Alcoa Corporation
Q3 2008 Earnings Call Transcript

Published: 8 Oct 2008

[Operator:]

Welcome to the third quarter 2008 Alcoa earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call Greg Aschman, Director of Investor Relations.

[Greg Aschman:]

Thank you for attending Alcoa’s 2008 third quarter analyst conference. At today’s conference Chuck McLane, Executive Vice President and Chief Financial Officer, will review the third quarter financial results. Klaus Kleinfeld, President and Chief Executive Officer, will highlight current market conditions. Before I turn it over to Chuck, I would like to remind you that today’s presentation contains some forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Alcoa’s actual results or actions may differ materially from those projected in the forward-looking statements. For a summary of the risk factors that could cause actual results to differ materially from expectations, please refer to Alcoa’s Form 10K for the year ended December 31, 2007 and Forms 10Q for the first and second quarters of 2008 and other reports filed with the SEC. In our discussion today we have also included some non-GAAP financial measures. You can find our presentation of the most directly comparable GAAP financial measures calculated in accordance with Generally Accepted Accounting Principles and our related reconciliation on our website at www.alcoa.com under the Invest section. At this point, let me turn it over to Chuck.

[Charles D. McLane:]

Before I move on to the financials let me first give you a brief synopsis of industry fundamentals and the current business environment. The third quarter saw a drop in alumina aluminum prices of nearly $1,000 a ton from a high of $3,271 on July 11 to a low of $2,377 on September 30. In fact from the end of the second quarter to the end of the third quarter the price dropped nearly $700, the largest quarterly price decline ever. The move was generated by a host of factors, specifically the flight to liquidity during the financial crisis, the weakening end market fundamentals and subsequent inventory builds, and the strengthening of the US dollar. During this downturn several of the raw material input costs have continued to rise and we have yet to realize the full impact from lower energy prices and the stronger US dollar in our cost structure. With that as a backdrop, let’s review the financial results. Earnings for the quarter were $268 million or $0.33 per share. Included in those results were restructuring charges of $29 million or $0.04 per share which were primarily associated with the idling of the Rockdale smelter. Sequentially currency translation was a negative impact of $52 million or $0.06 per share, which is essentially non-cash in nature. The single biggest contributor to the currency decline in this quarter arises from the depreciation of the Real to the US dollar against an intercompany loan in Brazil. You may remember in the second quarter that we had a similar phenomenon albeit in a different direction. In the second quarter the US dollar depreciated and we had a favorable impact of $49 million in currency translation. Revenues in the quarter were $7.2 billion down from the second quarter revenue of $7.6 billion and up from the third quarter 2007 revenue of $6.5 billion excluding divested businesses. Higher sequential input costs of $52 million comprised of coke, fuel oil and electricity continued to compress margins albeit at a slower rate than the first two quarters. Debt-to-capital stands at 36.3%. Net debt-to-capital including cash stands at 34.3%. Lastly, return on capital stands at 11.5% excluding growth investments. Before moving to the income statement and the normal bridges that we review, let’s revisit the first six months of the year on the next slide. Last quarter we explained that higher metal prices in the first half of 2008 as compared to the first half of 2007 were more than offset by increases to energy, raw material costs and the depreciation of the US dollar. Since that time our competitors in the aluminum industry have released their results. As you can see, everyone in the sector struggled with significant input cost increases in the first half of the year. Why the compression? Turning to the next slide, you will see the underlying reason for the increased costs as they continued into the third quarter. On a year-over-year basis coke, caustic, fuel oil and natural gas were up between 40% to over 100%. I will note that these are market prices and may differ from actual cost increases but they do give you an idea of both the trend and magnitude of escalation. With that said, I can assure you we don’t say solace in the fact that everyone is experiencing the same type of pain. Our emphasis is on what we can do to offset the compression and improve margins. From internal benchmarking to external benchmarking to alternate sources and the substitution of materials to contracting our capacity to match the economic environment in all of our businesses, we will leave no stone unturned in order to remain competitive in this difficult environment. Let’s now move on to the year-over-year bridge. You may remember that in the third quarter of 2007 we sold our interest in Chalco and realized a significant gain. In addition we took several restructuring charges and also incurred the last cost from the Alcan offer. Once you exclude these gains and losses, which net out to $218 million, you will see that our profit declined from $340 million in the third quarter of ’07 to $298 million in the recent quarter or from $0.39 a share to $0.37 a share. LME prices improved results by $145 million but were more than offset by the previously described raw materials, energy and currency costs. As you can see, we have been successful in mitigating a portion of the margin shortfall by enhancing our product mix in our downstream and midstream businesses, bringing on new low-cost volume in Iceland, and reducing both operating and administrative costs. In addition, our run rate on taxes also declined and contributed $50 million. As I said earlier, we are not simply accepting the increases but we are constantly acting to improve profitability despite the challenging environment. Let’s now move to the sequential income statement. Let me point out three lines on the income statement. The first is cost of goods sold as a percent of sales. The increase to this ratio relates to the previously described escalation in input costs. I’ll next point to the tax rate of approximately 25%. The rate is lower in the third quarter primarily due to the annual operating rate taking it down to 28%, which is what you should use and anticipate in the fourth quarter. Lastly, the other income expense line shows an unfavorable change of $114 million. The primary contributor relates to the translation impact from currency which we previously discussed. Let’s move to the sequential bridge. On a sequential basis, profitability was down from $539 million to $298 million. Prices lowered profits by $98 million while input costs, energy and currency reduced earnings by $97 million. In last quarter’s guidance we provided the following

[Klaus Kleinfeld:]

Just a few words on our third quarter and what’s ahead of us before I go into the presentation. Our business performed reasonably well despite severely weakened end markets and a rapid deterioration of aluminum prices. The after-tax operating income of the four major businesses was $633 million, almost exactly in line with the combined results of those same segments in the third quarter of last year. Both primary metals and engineered products segments achieved higher profits than in the third quarter of 2007 despite the significant run-up of raw materials and energy costs and the lowest build rates in recent memory for automotive and commercial transportation. Looking forward, we expect more serious impact from the softer end markets and the margin squeeze. The aluminum price has dropped nearly $1,000 per ton over the past 60 days. Credits have tightened both for our customers and the customers of our customers causing demand to decline further. In addition, the credit crunch has forced those seeking liquidity to sell metal driving a rapid rise in lower inventories. Despite all this we’ve managed to drive higher profitability from our alumina segment on a sequential basis and the engineered products segment achieved its strongest third quarter ever. We will continue to manage for the downturn and take aggressive actions to be well positioned when the market recovers. When I spoke last to you three months ago, I outlined the weakness that we saw in several of the North American end markets. I also explained that Europe was holding up somewhat better. China was still growing quickly, most analyst was expected 20% and growth in aluminum conception there. Well, the world has changed since then. At this point we are forecasting that all of our North American end markets will decline compared to 2007. Tighter credit markets, economic uncertainty, job losses have drastically reduced consumer appetite for new vehicles. Annual automotive production in North America is now forecast at 13 million vehicles. That’s a 14% decline from last year and the lowest build rate in 15 years. Even worse for the Big Three at 23% decline from 2007. Let’s turn to Europe. For the last three months the picture has changed quite a bit. On automotive we now forecast flat build rates year-over-year in contrast to the 3% growth rate projected earlier in the year. Eventually higher fuel efficiency standards in the US and in Europe will drive more aluminum content in cars and light trucks. But the short-term picture is not promising. And given the current uncertainty, there are most likely more risks to the downside. The heavy truck and trailer market in the US is substantially off its peak. Built Off Class 8 trucks will be roughly half of the peak in 2006. Given the weaker US economy, fleets have sufficient trailer inventory to cover immediate demand. And tighter emission standards should have resulted in an upswing but we see that those investments are getting pushed out. Annual trailer build rates are therefore running below 150,000 units, down about 35% from last year. Commercial building and construction has now begun to see the effects of the credit crunch. Leading indicators such as architectural buildings have hit historic lows during 2008. In Southern Europe the commercial building has been weak for some time and that malaise has now spread to most of the continent. Let’s move on to the global aerospace market. Overall the market is showing some resilience. New builds are up approximately 8% but air travel miles have stagnated and the number of planes idled has reached a level that we last saw after September 11. The airlines are cutting capacity to deal with lower demand and higher fuel prices. Therefore the spare market is beginning to tail off as well. On a positive note, power generation markets remain strong with growth rates of 15% to 30% depending upon the region. Despite any industrial economic slowdown that may be occurring, the power infrastructure needs will continue to drive growth. So how do these end markets effect aluminum demand? Let’s sum it up. China will grow about 15% this year, down from the previous forecast of 22%. That deceleration alone accounts for approximately 1 million tons and low demand. Brazil, the rest of Asia and the CIS states will continue to grow but the size of those markets as you can see here on that graph is not large enough to offset the declines in the more mature markets in the US and in Europe. All-in-all we project 6% global growth for this year, down 2% points from our previous projections. As we’ve seen global consumption growth slowing, aluminum inventory levels have increased in absolute as well as in day consumption terms. The LME inventory levels increased over 200,000 metric tons in September alone. Furthermore, aluminum prices have declined significantly about $600 per metric ton between July and September, and in fact the decline of 10% in August was the second highest one-month decline in the last 16 years. All of this has been reinforced by speculators liquidating their LME positions as they need additional liquidity. Day consumption has increased nearly three days over the last year to 29 days as of the end of August. But let’s not forget. The inventory level still is relatively low. Not long late in 2003 it was at a 49 day level. What’s the main message here? Once demand picks up again the inventory will act as a buffer and you see this fully reflected in the pricing. So much about the demand side. Let’s go to the supply side. At the current level, approximately one-third of global aluminum capacity’s under water and that estimate already assumes in that curve that you see on this graph here depicted as 2008. Input costs and energy costs will ease somewhat so that the cost curve will flatten a bit, which is reflected here in that graph already. In our industry it is always important to carefully review smelter-by-smelter the incremental production costs, specific energy situation together with other operational factors. In the current environment that’s acutely critical. As there are costs to exit and re-enter production, these decisions often do not come immediately. If you sum this all up, equilibrium of inventory supply and demand will most likely not occur immediately. Our most recent evaluation led us to last week’s decision to curtail our Rockdale, Texas smelter. The unreliability of local power supply has squeezed its margin. On the short term inventories have grown and consumption growth has slowed. But the longer term perspective is positive. Market indicators reflect an optimistic view on aluminum. Even with the recent price erosion, the long term kind of five year pricing outlook has not dropped nearly as much. In fact let’s just compare it with where we were last year that reflects the 23% increase over the forward curve at this point last year. As you may be aware, the LME is now trading at 20-year contracts also and it is important to note the market values of those contracts at nearly 40% higher than today’s price. We totally share the market view, the industry prospects are good in the medium term, and the current situation requires immediate action. At Alcoa we have more than a century of experience managing through economic cycles and to position the company well for the future. And that is why we are taking decisive action. Curtailing our Rockdale smelter was necessary. We will continue to monitor the situation in the markets and act accordingly. In general actively reviewing our portfolio as we also have done in the recent past will continue to be a part of our toolbox. At the same time we will adjust overhead and production capacity to match the current market conditions. And difficult economic times also offer opportunities to take a fresh look at the competitive landscape. Rest assured, we will use every lever possible to enhance our competitiveness, capture market share and deliver greater shareholder value. We are also addressing the cost side through many actions. One important cost block lies in procurement. We are aggressively going after those opportunities. The rapid rise of some input costs need to be stopped. We’ll consider all options to create value even if it requires backward integration. We’ve also been quite successful in repowering our smelter assets. I reported on this before as you’ll remember. Now in July we extended the power contract for our Wenatchee smelter giving us competitive power through 2028. We’ll continue to forge ahead on this front. To enhance liquidity we are stopping all non-critical capital spending and we are suspending our share repurchase program. We have moved back the average maturity of our debt and maintain high levels of cash on hand. So we face minimal obligations in the near term. These initiatives and many others enable Alcoa to be well positioned through all economic cycles. While we currently manage the downturn, the longer term trends such as population growth, organization, the drive for greater energy efficiency, and so on will offer massive opportunities. But today let me share with you some more short-term opportunities to create value. First, our smelter in Iceland is already today contributing nicely to the bottom line. Over the last two quarters we have also been able to further ramp up the output, and best of all the smelter is now producing the highest quality metal we have in our whole system. This is exactly what we expected when we commissioned this project. Over the coming two years we will lower our conversion costs by an additional 17% and we expect to creep up production by 30,000 metric tons. With this, Iceland is projected to contribute an additional $170 million in EBITDA by 2010. As you know we are also developing a new bauxite mine in Brazil in Juruti and we are expanding the Sao Luis alumina refinery. These investments will total nearly $2.2 billion. Juruti will provide high quality bauxite and the Sao Luis refinery will move down on the refining cost curve to near the lowest [deciles]. These are bold steps. The projects have not been without difficulty but work is progressing well. We are confident that we can start both projects up in 2009. By 2010 we expect the incremental contributions to be $80 million EBITDA for Alcoa. As the production becomes more efficient, the EBITDA will increase significantly. As you are well aware, we have a leading position in markets such as aerospace, power generation, automotive, and we’ve talked about those already. One industry which we have not talked about is can sheet. We’ve had a particularly long-standing leading position in this market and our history in the North American market has yielded benefits internationally. As countries develop, the can consumption grows. Countries like China and Russia are growing substantially and we invested there. We expect to grow our can sheet volume in the countries by more than 30% until 2011. And we will in addition be able to reduce our overall costs of the whole business by using more recycled aluminum. Additionally, our pricing caps expire by the end of 2009. All of this combined will add $300 million to Alcoa’s EBITDA in 2010. This month Alcoa celebrates its 120th anniversary and I’d like to give you a brief summary of my first five months as the CEO. We’ve laid out three strategic priorities

[Operator:]

(Operator Instructions) Our first question comes from John Hill - Citigroup.

[John Hill:]

I was wondering if you could provide a bit more commentary on the currency impacts. There’s a lot of numbers in the release and the presentation. If you could sort out between the economic impact and the currency translation impact, and there’s a $45 million number on the bridge, there’s a $52 million headline and there’s a $90 million in other income. So if we could sort out those numbers in economic versus non-economic, that would be great.

[Charles D. McLane:]

I think quite simply that you look at the $52 million totally from a translation standpoint and the $45 million would have both economic and translation in it. But to give you a little understanding of why it goes that way, you would in essence intuitively think that as the US dollar strengthens it’s going to be positive for us. And on an economic basis it is. In fact many of these jurisdictions have average costs and as time goes on, the costs will get even lower on two bases

[John Hill:]

Lastly just as a follow up, turning to flat-rolled and some of the opportunities through 2010, is the company still confident that Russia can make a meaningful contribution to that? I mean the Russian mills have taken a lot longer to contribute, costs have been ratcheted up as scope has changed, the benefits have stretched out. Are we here to call this an unequivocal success or how should investors judge that and what kind of contribution do you expect?

[Klaus Kleinfeld:]

Obviously the markets also are slowing down in Russia but we continue to be confident that on the longer term we will see a good profitability. A bit of that you saw on the can sheet side already. You have to put this whole thing in perspective. We have some very, very unique assets there. I mean we are the only can sheet manufacturer in Russia. We have the world’s largest extrusion press and can do things for certain markets that nobody else can do, and the good thing is also operationally we have been hitting quite a number of good milestones on the side of capital investments, being now done. We are through with about 90% of the equipment installations, 70% is up and running, so this is all progressing really well. And obviously once it’s up and running, we can finally make revenues with that and that took quite a while to get there. On the quality side this is getting much better. The feedback that we are hearing from our customers on that end is very, very positive. The same thing by the way is true when you look at the aerospace sheet market. We are now able to produce western aerospace grade plate over in [Belia Calisphon], which is accepted by the big ones and will also be accepted by the United Aerospace Association. All of that is good. I mean obviously things have been a little rough and I think we’ve talked about that but our mid-term view maintains to be positive.

[Operator:]

Our next question comes from Michael Gambardella - J.P. Morgan.

[Michael Gambardella:]

You did make a great trade on the Chalco position, but in hindsight it looks like the $1.2 billion that you put in with Chinalco you must have written that down quite a bit. Could you talk about what your commitments are in that transaction? Do you have to fund anymore? Can you get that money out at this point? And how much have you written it down?

[Klaus Kleinfeld:]

We’ve talked about that before. You know our view on that. Obviously nobody was expecting this sharp change that we have. I think I addressed also in my presentation. I think in today’s times it’s partly and I hope we can look back rather sooner than later and say, “Hey. We should have had a calm hand here at the rudder.” The long-term view even in the market as you see is positive, maintains to be positive. And I think that also explains our view on this investment. In addition to that I think it has allowed us to stay very, very close to Chinalco and pretty much be the only ones in China in our industry that are invested really in China and that are part of that system. And we are in active dialogue with Chinalco as we evaluate any further actions. So time will tell. On your second part of the question, mark-to-market or what happens to the investment, have we written it down? It gets mark-to-market but it doesn’t go through the income side.

[Michael Gambardella:]

How much has it been written down from the $1.2 billion?

[Charles D. McLane:]

About half.

[Michael Gambardella:]

Are there any commitments on your part to fund anymore in there or not?

[Klaus Kleinfeld:]

You know what the situation is. We have been allowed by the Australian authorities to bring the share up to 14.9% and let me leave it at that.

[Operator:]

Our next question comes from Kuni Chen - Banc of America Securities.

[Kuni Chen:]

Just an industry question. If you go back to your slide on the global cost curve where you show about a third of world capacity under water at this point, what do you think is an appropriate timing lag before you start to see more of these capacity closures in the industry particularly if you’re someone with $2,800 or $3,000 per ton costs?

[Klaus Kleinfeld:]

That’s the $1 billion question that the whole industry’s asking. That’s why I didn’t only show this chart, I also showed the other chart which shows the build-up of inventory. And I also went into the demand side. You obviously have to see like in classical old macroeconomics, how are those things moving against each other? On the demand side if things would calm down, which today after probably last week looks like unrealistic, but who would have thought that we are at this point in time when we last spoke together. I think you really always have to put it in perspective. There’s going to be a lag time until decisions are made and those lag times are determined by the true cash cost that people will be seeing, subtracted from it the cost of clothing and the cost of re-entry. Those numbers can actually be reasonably high. So people will continue for a while to cling on there. Then once they decide, if prices stay at that level, you still have the inventory buffer until it really starts hitting the price levels. But frankly my view on that is if the whole world doesn’t come to an end, and it sometimes feels like it but I don’t think it does, then we should continue to see quite a bit of demand. Look at the projections from what we’re seeing from China. We always talk things down, yes. But at the same time when you discuss with the people in China, “What do you believe is going to be the growth rate this year?” the people say yes, it’s going to be one digit growth rate and then you’re getting voices that are saying it’s going to be between 9.3% to 9.7%. And the most negative ones are at 8% and there are lots of arguments for that. So I think we really have to cautiously look at that and I think that’s also the reason why the forward curve, the LME forward curve is substantially higher than it was one year ago.

[Kuni Chen:]

And just a quick follow up. When I look at your capital spending plans going forward, obviously the last couple years capital spending has outpaced cash from operations so obviously we can take different views on metal prices for next year. But can you give us some view on how those pieces should balance out over the next couple quarters? Should we expect capital spending to be down sharply next year?

[Klaus Kleinfeld:]

I’d be happy to run you through it. I think the first thing you have to see is we are in the situation that there has been quite a bit of capital investment, and that’s why I showed you some of those investments like in Iceland and I showed you also what returns we are getting from that. Priority number one clearly is bring those capital investments onto the system and get a respective profitability out of it. And we’re talking about Iceland, I showed you that; we’re talking about Sao Louis and Juruti, I showed you a bit of that; and I sure hope that there’s going to be more. We have talked about Russia. We need to make sure that those investments will return. We talked about China. We have the China Bohai plant coming on line now and it is starting to return money. We talked about some investments in Brazil as trade show and hydro power. We talked about some investments in Warwick, which is mainly environmental but where we also get some additional returns. The main priority is the capital that we’ve put in there, make use of it and get the returns out. And that’s why we’ve also said any non-critical capital investment we will not do at this point in time. As long as we see this volatility out there, as long as we are not that clear on how exactly the metal price is moving and how exactly in parallel the input costs are moving, we will play this really, really cautious.

[Charles D. McLane:]

I was just going to add to it just to follow up on the quantification. All of those projects that Klaus was talking to are essentially complete by the end of this year with the exception of San Luis and Juruti, which will be complete by mid-year next year. So when you’re looking at us from a growth project standpoint and all those projects that have been going in, we’re toward the tail end of finishing and completing those projects.

[Kuni Chen:]

How much CapEx with Brazil continues into next year?

[Charles D. McLane:]

I would say our net exposure is about $500 million into the first half of next year.

[Operator:]

Our next question comes from David Lipschitz - Merrill Lynch.

[David Lipschitz:]

In the steel industry people have talked about cutting production and things like that. I know you took Rockdale off line. Is there any thought of the global players doing something similar over the next six months as the Chinese haven’t cut as much as potentially they should be where their cost structure is?

[Klaus Kleinfeld:]

That’s another one of those $100 billion questions I would say. That’s really hard to answer. I think I’ve put all the factors that go in here and the rest we will have to see. When you go to China the situation is even more amazing because if you go through a calculation of just the CLU data, you would see that’s a number that’s been around by some analysts I’ve seen that 80% of the smelter is I supposed under water giving you $1,900 metal price at the Shanghai Exchange. At the same time I think that does not take into account that about 65% of the smelters in China have some type of access to their own power or very specific subsidized power elements. And the big question here is, is that going to continue? What we already see is that there has been less growth of production in China than what everybody has been projecting before, 10% lower than the previous expectations. But in terms of heavy significant curtailment, I don’t think we’ve really seen that response. I know that there is a substantial debate going on in China as they are thinking about how they want to change their economy going forward into probably an economy that is less dependent on high power intense businesses. And we will see how the decisions are going to go. I do expect at this point in time China to be a net importer. In fact if you look at the facts, China has been a net importer in August but with very small amounts. So my projection’s rather it’s going to be in balance and the rest we’ll see. And the same thing holds true for other competitors.

[David Lipschitz:]

Would you consider taking the lead and saying, “Besides Rockdale taking anything else off line, we’re going to try to stabilize this market?”

[Klaus Kleinfeld:]

I think that we are looking at our smelters as I said and we’re looking at the specificity of the smelters. We’re looking at opportunities also in terms of are there power sales opportunities for instance, if we have our own power, and we will evaluate that as we go.

[Operator:]

Our next question comes from [Mark Linima] - Morgan Stanley.

[[Mark Linima]:]

In your taking decisive actions slide you mentioned reviewing the product portfolio with the end market segment and then capturing procurement opportunities even if you have to backward integrate. Can you give us any more detail on those?

[Klaus Kleinfeld:]

Let me start with the first one, review product portfolio. I think I reported a little bit about you have to see the three strategic priorities and maybe this simple term of profitable growth is not really describing what every business is and has been going through. We really asked the businesses to do a substantial review of their position, and what we meant with substantial is to literally say, “How do we achieve? What’s the market position and how are we doing competitively, benchmarking it competitively?” and also looking at what others do differently and getting a really good understanding. What is the fundamental underlying profitability of each of the respective segments? Because we have just been going through that exercise for the whole company, so it gives us a very, very good overview not just on the short term but also on the mid-term how the underlying industry profitability of the respective businesses we are in. And as we said before, we are very, very committed to making sure that the total portfolio that we as Alcoa have maximizes the capabilities that we have. So therefore I just want to indicate because I know that question’s out there with many having spoken to many of you in the last month, you should absolutely be aware we consider all tools and an active review of the portfolio is certainly one of those.

[[Mark Linima]:]

And the backward integration operation?

[Klaus Kleinfeld:]

On the purchasing side I think Chuck gave a little bit of color and I did too. As you see, one of the problems that we have been hit with over not just the last quarter but pretty much over the last year is that the margin squeeze, you would say, “Damn. Metal price was running up to $3,200 and the absolute margin was going up but the relative margin was shrinking. Why?” Because of the things that Chuck showed in his presentation because we had a lot of very substantial input costs, energy being one, caustic being another, coke being another, that had increases in there that are insane. And we were not able to manage that down. So we have taken a very serious look at that and said, “How is it possible that we as one of the largest consumers of some of those entities cannot get a more substantial reduction or less high increase out of those markets?” So that’s what we’re doing. And we actually said, this is way away, we’re talking here of something that is way outside of the normal purchasing discussions where you sit in front of a supplier and say I want a better price and the supplier says no, you don’t get a better price. We’ve done that and we’ve done more than that. So we have to really be smarter than that and also consider some nonconventional ways of how to act with procurement. One of those I mentioned before. If you have a market that is going up more than 100%, you wonder how that can happen and typically it happens because you see a concentration of market power on the other side. The only way or one way to break through that is if you develop your own assets in that category. That’s what I meant when I said we also consider backward integration, and there are some very, very smart and reasonably easy to execute ideas around that, also not necessarily on our own but together with some partners and that’s the avenues that we are pursuing. Chuck, do you want to add anything to that?

[Charles D. McLane:]

It takes a host of different factors. It could be changes in specifications, can you use different materials, is there a different way? The days of three bids in a cloud of dust are basically gone when you’re dealing with the kind of commodities that we are. So maybe a joint venture or percent interest, sourcing from nontraditional sources of countries. We’re looking at a host of different options and trying to lower our overall costs.

[[Mark Linima]:]

Is there any update on the power contracts in Spain or Italy?

[Klaus Kleinfeld:]

After I’m done with this conference call I actually go to the airport to go over to Spain. We’re working on it, let me put it that way, and we’re making good progress. But first of all it’s not entirely in our hands but it’s also not entirely in the hands of our partners. It’s a pretty complicated situation over there in Europe. But I’m reasonably optimistic that we will find a way to sort this out for Spain particularly.

[Operator:]

Our next question comes from Sophie Spartalis - Macquarie Research Equities.

[Sophie Spartalis:]

I wanted to follow up on the capital spending question that you answered earlier. If we were to look at the level of capital intensity required for aluminum projects, the market is clearly undervaluing this today. If you could just explain to me how and will you be able to justify spend over the next two to five years for your Brownfield and Greenfield projects? And just further looking at the expansion projects that you had flagged, such as the [Wager Rock] expansion, further expansions at Brazil and then also Guinea as well? And just as a second question, if you could just clarify what the insurance received was for the alumina business please?

[Klaus Kleinfeld:]

The insurance for what?

[Sophie Spartalis:]

For the alumina business. You were saying earlier that the $9 million effects from the gas destruction included your insurance recovery. I was just wondering if you could clarify what that amount was.

[Klaus Kleinfeld:]

Chuck, do you want to go there?

[Charles D. McLane:]

The insurance recovery was around $48 million but we don’t think that’s the end of it.

[Klaus Kleinfeld:]

On the first part of the question, I’m not sure whether I understood that correctly. Was your question on further expansion of certain assets around alumina? You mentioned [Wager Rock].

[Sophie Spartalis:]

Yes. You’ve spoken about how your non-critical investments won’t be occurring going forward. If you could just explain in terms of the alumina business, if we look at the level of capital intensity required for an alumina refinery, that’s clearly being heavily discounted in the equity. I’m just wondering how you’re going to be able to justify capital spend over the next two to five years for your Brownfield and Greenfield projects in that area?

[Klaus Kleinfeld:]

I think that’s why I said what I said. On the alumina side we have this really substantial expansion going on in Brazil. Alcoa’s financial stake alone is $2.2 billion and it’s the expansion of the Sao Luis refinery and it’s the new build of the Juruti bauxite mine. The Juruti bauxite mine, I don’t know whether you remember the chart that I showed. We’re going to bring it up so that you can see it. It’s actually starting production with 2.6 million metric tons per annum but the investment that we’ve made there on infrastructure investments actually is capable of substantially more. So there are potential expansions there. At the same time we want to take it one step after the other. And first we bring this on line and make good returns with that. The good news is if you talk about real future projects, we can continue to look at future projects because as I said before our mid- to long-term prospect in alumina and aluminum is positive. And at the same time typically a project does not have cash needs before five years from now. So even if we were to come to the conclusion that there is something out there that we would want to look into further, we would certainly not spend money on that right now. The clear priority is to get those things that we’ve put in the ground on line, make money with it, and we’re not going to put anything else up at this point in time.

[Sophie Spartalis:]

So does that mean that the [Wager Rock] decision I believe that was expected through 2009, is that likely to be delayed then given what you’ve just said?

[Klaus Kleinfeld:]

If we both would have had that conversation eight weeks ago, would you agree with me that we would have had a different view of the world at that point in time? So let’s not speculate too much. This is not a decision we have to make at this point in time. If we were to take it at this point in time, we would not do it at this point in time. But we don’t have to take it at this point in time; therefore it’s totally speculative and we’ll view it once we get there.

[Operator:]

Our next question comes from Jorge Beristain - Deutsche Bank Securities.

[Jorge Beristain:]

If you could run me through just at a very high level what you consider your product exposure by segment to be, just specifically for autos and aerospace?

[Klaus Kleinfeld:]

What exactly do you want to know?

[Jorge Beristain:]

Just at an aggregate level roughly for Alcoa, what percentage of your product do you believe ends up in the North American and European auto segment for example?

[Klaus Kleinfeld:]

On the Alcoa overall revenue side, you have 22% going into aerospace, 12% going into automotive, 11% into building and construction, 8% into commercial transportation, 4% into industrial gas turbines, 7% general industrial, 25% packaging, and 11% distribution.

[Jorge Beristain:]

And just so I can understand, because the number that was quoted for the pending spending on Juruti and Sao Luis of $0.5 billion into the first half of ’09 seems light. I mean we’re using a $3 billion CapEx budget for you guys for next year, so I guess just concretely could you give us the quote as to what will be the overall CapEx for next year and maybe just breaking out these Brazilian projects? And then how has your overall CapEx changed as you’ve said as you’ve cut to the bare bones because my understanding is you still have roughly about $1 billion per year or $1.2 billion of just maintenance CapEx to deal with?

[Charles D. McLane:]

Let’s start with Juruti and Sao Luis. I said that was our net exposure for next year. If you were to look at the AY exposure, it would be more like $800 million. So us looking at what comes through on our CapEx line less the minority partner’s contribution brings it down to the $500 million.

[Jorge Beristain:]

So it would be like closer to $1.3 billion that would flow through your balance sheet?

[Charles D. McLane:]

No. I said $800 million less the minority contribution of $300 million equals a net capital need of $500 million. And our CapEx at a depreciation level is about $1.3 billion or $1.4 billion but I think I would look at it in this manner; that is that we’re looking at every project individually and determining whether or not in the current economic environment in any way whether it’s critical to keep the plant facility operating. It’s hard for me at this point in time to give you an estimate for next year because I think those are all being reviewed and it’s just premature. We will do that at the end of the fourth quarter.

[Jorge Beristain:]

Lastly, in terms of the declining value that was booked on the Rio Tintos stake, can you explain why there is no need to flow that through the income statement on a kind of mark-to-market basis?

[Charles D. McLane:]

It’s not GAAP. You mark it down and it goes to other comprehensive income less the deferred taxes on your equity.

[Jorge Beristain:]

Okay, but that investment was never counted as part of your cash and cash equivalents. That was always counted as a long-term investment.

[Charles D. McLane:]

That was an investment.

[Operator:]

Our next question comes from John Redstone - Desjardins Securities.

[John Redstone:]

You point out that the price curve moves up going forward quite sharply actually. So the question of course is then can you envision a situation whereby Alcoa will take advantage of this curve?

[Klaus Kleinfeld:]

What exactly do you mean by that?

[John Redstone:]

What I mean to say is the prices offered out are considerably higher than where you are right now. Do you think you might consider at some point locking in those prices?

[Klaus Kleinfeld:]

There are three curves on there, right? The one is from September 30, 2008; the other September 30, 2007 and you can see it’s actually 23% higher the one now. But then there’s another one from June 30, 2008.

[John Redstone:]

That’s still with today’s curve.

[Klaus Kleinfeld:]

Exactly. I would make you an offer right away if you could promise to me where this curve would be sitting let’s say three months from now. We will take a look at opportunities when we feel that those are real opportunities. At the same time I think everyone of us is around long enough to have seen that people have been killing each other by taking a bet on something that then did not happen.

[John Redstone:]

Let me ask you another way then. Today’s price on the LME as we speak is $2,280 a ton. If we stay at this price level say through the fourth quarter, is it reasonable to believe that the smelter division of Alcoa will be profitable on an after-tax operating income basis?

[Klaus Kleinfeld:]

The LME price as you know is just one factor that determines the profitability even of the primary division. So let’s leave it at that.

[John Redstone:]

We’ll wait till next quarter to see what happens. How’s that?

[Klaus Kleinfeld:]

That’s exactly the message.

[Operator:]

Our next question comes from Anthony Rizzuto - Dahlman Rose & Co.

[Anthony Rizzuto:]

I know it’s been asked in other ways but Klaus are you concerned that the variable nature of costs with the strong linkage to metal along with the sharp fallen oil may impede actions being taken by others in the industry on the primary aluminum front?

[Klaus Kleinfeld:]

Chart 20. What we did there in this curve 2008, this is not the CRU curve. This is already the adjusted as the note in the bottom says, the adjusted cost curve and it’s adjusted by the current LME, the for x, and some of the input costs, coke here mainly. And you see this already coming down; I wouldn’t call it substantially but coming down and spreading out a little bit. I think this range that we were trying to indicate here; if you have a situation and we were I would say reasonably generous with that just to say it’s one-third because if you look at that chart you see that it really actually breaks through the $2,200 line lower than on the one-third. And the reason why we did it is because you never know because a lot of the Chinese smelters on the right-hand side and you never know what specific energy deals are in place there and whether that’s all fully reflected in that curve. I would think in a reasonably rational environment where cash is short people can only cling on so long if they are on that right-hand side.

[Anthony Rizzuto:]

As far as your other smelters Klaus you were asked about, Spain and Italy, obviously you’re going over to address that. I know you’ve done a good job entering into longer term power agreements with your level of self generation. You seem to be very well situated but are there any other locations outside of the European locations where you don’t feel as comfortable at this point?

[Klaus Kleinfeld:]

We have a large smelting system and we have always said that if you look at our position on the cost curve, the average position that we have is right in the medium point which basically means we have smelters that are really spread across the curve. That’s why I said before we will review going forward as we did now with Rockdale, we will review the position of that respective smelter, the whole environment and energy costs is just one aspect in there. There are some operational factors and that’s also for instance a factor whether we have our own self generated power or whether we have contracts that allow us to sell power in the open market. And all of that will go into our calculation and we will make the decision as we go.

[Anthony Rizzuto:]

It’s comforting to hear that because we’ve been working on some numbers, and I know you guys have, and it’s very easy to see those inventories balloon to very high levels. And that could do I think some serious longer-term damage if left unchecked.

[Klaus Kleinfeld:]

I agree with you and I think our message is credible because you saw we acted on Rockdale and you’ve seen Alcoa has done that before. By the way, don’t forget we will actually do the same thing also and cut down on the alumina production accordingly. So it will not be an imbalance between alumina production and aluminum production.

[Operator:]

Our next question comes from Oscar Cabrera - Goldman Sachs.

[Oscar Cabrera:]

I apologize. I came on the call late. If you could just clarify, and I’m’ sure you got questions about this, your CapEx program for next year, one or two questions ago you said maintenance CapEx of $1.4 billion to $1.3 billion. The overall number that we have been working with has been about $3 billion, and this is for 2009. Do you expect that CapEx to be around those levels? Are you still reviewing it and will be coming back to the market with further updates in the next quarter?

[Charles D. McLane:]

Yes, we did address that. We will come back to you. We are reviewing it right now based on current economic conditions. We’re dealing with only critical projects and at the end of the fourth quarter we will give some guidance to the outside world.

[Oscar Cabrera:]

Would $3 billion be something to work with before you come back to us Chuck?

[Charles D. McLane:]

I can’t give you a heads up on that other than saying we’re dealing with current economic conditions and saying we’re only doing capital projects. And you may have missed the point on the call where we talked about two growth projects being completed next year that net impact to us on Juruti and Sao Luis is $500 million. So take that into consideration along with how you’re viewing growth versus non-growth CapEx and you’re going to have to come up with your own number between now and January.

[Oscar Cabrera:]

I’ve seen in your primary aluminum expectations for globally, you have China growing at about 15%. Can you tell us what the underlying assumptions for GEP or IP numbers are in there?

[Klaus Kleinfeld:]

Actually we talked about that. There was a question even around that. I’ll just give you that we’re assuming that it will be in the one digit and kind of in the mid-9%. That’s kind of the assumption that we have and that’s pretty much also what you see as the mainstream opinion. And as I said before when you talk to people in China, I think the bleakest outlook that I’ve seen is about 8%.

[Oscar Cabrera:]

We’re actually currently in China and you’re right. That’s the consensus right now in terms of what the break-even of the economies.

[Klaus Kleinfeld:]

Oscar, tell me. Where is your China growth number?

[Oscar Cabrera:]

China for Goldman Sachs growth number is 8.7%.

[Klaus Kleinfeld:]

8.7%. That’s interesting. And when did you change that? It has come down, right?

[Oscar Cabrera:]

Yes. It slipped in 10 days now.

[Klaus Kleinfeld:]

That’s good. I think we’re in sync on that. That concludes the Q&A session. Thank you very much for taking the time with us. Thank you in particular for engaging with us. Let’s hope that when we get together again for our Q4 presentation that we see better calmer times, because I think that would just be appreciated by pretty much all of us. All I can tell you as a close, we’re working as hard as we can. We’ve got a real committed team, and we’ll work it no matter how the conditions are outside. We’re well prepared and the rest we’ll see. Thank you very much.

[Operator:]

Thank you for your participation in today’s conference. This does conclude your presentation.