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What’s the Upside for Alcoa amid Sagging Aluminum Prices?

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Slumping aluminum prices

As we discussed in the previous part, aluminum prices have corrected recently on fears of rising supply from China in the coming months. Earnings of aluminum producers such as Century Aluminum (CENX), Rio Tinto (RIO), and Norsk Hydro (NHYDY) are sensitive to aluminum prices.

While the risks to Alcoa’s (AA) Upstream business are well known, we’ll look at the possible upside for the business amid the price current scenario.

In the short term, there might not be much upside for Alcoa’s commodity business (XME). Although there is a risk of rising supply from China, the demand side of the equation also looks shaky.

Vehicle sales in the US and Europe could be stagnant in 2017. China’s car sales could also be subdued in 2017 unless the country extends its tax breaks.

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Demand side

In the long term, aluminum demand looks strong globally—especially in China. Aluminum has been able to find new uses, particularly in the automotive sector. Ford (F) is among the automakers have shifted to aluminum to reduce vehicle weight. The graph above shows aluminum’s increasing use in vehicles.

Supply side

On the supply side, China’s aluminum overcapacity should balance out much sooner than steel. Unlike steel, where Chinese demand has likely peaked, aluminum demand continues to grow in the country.

If China does not make significant additions to its aluminum smelting capacity over the next four to six years, we could see normalcy return to aluminum markets. Aluminum’s positive long-term fundamentals could present a long-term upside for Alcoa investors.

In the next part, we’ll look at the opportunities and threats faced by Arconic investors.

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