Fitch Places Alcoa’s ‘BB+’ IDR on Positive Watch

NEW YORK

Fitch Ratings has placed Alcoa Inc.’s (Alcoa; NYSE: AA) ratings on Ratings Watch Positive following the company’s plans to separate into two companies. A complete list of ratings follows this release.

Nearly $14 billion in commitments and securities is affected.

On Sept. 28, 2015, Alcoa announced that its Board of Directors approved a plan to separate into two independent, publicly traded companies. The transaction is intended to qualify as a tax-free transaction and it is expected to be completed in the second half of 2016. The Upstream Company (UC) will comprise the units that today make up Global Primary Products, and the Value-Add Company (VAC) will include the Global Rolled Products and Engineered Products and Solutions (EPS) units. The company intends to capitalize the UC targeting a strong non-investment-grade rating. The VAC is to be capitalized targeting an investment-grade rating. Pursuant to the company’s 8K filed Sept. 29, 2015, the debt of Alcoa would be retained by the VAC.

KEY ASSUMPTIONS

–The former EPS businesses are expected to benefit from the recent acquisitions of Firth Rixon, Tital and RTI International as well as internal growth;

–LME Aluminum prices remain fairly flat over the next 24 months as new capacity is added at the low end of the cost curve;

–Dis-synergies and make-whole premiums associated with the transactions are modest;

–Cash and pension obligations will be apportioned in consideration of the Alcoa’s rating targets;

–Free cash flow (FCF) generation will remain a goal of each company;

–There will be no shareholder distributions solely as a result of the transaction.

The UC had a very strong 2014 which weakened thereafter on lower aluminum prices. Alcoa has significantly restructured this business to lower costs as well as reduce exposure to the LME price, but aluminum price is a key determinant of earnings. Fitch believes FFO gross leverage of 3x and below is consistent with a strong non-investment-grade rating.

Fitch believes the VAC has more consistent margins and lower commodity price risk. Fitch believes FFO gross leverage of 2.5x-2.75x is consistent with an investment-grade rating for this entity.

COMPANY PROFILE

Earnings and cash flow benefit from Alcoa’s leading positions in aluminum, key aerospace, automotive and construction markets, strong control of costs and spending, and the flexibility afforded by the scope of its operations. The UC benefits from being vertically integrated and geographically diversified. The VAC benefits from scale in research and development, past restructuring efforts, and growing end-market demand.

RATING SENSITIVITIES

The Rating Watch Positive will be addressed when the VAC capital structure is known.

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

–FFO adjusted net leverage expected to be sustainably above 3x and FCF negative in the amount of $200 million or more on average.

POSITIVE: Future developments that may lead to a positive rating action include:

–FFO adjusted net leverage at the issuer expected to be sustainably under 2.5x-2.75x, and FCF positive on average.

–EBIT margins of at least 8% on average.

LIQUIDITY

At June 30, 2015, the $4 billion revolver maturing July 25, 2019 was fully available and cash on hand was $1.3 billion. The revolver has a covenant that limits consolidated indebtedness to 150% of consolidated net worth.

As of Dec. 31, 2014, near-term scheduled debt maturities were: $29 million in 2015, $28 million in 2016, $767 million in 2017, $1 billion in 2018, and $772 million in 2019.

PENSION CONTRIBUTIONS

According to the company’s form 10K, at Dec. 31, 2014, aggregate pension plans were underfunded by $3.3 billion, with U.S. pension plans underfunded by $2.7 billion on a U.S. GAAP basis. While funding was 75% on a GAAP basis, management announced that it is 90%+ funded on an ERISA basis. The minimum required contribution to pension plans is estimated to be $485 million in 2015. Management intends to apportion the obligations and assets according to the entity where the associated employees/retiree worked.

Fitch has placed the following ratings on Rating Watch Positive:

–Issuer Default Rating (IDR) at ‘BB+’;

–Senior notes at ‘BB+’;

–$4 billion revolving credit facility at ‘BB+’;

–Series A preferred stock at ‘BB-‘;

–Series B preferred stock at ‘B+’;

–Short-term IDR at ‘B’;

–Commercial paper at ‘B’.

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

Applicable Criteria

Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=991595

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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Fitch Ratings
Primary Analyst:
Monica M. Bonar, +1-212-908-0579
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst:
Gregory Fodell, +1-312-368-3117
Associate Director
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Megan Neuburger, +1-212-908-0501
Managing Director
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