Alcoa Corporation — Q2 2017 Form 10-Q
Business context and reporting period: The unaudited quarter and six months ended June 30, 2017. Alcoa, which separated from Arconic on November 1, 2016, operates bauxite mining, alumina refining, aluminum smelting and casting, and certain rolling and energy operations. The 2016 comparable periods include pre-separation results and allocated ParentCo costs, so comparisons are not fully like-for-like.
Financial performance
- Revenue: Q2 sales were $2.859 billion, up 23% from $2.323 billion; first-half sales were $5.514 billion, up 24% from $4.452 billion. Higher realized alumina and aluminum prices and higher shipment volumes were key drivers.
- Profit: Q2 net income attributable to Alcoa was $75 million, or $0.40 diluted EPS, versus a $55 million loss, or $0.29 loss per share, in Q2 2016. First-half attributable net income was $300 million, or $1.61 diluted EPS, versus a $265 million loss, or $1.45 loss per share.
- Margins: Cost of goods sold was 80.8% of sales in Q2 and 78.9% for the first half, compared with 83.6% and 85.5%, respectively, in 2016. These imply gross margins of 19.2% and 21.1%, versus 16.4% and 14.5%. Higher energy, caustic, maintenance, and other input costs partly offset the improvement.
- Segment Adjusted EBITDA: Q2 was $546 million versus $393 million; first-half was $1.159 billion versus $650 million. Alumina provided the largest improvement, supported by higher realized prices. The company changed its segment structure and performance measure in 2017; Adjusted EBITDA may not be comparable with similarly named measures at other companies.
- Cash flow: First-half cash from operations was $385 million versus cash used of $441 million in 2016. Investing activities provided $44 million, including $243 million of Yadkin sale proceeds, while capital expenditures were $159 million. Financing activities used $338 million, including a $247 million payment to Arconic and distributions to noncontrolling interests.
- Liquidity and debt: Cash and equivalents were $954 million at June 30, up from $853 million at year-end. Current assets were $3.583 billion and current liabilities $2.608 billion (current ratio about 1.37). Debt totaled $1.437 billion, including $19 million due within one year; cash was below total debt by about $483 million. Fitch assigned long-term debt a BB+ rating with a stable outlook in April 2017.
- Other balance-sheet items: Total liabilities were $8.730 billion and total equity $8.199 billion. Pension and other postretirement benefit liabilities totaled $2.842 billion. Environmental remediation reserves were $317 million.
Material changes and unusual items
- Results benefited from higher alumina and aluminum prices, improved shipment volumes, and the absence of pre-separation allocated interest and separation costs. Interest expense fell to $25 million in Q2 from $66 million, and to $51 million for the first half from $130 million.
- First-half other income included a $120 million gain on the sale of the Yadkin hydroelectric project for $246 million. Under the separation agreement, $243 million of proceeds was remitted to Arconic.
- Restructuring charges were $12 million in Q2 and $22 million for the first half, compared with $8 million and $92 million in 2016. 2017 charges included Wenatchee smelter contract costs and employee reductions; about 60 of approximately 110 affected employees had left by June 30.
- Q2 results included $13 million of higher energy costs and $13 million of mark-to-market losses related to power contracts following a rise in spot power prices and changes to hedging arrangements.
- At June 30, Alcoa reported $954 million of cash and $348 million of derivative assets, against $359 million of derivative liabilities. Some derivative valuations depend on significant unobservable assumptions, including long-term metal and energy prices.
Outlook, risks, and contingencies
- Alcoa announced plans to restart three Warrick smelter potlines, representing 161,400 metric tons of capacity, with completion expected in Q2 2018. It expected $30–$35 million of restart expense in the second half of 2017 and an approximately $25 million reversal of closure liabilities in Q3 2017.
- For Q3, management expected higher bauxite shipments and sales but higher maintenance and transportation costs; higher alumina costs for the Alumina segment; and higher alumina, energy, and carbon costs for Aluminum. Aluminum shipments and sales were expected to benefit from the Arconic tolling arrangement. Portland smelter production was expected to ramp to full capacity in Q4 2017.
- The estimated 2017 annual effective tax rate was 31.9%. The company noted that some domestic losses do not receive tax benefits and that tax outcomes depend partly on future taxable income and operating assumptions.
- Significant matters include an Italian energy-tariff dispute with a stated reasonably possible loss range of $0–$97 million; a Spanish tax assessment of $150 million for 2006–2009 under appeal; Brazilian tax disputes, including a $44 million assessment; and ongoing environmental remediation. Management said ultimate outcomes for several matters could not be reasonably predicted.
- Other principal risks include commodity price and premium movements, energy and input costs, foreign exchange, pension assumptions, operational disruptions, political and regulatory conditions, execution of restarts and restructuring, environmental obligations, litigation, and cyber or data-security incidents.
Important facts for investors to verify
- How much of the earnings improvement reflects sustainable operating performance versus higher market prices, the $120 million Yadkin gain, and lower separation-related costs?
- Whether higher alumina, energy, caustic, maintenance, and currency costs will pressure margins, and how power-contract settlements affect future results.
- Progress, costs, timing, and expected economics of the Warrick restart and Portland smelter ramp-up.
- Cash conversion, capital spending, distributions to noncontrolling interests, and liquidity needs; the filing reports positive operating cash flow but also material environmental, pension, and joint-venture commitments.
- Developments in the Spanish and Brazilian tax disputes, Italian energy matter, and environmental remediation reserves; the filing does not provide a clear ultimate loss estimate for several cases.
- Comparability of 2016 results, which were prepared on a pre-separation basis with allocated ParentCo costs, and the effect of the 2017 segment reorganization and revised Adjusted EBITDA measure.