumption. And then the only other thing I would mention as far as the environmental measures go, the Chinese smelters are nearly 90% coal-fired. So that puts them significantly higher on the CO2 emissions curves than us and many of the rest of world western players.

That's a fair point. And then sort of talking about that environmental impact, something you've especially been speaking about more on your earnings calls has been green aluminum, which has been a point of emphasis. Can you give us a sense of the market size of this potential opportunity time frame until it's really monetizable for you? And kind of how you stack up against peers in the sort of new green aluminum initiatives?

Well, the market is just getting started for green aluminum products. And to put it in perspective, we actually have 3 green aluminum products. And we've got our ECOLUM, ECODURA, and now the new EcoSource product. ECOLUM is a low-carbon product -- low carbon aluminum product. ECODURA has a higher recycled content. And now with the launch of EcoSource, EcoSource is a low-carbon alumina product. And it's -- we believe it's the world's first and the only branded low-carbon aluminum product. This is a growing early stage market for low-carbon products. I would tell you today, it's small, but we really believe that this is the way the world is moving. It just so happens that we are in a very good position to be able to offer low-carbon products, especially in comparison to some of the higher carbon-emitting facilities in China. A number of our competitors have launched similar products, and we don't necessarily see that as a bad thing, right? If -- with the new low-carbon products from Rio Tinto and from other western world producers think that will help build a low-carbon market and hopefully grow the demand for low-carbon aluminum. One thing to note when we're in our low-carbon products, we're including on our aluminum side, both the carbon and production of the aluminum, but also in the alumina and bauxite piece of that. And then lastly, I would say that we do have a breakthrough technology that's on the horizon. We announced a joint venture with Rio Tinto probably, what, 2 years ago now, where we are working on research and development of the Elysis product. And so Elysis is a low-carbon aluminum product and it's essentially doesn't generate any carbon in the manufacture of the aluminum. It would be the world's leading no-carbon aluminum product in the manufacturing of the aluminum itself. So a lot going on, both in the industry and for Alcoa.

Okay. Great. That's very helpful. It's sort of -- I want to transition over to sort of on the financial side of what you've been doing. You kind of reviewed some of the steps you took specifically this year with regards to COVID and managing costs. You talked about kind of idling or curtailing higher cost assets over the last couple of years. How do you think about what you need to do on that front, continuing into the future? Do you sort of keep some assets kind of open because of sort of significant exit costs and that's hindering your ability to do that further? Just sort of give us a sense of like any more sort of potential cost savings curtailing measures that we can expect from the company going forward?

Okay. Let me bifurcate that into 2 things. One is the repositioning of the portfolio and the second is the basic blocking and tackling that we have going on in the company when it comes to cost control. On the portfolio reposition, we gave ourselves 5 years from October of 2019. As I said, we took -- we began taking actions very quickly with the curtailment of Intalco and the initiation of the collective dismissal process for the Spanish smelters. But we will continue through -- work through our repositioning work, and we have another -- a little bit less than 4 years to go. So we will continue to progress that. And I should really say when we look at that, there's really 3 potential outcomes for the sites that are considered in that portfolio repositioning. It's the curtailment or closure, the sale of the site, or actually significantly improving the cost structure of the site by either renegotiating power contract or some other factor. So it doesn't always mean that we will close or curtail the site. There are the potential of either sale or significant repositioning through cost savings. If I then transition to more of the basic blocking and tackling that we do on a daily basis, we've been focused extremely large stake -- extremely focused this year on really 2 outcomes of the new organizational structure. And I'll hit the commercial side first. It's the first time that we've put all aspects of the commercial organization under a single leadership structure. We have end-to-end sight on all commercial activities that allows for just better decision making. We also have end-to-end working capital view that allows us to manage working capital for the entire company all the way from mining bauxite to the sales of rolled products at the end. That's the commercial side. The other piece is that for the first time as an independent company, we went out with a target for improving our cost structure and increasing our volumes, and that was $100 million target. A lot of focus this year on really getting back to the basics of using the, I'll call it, business system to drive continuous improvement through our plants, and that creeps production or takes out costs. And so we've seen good progress on that this year. And between the combination of those 2, initiatives are anticipating $200 million of improvement in 2020.

Okay, great. Switching over to another side that you mentioned, the portfolio review, the $500 million to $1 billion of proceeds. You're obviously in that range now with the Warrick transaction just announced. Does this mean you're kind of done with divestitures for a little bit or should we expect any more?

So yes, let me address that. When we went out with the asset sales, we felt it was important for our shareholders to understand that we were constantly evaluating the portfolio and trying to streamline the portfolio in a way that will drive shareholder returns into the future. We set a goal of $500 million to $1 billion of net cash proceeds. We sold the Gum Springs facility to Veolia earlier in the year for $200 million, plus an additional potential $50 million depending on some work that will be done in the future. And then just last night, we announced the $587 million of cash proceeds on top of an $83 million OPEB assumption for work. So at this point, we are at the top end of that range. Doesn't mean we would necessarily stop on potential asset sales. We will continue to look at the portfolio. And if it makes sense that somebody is willing to pay us more for an asset than what we think it's necessarily intrinsically worse, we'll consider it. And probably the best example is we continue to try to sell the Rockdale facility down in Texas. It's 30,000-plus acres of land in Texas. It's got a list price of $250 million, and we're working to sell that. So we are in our target range, Matt, but not necessarily stopping.

Okay. That's helpful. You've talked a lot about proportional adjusted net debt in the past as a key metric for you. Can you just -- for people who are less familiar, can you please explain what that is and sort of your target parameters around that figure?

Yes. Proportional adjusted net debt. Essentially, it is the cash, the debt, the pension, and OPEB, all on a net basis, attributable to Alcoa after removing the impact of our joint venture. So you know in our bauxite and alumina business, we have a 60-40 joint venture between us and Alumina Limited. We essentially take our portion, the Alcoa attributable portion of the cash, the Alcoa attributable portion of the debt, the Alcoa attributable portion of the pension and OPEB, and that comes up with the overall proportional net debt metric. At the end of the year, we were projected -- I think at the end of 2020, we were at $3.5 billion or projecting to be -- I should say, projected to be at $3.5 billion. We ended 2019 at roughly $3.4 billion. We're projecting 2020 to end up at about $3.5 billion. That's largely due to the fact that the discount rate in the pension has increased during the course of the year -- I'm sorry, has decreased during the course of the year, making the pension liability go up. And so we have a target of $2 billion to $2.5 billion of proportional net debt. We think we can get to the high end of that target within the next few years simply by making the required -- minimum required pension and OPEB contribution. So we'll continue down the path of delevering, both through the -- either funded debt and payments into the pension. And in the case of what we just did here or just announced on Warrick, the buyer is taking $83 million of OPEB liability there. So that will take that off of our books. So that's the target, and we're projecting to get there in the next few years.

Now that $3.5 billion, that's the level that's for end of 2020, that's before the Warrick sales. So presumably, that would be $600 million, $700 million lower?

That's before the work sale. Remember, the sale won't close until the first quarter. So that will -- if we use that -- all those proceeds and either leave it on in cash on the balance sheet or use it to pay down debt or put towards the pension, it will lower that number automatically.

Okay. So that brings you to the next question. You've talked a little bit about maybe $1 billion of cash as a target, maybe $3 billion of liquidity as a target kind of interchangeably. Pro forma for this deal, you've got well over $2 billion of cash and $3.8 billion of total liquidity. So you issued $750 million of bonds in the third quarter. You're going to have almost $600 million of cash from this sale in early 2021. What's the plan for all this cash?

That's a good question. We have a capital allocation model that we put out a couple of years ago, and we updated it most recently in October of 2019. That capital allocation model says a few things. First of all, we like to keep $1 billion of cash on the balance sheet. Why keep $1 billion? We're in a cyclical industry. Prices go up. Prices go down. We saw that in the middle part of this year with the COVID pandemic. Prices went down sharply, yet we were in a position to weather the storm with the cash on the balance sheet. So that's why we do that. Secondly, we sustain our operations. We typically spend between $300 million and $400 million of capital. That capital can sometimes be a little bit lumpy because sometimes you have large projects associated with mine moves or residue deposit areas, but we've typically spent between that $300 million to $400 million range. Beyond that, once we've done that, there's 4 potential uses for excess free cash flow. There's further delevering either through debt repayment or through pension contributions. We have some mid-sized growth projects that are available to us in our refining business. At this point, our mid-sized growth projects were all put on hold during the COVID crisis. We'll reevaluate them in the future. But at this point, those are on hold. A third potential use of cash and I should have said, these are not necessarily in rank order as returns to shareholders. And then the last is the newest potential use of cash, which is the portfolio repositioning. That portfolio repositioning doesn't come free. When we curtailed Intalco, that costs us some money. If we get to the point of curtailing the San Ciprián smelter after the collective dismissal process, that will cost us some money. So those are the 4 potential uses of excess free cash flow. I would tell you, though, that we are very focused on our net debt target -- our proportional net debt target. So we will evaluate those 4 uses of cash. But at this point, I would tell you, we're probably shading it towards trying to make sure we get to our net debt target over the next few years.

So obviously, the pension is a pretty sizable obligation, but you have some funded debt, the 24s are callable now. What's the priority between maybe repaying those near-term bonds and reducing the pension liability?

We'll be going through that evaluation in the first part of next year. So it will be an evaluation between what gives us the best economic return for applying that cash. So no definitive answer at this point, Matt.

Okay. We've had other companies talk to us about pension, who have significant pension liabilities, not really being an urgent matter. And it seems with you guys, it's a little bit more urgent. Why the urgency to pay down those pensions as opposed to maybe higher coupon funded debt?

The urgency around handling the pension is simply due to the size of the gross and net pension and OPEB liabilities versus the size of our company. When we launched out of Alcoa Inc., we had about 50,000 pensioners. We have, through all of our actions over the last 4 years, been able to get some of those pensioners over to insurance companies, we're down to probably more like 38,000 pensioners. When you look at both our gross and our net liability, it is large in comparison to, for instance, our market capitalization. And so it's larger than most other companies. We think that that adds complexity and variability that probably -- it would be better for us to have that complexity and variability eliminated over time. So we feel that for the investment thesis of the company, we should be a simpler company to understand and that you shouldn't necessarily have to understand all the pension in OPEB accounting. So our target is to have that eliminated over the next few years. And we believe that's the best way to unlock shareholder value and talking to many of our major shareholders, they tend to agree that the pension can be an overhang. And so we want to get that under control and essentially that makes us a simpler, better company.

That's a fair point. You -- the scene for Alcoa for a number of years now has been trimming higher cost and non-core assets. When and kind of how do we start to think about Alcoa maybe expanding, making acquisitions, or does this business grow best by shrinking?

In the near-term, Matt, we're going to follow that four-pronged capital allocation model. And so you notice we don't have acquisitions on that four-pronged allocation model-- capital allocation model. So we're going to continue to follow that. Debt repayment, potential mid-sized growth projects, returns to shareholders, and continue to position the portfolio. Just to reiterate where I started. Once we have the portfolio repositioned, we'll have a first quartile business for all 3 of our business segments, be an extremely sustainable company with -- still with western-style governance. So I think it positions the company very well to progress.

Okay, great. I think we're a little bit over our time, but I'm going to ask one last question. And that's -- given your increased liquidity and sale proceeds now you have from Warrick and maybe sort of hoping to emerge on the backside of COVID potentially next year with higher metal prices, give any updated thoughts on potentially attaining investment grade ratings? Historically, it seems like that's not been a priority for you. It's been a, we're going to accomplish our deleveraging goals and the chips fall where they may with the rating agencies. Is that still the way you think or is there an update to that?

That's still the case. And just to put the perspective on it, we target an optimal capital structure. We think that optimal capital structure gets us to the lowest weighted average cost of capital. The lowest weighted average cost of capital results in future earnings streams, future cash streams being valued the highest and so that results in the highest equity value. So that's how we think of the optimal capital structure. If that optimal capital structure happens to be investment grade, that's fine. But we don't target being investment grade. The rating agencies will make their determination and ultimately the market will make the determination on the creditworthiness of the company. We're targeting an optimal capital structure.

Okay, great. I think that's all the time we have. We're a few minutes over. So thank you for indulging me there. It's been my pleasure to have Alcoa at the conference. Please join me in thanking Bill Oplinger and the company for continuing to support Bank of America's conference. Thanks very much, Bill, really appreciate your time today.

Thank you, Matt.