Alcoa

Alcoa reported second-quarter underlying income of USD 562 million, up 51% from the first quarter. This included a 13% jump in realized aluminum price to USD 2.16 per pound and an 18% increase in aluminum shipments to 1.2 million metric tons. Lower bauxite and alumina volumes partially offset.

Why it matters: The strong increase in aluminum prices was the predominant driver of the earnings jump. Year-to-date annual production records at four aluminum smelters and one refinery helped unit costs, with aluminum EBITDA margin improving 490 basis points to 32%. Despite this, we reduce our 2026 earnings per share forecast by 27% to USD 3.75, mostly because we now don't recognize the transfer of South32 assets until 2027. Alcoa also decreased 2026 alumina production and shipment projections by around 3% due to issues at Pinjarra. Alcoa is buying most of South32's bauxite, alumina, and aluminum assets for up to USD 5.6 billion and will be entitled to the assets' cash flows from April 1, 2026, if the deal closes as expected in the first half of 2027. We see this as a sensible deal accretive to EPS and free cash flow.

The bottom line: Our USD 52/AUD 75 fair value estimate for no-moat Alcoa stands. We see aluminum demand growth supported by the shift to electric vehicles, which use considerably more aluminum, but with pricing capped by the potential for large, low-capital-cost Chinese capacity additions. Shares have fallen more than 40% since June and at USD 46.85 screen as somewhat undervalued. The fall is in sympathy with a 16% retreat in aluminum prices, with moderating energy prices playing a meaningful part. We think the market is beginning to overstate the energy pullback. Aluminum production is energy-intensive, and the metal can effectively be thought of as solidified electricity. It is also important in the energy transition as a substitute for copper in many instances, with pricing consequently strongly correlated with it in addition to the energy complex.

We forecast a 10-year EBITDA CAGR of 5.5% to USD 3.2 billion by 2035. This captures volume growth, including acquisitions, but a retreat in the aluminum price from 2030. We credit a midcycle EBITDA margin of 15% against 14% in the second quarter of 2026. In addition to South32 synergies, the improvement anticipates a lesser commodity price retreat for the higher-margin alumina segment than for aluminum. Our midcycle alumina price forecast is USD 344 per metric ton from 2030, against a second-quarter average of USD 307.

Second-quarter alumina EBITDA declined to negative USD 96 million, reflecting softer volumes and higher costs, with Pinjarra refinery suffering instability and disrupted gas supply due to Cyclone Narelle. Aluminum EBITDA jumped 55% to USD 1.1 billion, with the realized aluminum price up 13% to USD 4,750 per metric ton and margin improving to 32% from 27%.

Operating cash flow rose strongly, to USD 620 million from negative USD 180 million. Group net debt was steady at USD 1.1 billion, with leverage conservative at around 0.4 net debt/EBITDA. We estimate Alcoa could be unleveraged as soon as 2027, all else equal, though the adjusted net debt target is for USD 1.0 billion-USD 1.5 billion through the cycle. We project peak net debt of USD 4.4 billion immediately after the South32 acquisition, with leverage still manageable at 1.5 and expected to be back below 1.0 by 2028.

Our fair value estimate is USD 52 per share. Alcoa reported second-quarter underlying income of USD 562 million, up 51% from the first quarter. This included a 13% jump in realized aluminum price to USD 2.16 per pound and an 18% increase in aluminum shipments to 1.2 million metric tons. Lower bauxite and alumina volumes were partial offsets.

We still see aluminum demand growth supported by the shift to electric vehicles, which use considerably more aluminum, but with pricing capped by the potential for large, low-capital-cost Chinese capacity additions.

We forecast a 10-year EBITDA compound annual growth rate of 5.5% to USD 3.2 billion by 2035. This captures volume growth but also a retreat in the aluminum price from 2030. We credit a midcycle EBITDA margin of 15% against 14% in the second quarter of 2026. In addition to South32 synergies, the improvement anticipates a lesser commodity price retreat for the higher-margin alumina segment than for aluminum. Our midcycle alumina price forecast is USD 344 per metric ton from 2030.

We apply a 9.6% weighted average cost of capital, driven almost exclusively by above-average systematic risk. This is largely because of the cyclicality of alumina prices and relatively high fixed costs.

Alcoa lacks an economic moat. For alumina refiners, we apply the moat framework for commodity manufacturers, which dictates that cost advantage is the only potential route by which the company could establish an economic moat. Performance is closely tied to the aluminum commodity cycle, and we'd need to see a clear-cut cost advantage to assign an economic moat. Alcoa operates in the first quartile of the industry cost curve for bauxite mining and alumina refining. However, the bauxite mining and alumina refining cost curves are very flat, and we’d only consider companies with the very lowest unit costs to have a durable cost advantage. Alcoa’s assets do not meet this hurdle.

More importantly, Alcoa’s aluminum smelting assets do not operate near the low end of the global cost curve but in the second quartile, despite management curtailing and closing high-cost capacity in recent years, and the intended purchase of South32's aluminum suite assets in the first half of 2027. The aluminum segment, which we expect to generate roughly 40% of companywide profits in a midcycle environment, exhibits no clear competitive advantage and tends to deliver sub-WACC returns when the industry suffers cyclical downturns.

Further, Alcoa’s unfavorable cost position fails to fully reflect the impact of production from Chinese state-owned enterprises, which contribute more than half of global capacity. These have historically maintained production even in low-price environments. If we treat Chinese production as fixed through the cycle, Alcoa’s competitive position would be in the third or fourth quartile.

While vertical integration does provide Alcoa with better control over its raw material procurement and might provide some modest synergies, we don't think it captures economic rent relative to external sourcing of raw materials.

We expect global overcapacity to persist. Accordingly, we project Alcoa to generate only high-single-digit returns on invested capital in a midcycle environment, below its cost of capital. The company’s most likely route to earning an economic moat involves the ongoing closure of high-cost capacity and maintainably higher aluminum prices. Closure of old smelters with little to no book value could benefit ROICs.

Cost-efficient refining operations stem from proximity to bauxite mines and access to cheap power. In many cases, Alcoa benefits from such. However, prolific growth in Chinese alumina refining capacity means that future returns on invested capital will likely not materially exceed WACC.

Bauxite, the material used in alumina production, is relatively abundant. The US Geological Survey cites global reserves sufficient for approximately 100 years, with nearly half of the world’s reserves located in Australia and Guinea. Deposits are typically shallow and simple to mine, meaning that bauxite availability is unlikely to restrict the supply of alumina or aluminum in the longer term.

In recent years, Chinese refineries have become more efficient in alumina production, with lower energy costs diminishing the country’s relative cost disadvantage. China has significantly increased production and accounts for over half of global supply. The rapid increase in Chinese refining capacity indicates the low barriers to entry in the alumina industry. A material portion of Chinese refining capacity is operated by state-owned enterprises, which often continue to operate when unprofitable, diminishing the potential benefits that low-cost operators like Alcoa might otherwise realize.

We don’t expect Alcoa's economic moat potential to be undermined by material shareholder value destruction from environmental, social, and governance risks. These are largely based on industry risks already incorporated into our base-case analysis.

Some elements of ESG risk, like the potential for spills of dangerous waste, are further captured within our High Uncertainty Rating and WACC via a higher cost of equity. Alcoa aims to be the lowest carbon dioxide emitter among all global aluminum companies, per ton of emissions in both smelting and refining. In 2022, Alcoa exceeded its target of more than 85% of its smelting portfolio powered by renewable energy, primarily hydropower.

Alcoa's US smelting operations are likely to benefit from US sanctions on aluminum imports.

Alcoa’s commodity-facing operations have improved their cost positions in recent years.

Alcoa is a beneficiary of continued global economic growth and increased demand for aluminum via the electrification of transport.

Aluminum prices could move sharply lower into the future, weighing heavily on companywide profitability.

Overcapacity is likely to remain a material headwind to aluminum price appreciation, driven largely by low-cost capacity additions in China.

Aluminum is abundant. Barriers to entry in alumina refining are low, and China's alumina production is willing to behave counter to traditional economic considerations.