Alcoa Corporation
Q4 2007 Earnings Call Transcript

Published: 10 Jan 2008

[Operator:]

Good day ladies and gentlemen, and welcome to the fourth quarter 2007 Alcoa earnings conference call. My name is Antoine and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question and answer session towards the end of this conference, at which time (Operator Instructions). I would now like to turn the call over to Mr. Tony Thene, Director of Investor Relations.

[Tony Thene:]

Thank you, Antoine. Good evening and thank you for attending Alcoa’s fourth quarter 2007 analyst conference. At today’s conference, Charles McLane, Executive Vice President and Chief Financial Officer who will review current market conditions, the fourth quarter financial results as well as 2007 full-year results; Alain Belda, Chairman and CEO will then give a summary of 2007 and an outlook for 2008. Before I turn it over to Charles, I would like to remind you that in discussing the company’s performance today, we have included some forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements relate to future events and expectations and involve known and unknown risk and uncertainties. Alcoa’s actual results or actions may differ materially from those projected in the forward-looking statements. For a summary of the specific risk factors that could cause results to differ materially for those expressed in the forward-looking statements, please refer to Alcoa’s Form 10-K for the year ended December 31, 2006, and Forms 10-Q for the quarters ended March 31, 2007, June 30, 2007 and September 30, 2007 filed with the SEC. In our discussion today, we have also included some non-GAAP financial measures. You can find a presentation of the most directly comparable GAAP financial measures calculated in accordance with generally accepted accounting principles and related reconciliation on our website at www.alcoa.com under the Invest section. At this point, let me turn it over to Charles.

[Charles McLane:]

Thanks Tony. Before we jump to the quarterly results, let me give you a quick update on aluminum market conditions. Although Alain will provide an outlook for 2008 later in the presentation, in our view, market fundamentals continue to remain strong. In November, global days of consumption on reported stocks decreased to just under 25 days, 3 days lower than a year ago thereby remaining at historic lows. Let us take a look at how those consumption rates break down by region. We estimate that 2007 primary aluminum consumption increased by 10% leaving a global surplus of approximately 300 thousand tons. Certainly, the weakness in North America has been well-documented, and we estimate that 2007 consumption decreased by almost 10% driven by weakness in the transportation and distribution markets. But we are seeing strong growth in Latin America of 13% and the CIS of 14% as well as close to double digit growth in India, Vietnam and Thailand. Certainly China remains the major driver of growth at 37%. Let us review how China’s unprecedented growth is affecting the global supply-demand balance. As you are aware, smelter comparative growth in China has essentially kept pace with the tremendous consumption growth. Yet throughout 2007 and into 2008, China took specific actions designed to control the rapid growth and production. Export rebates were removed on extrusions, rod and billets. Import duties were reduced to zero on primary aluminum and alumina. NDRC required provincial authorities to abolish preferential power rates. Equity requirements are being raised on fix-asset investments to discourage unbridled growth in the sector. Land use is becoming closely managed. Industry-specific guidelines on energy consumption have been issued as well as air and water standards. In addition, we continue to see and hear reports that aluminum is gaining share over copper in China where the reluctance to reengineer is much less than in the West. In summary, we have a fundamentally sound market today. Granted, three-month metal price continued to exhibit a great deal of volatility but the marketplace continues to assign confidence in the future prospects for aluminum as witnessed in the forward curve. Now let us talk about the downstream end-markets. It should be no surprise that weaker market conditions, particularly those in North America and Europe had a negative impact on our fourth quarter results. As we described in last quarter’s presentation, our aerospace businesses continue to be negatively impacted by supply-chain de-stocking as the industry caught up to demand in the second half of the year. Even so, on the whole, the 2007 aerospace market exhibited persistent strength with commercial delivery rates up 8% in the year. Aircraft orders for the year reached a record high of over 2700, which is 25% higher than the 2005 record. Although global automotive production was up roughly 5% in the year, in North America, where our customer base is concentrated, conditions were much weaker. Specifically, the “Detroit 3” production rate declined 4% from the year-ago quarter and nearly 6% for the full year. As we have discussed throughout the year, North American Class 8 demand softened due to the large 2006 pre-buy that has added roughly 100,000 units of excess dealer and trucking fleet supply. North American heavy truck is very weak right now. Freight miles are down and the U.S. Industrial sector is being pressured by housing and automotive declines. In the fourth quarter, North American Class 8 production was down roughly 52% from the prior year quarter and down 44% on a full year basis. We were able to mitigate a portion of this decline through the growing penetration of aluminum truck wheels and increased sales of value-add products. The non-residential building and construction market remained strong in spite of the prevailing uncertainty in the credit market, and the decline of select new projects in the second half of the year. In 2007, North America grew by 6% while Europe grew by roughly 3%. Through improvements in delivery performance and new technology, we were able to capitalize on strong market conditions and post double-digit revenue growth in this market. Finally, heavy duty industrial turbine build rates have been on a steady path of recovery since 2004, primarily driven by increased power demand in Europe, the Middle East and Asia. In 2007, orders for all sizes of industrial gas turbines were up significantly year-over-year, while sales volume also increased. Now let us take a look at the fourth quarter results. Income from continuing operations was $624 million, or $0.74 per share. Included in the results are restructuring adjustments and a tax benefit totaling $323 million or $0.38 per share, almost all of which stems from the recent agreement to sell the Packaging business. Taxes were lower than anticipated as we will be selling a combination of assets, plus the shares of stock in subsidiaries, versus the originally anticipated asset sale. This will allow us to include a significant portion of the associated goodwill in our tax basis. The combined financials of the transactions are now as follows

[Alain Belda:]

Thank you Charles. Well we certainly had a rewarding and eventful 2007. Did everything go according to plan? Obviously, as Charles pointed out, no. But life would be pretty boring if it did. But we are paid to manage such unexpected events such as metal price volatility, currency fluctuation and inflationary pressures, and production interruption – we are paid to manage those over the quarters of the year, unfortunately some of them don’t come evenly distributed every quarter. I believe we did that very effectively this year. As I reflect on 2007, I am most proud of how we lived our values everyday

[Operator:]

Your first question comes from the line of Kuni Chen - Banc of America Securities.

[Kuni Chen:]

On aerospace, I just wanted to clarify some of your comments. It seems to suggest that destocking continues into the first quarter and then you see that turning around in the second quarter. Can you talk about how that impacts your various aerospace businesses, whether its plates or castings, just give us a sense to your conviction level of that turning around in the second quarter?

[Alain Belda:]

I think it affects all of those business that you’ve cited. You had a destocking, the A380 was delayed and they had parts and pieces for about 20 of those airplanes; that’s a very aluminum-intensive and very fastener-intensive business. So as they go through this first 20 airplanes, which should be done in that period of time, they start ordering again to fill in the pipeline. 787, you’ve read the same stuff with the fasteners and the delay they’ve had. So we really expect that it’s on hold at the moment as it was in the fourth quarter, but starting the second quarter you will see the orders come in. Chuck, do you want to add anything?

[Charles McLane:]

In the flat rolled products segment probably you’re going to feel it a little heavier going through the first quarter than in the fasteners just because of the distribution channel and the supply chain.

[Kuni Chen:]

On capital spending, can you just give us your outlook for ‘08? Is it fair to say that we can perhaps expect to see some acceleration in CapEx given use of proceeds from some of the asset sales?

[Charles McLane:]

Well, if we had to look right now for anticipated CapEx in ‘08, it would probably be about $3 billion, because we’ve got projects that are going on right now that we are still going to be finishing up the major refinery expansion that’s going on in Brazil, as well as the new bauxite reserves. So, if you looked at Brazil alone, it’s going to be a little over one-third of that. Then 75% of what would be remaining would just be sustaining capital. So, right now we’re looking at about $3 billion and not really any acceleration of that because the projects are on a schedule.

[Operator:]

Your next question comes from John Hill - Citi.

[John Hill:]

Good evening, everyone and thanks for a very detailed presentation as usual. I was wondering if we could spend a moment or so on the alumina segment and the profitability there. It seems your volumes were up, revenues were up $44 million; at the same time DD&A was down, tax was down 40 yet ATOI is off $10 million. I would think with the volumes and such in terms of the down draft of DD&A and tax it would have at least held ground, if not dropped some of that to the bottom line. That seems a rather severe penalty relative to currency and input costs and escalation. Can you explain for us how we get back on track there?

[Charles McLane:]

I’ll explain to you the deviations a little bit John. Right now, as you are aware in our refinery businesses you’re looking at natural gas and fuel oil; both of them had significant increases and had been going up, but many of our operations are in Western Australia so the Australian dollar to the US dollar was down significantly. We are talking about a deviation in this segment alone of close to $30 million on currency. So if you start taking that into consideration along with higher freight costs, ocean freight being up 30% year over year, it doesn’t take long there. The fact is we were able to mitigate most of that to increase production to only bring the deviation down to $10 million.

[Alain Belda:]

Also, I was in Jamaica in early December while they were recovering from the hurricane time and that was a pretty big disaster. Not only did we lose port and all that stuff, but all the material froze in the pipeline given that we completely lost power, even the reserve power. So it’s been taking a little bit longer and a lot more maintenance and repair work to get that fixed.

[Charles McLane:]

John, as Alain talked on the catalyst, the Pinjarra upgrade that has taken a little longer to get to a total capacity we are expecting an additional 90,000 tones out of Pinjarra going forward and you’re going to, as he said, we will get additional volume out of Jamaica as it fully recovers.

[John Hill:]

Great perspective, thank you. On the share buyback, what type of procedures are you contemplating and would you consider a tender for the shares, given the large size of the buyback and current valuations?

[Charles McLane:]

Probably not, as I am looking towards my boss here. We manage our capital structure and we’re opportunistic and you can see what we paid for the shares to this point in time so obviously we think it’s a bargain now if we paid $36 leading up to this point, it’s a bargain now. But we’re going to manage our capital structure based on all our requirements. I’d just say that you’re going to have to stay put and see how we handle that.

[Operator:]

Your next question comes from Oscar Cabrera - Goldman Sachs.

[Oscar Cabrera:]

Just talking about your 2008 catalyst, you’re expecting about $0.40 to $0.50. Would you be able to segment where you expect most of it?

[Alain Belda:]

I’m sorry, you were cutting off. Do I expect what?

[Oscar Cabrera:]

You talked about 2008 catalyst being Icelandic production, Pinjarra at full capacity and quantified this between $0.40 and $0.50. Would you be able to segment where you expect these to come from?

[Charles McLane:]

You’re asking for us to identify the amount of that improvement in each one of the catalyst? We really would rather not get into a specific target for each one of those. Certainly the Iceland production, you’re looking at going from a startup position where you are incurring costs, which we had on the bridge was over $100 million to a producing situation. So that’s going to be a significant turnaround in Iceland. If you look at the recovery from the primary curtailments -- Rockdale, Tennessee, Jamaica and Guinea -- here again, significant if you’re looking at what that impacted us in ‘07 and that turning around completely in ‘08. We would just rather leave it as you can look at those and say it’s going to get us $0.40 to $0.50 a share in next year.

[Oscar Cabrera:]

Just a clarification on your comments in the aerospace business. What particular products in the aerospace are affected by the restocking? You imply that flat rolled would be the most impacted by this destocking?

[Charles McLane:]

Well, what we said was that all products actually had some build-up in the supply chain just because of some of the delays in some of the platforms, and also the distribution channel was building, going through the year. So, the run off in the distribution channel we thought will take a couple of quarters to move through it and it will be a little more accentuated in the flat rolled than it will in the fasteners and the airfoil business.

[Operator:]

Your next question comes from John Redstone – Desjardins Securities.

[John Redstone:]

I wanted some clarification on your flat rolled product operations and the fact that you mentioned that you were down $78 million year over year. Of that $78 million, you mentioned that $37 million of that was due to your Russian and Chinese operations. Now that $37 million drop, is that all due to startup costs?

[Charles McLane:]

Well, when you look at the $37 million of the change, we were talking about a sequential change actually from the third to the fourth quarter. Basically the way you have to look at Russia is it’s in the process of significant project management. I mean, we’re trying to build-up a basis in four distinct markets. An aerospace market -- and we’re talking about equipment modernization and installations to serve every one of these market s -- so aerospace is in the middle of qualifications. We’ve got an oil and gas market that we’re in the middle of building capacity for that. That’s got a potential market to us of $1 billion. The can sheet business, we have customers that are building capacity in Russia right now. We’re putting in capacity to meet those customers needs. So it’s just a mass amount of projects. The project management that’s going on and the issues that you run into, these were older facilities. You dig foundations, you find a lot of things in the ground that you might not anticipate being there so it has taken a little longer than anticipated. We expect to see significant recovery in the Russia results next year.

[John Redstone:]

When you say next year --

[Charles McLane:]

This year. Excuse me. In ‘08.

[John Redstone:]

Starting in this quarter?

[Charles McLane:]

It will gradually get better each and every quarter, so starting this quarter it should be better and then next quarter even better, et cetera.

[John Redstone:]

On the Bohai plant, when would you expect to see a ramp up completed at Bohai?

[Alain Belda:]

Bohai, we’re at 40,000 tons this year and we expect to be at full capacity in 2010 at a 150,000 tons.

[Operator:]

Your next question comes from Charles Bradford - Bradford Research.

[Charles Bradford:]

On the tax rate, what would you put the normal tax rate at for the fourth quarter?

[Charles McLane:]

It’s pretty close to 29% for the year. In the fourth quarter it was about 25% in order to get us to the 29% range, Charles.

[Charles Bradford:]

What would you look for in the form of depreciation for ‘08?

[Charles McLane:]

It’s probably going to be in the range of about $1.3 billion.

[Operator:]

Your next question comes from Tony Rizzuto - Bear Stearns.

[Tony Rizzuto:]

Could you tell us if the 2008 catalyst include any of the share buyback, the remaining shares authorized, the per share amounts that you guys lay out?

[Charles McLane:]

No it does not, Tony.

[Tony Rizzuto:]

I was wondering if you could talk a little bit about, there is some talk about a potential strike, a general strike in Guinea. Can you tell us about the environment there and what’s the latest there and what we might expect?

[Alain Belda:]

We expect what we don’t expect. They are going through the political situation; it’s the same situation we had before. I mean you have got succession in the government. We hope that they work it out like we did last time and they might get into a problem.

[Charles McLane:]

Tony, as you are aware, there’s been general strikes there before that really haven’t impacted us and the last one did. Our view is I think they understand that our industry there is very important to them. We’re hoping for the best and managing and watching the situation, but we are really not sure exactly what will happen.

[Alain Belda:]

They really didn’t like the results they had last time at the government level and the country economy, so my guess is they will be more rational this time.

[Tony Rizzuto:]

Just a quick follow-up on the Russian investment. Have you had any better success, I guess, in terms of getting some of that equipment that you had some issues with? Maybe some of the furnaces and have you had any further adjustments, I should say, in maybe the workforce size there?

[Alain Belda:]

No, we continue to have reduction on personnel, that’s one. On the equipment, I think the kind of problem we run into, Tony, are we would probably find it everywhere else. Question is we don’t know Russia enough. One example was about two years ago they had the roof collapse on a sport arena. As a result, they put in some new rules which nobody really understands. Well guess what? We are building some big work. You’ve been to Tennessee, right Tony?

[Tony Rizzuto:]

Yes.

[Alain Belda:]

Okay, so we are building those two accumulators like the one you have in Tennessee, they have to go through the roof. To touch the roof you need all kinds of new certification; that takes time. We didn’t know when we started that we needed that. The construction company didn’t know that they needed to have anything. The result is that it took longer. So now it’s proceeding ahead but you had to go back, look for the design of a 50-year roof which nobody had, so you had to make them, certify them, and all that. So it’s this kind of problem that you run into, or the one that Chuck described, you have to make a foundation and you find something under the foundation which shouldn’t be there. But I think its working well now. I mean, we’ve got a lot of things getting commissioned right now. We are getting things commissioned in January, March and all the way out to June we have got some big pieces of equipment going on production.

[Tony Rizzuto:]

I don’t want to read too much into it, but when you talk about the catalyst in terms of the annualized EPS impact, would we be fair in saying that’s not a full year impact you expect and that’s an annualized? And maybe you won’t get there until the second half of the year?

[Alain Belda:]

That’s a full year impact, but again, this is on the same condition of pressure and temperature; things change in this world.

[Tony Rizzuto:]

Right, understood. I appreciate it.

[Operator:]

Your next question comes from David Martin - Deutsche Bank.

[David Martin:]

I just wanted to come back to your comments on the quarter over quarter bridge chart when you talked about currencies, the currency benefit which I think was $50 million. Can you clarify that?

[Charles McLane:]

I’m going to give you an answer. The quarter-to-quarter impacts and being in a local currency and purchases are being made, we call those economic impacts. So if you’re a US dollar company and you’re making local purchases in Australia you are having a higher cost. That’s negative in the segment and they had that. The favorable amount that you’re seeing show up is the result of taking what’s on the balance sheet and translating it. That just happens we had tremendous working capital efficiency, so that’s all it represents.

[David Martin:]

That’s just a translation, that’s not net of the operating impact?

[Charles McLane:]

It is net of the two but you’re looking at the change between quarters. So if you looked at what was the translation in the third quarter to the fourth quarter, it’s a net difference between the two, but that does represent the total of the two.

[David Martin:]

Secondly, on outage and start up costs, can we assume they’re going to be zero in the first quarter?

[Charles McLane:]

You can, I mean, it’s going to be like this. We won’t be up to a 100% of capacity in the first quarter but we’re out of the startup phase where we’re actually going to be making and shipping products.

[David Martin:]

Lastly on the price caps in the ‘08 catalyst chart, just remind us where you stand on remaining price caps post ‘08?

[Charles McLane:]

Well, they run out, its basically one customer less in ‘08 and ‘09. It runs out at the end of ‘09. It represents about 5% of our total shipments.

[Operator:]

Your next question comes from Mark Liinamaa - Morgan Stanley.

[Mark Liinamaa:]

I would be interested in any comments you could give us on how receptive counterparties are to long term LME-linked contracts in the power space? If possible give a target power rate at say $2,200 per ton fixed price?

[Charles McLane:]

Could you repeat the question? I am not sure I completely understood it.

[Mark Liinamaa:]

I am just trying to get a sense of how receptive counterparties are to long-term contracts right now as you renegotiated some of your contracts, your repowering situation?

[Charles McLane:]

We’re pretty successful so far, to tell you the truth. Without getting into the specifics of the contracts, we completed a couple recently, one has given us a 20-year extension, the other one a 30 with an additional potential ten years, and they’ve been at comparable type of rates as to what we’ve been experiencing, so we are pleased. In addition to that, we have got several others that we’re working on that that chart represents that by the end of 2008, we think will be completed as well. So the negotiations that are going on now, because some of these things take place four or five years from now and they are complex, it is taking us a while to work through them.

[Mark Liinamaa:]

With the rates that you’ve been able to achieve, which were pretty encouraging in the previous resets that you did, would they be representative of what you would think fair deals would be going forward?

[Charles McLane:]

Yes, we would.

[Alain Belda:]

This is an important movement because a lot of you guys have been talking about 2014, 2015. We’ve started working on all these things about four or five years ago. We get to renewal of the contracts, which gives us the opportunity also to look back at some of these plants, maybe reinstall equipment. Given a 20 year window, it changes completely the way you run the plant, and the decisions you’re going to make about automating more, reducing the cash costs of these plants because these are significantly competitive power prices in the market.

[Charles McLane:]

And if you are successful -- and as we’ve been successful so far and anticipate future success -- and compare the cost of that for a 20 or 30 year smelting facility versus a greenfield or a brownfield, much better economics.

[Operator:]

Your next question comes from Brian MacArthur - UBS.

[Brian MacArthur:]

So this chart, just so I make sure I’m reading it right with the power contracts going forward, there is a little uptick in ‘09 which I assume under the self power is really what you’re talking about in Brazil, i.e. the Brazil part you’re talking about is already in this chart, is that right?

[Charles McLane:]

Yes.

[Brian MacArthur:]

In the contracts, can I assume that because it’s the beginning of ‘08, we’ve included the stuff that’s just been negotiated at Messina and Wenatchee?

[Charles McLane:]

It’s in the chart, but in ‘08 they don’t run out until later anyway. So, it’s included in the light blue area.

[Brian MacArthur:]

Okay. So it has been reflected in that. I was just figuring it out, this is a picture as of today going forward?

[Charles McLane:]

That is a picture of what we feel we’re going to be at by the end of ‘08.

[Brian MacArthur:]

Secondly, can you tell me just how much money you put into Russia so far?

[Alain Belda:]

Well, we started with $257 million. My guess is we probably are at about $200 million right now in terms of investments and working capital.

[Brian MacArthur:]

It sounds like thought we are heading towards $350 million or $400 million, is that a reasonable number, or are you still happy with the $200 million?

[Alain Belda:]

Most of the equipment is bought, in the process of getting installed and we don’t see that we need any more equipment than what we have there right now.

[Charles McLane:]

Right. To give you an idea, Brian, our view right now was by mid year -- and this is not just three or four pieces of equipment by the way -- this is a lot of different projects going on. Of all the projects that have been going on in Russia, 90% plus of them are going to be complete by mid-year.

[Brian MacArthur:]

So then effectively its been more the capital costs haven’t become huge in all this it is just that the timing has been the problem more than anything else and therefore when we finally get to our run rate of whatever number we think it is, you’re still up for the same return on assets if I were to look at it that way, just delayed going forward?

[Charles McLane:]

That’s correct.

[Brian MacArthur:]

I think you said earlier you were talking about $3 billion in capital this year, you said there was $1 billion in Brazil, which was kind of growth, but then you said the other $2 billion, 75% of it is sustaining? That sounded high to me, that sustaining capital was up at a $1.5 billion right now. Is that right?

[Charles McLane:]

Well there are things like red mud lights and some power scrubbers that need to be redone and environmental things, so all of those are flowing into it as well, Brian.

[Brian MacArthur:]

But would you say $1.5 billion would be your sustaining capital at a run rate going forward now?

[Charles McLane:]

Well, it depends on how many power contracts that we get renegotiated, whether we do that or greenfield facilities, we’re going to have some costs like that, yes.

[Alain Belda:]

That also includes, for instance, we’re rebuilding the Warrick Power Plant. That’s been a $400 million project over two or three years. We are repowering our hydroelectric plants in the Tennessee area and the North Carolina plant. So there is a lot of pretty substantial investments in the U.S. which are not exactly what you see normally as current, run of the mill expenditures.

[Operator:]

There are no further questions at this time. I would now like to turn the call back over to Mr. Tony Thene for any closing remarks.

[Tony Thene:]

Thank you for attending the fourth quarter call. Thank you for your questions. This now concludes our fourth quarter earnings call.