Alcoa Bonds Face Cut to Junk as Ratings Firms Await Profit Gain

NEW YORK, Apr. 23 -- Alcoa Inc. may be running out of chances to post earnings that will keep ratings companies from lowering its debt to junk, which would raise borrowing costs and reduce the largest U.S. aluminum maker's access to capital.     Following "mediocre" first-quarter results last week, ratings companies may downgrade Alcoa's debt if earnings don't improve this quarter, said Joel Levington, managing director of corporate credit for Brookfield Investment Management Inc. in New York, which handles $24 billion in assets.

"There is a very solid case for a downgrade to junk post- earnings," Levington, who was a director at Standard & Poor's from 1998 to 2006, said in an interview. He doesn't hold Alcoa bonds. "When we look ahead, we do not see a profile that we would deem worthy of investment-grade ratings for Alcoa until late 2011 or early 2012."

Alcoa was cut to the lowest investment-grade rating in February 2009 by Moody's Investors Service, Standard & Poor's and Fitch Ratings after the recession slashed demand for the metal used in beverage cans and cars. Each has a negative outlook on the company, meaning it's on review for possible downgrade.

Alcoa is committed to restoring its strong investment-grade credit rating, Treasurer Peter Hong, 52, said in an interview. The company said last week it had $1.3 billion of cash on hand and will be "free cash flow positive" this year.

"We are generating a lot of cash, and we will continue to do so," Hong said. "Over time we will continue to bring our debt down."

Alcoa had $9.76 billion in debt at the end of March, including $666 million due within one year. Alcoa will reduce its debt, and the company plans to pay down $511 million due in August from cash flow, Alcoa's Hong said.

'Until Proven Guilty'

Alcoa's bonds should trade like junk and investors should sell the company's notes due in 2018, said Carol Levenson, a corporate bond analyst at Gimme Credit LLC in Chicago.

"With a company of the size and prominence of Alcoa, the tendency among the rating agencies is to consider it 'innocent until proven guilty,'" Levenson said. "We have not been so generous and have considered it a speculative-grade credit for some time."

The worst consequence of a downgrade for Alcoa would be decreased access to capital markets as some investors can only hold investment-grade debt, Levenson said.

At the higher rates Alcoa might have to pay if it were downgraded, it could add about $50 million in extra costs if the company needed to refinance all of its outstanding debt, Levenson estimated.

Credit Default Swaps

Swaps to protect Alcoa's debt from default rose 5.7 basis points to 205 basis points yesterday, according to CMA DataVision prices. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

BB rated debt yields 1.9 percentage points more than the three lowest tiers of investment-quality, according to Bank of America Merrill Lynch data as of April 22. That comes out to $190,000 a year in extra interest costs for $10 million of debt.

Alcoa's 5.72 percent notes due in 2019 traded at 99.23 cents on the dollar to yield 5.83 percent, or 2.06 percentage points more than similar-maturity Treasuries, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

That compares with a yield of 4.96 percent for BBB rated bonds, the three lowest ranks of investment quality, according to Bank of America Merrill Lynch index data as of yesterday. The extra yield investors demand to buy BBB ranked debt instead of Treasuries was 1.92 percentage points, the index data show.

BB rated corporate bonds, the three levels below investment grade, yield 6.86 percent, or a spread of 3.96 percentage points, index data show.

Alcoa Loss

Alcoa's first-quarter net loss narrowed to $201 million from $497 million a year earlier. Sales rose 18 percent to $4.89 billion amid aluminum prices that were 57 percent higher on average in the first quarter than a year earlier. Alcoa made fewer sales of the metal for gas turbines and building materials.

"It's been a perplexing couple quarters as aluminum prices go up and Alcoa's earnings don't seem to respond the same way," Carol Cowan, a New York-based debt analyst at Moody's, said in an interview. "It's going to take a year to get there for them to come back to metrics more appropriate for the rating."

Debt Ratios

Moody's now rates Alcoa Baa3. Measures of the company's credit, such as the ratio of debt to earnings before interest, taxes, depreciation and amortization, or Ebitda, are higher than what generally is required for investment-grade status, Cowan said. Alcoa had net debt of about 6.9 times trailing 12-month Ebitda at the end of the first quarter, according to data compiled by Bloomberg.

The ratio for investment-grade companies normally is less than 3.5, and the Moody's rating calls for Alcoa's ratio to be no more than 4 by the end of this year, Cowan said.     Standard & Poor's, which rates Alcoa BBB-, is looking for the company to increase Ebidta in the next several quarters, analyst Marie Shmaruk said in an April 15 interview.

"They are not there yet, which is why they are still on a negative outlook," Shmaruk said in a telephone interview from New York. "It's generally an improving story, but we need to see a little more improvement."

Alcoa's Hong declined to estimate the likelihood the company would meet the rating firms' full-year targets, citing a policy against providing forecasts.

Earnings Gain

A possible downgrade of Alcoa is "not a big concern," said William Selesky, a New York-based analyst with Argus Research Corp. who rates the shares "buy" and doesn't own any. He estimates Alcoa earnings will gain 45 percent to $1.16 in 2011.

"A global economic recovery is going to help all producers of aluminum," Selesky said in an interview. "Since Alcoa is the biggest company in North America, its size will create an earnings-growth story that is better than most people think."

Alcoa's debt-to-Ebitda has dropped from more than 10 last year, yet the ratio still will exceed 4 by the end of this year, missing the Moody's target, Brookfield's Levington said.

"When you talk about metrics on earnings to debt, there is improvement to be had," Monica Bonar, a New York-based analyst for Fitch, said in an interview.