Alcoa will report its Q1 2015 results and conduct a conference call with analysts on Wednesday, April 8. We expect the company’s increasing emphasis on its high-margin value-added products to positively affect its results. In addition, higher average aluminum prices in Q1 2015, as compared to the corresponding period in 2014, will also positively impact the fortunes of the company’s upstream Primary Aluminum and Alumina business segments.

The company has steadily shifted its product portfolio towards value-added products, in order to reduce its dependence on aluminum prices, which have experienced an extended period of weakness over the past several quarters. The company’s value-added products enjoy pricing premiums and higher margins compared to its upstream businesses. The benefit of such a strategy is likely to be reflected in its results.

Aluminum Pricing

Aluminum has diverse applications in industry. It is an important input in the packaging, aerospace, automotive, construction, commercial transportation, power generation, capital goods, and consumer durables industries. Thus, demand for aluminum is broadly correlated with industrial growth. Economic weakness in Europe and slowing Chinese growth have contributed to the weakness in aluminum demand, and consequently prices, over the last few quarters. China, the world’s largest consumer of aluminum, is expected to witness a slowdown in GDP growth to 6.8% and 6.3% in 2015 and 2016 respectively, from 7.4% in 2014.

On the supply side, production capacity was not reduced corresponding to the subdued demand conditions over the last few quarters. Persistently high aluminum inventory levels relative to demand, have kept London Metal Exchange aluminum prices depressed. This inventory was built up partially as a result of aluminum being tied up in financing deals, which were made possible due to low interest rates. Despite inventories being at a record high, market forces failed to rationalize supply through the shutdown of smelting capacity. Though global aluminum majors like Alcoa and Rusal did make significant smelting capacity cuts, the same was not true of Chinese companies. This was primarily due to state intervention in the form of a provision of subsidies or renegotiated power contracts to smelters, which serve as a disincentive to cut production. China accounts for around 45% of the world’s aluminum production, and the expansion in production by Chinese producers more than made up for capacity cuts by global majors. This oversupply situation kept aluminum prices depressed over the last few quarters. This also prompted Alcoa to shift its product portfolio towards value-added products, in order to reduce its reliance on aluminum prices.

However, aluminum prices have rebounded recently. Global smelting capacity cuts in response to low prices have finally taken effect. LME warehouse stocks of aluminum were down around 21% in December, since the start of 2014. In view of the global smelting capacity cuts, according to a poll conducted by Reuters in July, the market for aluminum is expected to move from an oversupply of 235,500 tons in 2014 to a deficit of 4,444 tons in 2015. However, global smelting capacity restarts in response to higher aluminum prices are expected to lower or eliminate the extent of the deficit this year. In any case, the tightening of the physical supply of aluminum has provided a boost to aluminum prices.

LME aluminum prices averaged roughly $1,700 per ton over the course of the first quarter in 2014. These prices averaged close to $1,800 per ton in Q1 2015. Higher aluminum prices are likely to translate into better results for the company’s Primary Aluminum and Alumina business segments.