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Inventory Remeasurements Impact Alcoa’s Downstream Profit in 4Q14

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Downstream profits

Let’s look at the 4Q14 earnings of Alcoa’s downstream operations, which are reported under engineered products and services (or EPS). EPS is the most profitable segment for Alcoa and produces value-added aluminum products. Constellium (CSTM) also produces primarily value-added aluminum products. However, mining giants like Rio Tinto (RIO) and BHP Billiton (BHP) don’t have value-added operations.

The focus on value-added products has been a key pillar of Alcoa’s transformation. Alcoa’s share of revenues from value-added products has risen steadily over the past few years. Alcoa (AA) comprises more than 3.5% of the SPDR S&P Metals and Mining ETF (XME).

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Profits flat

The above chart illustrates the 4Q14 financial performance of Alcoa’s EPS segment, showing its profits are almost flat on a year-over-year basis. Alcoa’s downward remeasurement of Firth Rixson inventory in accordance with purchase accounting standards created a negative impact of $12 million.

Results below guidance

After-tax operating income (or ATOI) of EPS segment is up by ~5% year-over-year (or Y-o-Y) after excluding the negative impact from Firth Rixson. Alcoa provided guidance of 8–12% growth in ATOI on a Y-o-Y basis. The final results of the EPS segment, which could be due to cost pressures, are below the guidance given by Alcoa. Cost increases contributed to a negative impact of $47 million.

Alcoa delivered a strong overall performance in 4Q14, reflected by its record cash flow. In the next article, we will analyze Alcoa’s 4Q14 cash flow.

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