Q3 2022 Alcoa Corp Earnings Call
[music].
Good afternoon, and welcome to the Alcoa Corporation third quarter 2022 earnings presentation and conference call. All participants will be in a listen only mode. So do you need assistance. Please signal conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions to ask a question.
And you May Press Star then one on your phone and first of all your question. Please press Star then two please note. This event is being recorded I would now like to turn the conference over to Mr. James Dwyer, Vice President of Investor Relations. Please go ahead Sir.
Thank you and good day everyone.
I'm joined today by Roy Harvey Alcoa Corporation, President and Chief Executive Officer.
William Oplinger, Executive Vice President and Chief Financial Officer.
We will take your questions after comments by Roy and Bill.
As a reminder, today's discussion will contain forward looking statements relating to future events and expectations that are subject to various assumptions and caveats factors.
Factors that may cause the company's actual results to differ materially from these statements are included in today's presentation and in our SEC filings.
In addition, we have included some non-GAAP financial measures in this presentation.
Reconciliations to the most directly comparable GAAP financial measures can be found in the appendix to today's presentation any.
Any reference in our discussion today to EBITDA means adjusted EBITDA.
Finally, as previously announced the earnings release and slide presentation are available on our website.
With that here's Roy.
Thank you, Jim and thanks to everyone for joining our call today as always we will first review the quarterly financial results, then discuss our markets and our company and finally, we'll answer questions. After we conclude our prepared remarks.
Before we get into the details however, I'd like to quickly highlight the work that we've done at Alcoa over these past several years to strengthen our company. So we can be successful through all market cycles.
We've built a much stronger foundation, our balance sheet is strong and we are well positioned to address current challenges focusing on driving improvement on items within our direct control.
We also remain future focused.
The long term fundamentals for the aluminum industry remain bright and we know that we are the company to deliver in a world where strong ESG performance is required.
Now turning to some thoughts on the quarterly results.
First and most importantly, we did not have any fatalities or life altering serious injuries in the third quarter, our commitment to safety is an unwavering priority.
On our financial results, our quarterly net loss was driven primarily by a noncash charge for pension and <unk>, coupled with the sequential decline in aluminum and aluminum prices and higher costs for energy and raw materials.
In the quarter, we continued to maintain a strong balance sheet and provided returns to our stockholders.
We finished the third quarter with a cash balance of $1 $4 billion after paying cash dividends of $18 million and repurchasing $150 million of stock.
We completed another pension annuity purchase which transferred approximately $1 billion in pension obligations and related assets.
Next we're continuing to take actions on our operating levels. Russia's war against Ukraine has created uncertainty and a significant energy crisis, which has impacts globally, but it's most acutely seen in Europe . This situation was also having dramatic knock on effects for the global aluminum industry, which.
Requires a reliable and affordable energy.
While our company has limited overall exposure to spot energy costs two of our plants in Europe experienced significant losses in the quarter driven by the volatility in the European energy market.
Our list of plant in southern Norway is our smallest smelter and in September we curtailed a third of its 94000 metric tons of annual capacity to mitigate spiking electricity costs. We have however put in place a new fixed price contract that is expected to improve the situation as we move forward beginning in the fourth quarter.
But this year the.
The other challenges that are sounds a pretty on alumina refinery in Spain cost for natural gas had been exorbitant and remain volatile in the third quarter, we reduced production to 50% of the site capacity.
In other operational adjustments, we continued to progress on the full restart at the hour Mark smelter in Brazil, and on the restart of some modest capacity at the Portland aluminum joint venture in Australia for those sites, we have competitive medium to long term energy agreements also the power Alley Omar will be fully renewable.
And we're working to boost the percentages of renewables for the Australia smelter.
From an innovation perspective, we announced last month, a new high performance alloy for the builder market that has advantages for a wide range of markets, including high demanding structural applications in the automotive and construction industries.
And from a sustainability standpoint, we are proud to now see all our Brazilian locations certified to the aluminum stewardship initiatives performance standards with the addition of our post what you called a site, which includes bauxite mining alumina refining and aluminum casting.
Finally, we remain bullish on aluminum long term fundamentals, while the industry has certainly seen challenges in the short term. We continue to believe the future of our commodity is bright as energy scarcity and de carbonization goals are expected to positively influence the aluminum industry fundamentals and in this context I'll call.
As history and focus on our portfolio, our R&D programs and sustainability credentials can help us realize greater shareholder value.
For now, though let me turn it over to Bill to walk through our third quarter numbers. So let's go ahead.
Thanks, Roy the results for the quarter or a net loss of $746 million or $4.17 per share special items in the quarter totaled $686 million with 629 million in noncash charges related to the 1 billion dollar U S pension and <unk>.
Card in August .
Other special items include the Mark to market of energy contracts and the closure of our long curtailed magnesium smelter in Eddy Washington.
Third quarter, 2022 revenues declined $793 million to $2 $85 billion on lower aluminum and alumina prices.
Lower revenues translated into EBITDA of $210 million $703 million lower than the prior period.
Adjusted net loss was $60 million and diluted loss per share was 33 cents per share.
Let's take a closer look at the sequential change in EBITDA.
When comparing the third quarter EBITDA to the second quarter, the largest driver was $516 million of lower metal and alumina prices, followed by higher energy and raw material cost of $126 million.
These factors combined for $642 million of the $703 million EBITDA decline.
The other category consists of the volume and cost impacts on the intersegment eliminations and the net of various nonrecurring items, primarily in the alumina segment in both the second and third quarters.
In the segments bauxite improved $10 million on higher intercompany pricing and better volume, partially offset by lower unfavorable mix of contracts that CPG and higher production costs.
In the alumina segment, the $274 million EBITDA decline was due to lower index prices.
Our production cost higher gas prices at San <unk>, and higher caustic prices, partially offset by benefits of the <unk> brand refinery production production.
The largest EBITDA decline was in aluminum $444 million due primarily to lower metal prices and the inability of production cost improvements to fully offset higher energy costs.
Higher carbon costs and slightly weaker from value added pricing.
Below the segment level other corporate expense reductions more than offset slightly higher transformation and intersegment elimination impacts.
Let's take a deeper dive into raw materials costs.
The cost of major raw materials increased substantially in the third quarter in both the alumina and aluminum segments when converted to a percentage of our selling price costs for carbon materials used in the smelters has averaged 12% for the 2017 to 2021 five year period in.
In the third quarter costs increased to 18% the difference between carbon costs being at a five year average versus the third quarter of percentage was an unfavorable impact of approximately $100 million in the quarter.
Likewise caustic costs had run about 9% of the alumina selling price over the prior five years.
Third quarter 2022, caustic costs in the alumina segment rose approximately 60% compared to the five year average to 15%.
That impact was approximately $75 million in the third quarter.
Overtime, we expect carbon in caustic costs as a percentage of sales price to normalize and revert to the mean.
Let's move on to the balance sheet and capital returns.
We returned $168 million of capital in the third quarter $150 million of share repurchases and $18 million of quarterly dividends.
Year to date capital returns totaled $555 million and year to date return on equity is 25, 9%.
The balance sheet remains strong with a $1 $4 billion cash balance and proportional adjusted net debt of $1 3 billion.
Days working capital did increase in the quarter to 50 days on lower revenues, even though working capital itself declined $143 million.
Free cash flow less noncontrolling interest distributions was essentially breakeven in the quarter.
Turning to cash flow.
The third quarter cash balance declined $206 million sequentially to $1 $4 billion, primarily due to capital returns to stockholders of $168 million EBITDA and releases of working capital funded capital expenditures cash income taxes rehabilitation spending in <unk>.
Other cash uses.
On a year to date basis, our largest use of cash remains increased working capital closely followed by returning capital to stockholders cash income taxes and capital expenditures.
For the fourth quarter, we expect working capital to continue its recent trend of being a source of cash.
Now for the outlook for the remainder of the year.
We are refining our full year 2022 outlook, starting with shipments as a result of the lower operating rate at San <unk> refinery and lower than expected, Australia and refinery production. We are lowering our full year bauxite shipments 1 million tons to a range of 43 to 44 million tonnes and <unk>.
Moving alumina shipments lower by one 5 million tonnes to 13, one to $13 3 million tonnes.
The aluminum shipments outlook remains unchanged.
There are several improvements versus prior projections totaling $40 million expected on a full year income statements.
In EBITDA, we expect transformation expenses to improved $5 million and other corporate expenses to improve $10 million.
Below the EBITDA line, we expect depreciation to approved $20 million and nonoperating pension and <unk> expense to improve $5 million.
For full year cash impacts, we expect environmental and Aro payments to improved $15 million to $140 million.
For the fourth quarter, excluding index sales prices or currency impacts, we expect improvement in many areas.
In bauxite, we expect adjusted EBITDA to improve approximately $5 billion on higher third party shipments.
In alumina, we expect approximately $20 million and lower energy cost at the San <unk> refinery.
Additionally, we expect the benefits of the sand separate curtailment to offset the impact of lower bauxite quality in Australia, and higher raw material costs.
In the aluminum segment, we expect alumina costs to be favorable by $30 million also higher raw material costs lower warrant power plant sales and lower value added product premiums are expected to be offset by lower energy costs at Lister.
Further due to rapid metal price changes at the end of the third quarter and inventory adjustments made to net realizable value. We expect EBITDA in the fourth quarter to be $40 million higher than calculated using prorated annual metal sensitivities.
In addition, there is a potential negative impact from government action. The Norwegian government has issued a budget proposal that limit C. O two compensation to be paid in 2023 based on 2022 power purchase if the proposal is approved the unfavorable sequential EBITDA impact in the fourth quarter would be approximately $35 million.
As we reversed this accrued benefits.
Finally, a word on taxes based on recent pricing the company expects fourth quarter 22 operational tax expense to be approximately 50 million to $60 million now I'll turn it back to Roy.
Thanks Bill.
I'd like to start my comments by focusing on the long term fundamentals of our markets. While the world is currently in a period of heightened uncertainty.
Look for our industry remains very positive and this view isn't merely supported by the fact that year over year demand is consistently increasing that's been the case for more than a decade, rather I'd like to highlight the structural changes driven by evolving energy markets on both the demand and supply sides of our industry.
Both the source and cost of energy suppliers helped determine whether a facility can compete economically renewable energy provides a further differentiation through lower carbon emissions still de carbonization is not just a facet of energy sourcing and therefore aluminum production, but it is also embedded in that.
Choices of our customers and ultimately for their final consumers.
For example, one tactic to reduce carbon emissions is to reduce vehicle weight by replacing heavier metals with lightweight aluminum, especially during the transition from internal combustion engines to electric vehicles on the left hand side of this slide you'll see that the amount of aluminum in passenger vehicles in North America. As one example is.
<unk> to increase by nearly 25% by 2030 using 2020 is the baseline.
This change is primarily driven by the transition to electric vehicles, which on average contained 40% more aluminum in vehicles powered by internal combustion engines.
Another important end use market for aluminum is packaging demand in that sector is expected to increase steadily and consistently aluminum into sustainable choice for packaging due to its recyclability, it's low weight and a format that makes it easier to ship all of which helps reduce emissions.
Next both the generation and transmission of solar and wind power will require more aluminum than other forms of energy such as thermal and hydro nuclear solar generation. For example requires approximately 13 metric tons of aluminum per megawatt of generating capacity compared to coal that.
Only requires about one metric ton.
While these examples are meant to illustrate my point they demonstrate the demand for our commodities should continue to grow long into the future and is positively supported by de carbonization and the trend toward renewable energy.
Now moving to the right hand side of the slide to reduce their carbon footprints. We are continuing to see aluminum producers move to renewable power and away from coal, which is still the predominant source of energy in the global aluminum industry today.
<unk> energy sources as we know are constrained by availability posing a limit for capacity to grow in the future of the 15 million metric tons of new primary smelting capacity that we believe is required by 2030, only 6 million metric tons are currently expected to be sourced with renewable energy.
This is one area, where alcoa is already a standout 81% of our global smelting portfolio was powered by renewables, mostly hydro and some wind and we're continuing to work on boosting that percentage in the years ahead.
Finally energy is also affecting the amount of aluminum produced today's aluminum market has been significantly impacted by the European energy crisis, which is rooted in Russia's invasion of Ukraine due to the increased power cost in Europe . It has been reported that more than 1 million metric tons of aluminum production have.
Been taken offline with another 1 million metric tons under threat.
The combination of increased uncertainty weakening European demand in the global energy market distortions created by the ongoing Russian aggression in Ukraine demonstrate how quickly our energy markets and therefore, the aluminum industry can be impacted.
In March of this year, our company made the proactive decision to cease buying raw materials from we're selling our products to Russian businesses that had an adverse financial impact on our business, but it was the right decision to make and now we are seeing an increasing number of customers implement this same policy.
We believe governments should consider sanctions on Russia metal as the distortions in the energy market can be directly linked to the invasion of Ukraine and in the meantime, Russian companies continued to produce and sell their metal, while north American and European producers are curtailing smelters amidst declining aluminum prices skyrocketing entered.
<unk> costs and supply chain issues.
Thus, we believe urgent action is necessary on the us and its allies.
Now, let us take a closer look at what is happening in our industry. Today. We're again energy is the key driver.
The fundamental difference in this downturn is that it is being driven by an energy crisis centered in Europe and thus its first impact has been to electricity intensive industries, such as aluminum smelters and thus what we see today as an industry with significant supply challenges followed by impacts to aluminum demand is downstream costs continue to inflate.
Significant uncertainty weighs on economic growth.
The chart shows data on historical trends for aluminum supply and demand, including days of consumption for inventories held in warehouses.
The data illustrate the uniqueness of this energy driven downturn during the global financial crisis in 2008, and the COVID-19 pandemic in 2020 sharp downturns and global demand drove significant increases in inventories and sharp declines in the price of aluminum products I.
I would note here that we have seen significant delivery of metal to <unk> warehouses over these last few days, we believe that this metal represents material that was already held in global inventories and is thus more representative of a shuffle between inventories rather than simple overproduction anecdotally, we continue to see.
Strength in demand for most of our value add products in North America, and Europe , while noting uncertainty in demand for some products, particularly for billet and Europe . These.
These factors help to explain the environment, where we find ourselves raw material and energy prices are at historic highs while prices have notched downwards based on continuing uncertainty. We can further illustrate the situation by examining global cost positions for Chinese smelting capacity that is operating we believe that between 'twenty.
30% is operating on a cash negative basis in the rest of the world between 45% to 55% of aluminum production is currently operating under water.
In alumina the percentage of refineries operating on a cash negative basis is less than what we're seeing in metal, but still significant in.
In China, approximately 25% to 35% of refineries are operating at a loss and the rest of the world as lower ranging from 10% to 20% operating on a cash negative basis.
Now, let's talk about our specific impacts focused on two locations and what we're doing to address the challenges.
In 2021 energy comprised approximately 27% of our company's total alumina refining costs in aluminum smelting electricity costs were approximately 31% of the total cost of production company wide. Our two greatest areas of exposure to spot energy prices or the list of smelter Amazon's debris on.
Minnery both in Europe .
Let's start first with our smelter in southern Norway, while our company overall only has about 5% of our smelting portfolio exposed to spot energy prices. This smelter represented approximately 65% of this spot exposure in the third quarter. In fact, we had some periods when we were paying as much as 600.
Dollars per megawatt hour and the site lost $47 million in EBIDTA in the third quarter.
In August we made the decision to curtail one of the sites three potline to mitigate the high cost of energy Importantly, we also negotiated an agreement with our power utility to provide more predictable energy costs throughout the remainder of the year and into 2023, we expect the site to see significant improvements in the <unk>.
<unk> fourth quarter as a result, and we are continuing to monitor the situation.
Next let's turn to the <unk> refinery in January of this year, one on San <unk>, two natural gas suppliers terminated its contract that supplied approximately 50% of the refineries in natural gas demand until June 2022, and 25% from July to December of this year.
While we've been negotiating new contracts, we've been exposed to spot rates since February .
The cost of natural gas in Spain have been exorbitant into third quarter, we began to cut our production at this facility. So we'd use less gas and avoid these high costs at the end of the quarter. We had adjusted production to approximately 50% of the site $1 6 million metric tons of annual capacity.
However, gas prices continue to escalate eroding the savings from reduced production.
In the third quarter this answer pretty on refinery lost $69 million in EBITDA due to these conditions.
The high volatility for gas cost in Spain makes future estimates difficult to predict we are actively reviewing the locations operating levels and commercial options, including considering further adjustments to production as well as evaluating options for support we will continue to look at ways to improve the cost structure at <unk>.
Both facilities.
Let me now discuss some other items that we're working to improve in our global smelting portfolio, we're continuing to address our overall capacity, including progressing with restarting previously idle capacity at two sites in Brazil, We continued to add new parts of the operations of the al <unk> joint venture.
Where the restart continues to progress all cause fully owned subsidiary in Brazil owns 60% of the RMR smelter or 268000 metric tons with the remaining percentage belonging to <unk> 32, we expect most of the smelter capacity to be operational by the end of the first quarter of 2023.
Separately in the United States on July 1st we safely curtailed one of the three operating smelting lines at our work facility, we experienced staffing shortages the smelter and the decision to curtail one line allowed us to focus on stability for the two remaining operating lines.
In Spain, we have now reached two agreements for wind power that would support 75% of the energy needs for the restart of the <unk> smelter. We reached an agreement in 2021 to curtail the smelter until early 2024 to work on a plan to develop an energy solution, which will depend on a V.
Buyable, Spanish energy framework, and a permitting process for the wind farms. It's good to see continued progress on this solution, but there is still much work to be done.
Next turning to the right hand of this slide in Australia. We are now implementing plans to improve the performance in our refinery system. So we can recover from lower volumes that were due to unplanned outages and maintenance, we are bringing a renewed focus on system wide performance, including our people processes and equipment from our <unk>.
People perspective, we're actively working to effectively manage the impacts of accelerated employee turnover due to higher than historical levels of attrition and retirement.
And our processes, we are working to redeploy maintenance and operating strategies for all equipment and make our reliability excellence program, even more friendly to users. So it can support a system that includes visible and relevant metrics, which are tracked with clear trigger levels for escalation.
Also we're working to address the challenges from lower grades of bauxite delivered from our co located mines.
<unk> ability and bauxite grades requires processing higher mud and sand loads and removing higher levels of impurities, resulting in lower production volumes and higher costs.
While we have a focused effort and a clear understanding of the drivers for improvement it will take some time to restore stable operating performance a full system capabilities.
Moving on to the next item in July we announced our return seeking capital project to increase cost and capabilities that our nation, both smelter in Canada.
That new England production line will meet needs for value add products, such as foundry alloys and is expected to be completed in the first quarter of 2023.
Looking towards the future we have numerous initiatives that support our strategic priority to advance sustainably and our vision to reinvent the aluminum industry. We've now added all of our locations in Brazil to the rigorous certification process from the aluminum stewardship initiative, which is the most comprehensive in the industry.
Last month, we also introduced our new extra strong alloy that is intended for the lightweight and high strength applications that use buildup.
We also received recognition last month for an existing alloy that is gaining traction in one piece castings known as Mega four giga castings for the automotive market.
Most of the worlds aluminum alloys were first developed by Alcoa, and we have decades of metallurgy and engineering leadership to help our customers solve challenges, including developing light weighting solutions for electric vehicles.
In closing today I want to quickly reiterate a few important items our balance sheet is solid our proportional net debt is low and we finished the quarter with $1 4 billion of cash on hand.
This quarter. We also continued to provide capital returns to our stockholders in the form of a quarterly dividend and completed stock purchases.
As we move forward, our three segments remained well positioned on a cost basis, and we are addressing operational improvements across our system, including INR, Australia refining system.
We are working to deliver today as we prepare for tomorrow, including realizing our vision to reinvent the aluminum industry for a sustainable future. We have a robust technology roadmap of breakthrough R&D projects that have the potential to decarbonize, the aluminum industry and differentiate alcoa.
We're proud of the existing innovation and problem solving that we bring every day to our customers, including the industry's most comprehensive portfolio of low carbon products and our sustained alone.
Now Bill and I look forward to taking your questions.
Operator, do we have on the line.
We will now begin the question and answer session to ask a question you May Press Star then one on your phone if you're using a speakerphone. Please pick up your handset before pressing the keys.
To withdraw your question. Please press Star then two when called upon please limit yourself to two questions and our first question will come from Carlos <unk> with Morgan Stanley . Please go ahead.
Thank you very much.
For the for my questions. The first one would be I.
Maybe ray or a BLA, who can clarify a little bit more of the situation in Norway.
In terms of the the government trying to pass a proposal to change the carbon dioxide compensation.
Is this something that requires.
Approval by by Congress, or it's just that the government decision.
These are when do you expect a decision to be to be announced and you.
What what is behind D. C is this something that could be just temporary and potentially reverse later on or something that you envision.
That is here to stay.
And then second in terms of that.
They share buybacks and returning money to shareholders and clearly the company has been focusing on that as of late but given the challenging conditions at the company and the industry are facing and how do you see the the share buybacks going forward.
Thank you thanks.
Thanks, Carlos it's still and let me address I'll address both of those.
The the the Norwegian government.
<unk> that we referenced is that there is a draft Norwegian budget out there that eliminates indirect sidoti compensation for the first 200 knock per ton of carbon so up to that 200 dollar I'm, sorry up to that 200 Nokia level.
They will no longer cover that indirect compensation. So during the course of this year, we had been accruing a benefit of $25 million.
Would accrue an additional benefit in the fourth quarter of 10.
So in in the fourth quarter will have a negative impact of $35 million.
And our results if that were to come to pass.
We're in the process of tracking it and we'll keep we'll keep you posted on whether that happens or not and I'm not going to speculate on whether that would go into future years. It appears that it probably would as you know that puts pressure on motion, but probably more so puts pressure on list. A list is a high cost facility with the <unk>.
<unk> situation, where it's at and it would be an incremental $12 million to $13 million of cost per year unlisted. So that puts us puts a lot of pressure on list us. So we'll keep you in the loop when we learned more about that.
Regarding share buybacks.
As you saw we did a $150 million of share buybacks in the third quarter I think we've done around $550 million year to date.
At this point there is a lot of uncertainty in our markets and a lot of geopolitical uncertainty in the world. So we will continue to evaluate the capital distributions and we will make our decisions based on cash flow and at how strong the markets are so.
That's our that's where we stand.
Alright excellent. Thank you and good luck with the quarter guys.
Carlos.
The next question will come from Lucas pipes with B Riley Securities. Please go ahead.
Hey, good afternoon, everyone.
So so that the sticky costs for power and carbon are intuitive in this environment, but obviously costs for caustic soda and some of the alloy materials have also remained really elevated and I wonder if you could comment on what is causing these costs to be to be so sticky I would really appreciate your perspective on this.
Okay.
Well I think it varies Lucas by individual cost item the carbon costs are largely related with oil prices.
And as oil goes typically the carbon prices will go also caustic is much more complex given the fact that.
There are a number of different products that come out of the atom.
For caustic so.
For us in particular as we look forward, we're anticipating that.
Carbon costs.
We buy it are starting to peak and actually go down in the fourth quarter.
But caustic prices continue to be stubbornly high now when you look at that on a lagged basis as it flows through our cost of goods sold were anticipating around $25 $28 million or higher.
Raw material costs in the fourth quarter, that's built into the guidance that we've provided so that's not on top of the guidance that we've provided.
But that's based on the fact that we continue to have lagged cost, but we start are starting to see carbon peak out and.
Projecting for it to go down in the future cost sector remained stubbornly high.
On the alloy materials I think that's also in the aluminum segment about 3% higher of your total costs year on year.
Alloying materials have gone up over time, but.
They they will very just very much like you see <unk> prices vary and so we've started to see some of the alloy costs come come down a good deal of that ends up getting passed through to our customers and positively and negatively.
They get it gets pass through one way or another to the customers.
That's helpful. Thank you and then.
Quick second question on list, that's the power solution.
Cover two thirds of capacity that is currently operating on with wood.
You consider.
Turning to full nameplate and then with this power solution.
Get the smelter to be EBITDA neutral from the loss in the third quarter. Thanks. Thank you very much.
Yeah. So let me, let me field that one Lucas so so first and foremost the contract the contract that we have for energy for the fourth quarter and then all of 2023 covers the full consumption of the of the facility or the remainder of the remainder of the consumption of the facility that was exposed to spot.
So that gives us the flexibility to move back up to full production.
If and when we choose to do that and of course that ends up being a decision about what's happening with market factors what were seeing on an aluminum from.
From an aluminum basis for our regional premiums as well as demand.
And then what the rest of the input costs are going to look like so that that program. The decision to move forward to fix those costs was designed to continue to make Lister an EBITDA positive contributor to our bottom line.
But I have to put a caveat in there.
Which we have to understand that with raw material prices as high as they are in aluminum prices also slipping.
That calculation can be different and we have the option to be able to move to a curtailment, if we need to as part of the as part of a contract that we have and as always and I know, we always get this question, but we look across our portfolio with particularly at those highest cost plant to determine what is the best outcome. What is the right thing to do for us.
Protect the plant to think about the short medium and long terms and then and then to act decisively when we make decisions.
That's very helpful. I appreciate the color and best of luck. Thanks.
Thanks Luca.
The next question will come from Timna Tanners with Wolfe Research. Please go ahead.
Hey, good afternoon guys.
Kevin.
I wanted to get your perspective on the Midwest premium declines just any thoughts there and also on the <unk>.
If there are lots of materials and that allowed us not just ship to China, and China ship sit out again or is there something I'm missing on that.
<unk>.
So let me hit your first question Midwest premium. So that's a it's hard to give you a concise and decisive answer about what's going on.
Of course, and you'll know that part of it is because there is a duty paid and duty unpaid now part of it is related to the the underlying price of Ele me and so lets take that for a given and set up to the side.
The other piece of course has to do with the dynamics around what is being imported are shipped into the United States. When that is in fact, arriving.
And then what are the what are the different customer demands and requirements that that you see associated with that and so it's an and.
Then sort of the third category to put it is that their sentiment too. There's also a forward looking view about what what people think as far as what supply and demand will be for those specific products and for commodity grade material inside the United States.
So all that comes together to have put into place a good amount of pressure on the Midwest premium.
Of course that will also depend on what happens.
And what happens with further Russian metal coming into your out of states and the decision that the U S government might take about applying sanctions.
We said in our prepared comments, we support sanctions and believe it just makes intuitive sense that no more Russian metal should be coming into the United States.
I think it also depends on relative premiums in the U S versus in Europe . So there is a direct connection Europe and elsewhere of course, but most importantly for Europe Theres, a direct connection and that as those two markets change metal might be falling from one place to the other with a lag and so you can also see some lag effects happen is.
Shipments might be coming in overseas.
Tim the can you repeat your second question, because I was out of Russian metal and whether and whether it can just simply go through China and then.
And.
In the warehouse yeah. So I mean, that's it's certainly an important question and I think the answer probably is yes, there's lots of ways to get around to.
To get around.
What might be sanctioned in one country versus the number of countries theres ways to also get around.
Whatever might happen as far as the <unk> separate process to think about what theyre going to do as far as as.
As far as the ability for Russian metal to be send back into the warehouse.
So there's always ways to try and move that around its why we sort of when we looked at the broader ratio. We tried to simplify it into a position for Alcoa I'm in a position that we can lobby floor with the U S and with Europe for example.
And believe it the simple solution is simply to follow what we did really back at the beginning of the year, which was simply to say it doesn't make sense for us to be buying or selling to Russian entities and so for us. It just makes it just makes sense that we moved to a sanction regime, given what's happening in Ukraine, right now and the knock on impact of that.
It's happening across the world.
When we look at the when we look at the fact, how difficult. It is right now and we can see this in lifting the ban how difficult. It is to operate inside of Europe . We've also seen the same the same type of knock on impact from inside the United States.
It doesn't make sense that Russia continues to produce and sell without any kind of sanctions regime on that and so for us.
That is the easiest solution to be able to try and to try and bring a little bit of sensibility to this market.
And to try and build that sanctions regime in such a way that we're also ensuring that there is no <unk>.
Heating more games being played with trying to bring China, and Russia and metal into a different to a different a different entry point.
And of course, the flows of metal around the world are it can change with time and I think we've already seen that for aluminum going into Russia, and middle already coming out of Russia.
But at the same time, unless you take that first and common sense step youll never start to have any kind of any kind of impact.
Yeah.
No I appreciate that.
Snacking too, but if I could just have one more to follow up on your additional business considerations I just want to make sure I understand that some.
The comment here about that 40 million higher than calculated using prorated annual metal sensitivity cepheid.
And just you know that the sensitivities that you gave at I'm coming up with like today's price like 150 million Delta Q1 over Q3, Q4, and then you would add back 40 million because of <unk>.
Different factors because of the rapid changes in the commodity price is that the way that we should do the math, yes, largely timna.
Thanks for the question and let me just take a moment to run through the additional business considerations because theres a lot. There. So I think it's important to clarify it.
Your your summary is right.
Use the annual sensitivities and then add back $40 million, there's really two reasons for that one as we recorded about $20 million of net realizable value declines in our in the third quarter and then we as we look forward. We just look at the sensitivities and sometimes they don't annual sensitivities don't.
Lately predict the quarter and Thats why we gave you the $40 million there. The other thing to consider in the aluminum space that we think are alumina will be $30 million improvement.
Over the.
In the fourth quarter and the rest in the aluminum space is pretty flat it it comes out to to offset the other.
These items, so higher raw material costs lower work power plant sales.
But product premiums that all nets out to about a about zero once you factor in the benefit from Leicester.
So that's the that's the aluminum segment alumina, we expect to be about $20 million better in bauxite, we expect to be $5 million better so the guidance itself.
Once you've baked in the current metal prices current currencies the performance guidance is actually pretty strong.
Thank you.
Thank you.
Yeah.
The next question will come from Emily Chang with Goldman Sachs. Please go ahead.
Good afternoon, Roy and Bill and thanks for taking my questions Mike.
My first one is just around energy costs and coming back to those business considerations I wanted to focus on the alumina segment.
Looks like there's about a 20 million dollar improvement quarter over quarter on on sort of an improved energy prices for Purion could you, perhaps shed some light as to what those electricity prices energy prices during the second quarter and what you also.
Calculating.
But what you are baking into to come out with that 20 ml improvement.
Oh, you know Emily.
<unk>.
It's dangerous for me to do stuff off top my head, but.
I think the the gas price in the third quarter was something around $35 of Giga, Joule and and we're projecting that it improves in the fourth quarter based on what we know today. So that's the origin of that $20 million improvement. If I then kind of broaden out. Your question. There is there is a number of things that are going on in the <unk>.
Lumina segment, so you've got the benefit of lower energy costs in San separate but on top of that because we've curtailed stands that brand and we were losing money on every ton that we were shipping you get a positive benefit also there from the curtailment and that is what is offsetting some bauxite some lower bauxite.
Alrighty issues in Australia, and the higher raw material costs that I think I alluded to in the answer to Lucas's question around caustic costs. So in net the alumina segment should be $20 million better with energy costs being better and then everything else nets out to flat to zero.
Great.
And then my follow up is just around capital allocation I know you've touched on the capital return piece, but maybe quickly if you could touch on the balance sheet, our pensions and perhaps even early 2023 capex expectations. I know there was some place to sequentially increase 23 vessels 22, I think was the guidance.
The last analyst day, but any early look that would be helpful.
So we have an update at the capital look since the last time, we haven't updated it externally since the last time, we showed it at the analyst day and my recollection is that sustaining capital for 2023 was going to be around $550 million return seeking capital was going to be about $100 million. So up from the $4 50 and 75 from.
From this year.
As far as capital allocation goes.
And the balance sheet, we ended the quarter with a cash balance of $1 $4 billion. We a proportional net debt of I believe around $1 $3 billion. The pension the pensions globally are in much much better shape in the U S. For instance, with the raising discount rate are there there are over 100% fund.
So we don't have significant cash contributions over the next few years for the pension we have the ongoing cash contribution associated with <unk>.
But that's in the neighborhood of $50 million to $60 million and then we don't have any material.
Debt is coming due.
Until 2027, so over the next few years the balance sheets in great shape and will serve us well throughout the throughout the business cycles.
Great. Thanks, Bill Thanks, Roy Thanks Emily.
Yes.
Again, if you have a question. Please press Star then one our next question will come from Lawson Winder with Bank of America Securities. Please go ahead.
Hello, gentlemen, good evening and thank you for the update if I could just.
Sorry to push push deeper on the capital allocation and the buyback and maybe understand.
How do you think about that cash flow and what drives the buybacks. So so with the context that in Q3 your free cash flow was about $6 million. After after total capex.
Add back $150 million a.
Of shares or are you just kind of looking at working capital return in more of the driver as opposed to a free cash flow.
Well in the case of the third quarter.
Third quarter, we added entered the quarter with a very strong cash balance and we've been pretty clear with our capital allocation framework that we will maintain a strong balance sheet today, we have an investment grade balance sheet for the first time ever.
And we will sustain the operations through the sustaining capital and then after we've done that.
We have three potential uses the first and not necessarily in rank order, but the first is returning cash to shareholders.
The second is positioning for growth in the future and the third is repositioning the portfolio.
And so specifically around the third quarter loss and it was we had excess cash we did not have uses that would create significant value.
And therefore, we returned to cash to shareholders.
Okay. Thank you for that additional color and then if I could maybe asking about the.
Palomar smelter restart there.
So I mean, you took the decision to restart that about a year ago and there was a lot of reasons driving that and I just wanted to follow up and see if the reasons driving the restart still held today.
Some of the things you mentioned like a stronger market.
FX, which is which has now gone the other way.
Yeah, I mean, so does the restart of LMR still makes sense in the current.
Aluminum price environment. Thank you.
Yeah. It's a good question and of course, we always go back and look and try to understand the decisions that we make and try and learn from them.
<unk> as you as you started to say there is therefore, a bunch of decisions are a bunch of.
A bunch of circumstances that led us to that decision a strong local market.
A the availability of a renewables based and low cost energy contract.
Which in turn helped us ensure that that is in the bottom half of the cost curve and so that means it's a very competitive plant.
It's a modern technology, and so and I actually worked at that facility and it's a it's a very it's a good technology and we have a very good available workforce to be able to run it well and you would be surprised.
Rise how important that is in today's in today's day and age it's become more and more important.
And then there are some other more financial considerations, which are what do premiums look like in the area. How much can we actually be able to sell domestically versus having to export how much can we turn into value added products.
And then we also had a series of of.
Oh tax et cetera.
Credit monitor that.
In order to monetize we have had to have domestic sales. So all of those things of course, the aluminum prices have changed and so they are a little bit different than when we made that decision, but all of these other pieces actually support that as being a very smart decision.
Difficult to bring up a plant that is coming up after a number of years being curtailed, but again. The advantage here is that we've got a workforce that knows how to do it and we've actually been able to upskill and upgrade and have a great number of people come back working for US we're making good progress on on seeing that smelter come back to life again, it's.
It's complicated because of the availability of resources and getting the essentially the raw materials at the qualities that we want.
But in the end, it's going to be a great plant I truly believe it's going to be a great investment and it's going to be a great investment because its low on the cost curve.
Okay. Thank you very much for those comments.
Awesome.
The next question will come from Chris <unk> with Jefferies. Please go ahead.
Hey, guys. Thanks for taking my question Bill sorry to.
That's kind of a question about balance sheet and capital returns, but just kind of another way to think about it here. If you have a $1 $4 billion of cash roughly before you announced your first capital return I think the criteria was to get to a $1 billion to maintain a cash balance of at least $1 billion. So you have $1 4 billion now in the third quarter.
Capital returns came out of the balance sheet ratio of free cash flow breakeven shall.
Should we assume that you are comfortable funding capital returns with the balance sheet as long as that cash balances above a $1 billion or do you need to have free cash flow to fund. The capital returns I think you had mentioned earlier that the decision about capital returns depends on cash flow, but in the third quarter. It looks like it was balance sheet in that casual that drove the capital returns. This is Mike.
First question.
Yeah. So.
Good question and I appreciate it.
Unfortunately, there is not necessarily a binary answer between the two we want to maintain a strong balance sheet. We've historically said, we're comfortable holding $1 billion of cash on the balance sheet from time to time, we've been below a $1 billion and you didn't see us rush out to get our cash sources.
From time to time, we will be above a $1 billion and that's where we are today. So it's a combination of how much cash we have and as we look forward at the cash generation and the markets are how much cash we see coming in.
And we'll make the best decision based on those two factors so not not a single answer necessarily.
Thanks for that and then just a quick one on the on the Russian sanctions and what that might mean for the market wouldn't it be the case that commodity trading companies.
Not want to hold metal that they cannot sell to the <unk> in which case the conduit for that metal to get from Russia to China and other regions just wouldn't be there.
I think that'll be severely disruptive to the market and probably lead to that.
Very tight conditions quickly because again trading companies wanted to have readily marketable inventory and if you can't sell to the LMA, it's not readily marketable am I thinking about that correctly.
Yeah, Chris I think I think you are thinking about it correctly as much as we can try and predict what the effects could be.
I think it's already clipped so let me put what's clear to me. So far we certainly decided that we didn't want to we didn't want to either sell or buy from Russia. So that's sort of point number one point number two we've seen many companies go in that same direction.
As the calendar year turns what we're seeing are more and more people more and more customers of ours and in general people in the marketplace that are making that same decision. So the market is already starting to adapt to a world where that metal simply isn't available at an acceptable.
So if sanctions are imposed I think what happens is you see that that process accelerate and become much more black and white.
And I think when you look at the different trading companies that are out there I think youre exactly right, they're not going to want to hold on to metal that are that in the end will either be deliverable to the LMA or deliverable to most of the customers and certainly customers that are willing to pay full price or even at discounts.
So all that says and you look at some of these recent deliveries to the army warehouses and we don't have transparency into what was delivered and who delivered it and what metal it was.
By if I had one wish I'd tell you I really would like to have a lot more transparency from from the <unk> when it comes to what's being delivered because but then we could actually no.
What is the source of this more than 200000 tons that has come online over this last these last few days.
It sort of goes to show you that there is a high likelihood that people holding that metal.
Simply will not have a place for it to go if those sanctions are imposed and with some of the discussions and some of the news reports that we've seen there is certainly a lot of a lot of interest to see what the U S government and the European the European government et cetera are going to decide on that so all that to say I think you're I think you're hitting on a correctly.
Would there be a significant crunch.
Again, the market is already starting to adapt to us it's hard to predict how what's happening because of the knock on impacts on demand and with so much supply changing around the world and.
And the fact that you have 50% of your smelters in the world that are underwater at these prices.
It tells you that there is a lot of catalysts for significant changes in the market in and having the Russian metal not be able to be delivered will be just one more of those pieces that could that could have a fundamental impact.
Thank you for that I appreciate it.
Thanks, Chris.
Yeah.
Our final question will come from Lucas pipes with B Riley Securities. Please go ahead.
Thank you very much for taking my follow up question I just wanted to circle back on the on the bulk site quality issue do you have a sense for what the EBITDA impact was during the quarter sorry, if I missed it and then in terms of timing how long it might take to work through this issue. Thank you very much.
So let me address the first part of the question and Royal address the second.
In aggregate the issues that we saw in Western Australia, where about $50 million drag on earnings in the third quarter don't chalk all that up to bauxite quality, though there is there is a couple of components. There there was the.
The issues around availability of equipment and maintenance problems that Roy referenced.
That led to lower volumes out of our out of Western Australia, which is about half of that $50 million and we ended up spending more on maintenance and other things at that was about another $25 million. So the net impact was $50 million with the bauxite.
Quality being a part of that $50 million.
And Lucas to chime in on the second question or the second half of your question.
Don't think we can give you I don't think we can give you a clear answer on when do we see that.
Improved back to original condition, because that depends on a number of different factors number one.
We're in the midst of ensuring that we're optimizing the resource for the long term.
Bauxite quality changes, depending on where you are choosing to mine and how you are how you are essentially using those pits and bring them together into inventories et cetera. So there is a fundamental a fundamental variants that comes up because of the resource itself and how we choose to make sure that that resource will last us for the long term on the other side of that is also our ability to.
To operate well at the bauxite grades that we're experiencing when you have lower bauxite grades you tend to have more module that have more sand you need to be able to manage that.
Both of those things are within our control and our choices that we make and so we are in the midst of looking how can we try and how can we make sure that we're mining in the right places at the right time and getting the grade to make them predictable and on the other side. We're also doing a lot of work to make sure that we can handle those lower grades and be able to adapt them. So that we can operate more efficiently.
We.
We're putting a lot of effort into making sure that we can have more predictable results I think we've tried to build into the additional consideration in the guidance, we're giving what we expect to happen from a from an alumina segment standpoint.
We will keep Lucas, we'll keep you and we'll keep the market updated as we as we roll those changes and as we see those improvements occur I believe we have the right. The right people working on the right things I'll tell you. It is an incredibly.
Incredibly difficult time to operate anywhere but at the same time I also think we have a we have a great number of resources, both centrally and our centers of excellence, but also on site to be able to solve these problems and find ways for us to be able to better manage these issues.
I appreciate the color, thanks, again and again best of luck.
Thanks Lucas.
This concludes our question and answer session I would like to turn the conference back over to Mr. Roy Harvey for any closing remarks. Please go ahead Sir.
Thank you once again for listening to our call. We've appreciated the questions today as they work to finish the year. We will remain focused on the items that are within our control. So we can deliver today and prepare for the future.
I look forward to talking to you again in January when we will discuss our full year and fourth quarter of 2022 results.
Until then please be safe stay close to your family and friends Goodnight.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.
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