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Investing in Aluminum

Written By Briton Ryle

Posted March 9, 2015

The third largest aluminum producer Alcoa Inc (NYSE: AA) has been slowly growing into a conglomerate by creating its own assembly line of companies that runs from metal production to consumption all under one name.

And it couldn’t come at a more important time. After its stock reached an all-time high just under $49 in 2007 and then plunged to an all-time low just above $5 by the end of the 2008-09 economic crisis, Alcoa decided it just can’t afford to be a one-trick pony anymore. Like any other resource-based company, its survival depends on diversifying into other areas that are downstream from its main resource extraction activity.

Expanding downstream essentially brings metals extraction, refining, and consumption all under one company, allowing it to tap profits all along the way. It’s like a food company buying everything from farms to food distributors to supermarkets – controlling the entire production chain from start to finish.

But when you’re dealing with aluminum – one of the most diversely used metals which is found in everything from food packaging, to construction materials, to appliances, to automotive parts, to electronics – Alcoa had an almost endless number of streams to choose from. Choosing the right downstream was going to require some strategic thinking. It would have to be an industry that had a long future ahead of it, whose products have a lot of room for price mark-up.

The answer? Aerospace – one of the fastest growing markets for aluminum, offering plenty of room for expanding margins. Alcoa has lost no time extending its aluminum chain, making two acquisitions in the aerospace industry last year, and announcing today its third acquisition in the space.

Alcoa chairman and Chief Executive Klaus Kleinfeld announced in a statement obtained by The Street:

“We are combining … innovators in materials science and process technology, shifting Alcoa’s transformation into a higher gear… [which] expands our aerospace portfolio market reach and positions us to capture future growth to deliver compelling value for customers, shareholders and employees.”

Last year’s acquisitions helped lift Alcoa’s stock from $8 at the end of 2013 to nearly $18 near the end of 2014. Will this latest purchase lift it even higher?

Alcoa’s First Acquisition: Firth Rixson

Alcoa’s expansion of its aluminum production chain began with its purchase of Firth Rixson, a U.K. manufacturer of jet-engine components which use aluminum and other metals produced by Alcoa’s metals divisions.

“Alcoa said Thursday [June 26, 2014] that it will pay $2.35 billion in cash and $500 million in company stock to Oak Hill Capital Partners, Firth Rixson’s owner,” Forbes broke the news. “Alcoa could also pay an additional $150 million if Firth Rixson achieves certain earnings targets (but did not specify what those earnings targets are).”

Firth Rixson is the world’s largest supplier of seamless rings and other specialty metals parts used in aircraft engines. Alcoa explained that its purpose in acquiring Firth Rixson was to “gain more ground in the aerospace industry by providing a broader range of high-growth jet engine components”, estimating that “Firth Rixson’s revenue will grow 60% over the next three years and contribute $350 million in EBITDA in 2016,” Forbes reported, with sales expected to growth 12% annually over the next five years.

“The acquisition of Firth Rixson is a major milestone in Alcoa’s transformation,” Kleinfeld announced in a note obtained by Forbes. “This transaction will bring together some of the greatest innovators in jet engine component technology; it will significantly expand our market leadership and growth potential. Firth Rixson increases the earnings power and broadens the market reach of our high-value aerospace portfolio and will deliver compelling and sustainable value for customers and shareholders.”

Alcoa’s Second Acquisition: Tital GmbH

Alcoa’s second major acquisition in the aerospace industry came a few months later in December of 2014, when it announced it would purchase Germany-based Tital GmbH, “a leader in titanium and aluminum structural castings for aircraft engines and airframes,” the company’s press release introduced.

Alcoa reported that revenues from titanium-made aerospace components are expected to increase 70% over the next five years as titanium rapidly becomes the metal of choice in next-generation jet engine structural components, given how the metal can withstand extreme heat and pressure, and is lighter than steel.

“This acquisition is the next step in building a powerful aerospace growth engine,” Kleinfeld noted in the company’s press release. “As a fast-growing innovator, TITAL will increase our share of highly differentiated content on the world’s best-selling jet engines. The company’s talent and customer relationships will boost Alcoa’s expanding global aerospace leadership as we meet the future needs of our customers.”

Alcoa’s Third Acquisition: RTI International Metals

In its most recent extension into the aerospace industry, Alcoa today announced its purchase of RTI International Metals, Inc. (NYSE: RTI), a Pittsburgh, Pennsylvania-based manufacturer of titanium mill products that melts, forges, processes, produces, stocks, distributes, finishes, cuts, and delivers such titanium products as blooms, billets, sheets, plates, and titanium alloys which are further processed for aerospace, defense, industrial and consumer uses.

“Terms of the deal call for New York-based Alcoa to pay 2.8315 of its shares for each RTI International Metals share for total consideration of $41 a share, a premium of 50% over RTI’s close on Friday,” The Street reported. “The deal values RTI’s equity at about $1.26 billion, with Alcoa also assuming $330 million of RTI cash on hand and up to $517 million in convertible notes.”

Dawne S. Hickton, chief executive of RTI, noted to The Street that the deal is “a natural strategic fit for both RTI and Alcoa,” and that “innovation and scale are critical to winning in both the titanium and aerospace industries today.”

Leaning New Tricks

Indeed, innovation and scale are vitally important to staying alive in the ever more difficult resources sector, where labor costs are continually rising, and easy ore is more difficult and more costly to find.

For its part, Alcoa’s management team and board of directors are proving themselves to be highly innovative forward thinkers in their plan to steer Alcoa in a new direction into the aerospace industry.

Yet the company isn’t simply uprooting itself and then transplanting itself in an entirely new area of business as many companies in transformation have done. Rather, Alcoa is merely extending its sphere of influence into other markets downstream from its original metals extraction business activity. It is not merely moving into new markets, but growing into them, while still holding on to its original core aluminum and other metals extraction activities.

In this way, investors have more security in knowing that Alcoa isn’t becoming an entirely new company in an area where it has not been tried and tested, but is merely expanding its activities to derive additional profit and value from its metals business by adding end users of its products to its portfolio of divisions.

This gives Alcoa longevity, not only in that it is expanding into an industry with a long-term future ahead of it, but also in that it is lengthening its production chain by attaching new stages of production downstream from its core extraction business – thereby adding assets to its company, margin to its prices, and value to its stock.

Joseph Cafariello