Citi Skeptical Of Alcoa Split: Are There Benefits?

• Alcoa Inc AA has announced that it will be splitting its Value-Add and Upstream businesses into separate public companies.
• The decision is somewhat of a surprise given the company’s past statements and the current commodity environment.
• Citi fails to see the benefits to such a move, but maintains its bullish outlook for Alcoa.

Alcoa has announced that it will be splitting its business into two seperate entities by the end of 2016. This announcement comes as somewhat of a surprise to Wall Street, and Citi Research analyst Brian Yu issued a new note this week in response to the decision.

The plan
Alcoa is planning in splitting its Upstream operations and its Value-Add operations into two unique public companies. It has not yet made details on capital structure, stand-alone financials, costs and other terms available.

Follow-up call
Yu placed a follow-up call to Alcoa to gain some insight into the justification for the move. According to Alcoa management, the Value-Add business has become large enough to compete on its own, and the Upstream business is stable enough to weather the downturn in commodity markets.

Change of heart
Yu notes that Alcoa management had previously expressed concerns over the stand-alone viability of its Upstream business. He also mentions that the timing of this move is particularly surprising given the instability of the commodity environment.

Outlook
Citi is not convinced of the benefits of the move from a business perspective. “The split will likely result in higher public company costs, and Alcoa has yet to demonstrate the full earnings potential of the recent Fifth Rixson, RTI and Tital acquisitions,” Yu explains.

While the Alcoa Value-Add company will likely give investors an attractive larger-scale specialty metals alternative than smaller peers Allegheny Technologies Inc ATI, Constellium NV CSTM, Carpenter Technology Corp CRS and Kaiser Aluminum Corp KALU, Yu questions investor appetite for a stand-alone aluminum producer.

Citi maintains its Buy rating on Alcoa for now, but will be watching closely for details and potential implications of the split.
 

Disclosure: the author holds no position in the stocks mentioned.