Alcoa Corporation (AA) Earnings Call Transcript & Summary

All right. Well, good morning, everyone. I'm Curt Woodworth, metals mining analyst at Credit Suisse. We're very pleased to have Alcoa with us today. I think a lot of you know Bill Oplinger, who is CFO of the company. We sent out the slide deck to -- from the Alcoa investor presentation. It's also on the website, if you'd like to refer to that. Bill, I know you have a couple of opening remarks. I'll kick it over to you, and then we can get into more of the Q&A.

Thanks, Curt. I appreciate you sponsoring this and glad to be here today. Just real briefly on our company, and I thought I'd cover a couple of points in my opening remarks. Many of you know our company, large vertically integrated primary aluminum company, have 3 lines of business. We've got a Bauxite business that is a very large low-cost Bauxite business. On the refining side, a great refinery portfolio. It's large and also first quartile, so an extremely strong refining position. And then on the aluminum side, we have a second quartile aluminum business that in market environments like today that is very profitable. So company has been around since November of 2016 when we spun out of Alcoa Inc. And has really done a lot to position ourselves for success as we go forward. The market environment today is very strong. Demand, we're seeing consistent year-over-year 10% plus demand growth for primary aluminum. It's in all major markets, all major industrial segments. So very, very good demand. but also some supply side constraints in the aluminum and the alumina side of the business. Those are both short-term and the long-term supply side constraints that we believe is shaping up to make for a very strong aluminum market for quite a while. You've followed our company, we've been focused over the last 5 years on strengthening the balance sheet. Today, the balance sheet is in a much better position than it was 5 years ago. We have a net debt target of $2 billion to $2.5 billion of proportional net debt. We ended the second quarter at $2.1 billion, so we are within our target range. Our pensions that when we originate pensions were a big overhang for the company. Currently, the pensions are greater than 90% funded globally. Our U.S. pension is more like 100% funded at this point. So pensions are no longer an issue for the company. And then when we think about future capital allocation, it really has 3 different areas that we can allocate capital going forward. We continue to reposition the portfolio. We announced a strategic review of the portfolio back in 2019 that talked about having 1.5 million metric tons of smelting capacity under review, 4 million metric tons of refining capacity. We've taken a number of actions on that review. We curtailed the Intalco smelter last year in the midst of the COVID pandemic. We are taking action in Spain, and that is yet to be resolved, but we continue to take action on the repositioning of the portfolio. The other is an opportunity for growth. Currently, our midterm or I should say, our mid-sized growth projects are on hold. We have 2 midsized growth projects in the refining business in Western Australia. A third midsized growth project in refining in Brazil. Those are currently on hold and we'll continue to work through the capital requirements of those and see if we can make those successful through the cycle, but at this point, not executing upon those growth opportunities. And then the third is returning cash to shareholders. And we are in a situation where at today's market prices, we're generating a lot of cash. So working through the return to shareholders over the next few quarters. So if we then transition to the third quarter, the third quarter should be another record quarter. And so another really, really strong quarter for us. We would expect EBITDA to be roughly $100 million higher than the second quarter. One important point, Curt, is that we are fully exposed to alumina and aluminum prices. We don't have any type of a sell-forward program. So we should see the benefits of these high alumina and aluminum prices flow through on the normal lags that we highlight. But unlike some others, we are fully exposed to the high alumina and aluminum prices. We did have the Alumar ship unloader failure during the course of the quarter. That's going to cost us probably $25 million to $30 million in lost volume and higher costs in the quarter. But clearly, alumina prices have increased over the quarter. And as I've said, we're fully exposed to the higher prices. And of course, stronger earnings probably mean stronger, higher taxes. So we're increasing our estimate of taxes from approximately $100 million to $125 million, which is a good thing for us because the earnings are as strong as they are. So if I were to just summarize before we turn it over to Q&A, Curt, really exciting times in the industry. We have a confluence of positive short-term and long-term factors that are driving prices higher. And the company is really well positioned to take advantage of those higher prices and has been repositioned over the last 5 years to be successful throughout the cycle, but really successful in this pricing environment. So with that, Curt, I'll take questions.

Yes. Thanks, Bill. Maybe we could start with the alumina side of the business. I think the smelting and kind of the LME price has gotten a lot of the press for the most part, but we've seen a pretty massive inflection in the alumina price. Last time I checked, it was roughly $380 in the Pacific Basin. I think it's over $400 in the Atlantic Basin. I know there have been some outage-related impacts, but it also seems like the market fundamentals are improving. So I was wondering if you could comment a little bit about how you see that market progressing? Some of the supply outages? Do you think that they're going to be benefiting the market for any duration of time. And can you remind us how much of your alumina you sell on an Atlantic basis versus Pacific basis?

Yes. So let me just address the entire market to start. Alumina is fundamentally different than the aluminum market. And what makes it fundamentally different is the inability to store inventory. So the inventory in the alumina market is really the inventory that's on the oceans going to the smelters and the inventory that sits in the silos and the smelters. Unlike aluminum, which has a fair -- from time to time, has had a large storage of metal, alumina can't store that. What that means is that temporary disruptions of production will send prices higher. And that's what we've seen recently. We've seen 3 disruptions of supply in the Western world and some other disruptions in China that have driven prices up to the above the $380 level. The 3 in the Western world, obviously, Gramercy was impacted by the Ida Hurricane, and I believe Gramercy is ramping back up currently. We had our own issue at Alumar with the bauxite unloader, where we had a structural failure there of the bauxite unloader. We're in the process of rectifying that, and we would expect that we will have that facility back up and running at full capacity in the fourth quarter. And then the Jamalco plant, which is the Clarendon works in Jamaica was -- had a fire in the power plant there, and that's completely curtailed. In addition to that, on the Western -- on the Chinese side, we have seen some curtailments in China related to energy consumption and carbon emissions. And so we've seen some cuts in places like on [indiscernible]. And that's really based on the fact that the Chinese are focused on this dual control mechanism of reducing energy consumption and energy usage, targeting lower carbon emissions. And so we've seen that in China also. So all of that adds up to a pretty strong market environment currently for alumina. As far as what the mix is off the top of my head, I'd have to look, Curt, but we've got essentially the Alumar facility and we've also got the San Ciprián facility that feed into the Atlantic market. We can arbitrage shipments between the Pacific and the Atlantic which we do occasionally, but those are the 2 refineries that are located in the Atlantic market. I didn't mention post this is a small refinery that's focused purely on the nonmetallurgical grade alumina.

Okay. And then it seems like on the supply side with respect to the smelters, globally, there's some interesting dynamics. Obviously, we're aware of what China is doing with respect to peak carbon by 2030. I've heard some speculate that they would like to try to achieve that by 2025, and obviously be neutral 2050 or later. I guess; a, do you think that China is going to be consistent with their goal to cap capacity at 45 million tons? Because it seems like they're going to start to bump up against that theoretical limit mid- to late next year. Because at the same time, they need to fix carbon, but they also don't want more severe inflation in their economy. So; a, curious how you see that developing? And then b, in Europe, the whole carbon border tax and how that can implement future supply decisions with respect to smelter growth in Europe and kind of how you see that potentially the incentive price dynamic going forward?

Right. So in China, we think that the Chinese are serious about the 45 million metric ton in cap. They have shown a level of focus that has really convinced us that they will be consistent with that 45 million metric ton cap. They have -- as we -- as we highlighted over the last couple of quarters, they've instituted this dual control policy that highlights the provinces based on energy -- total energy usage and energy intensity per GDP. And it shows that the provinces that aren't meeting their targets are clearly and transparently highlighted and that's driving behavior within the country. So we do believe that they will be bouncing up against their cap. What that ultimately means is that they will, in our view, restrict supply going forward. So it's favorable for the industry. In Europe, as far as the C BAM goes, we believe that any focus on carbon and pricing carbon is helpful for the industry. And it will help price carbon so that the industry takes action to reduce carbon emissions across the industry. And so while we are in the midst of evaluating the total impact of C BAM, I think that any effort to highlight the cost of carbon in the industry is a positive. Typically, what that means is that it will increase cost curves, will steepen the cost curves of the industry and really make sure that the industry is responsive on reducing carbon emissions.

And then physical premiums continue to be pretty well supported here. And you talked about how you cannot really store alumina, you can aluminum, but what we've seen is that a fair amount of the aluminum at least on the LME is tied up in these carry trades. So it's not metal that necessarily is that accessible to the physical market. And some of these logistical constraints have evolved and obviously, the efforts by Russia to kind of penalize or trying to put tariffs on exports has impacted things as well. So just curious do you think physical premiums can sustain at this level? Do you see any change in behavior from the customer base just given how high prices have gone here?

Yes. We typically try to stay away from forecasting either prices or premiums. But if I could give you our view on what's going on in today's market, very strong demand in North America, continues to be strong. And we believe that will continue into 2022. What that means is that North America is short aluminum, it's got to incent metal into North America. Similar situation in Europe that the demand situation is very strong. So the marginal unit has to come from outside of North America, and it's competing against a European duty that's also high. So our belief is that the premiums that we have today when you factor in the demand side of the picture and some of the transportation and logistics costs and issues in the market are well warranted.

And then with respect to billet premia and value add, we've seen in prior cycles, a decent step-up in your average price realization for value-add premia or billet premium. I believe that a fair amount of those premiums are set on an annual basis. And we've seen a pretty dramatic recovery certainly in billet premia. Can you just kind of remind us on the mechanics of that and sort of what the potential incremental benefit could be at premiums we're able to hold at this level in the year-end?

Yes. So we -- just to put it in perspective, globally, about 55% of our total product is value-add. That is up substantially from a year ago during the COVID pandemic. That ratio fell down to around 45%, has built back up to around 55%. And the way pricing works in the industry is billet in Europe is typically priced on a quarterly basis. So we have seen some of the benefits of higher billet premiums during the course of this year. However, most of value-add products are negotiated towards the end of the year for the following year. So we're in the process of negotiating our value-add products contracts today for North America and non-billet value-add products in Europe. So those negotiations are going on today. Clearly, a strong market environment that we will be pushing for the best pricing that we possibly can get going into 2022.

And historically, does the sands billet, does the value-add premium tend to follow directionally what the billet premiums are doing? Or is there any kind of nuances to this? I know there's a lot of different cast house products that you guys sell.

Right. So to make a broad sweeping statement that, that follows billet. In large part, they're following the same market drivers in that the economy is stronger. But billet is historically more driven by building construction demand, whereas things like slab is automotive, aerospace. And right now, they're both very strong because of the overall demand perspective in the world, overall growth in the world coming out of the pandemic. But they're not necessarily completely tied to each other going forward. And I should have mentioned packaging, right? I mean packaging is -- the aluminum packaging business has done great and continues to do great, and that drives slab demand.

Yes. Okay. And then with respect to the footprint, obviously, you've got assets that you have been restructuring, you also have a fair amount of capacity that is idle. Is there any thought to restarting any capacity that you have given where prices are? And then with respect to some of the refining projects, the mid-sized growth projects that you've identified. What's the potential timing around that? What would you need to see to be able to move forward on some of those?

So let's take each individual segment one by one. When we look at the Smelting business, we have some capacity available at Portland. There's idle pots and we would be considering whether those idle pots makes sense to restart. So you're looking at marginal energy cost versus a payback on those pots. So that's a fairly simple analysis. Then if I come over to North America, there are 3 facilities that are -- have been in long-term curtailed state or have structural issues around them as far as potential restarts. You got the Wenatchee facility out in the Pacific Northwest. It's been curtailed, roughly, let's say, 10 years and small pot technology and while it has availability to green energy, the pot technology is very old and inefficient. Intalco was recently curtailed during COVID. And Intalco has some issues that would need to be worked through, if it were looking at restarting. But given the fact that it was just curtailed what about 18 months ago. It's probably not a potential for a restart. And then Warrick has some idle lines. And Warrick is something we would analyze, but given the fact that its energy is coal-based technology, coal-based energy, it's unlikely that the incremental capacity at work, it would be restarted. And then that leaves the Alumar facility down in Brazil. We've been pretty open that we've been analyzing the restart of Alumar. And as we said, I think a couple of quarters ago, the real key there is getting long-term power contracts that will make Alumar successful through the cycle. And we would not be restarting Alumar just to capture any short-term gains. It would be to position Alumar for success for -- through-the-cycle view. And that's the analysis that's going on there. When we then transition to the refining side, we don't have any curtailed capacity at this point. The last curtailed capacity we had with Point Comfort. Point Comfort is being demolished. So there is no chance that Point Comfort comes back. It's closed and in the process of being taken down. And then the mid-sized growth projects that we alluded to, the 2 in Australia and 1 in Brazil. At this point, we've not determined that they can provide a good enough return through the cycle at our assumption around long-term pricing assumptions that we would go forward with the projects. We'll reevaluate that and we continue to reevaluate it. Need to work on the capital costs, Western World capital costs in relation to what the Chinese can build at are disadvantaged. So we would need to determine whether we can get those capital costs lower in the future.

And then with respect to capital return to shareholders, do you have any kind of framework on how you evaluate potential buybacks or dividends? And then with respect to your debt target. Is your thinking that you want to keep it within this range? Or would you look to go below that target and let cash build up?

Yes. So let me address the first one -- the second one first, and that is the $2 billion to $2.5 billion target is a target that we set a number of years ago. We were higher than that target for quite a while. I could potentially see us going lower than that target during really good market cycles. And I think today is a very good market cycle. So there's the potential to go lower than that target. As we consider the trade-off between dividends and buybacks, if we were to announce a dividend, Curt, it's a signal that we believe we can sustain that dividend through the cycle. And a dividend is a really serious signal that we can sustain that. And -- so that's the consideration as we consider dividends. Buybacks are simpler. The problem, as you well know, and probably everybody on this call knows, you end up buying back when cash flow is good. But if we were to buy back, it should be seen as simply a return of cash to our shareholders. We don't necessarily sit there and try to arbitrage what our intrinsic share price is. It would just be seen as we're returning cash to shareholders in the most efficient way that we can.

And in terms of getting to a level where you feel the business could support some level of a sustainable dividend. Are there any key metrics you're looking at? Is it more market-related? I assume the balance sheet is basically where you needed to be. And frankly, you've done a lot of heavy lifting around the asset base as well over the past several years.

I think those are all correct, Curt. And our balance sheet is in such a better position than it was a number of years ago. We've done all the right things. When you look at, for instance, we just announced that we would be calling the 2026 bonds. So at this point, we've got no sizable maturities until -- once that is completed, no sizable maturities until 2027. So we have a great runway of no debt due over the next 5 years. Combine that with what we've done on pension, right? The pensions are largely fully funded. And we have $1 billion prefunding balance built up in the U.S. pensions that allows us not to make significant contributions again over the next 4 or 5 years. We will be looking at potentially annuitizing part of the pension to get rid of the gross liability risk if it makes sense, right? And you've seen us do that twice over the last 5 years. So from that perspective, the balance sheet side, the company is in much better position than it had been over the last 5 years. We've done a lot of the hard blocking and tackling on the asset portfolio. right? And so we've curtailed Intalco. We're working on the San Ciprián situation. So we've done a lot there. We permanently closed Point Comfort, which was a structurally high-cost facility. So from that perspective, we feel like we've done a lot of good things. And one of the things, Curt, we're kind of running out of time, but we haven't even talked about the ESG story. As we look forward, we think there will be a green aluminum market that will drive some level of premiums. We think we're well positioned throughout the portfolio. We've been driving for ASI certification across a large portion of the portfolio. And I think overall, the company is in great shape as we move forward to take advantage of some of these great market factors that are currently impacting us.

And with respect to the ESG and kind of sustainability of the company, can you give us an update on the Elysis JV? And also remind us, I think your green energy across our smelting system roughly today, where do you see that headed in? And the event that the inert anode is commercially viable, is that the type of situation where you have the need or the desire to retrofit a lot of your existing assets? Would that require a lot of capital? And is this the type of technology that you could commercialize the third parties as well as another revenue stream?

So yes, to a lot of that. When we look at Elysis. Elysis is a breakthrough technology that has lower operating -- the projections are lower operating costs, lower capital -- better capital efficiency, lower capital intensity. The combination of those 2 alone, we believe our model suggests that Elysis should be a viable technology. On top of that, it doesn't generate CO2, it generates oxygen. So that the green aspects of Elysis, we believe, is just a further benefit on top of the financial benefits of Elysis. It's an R&D project. We just need to make sure that's clear. We continue to move the project forward. We -- next major milestone is in 2024 when we say that we should have a commercialized package. And at that point, we will have some big decisions to make. Depending on the economics projected, we could be in a mode where we retrofit some of our plants. We could be in a mode where we sell the technology but it is truly the next breakthrough technology for this industry that hasn't had a significant breakthrough technology in a long time. And it's us and Rio and great, great partnership based out of Quebec analysis, and we think that it will be a success, and it will change the industry fundamentally.

And in terms of the green premium or even like value-add premium for some -- a lot of aluminum processing companies are a lot more focused on this as well. Are you seeing any material evolution in that? Are you starting to obtain a green premium? Or is it the type of thing where maybe that type of premium is just going to be embedded in say, a value-add premium negotiation at year-end?

So we are seeing small green premiums. It's a small market currently. It's a fairly well-supplied market because many of the Western world producers have the capability to meet a green standard, not all the same green standard. But there's -- it's a small burgeoning market that has premiums. And I would say, Curt, probably the more important thing is that as we look at the long-term trends in this industry, there's 4 ways to monetize this green trends and the ESG trends. There's the green premiums, and we talk about that. That will grow over time. I think the market for green aluminum will grow over time. However, with carbon costs becoming real, the cost curves of the industry will start to shift upward, and you'll see a steepening of the cost curve. I think we showed a couple of quarters ago how steep those cost curves can become, which is really beneficial for a company like us that's at the bottom of the cost curve. The third one is the new technology. We talked a little bit about Elysis. We have similar green technologies in the refining space. We're focusing a lot of effort on trying to come up with green technology is in refining. When you look at the refining growth over the next 10 years, a lot of it is coal-based. That's not our growth. That's the rest of the world's growth. It's going to be coal-based. We don't know that, that should -- that growth should actually happen. And probably the fourth way you monetize the ESG is being invited into new projects around the world. We're not looking at new projects currently of significant size. But over the next 10, 20 years, this industry is going to grow, and we believe we'll be positioned to be right there at the forefront because of our ESG credentials.

Okay. And then maybe just quickly on Bauxite in terms of the dynamics in Guinea, where I think they supply over 50% of China's needs. Are you seeing any impact in that market from what's going on there? Are you looking to change strategically at all what you do in Bauxite? I know a lot of that is priced on an annual basis in terms of how you're thinking about commercially positioning that business into next year.

Yes. So we're not seeing any near-term impacts from the changes in Guinea. Our facility that we're a partnership in CBG is running today just fine. So no near-term impacts. Just to put it in perspective, for us, Guinea provide 7% to 8% of our total bauxite. So it's good that it's running well currently. However, what the changes in Guinea do highlight is the supply lines for the industry have a lot of basis in Guinea, as you said, the bauxite coming out of Guinea into China is over 50% of their needs. And it just shows that the industry itself has -- Guinea is really the basis for a big chunk of the industry and what happens in Guinea has impacts on the industry in general. So no near-term impacts at this point, but we need to watch it as it moves forward.

Okay. Gravel. I think we have about a minute left, covered most everything I wanted to cover. So if you have any final remarks or things that you want to highlight that we didn't touch on or else we can end the session, Bill.

No, I'll just summarize, Curt. It's an exciting time in the industry. Probably one of the most exciting times, if not the most exciting time I've seen over the course of the 20 years, the industry is changing. You've got a confluence of market factors between the long term and the short term that are impacting prices. When you look at Alcoa and what we've done over the last 20 years and most recently over the last 5, I think we're really, really well positioned to take advantage of these changes in the industry. So a lot of exciting times currently. And I appreciate you inviting me on to the conference.

It was our pleasure. Thank you very much for participating.

All right. We'll see you.

See you.