Fitch Downgrades Alcoa's IDR to 'BB+'; Outlook Stable

NEW YORK--()--Fitch Ratings has downgraded the ratings for Alcoa Inc. (NYSE: AA, Alcoa) including its Issuer Default Rating and senior unsecured debt to 'BB+' from 'BBB-'. A full list of rating actions follows at the end of this release.

The Rating Outlook is Stable.

RATING DRIVERS:

The downgrade reflects Fitch's view that financial leverage will remain above 2.5x on a total debt/EBITDA level and above 3.5x on an FFO adjusted level through 2014. Significant pension contributions will keep FFO adjusted leverage above 3.5 through 2015. The company has generated free cash flow after capital expenditures and dividends to shareholders since 2010 despite weak aluminum prices. Profitability has been hampered by global oversupply in aluminum.

Upstream Challenges

Alcoa ranked as the third largest primary aluminum producer in 2013. Its aluminum production is about average cost and its alumina production is in the low second quartile. Roughly 60% of alumina and 79% of primary aluminum by volume was sold to third parties in 2013. The primary aluminum market has been suffering from production surpluses as new low cost capacity was added and high cost capacity was slowly curtailed. This excess supply has been soaked up by financial buyers and held in inventory.

Alcoa took 253,000 tonnes of capacity offline in 2013 and announced a further 418,000 tonnes of capacity curtailments, including 274,000 tonnes of permanent closures, so far in 2014. Of the company's 4 million tonnes of smelting capacity, 655,000 was curtailed at Dec. 31, 2013. Announced capacity cuts excluding China since January 2013 aggregate about 1.5 million tonnes. Global consumption was about 49 million tonnes in 2013 and LME stocks were 5.4 million tonnes at April 8, 2014.

Fitch believes that production curtailments should result in balanced physical markets and that prices should slowly improve from current lows. Inventory financing transactions are expected to continue as long as the economics work: interest rates are low, the market is in contango, and warehouse rents are low. A reversal of those conditions could bring substantial material into the market.

On the margin and all else equal, Alcoa reports that a $100/tonne increase or decrease in the average price of primary aluminum as reported on the London Metal Exchange (LME) would increase or decrease annual net income by $240 million. In 2013 the LME price was about $173/tonne lower than it was on average for 2012. Alcoa's realized prices for primary aluminum for 2013 were only $83/tonne lower than the average for 2012. Net income excluding special items increased $95 million in 2013 compared to 2012.

Alumina markets have their own fundamental dynamics and Alcoa has been working to move its contracts to indexed base pricing rather than pricing based on the LME price of aluminum. For 2014, 65% of third party shipments are on spot or alumina index based.

Downstream Opportunities:

Engineered Products and Solutions (EPS) and Global Rolled Products (GRP) benefit from the scale of research and development, past restructuring efforts and growing end-market demand.

In 2013, EPS accounted for nearly half of EBITDA and EPS taken with GRP accounted for 72% of 2013 EBITDA. Capital investments of $300 million in Davenport, IA, $300 million in Alcoa, TN and $400 million (Alcoa's portion $95 million) in the Saudi Arabian JV, enable the company to capture growth in auto body sheet demand. Fitch estimates that EPS and GRP will represent more than $2.2 billion in EBITDA by 2016.

Expectations:

Fitch expects earnings in 2014 and 2015 to continue to reflect weakness in primary aluminum. Fitch also expects 2014 EBITDA to be at least $2.6 billion. Total debt to EBITDA will likely be as much as 2.9 times (x) at the end of 2014. FFO adjusted leverage is impacted by minimum pension contributions in the amount of $625 million in 2014. In the longer term, Fitch expects FFO adjusted leverage to drop below the 3.9x at March 31, 2014.

For 2014, Fitch expects Alcoa to be free cash flow neutral after capital expenditures of $1.2 billion but before $137 million in dividends and the $125 million investment in the Ma'aden joint venture. The first quarter generally shows high seasonal working capital; a key focus is working capital management, and turns have reduced year-over-year for the period under review. Fitch expects cash to start building in the third quarter of 2014. Cash used for operations was $551 million in the first quarter of 2014, reflecting seasonality, some automotive inventories related to the ramp-up, and payments on the Alba settlement. Fitch expects any earnings or cash flow shortfall to be met with further cuts to spending or asset sales.

Strong Liquidity:

At March 31, 2014, the $3.75 billion revolver maturing July 25, 2017 was fully available and cash on hand was $665 million. The revolver has a covenant that limits Consolidated Indebtedness to 150% of Consolidated Net Worth. As of Dec. 31, 2013, Alcoa had 10 additional revolving credit facilities providing a combined capacity of $1.2 billion of which $1 billion is due to expire in 2014 and $150 million is due to expire in 2015.

As of March 31, 2014, near-term scheduled debt maturities are estimated to be: $133 million in 2014, $30 million in 2015, $30 million in 2016, $778 million in 2017 and $1 billion in 2018.

Pension Contributions:

At Dec. 31, 2013, aggregate pension plans were underfunded by $3.2 billion, of which the U.S. pension plans were underfunded by $2.7 billion on a U.S. GAAP basis. The minimum required contribution to pension plans is estimated at $625 million in 2014.

The Stable Outlook reflects slowly improving trends despite prolonged weakness in the primary aluminum market and progress toward reducing financial leverage to levels more consistent with the rating.

RATING SENSITIVITIES:

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

--Operating EBITDA below $2.5 billion in 2014;

--Total Debt/EBITDA sustainably above 3x and free cash flow negative in the amount of $200 million or more.

Positive: Not anticipated over the next 12 months given over supply in the aluminum market, but future developments that may lead to a positive rating action include:

--FFO adjusted leverage to be sustainably over 2.5x, and free cash flow positive on average.

Fitch has downgraded Alcoa's ratings as follows:

--IDR downgraded from 'BBB-' to 'BB+';

--Senior unsecured debt from 'BBB-' to 'BB+';

--$3.75 billion revolving credit facility from 'BBB-' to 'BB+';

--Preferred stock to 'BB-' from 'BB'.

--Short-term IDR to 'B' from 'F3';

--Commercial paper 'B' from 'F3'.

The Rating Outlook is Stable.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology', dated Aug. 5, 2013.

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

Additional Disclosure

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http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=826780

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Monica M. Bonar, +1-212-908-0579
Senior Director
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Christopher M. Collins, CFA, +1-312-368-3196
Director
or
Committee Chairperson
Eileen Fahey, +1-312-368-5468
Regional Credit Officer, Americas
or
Media Relations
Brian Bertsch, +1-212-908-0549
brian.bertsch@fitchratings.com

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Monica M. Bonar, +1-212-908-0579
Senior Director
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
or
Secondary Analyst
Christopher M. Collins, CFA, +1-312-368-3196
Director
or
Committee Chairperson
Eileen Fahey, +1-312-368-5468
Regional Credit Officer, Americas
or
Media Relations
Brian Bertsch, +1-212-908-0549
brian.bertsch@fitchratings.com