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Stock Strategist Industry Reports

Alcoa's Upstream Value Not Shaken by Economic Uncertainty

The focus here is on selling prices and input costs, not demand.

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Aluminum is a highly cyclical industry, and  Alcoa's (AA) shipments have not yet recovered to prerecession levels; aluminum prices are still more than 35% below their 2008 peak after losing some of their gains in the past few months. We think that long-term fundamentals support aluminum demand and pricing and that Alcoa is well positioned thanks to its global scale, strength in alumina, favorable cost position, and growth projects in lower-cost assets. However, global macroeconomic concerns challenge the near term.

Earnings at Alcoa's alumina and primary metal segments--its upstream businesses--don't depend as much on end market consumption as the downstream businesses. Alumina is perpetually in short supply relative to aluminum capacity, and Alcoa always can sell any excess aluminum output to the London Metal Exchange warehouses, particularly with today's high premiums and easy financing. The key is whether the LME price of aluminum is high enough to make production attractive. While the LME price ultimately should be a function of demand, we find that in the short term it tracks global economic sentiment more closely than actual production and consumption patterns. Warehouse inventories have been declining this year, suggesting that demand is still strong. We expect global aluminum consumption growth to be in the double digits for 2011.

Bridget Freas does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.