VIDEO Sometimes geopolitical events can help shape an investment thesis. International policy, especially with regard to trade, can create opportunities to purchase companies who are likely to see improved results. Alcoa Corporation is one of those opportunities. ( AA - Free Report) The financial news lately has been dominated by stories about global trade, tariffs and the prospect of a trade war. In March, President Trump imposed a 25% tariff on imported steel and 10% on imported aluminum. Canada, Mexico and the European union were granted temporary exemptions. Later in 2018, the Trump administration rescinded those exemptions and officially imposed those tariffs on steel and aluminum imported to the U.S. from Canada, Mexico and the E.U. China and the E.U initiated official complaints to the World Trade Organization regarding the tariffs, which they deem a violation of WTO rules. Trump claims the tariffs are allowed as they have a national security purpose. China, Canada and the EU have responded with retaliatory tariffs of their own on American-made goods. While the situation in North America and with the EU seem to be working slowly toward a resolution, in a widely anticipated move, the Trump administration announced last week that it would be imposing tariffs on an additional $200B worth of Chinese imports. The tariffs went into effect on September 24 th starting at 10% and will rise to 25% on January 1 st, 2019, presumably to mitigate their impact on holiday shoppers in the U.S. who are purchasing Chinese imports. Approximately half of all Chinese goods imported into the U.S. are now subject to some tariffs and the president made it clear that he was prepared to impose tariffs on an additional $267 billion worth of imports - which would mean virtually all Chinese goods would be subject to some tariffs. He specifically mentioned that any perceived effort on the part of the Chinese to target the American Farming or Manufacturing industries would be grounds for the imposition of additional rounds of tariffs. One criticism of Trump’s trade policy is that the imposition of tariffs essentially picks “winners” and “losers.” As an investor, it’s important to take note of the fact that there are in fact winners. It’s only common sense to seek out investment opportunities in companies that are poised to benefit. Acquiring Pricing Power Producers whose finished goods are the subject of protection in various jurisdictions can now operate with reduced foreign competition and/or raise prices so that they are commensurate with the more expensive tariff-inflated products. U.S. companies who rely on steel and aluminum have reported increased costs for raw materials even when they don’t rely on imports because of these price increases from domestic suppliers. In their most recent quarterly presentation, Alcoa reported an increase in primary aluminum prices of 6% over Q1 2018 and 19% over Q2 2017.
The higher prices realized resulted in a big earnings beat as the company netted $1.52/share versus a Zacks Consensus Estimate of $1.33/share. Several recent upward revisions have resulted in full year estimates of $4.22/share - a 40% increase over 2017. AA is a Zacks rank #1 (Strong Buy). Increased Capacity is Within Reach Alcoa specifically addressed the issue of restarting shuttered plants in direct response to the effects of tariffs on global supply and prices. If the tariffs stay in place for a long period of time, Alcoa can fairly easily increase production with minimal capital expenditures. They did note however that the extra capacity that could potentially be utilized was older and less efficient and although it was not explicitly noted, that probably means that those production increases could come at a higher cost of goods sold. Wrapping it all Up Alcoa is at the center of a perfect storm – the good kind of perfect storm. U.S. manufacturing and construction are extremely healthy, creating strong demand for metals products, and tariffs on imports give the company pricing power and reduced foreign competition as they sell their products into markets that are hungry for raw materials. If the trade war drags on, Alcoa is in a perfect position to benefit from it.
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