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Morningstar | Alcoa Will Face Margin Compression as Lower Aluminum and Alumina Prices Take Hold

Alcoa is a vertically integrated aluminum company involved in every phase of aluminum production, from bauxite mining to the manufacture of finished aluminum goods. In November 2016, the legacy Alcoa operations were split into two publicly traded companies. The upstream company maintained the Alcoa name and continues to trade under the AA ticker. Alcoa's key end markets include transportation, building and construction, and packaging.Alcoa operates three reporting segments. Alcoa’s bauxite segment involves the mining of bauxite, a reddish ore that is refined into alumina and then smelted into aluminum. The bauxite segment is well positioned for future growth, as China is not self-sufficient in bauxite and must import roughly one third of its bauxite needs. The alumina segment refines bauxite into alumina (aluminum oxide), and the aluminum segment smelts alumina into primary aluminum. Alcoa's aluminum segment includes the company's smelting, cast products, rolled products, and energy operations.Bauxite, alumina, and aluminum prices are the key drivers of profits for Alcoa. However, aluminum represents the single largest input cost for the company's casting and rolling operations. Therefore, when primary aluminum prices rise, lower profits from the cast and rolled products segments slightly offset higher profits from the company's smelting operations.Alcoa has a middling position on the industry cost curve for aluminum smelting. Because of large-scale, low-cost capacity additions in China, we expect the company to lose ground on the industry cost curve over the long term. Alcoa enjoys a far more attractive cost position in bauxite mining and alumina refining, operating near the low end of the cost curve for each industry.