S&P Rates Alcoa (AA) at 'BB-' Amid Upstream, Downstream Separation

September 20, 2016 3:06 PM EDT

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-S&P Global Ratings said that it has assigned its 'BB-' corporate credit rating to Alcoa Upstream Corp. (Alcoa Corp.). The outlook is stable.

At the same time, we assigned our 'BB-' issue-level rating and '3' recovery rating to the company's proposed $1.0 billion senior unsecured notes. The '3' recovery rating indicates our expectation for meaningful (50%-70%; lower half of the range) recovery in the event of a payment default.

Our recovery analysis, and resultant 'BB-' issue-level rating on the company's proposed $1.0 billion senior unsecured notes, assumes a capital structure that includes a $1.5 billion senior secured revolving credit facility, which we expect to rate once supporting documentation is provided.

We have reviewed the implications of Alcoa Inc.'s business separation and assessed Alcoa Corp. on a stand-alone basis. Following its separation from Alcoa Inc., Alcoa Corp. will be solely focused on bauxite mining, alumina refining, and aluminum production via its large smelting operation, as well as aluminum can packaging for the North American market. The direct price risk of alumina and aluminum previously absorbed by Alcoa Inc. will reside entirely at Alcoa Corp. "We expect Alcoa Corp. to maintain its strong brand and cost-competitive industry leading positions across the aluminum value chain, which it will inherit from Alcoa Inc.," said S&P Global credit analyst Ryan Gilmore. "However, our assessment also takes into account that Alcoa Corp. is an unproven, smaller, and less diversified stand-alone entity whose earnings will be highly sensitive to volatile aluminum prices." As such, we view Alcoa Corp.'s business risk profile to be fair.

The stable outlook on Alcoa Corp. reflects our expectation that the company will maintain strong liquidity, with sources of at least 1.5x its uses over the next 12 months. We also expect it to maintain an FFO-to-debt ratio of more than 20% and an adjusted debt leverage metric of about 3x over the next 12 months.

We could lower our ratings on Alcoa Corp. if the company's operating results experienced meaningful pressure, which could occur if aluminum prices weakened or the company's volumes declined due to weaker economic conditions. We could also take a negative rating action on the company if Alcoa Corp.'s suite of credit ratios weakened to a level that corresponds with a highly leveraged financial risk profile, versus an aggressive financial risk profile, or if its FFO-to-total debt ratio fell below 12% for a prolonged period.

We could consider raising our rating on Alcoa Corp. if market conditions allow the company to generate substantial cash flow and improve its credit measures. Specifically, we could raise our ratings if the company improved its credit measures and sustained them, specifically an adjusted debt-to-EBITDA metric of notably less than 2x or a FFO-to-debt ratio of greater than 30%. We could also raise our rating if we revised our assessment of the company's business risk profile to satisfactory from fair due to materially greater product, end-market, and geographic diversity; an improved scope of operations; and less commodity price sensitivity or a stronger contract profile.

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