UPDATE: Alcoa (AA) credit rating raised to BB from BB- at S&P; Outlook Positive

(Updated - December 5, 2017 1:21 PM EST)

Alcoa (NYSE: AA) credit rating raised to BB from BB- at S&P; Outlook Positive

• Pittsburgh-based Alcoa Corp.'s stronger credit measures should remain solid in 2018 and 2019, taking into account our aluminum price assumption, which is almost 30% higher than a year ago.
• Earnings and cash flow are sharply higher in 2017, along with strong aluminum and alumina prices, potentially enabling Alcoa to build cash in the absence of large growth capital expenditures or shareholder returns.
• We are raising the corporate credit rating on Alcoa to 'BB' from 'BB-'. The outlook remains positive.
• We are also raising our issue-level ratings on the company's senior secured and unsecured debt to 'BBB-' from 'BB+' and to 'BB' from 'BB-', respectively. The recovery ratings on the debt are '1' and '3', respectively.
• The positive rating outlook on Alcoa Corp reflects our view that improved credit measures are readily sustainable, due to an improving medium-term profit outlook and good financial capacity to support sustaining investment in this capital-intensive business.

S&P Global Ratings today raised its corporate credit rating on Alcoa Corp. to 'BB' from 'BB-'. The outlook is positive.

In addition, we raised our issue-level rating on the company's senior secured credit facility to 'BBB-' from 'BB+'. The '1' recovery rating indicates our expectation of very high (90%-100%; rounded estimate: 95%) recovery in the event of a payment default. We also raised our issue-level rating on the company's senior unsecured notes to 'BB' from 'BB-'. The '3' recovery rating indicates our expectation of meaningful (50%-70%; rounded estimate: 65%) recovery in the event of a payment default.

Our higher rating on Alcoa stems from the company's sustainably improved credit measures, supported by higher aluminum prices, cost reductions, and net debt reduction since the company's separation from the downstream operations of Arconic Inc. only a year ago. Moreover, a new leadership team of experienced Alcoa managers has demonstrated a smooth transformation to reduced business complexity since the separation, offsetting its short track record as a stand-alone entity.

The positive rating outlook on Alcoa Corp reflects our view that improved credit measures are readily sustainable, given an improving medium-term profit outlook and good financial capacity to support sustaining investment in this capital-intensive business. Our expectations for Alcoa's higher margins and better earnings stability are underpinned by our view of the company's more cost-competitive assets and better output discipline in primary aluminum, which should enable it to drive fully adjusted debt to EBITDA down toward 1.5x in 2018.

We could raise the ratings in a year if Alcoa maintained fully adjusted debt to EBITDA of about 2x, with financial policies that support moderate debt leverage and improved cash flow visibility from good execution of cost reductions, which could confirm a stronger competitive position in the cyclical, commodity-oriented aluminum industry. We believe such a scenario would be likely if market conditions for aluminum and alumina remain robust through 2019, enabling the company to generate up to $1 billion of discretionary cash flow (after dividends) annually at our assumption of $2,100/tonne for the next three years.

We could revise the outlook back to stable from positive if adjusted debt to EBITDA reversed course and rose to 3x, which we believe could occur if aluminum prices declined sharply or if the company adopted decidedly more aggressive shareholder return strategies, both of which we view as unlikely. We estimate that Alcoa's debt leverage would increase to 3x in 2018 if LME aluminum prices dropped to about $1,650/tonne, or about 30%, which would represent an unusually large decline in one yea

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