Fitch Revises Rating Watch on Alcoa's 'BB+' IDR to Evolving

Fitch Ratings has revised the Rating Watch for Alcoa Inc.'s (Alcoa; NYSE: AA) ratings to Evolving from Positive. A complete list of ratings follows this release.

Nearly $14 billion in commitments and securities is affected.

KEY RATING DRIVERS

AA's ratings reflect weak market conditions in the upstream businesses and slow growth in the value-add businesses resulting in total-debt-to-EBITDA expected to exceed 3x and funds from operations (FFO) adjusted leverage expected to exceed 4.5x.

The Rating Watch has been revised to Evolving from Positive to reflect expectations that the separation may not result in investment grade credit metrics at the Value-Add Company (see below).

On Sept. 28, 2015, AA announced that its Board of Directors approved a plan to separate into two independent, publicly traded companies. The transaction is intended to qualify as a tax-free transaction and it is expected to be completed in the second half of 2016. The Upstream Company (Alcoa) will comprise the units that today make up Global Primary Products, and the Value-Add Company (Arconic) will include the Global Rolled Products, Engineered Products and Solutions (EPS) and Transportation and Construction Solution (TCS) units. The company intends to capitalize Alcoa targeting a strong non-investment-grade rating. The separation is not conditioned upon Arconic achieving an investment-grade rating. Pursuant to the company's 8K filed Sept. 29, 2015, the debt of Alcoa would be retained by Arconic.

The segments comprising Alcoa generated adjusted EBITDA of about $2 billion in 2015 down nearly $300 million from $2.2 billion in 2014 mostly related to the decline in LME aluminum prices to $1,661/tonne on average in 2015 from $1,867/tonne in 2014. AA guides that 50% of third-party revenues are exposed to the LME price and that a $100/tonne change in the LME price affects Alcoa's EBITDA by about $210 million. LME aluminum prices for the first quarter of 2016 averaged about $1531/tonne and Fitch's Mid-cycle price assumption for 2016 is $1,600/tonne. Fitch believes FFO gross leverage of 3x and below is consistent with a strong non-investment-grade rating.

Fitch believes Arconic has more consistent margins and lower commodity price risk. Arconic's businesses generated adjusted EBITDA of about $1.9 billion in 2015, relatively flat compared with 2014. AA's 2016 goal for adjusted EBITDA at Arconic is about $2.1 billion. Fitch believes FFO gross leverage of 2.5x-2.75x is consistent with an investment-grade rating for this entity but that capital-raising at Alcoa to reduce Arconic debt will be limited. Fitch expects FFO adjusted net leverage to trend below 3.5x.

PENSION CONTRIBUTIONS

According to the company's form 10K, at Dec. 31, 2015, aggregate pension plans were underfunded by $3.3 billion, with U.S. pension plans underfunded by $2.9 billion on a U.S. GAAP basis. While funding was 75% on a GAAP basis, management announced that it is 90%+ funded on an ERISA basis. The minimum required contribution to pension plans is estimated to be $300 million in 2016, of which $218 million is for U.S. plans. AA intends to apportion the obligations and assets between Alcoa and Arconic according to the entity where the associated employees/retiree worked. Management relates that they are in discussion with ERISA concerning the apportionment.

KEY ASSUMPTIONS

--The EPS and TCS businesses are expected to benefit from the acquisitions of Firth Rixon, Tital and RTI International as well as internal growth;

--LME Aluminum prices are as per Fitch's Mid-Cycle price assumptions;

--Dis-synergies and make-whole premiums associated with the transactions are expected to be modest;

--Cash and pension obligations will be apportioned;

--Free cash flow generation will remain a goal of each company; --There will be no cash distributions to shareholders solely as a result of the transaction.

RATING SENSITIVITIES

The Rating Watch Evolving will be addressed when Arconic's capital structure is known.

NEGATIVE: Future developments that may, individually or collectively, lead to negative rating action include:

--FFO adjusted net leverage expected to be sustainably above 3.3x and free cash flow negative in the amount of $200 million or more on average.

POSITIVE: Future developments that may lead to a positive rating action include:

--FFO adjusted net leverage at the issuer expected to be sustainably under 2.5x-2.8x, and FCF positive on average.

--EBIT margins of at least 8% on average.

LIQUIDITY

At Dec. 31, 2015, the $4 billion revolver maturing July 25, 2020 was fully available and cash on hand at March 31, 2016 was $1.4 billion. The revolver has a covenant that limits consolidated indebtedness to 150% of consolidated net worth.

As of Dec. 31, 2015, near-term scheduled debt maturities were: $21 million in 2016, $771 million in 2017, $1 billion in 2018, $1.1 billion in 2019, and $1 billion in 2020.

COMPANY PROFILE

Earnings and cash flow benefit from AA's leading positions in aluminum, key aerospace, automotive and construction markets, strong control of costs and spending, and the flexibility afforded by the scope of its operations. Alcoa benefits from being vertically integrated and geographically diversified. Arconic benefits from scale in research and development, past restructuring efforts, and growing end-market demand.

FULL LIST OF RATING ACTIONS

The Rating Watch for the following ratings has been revised to Evolving from Positive:

--Long-term IDR at 'BB+';

--Senior notes at 'BB+';

--$4 billion revolving credit facility at 'BB+';

--Series A preferred stock at 'BB-';

--Series B preferred stock at 'B+';

--Short-term IDR at 'B';

--Commercial paper at 'B'.

SUMMARY OF FINANCIAL STATEMENT ADJUSTMENTS

- Leases: Fitch has adjusted the debt by adding 8x of yearly operating lease expense of $210 million for 2015.

- Hybrids: 100% Equity Credit was allocated to the class B mandatory convertible preferred stock and 50% Equity Credit was allocated to the class A preferred stock reported by the issuer as Equity. As a result $28 million has been moved from Equity to Financial Debt.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Short-Term Ratings Criteria for Non-Financial Corporates (pub. 13 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869259

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1002958

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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