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Alcoa Corporation (AA)

Q4 2017 Earnings Call· Wed, Jan 17, 2018

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Transcript

Operator

Operator

Good afternoon, and welcome to the Alcoa Corporation Fourth Quarter 2017 Earnings Presentation and Conference Call. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to James Dwyer, Vice President of Investor Relations. Please go ahead.

James Dwyer

Analyst

Thank you, Austin, and good day, everyone. I'm joined today by Roy Harvey, Alcoa Corporation President and Chief Executive Officer; and William Oplinger, Executive Vice President and Chief Financial Officer. We will take your questions after comments by Roy and Bill. As a reminder, today's discussion will contain forward-looking statements relating to future events and expectations that are subject to various assumptions and caveats. Factors that may cause the company's actual results to differ materially from these statements are included in today's presentation and in our SEC filings. In addition, we have included some non-GAAP financial measures in this presentation. Reconciliations to the most directly comparable GAAP financial measures can be found in the appendix to today's presentation. Any reference in our discussion today to EBITDA means adjusted EBITDA. Also, a note on financial statements methodology. Because Alcoa Corporation commenced operations as a stand-alone public company on November 1, 2016, the financial statements are a combination of financials carved out from Alcoa Inc. prior to November 1, 2016, and actual results of Alcoa Corporation thereafter. Accordingly, the fourth quarter 2016 results are part carve-out and part actual results, while the 2017 quarterly results are entirely actuals. Finally, as previously announced, the earnings release and slide presentation are available on our website. With that, here's Roy.

Roy Harvey

Analyst · Bank of America Merrill Lynch

Thank you, Jim. I'd like to welcome everyone to our call. Alcoa significantly grew profits in the fourth quarter, most notably in our Alumina segment as we continue to benefit from favorable commodity prices. We reported an adjusted net loss of $196 million or $1.06 per share largely due to the decisions aligned with our strategic priorities. On an adjusted basis, net income was $195 million. Our fourth quarter results represent our highest adjusted EBITDA since our launch just over a year ago. We generated $775 million in adjusted EBITDA, excluding special items, up $214 million sequentially primarily on higher alumina prices. While this is up nearly 40% from the prior quarter, 4 short-term operational and financial impacts contributed to results that were about $50 million lower than our stated expectations. Those 4 things were roughly equal in impact. First, beginning in Brazil. A drought caused our Juruti mine on the Amazon River to experience an acute water shortage that constrained our bauxite washing capacity with follow-on impacts to our Brazilian São Luís refinery. Second, that same drought also affected profits from the Brazilian hydropower system. Third, in Spain, where we are exposed to market power pricing, our smelting system experienced significantly higher power prices. Finally, we have lower-than-expected global alumina shipments due to weather delays and difficulties with shiploading. While some of these impacts were unforeseen shifts in the market, others highlight opportunities to improve our operating system. We have taken actions to address those items within our control and avoid this from recurring. From a cash perspective, we reduced our days working capital to 11 days and generated $455 million in cash from operations, increasing our year-end cash position to just over $1.3 billion. This past quarter, we continued to aggressively execute on our strategic priorities to reduce…

William Oplinger

Analyst · Bank of America Merrill Lynch

Thanks, Roy. I'll briefly run us through the financials. Sequentially, revenues are up 7%, increasing $210 million to $3.2 billion on higher shipments in our Alumina segment and higher alumina and aluminum prices. Compared to last year, revenues are up 25% on higher prices for alumina and aluminum and higher shipments across all 3 segments. In the quarter, the net loss attributable to Alcoa Corporation was $196 million or $1.06 per share primarily due to restructuring costs associated with the resolution of the Rockdale Energy contract and the announced closure of their Rockdale operations. Special items in the quarter totaled an unfavorable $391 million pretax with the largest amount resulting from the Rockdale contract termination and closure decision. Out of the $391 million, $297 million is restructuring comprised of the Rockdale contract termination, Rockdale plant closure, and take-or-pay energy contracts that curtailed smelters, less a reversal of a reserve for an Italian power matter. $39 million of special items and COGS associated with the restart of the Warrick smelter that Roy mentioned previously. Combined restart cost for Warrick have been slightly higher than we had previously estimated, but execution of the project remains on track for completion in the second quarter of 2018. And lastly, $68 million of discrete tax items are primarily deferred tax asset revaluations in foreign countries as well as a $22 million charge related to the U.S. -- the new U.S. tax legislation. Now let's look at our adjusted EBITDA and the full income statement after special items. Our fourth quarter adjusted net income at $195 million is 44% higher than the third quarter. Compared to the prior year, our adjusted net income improved $169 million. Adjusted diluted earnings per share improved $0.32 sequentially to $1.04 per share and grew $0.90 per share year-over-year. Adjusted EBITDA…

Roy Harvey

Analyst · Bank of America Merrill Lynch

Thank you very much, Bill. I'll begin with an overview of the markets and our fundamentals-based outlook for bauxite, alumina and aluminum as we enter 2018. For bauxite, we ended 2017 with a balanced market. 2018 will likely seek Chinese stockpiles grow as Chinese refineries continue to have an appetite for imported bauxite and supported by increased Indonesian exports and continued production growth in Guinea. For alumina, we estimate that we ended 2017 in a balanced market. For 2018, our forecast also remains balanced. For environmental reasons, we have seen China curtail some refining capacity for the winter heating season between November 15 and March 15, and we anticipate that they will do so again next winter. We have also incorporated the impact from the disruption at the Becancour smelter in our world ex China alumina balance figures. In aluminum, we finished last year with strong demand growth above 5%, and we continue to see strong demand growth in 2018 in the range of 4.25% to 5.25%. Outside of China, we are expecting even higher primary aluminum demand growth in 2018 relative to 2017 driven by macroeconomic and end use market improvements. We also see supply reductions in part driven by the smelter disruption at Becancour. In China, we are forecasting a lower surplus than we saw in 2017 driven by still robust demand growth in 2018 and relatively lower-than-expected supply growth due to the policy-driven curtailments we expect to impact the start and end of this year. Supply growth is also expected to remain disciplined as China enforces its capacity and permitting framework. In fact, the Chinese government reaffirmed its commitment to enforcing this framework earlier today in a policy announcement and set a deadline for the end of 2018 for smelter operating permits to be exchanged. While the…

Operator

Operator

[Operator Instructions]. And our first question comes from Timna Tanners with Bank of America Merrill Lynch.

Timna Tanners

Analyst · Bank of America Merrill Lynch

So I'm going to ask two questions. And the first one is I appreciate your perspective on China and certainly the step downs are compelling. But I was wondering, are analysts in China a bit worried about 5 million tonnes of alumina capacity coming back online? And lower alumina prices means the aluminum producers, as you mentioned, are making a margin again. These high aluminum and alumina prices seem to be inviting new capacity or talk of new capacity not just in China. But this morning there was an article in AMM on a new producer starting up potentially in the U.S. So can you talk us about what you're seeing on the risk of new capacity if you think it's going to be an issue materially going forward?

Roy Harvey

Analyst · Bank of America Merrill Lynch

Yes, Timna, let me try and address that. So as you know, we try and incorporate our expectation for likely restarts and likely new capacities come online, and we are aware that there are a number of new refineries that have been under construction and that will be coming online. Now that's a bonus or a positive thing for us because we have the opportunity to sell bauxite, but also it tends to change the balances between alumina supply/demand and, in the end, also has impact on aluminum supply/demand because of the underlying economics. So we try and take a pretty balanced view and, in fact, do a refinery by refinery review to try to see what we really think is credibly possible to restart or to be turned -- brought online. And so I think the main answer to your question, Timna, is that economics are going to the help prove how those supply/demand economics pull through. So what we have seen in China is that the market reacts pretty quickly to the changes in the -- in pricing scenarios. And so right now we continue to see a market where you see a balanced supply and demand in alumina, and you've seen the impact on smelters and downstream. So I think our view of the market says that both economics and then also the policy side of China is going to keep us more or less in a balanced condition even with those new -- even with the new and restarted portions of capacity coming back online.

Timna Tanners

Analyst · Bank of America Merrill Lynch

Okay. Great. And then if you could provide a little bit more color on your guidance. So clearly, if we just implicitly look at fourth quarter EBITDA and annualize it, your guidance is below that and the biggest buckets are alumina prices coming down, it seems like, and then some puts and takes. But am I missing any big items? And can you help us understand in the guidance why flat volumes? Is it Becancour coming off, anything else coming on? Is there Wenatchee assumption in there?

William Oplinger

Analyst · Bank of America Merrill Lynch

Yes, so I'll handle that one, Timna. If you simply take the fourth quarter and annualize it, you have to factor in the guidance around higher raw material cost. So we are guiding to approximately $400 million of higher raw material costs. And then also, the fourth quarter would have seen higher alumina prices, and so the alumina assumption that we've built in is lower than what we saw in the fourth quarter. And then the other -- I guess, the other major impacts, metal prices ride along the same lines, and currencies -- with the dollar weakening, currencies are a negative impact also in the guidance. So as far as the volume question goes, we're seeing creep in both the bauxite and on the alumina side, so we're going to pick up some incremental volume there. But we've also built in -- on the aluminum side, we've built in the Becancour curtailment for the full year. So we have that running at 1 line, which essentially loses 200,000 tonnes of volume out of the numbers.

Operator

Operator

Our next question comes from Curt Woodworth with Crédit Suisse.

Curtis Woodworth

Analyst

Yes, I also had a question on the guidance, too, Bill, because you also had a $55 million LIFO hit this quarter and then you talked about a $50 million impact from the drought and some of the operational issues. So that would put your run rate and EBITDA closer to $3.5 billion. And then your LME assumption's, I think, 100 a tonne above what it was this quarter, that would give you another $200 million. And I hear you, the alumina price is lower. But it seems like on a like-for-like basis, you'd be closer to maybe $3.6 billion run rate? So is it -- like, do you feel like you're being conservative in the guidance? Is that math somewhat incorrect? And can you talk about what your assumptions are for FX and what the impact of that was on the guide?

William Oplinger

Analyst · Bank of America Merrill Lynch

Yes, sure. I guess, some of the big impacts from what you're looking at is, in the fourth quarter, as we discussed, the alumina prices were a little bit higher. The one-time impacts that Roy alluded to, I would say won't recur. So if we were to look at the fourth quarter, I'd say we made $775 million, we'll take you up to around $825 million on a run-rate basis. Then you get the $400 million of higher incremental raw material costs, roughly $100 million of higher currency costs during the course of the year, and that gets you -- should get you back down to the $2.6 billion to $2.8 billion range if you do it that way.

Curtis Woodworth

Analyst

Okay, that's helpful. And then just on the discretionary payment into the pension. Does that capital payment count against the capital return basket that you were provided for when you renegotiated your revolver, which I think gave you $350 million this year, plus I think you had a carryover benefit from last year, so you had, I think, roughly $525 million of total capital return this year so...

William Oplinger

Analyst · Bank of America Merrill Lynch

The $300 million does not account for that capital return. So you're doing the math right in our revolver. And just to be clear on that, so the thinking is that we make a $300 million discretionary payment to the pensions. We currently sit with cash at $1.36 billion. And then any incremental cash above that $1 billion will be split between delevering, further delevering, and returns to shareholders. And the next logical question that I'm sure people ask is how we do this return to shareholders. We haven't decided yet. And when we get to the point of doing those, we'll announce how we're going to do it.

Curtis Woodworth

Analyst

Do you think it's likely you'll initiate a dividend policy this year?

William Oplinger

Analyst · Bank of America Merrill Lynch

It's likely that we will return cash to shareholders this year. So we haven't decided whether it's a dividend, a special dividend or a share buyback at this point.

Operator

Operator

Our next question comes from David Gagliano with BMO Capital Markets.

David Gagliano

Analyst · BMO Capital Markets

Just to keep along the same lines of some of the questions earlier. I just want to clarify, Bill, you just mentioned some numbers, but I apologize, it's still not adding up to me. So $775 million 4Q, add $50 million back, $825 million, which annualizes, obviously, $3.3 billion. And then you gave a $500 million of negative, which is $2.8 billion, so that's a high end of the range. What else is it like -- how much for Becancour, for example, for that 200,000 tonnes? What's the financial impact in the EBITDA for that assumption?

William Oplinger

Analyst · BMO Capital Markets

Yes. And that's a good point, Dave. Becancour is included in those numbers so you have to back out something for Becancour. Now given the fact that we're in the midst of the situation at Becancour, we're not providing guidance on the specific financial impact of the lockout, but you can see what the tonnes impact is, and that should give you an idea of how much that negatively impacts us.

David Gagliano

Analyst · BMO Capital Markets

So $2.6 billion to $2.8 billion is before Becancour, okay.

William Oplinger

Analyst · BMO Capital Markets

I'm sorry, it includes Becancour. So the negative impact of Becancour is built in to the $2.6 billion to $2.8 billion.

Operator

Operator

The next question comes from Piyush Sood with Morgan Stanley.

Piyush Sood

Analyst · Morgan Stanley

First question, seems like caustic prices have starting to soften recently. So just want to understand the caustic price or maybe the price change underlying your assumptions so that we can kind of flex the guidance as we want. Or another way to ask that question is, of the $400 million higher costs, how much of that is from caustic?

William Oplinger

Analyst · Morgan Stanley

Yes. So Piyush, great, great question. Out of that $400 million of higher cost, it's pretty evenly broken down between higher caustic. So roughly 50% of that is higher caustic, and the other 50% is carbon products on the smelting side. And so for assumption's sake, I think you can use $200 million and $200 million for each of those.

Piyush Sood

Analyst · Morgan Stanley

That's helpful. And the transformation guidance appears to exclude any cost associated with Wenatchee settlements. So I just want to understand what's the time line to make a decision. And it seems the decision would, one way or the other, impact cash generation this year. Just want to get a sense of kind of the timing and the magnitude that we should look at.

William Oplinger

Analyst · Morgan Stanley

Yes. So the timing is the middle part of this year. It would be around, I believe, June or July. And the amount is around $63 million. We've not made a decision on whether we would restart Wenatchee at this point, and we'll be running through the numbers and discussions with Chelan PUD in the first quarter of this year.

Piyush Sood

Analyst · Morgan Stanley

All right. And last one from me and I'll get back in the queue after that. The aluminum sensitivity in the back, it's gone down to 203 for every $100 change from 215. So the difference is probably just ABI, or is there some additional cost baked in?

William Oplinger

Analyst · Morgan Stanley

It's ABI, ABI.

Operator

Operator

Our next question is from Alex Hacking with Citi.

Alexander Hacking

Analyst · Citi

Roy and Bill, I have a couple of clarifications if it's okay. First one is on the $400 million projected cost increase. Can you just clarify what's the baseline for that? Is that versus FY 2017 or is that versus 4Q levels?

William Oplinger

Analyst · Citi

FY '17.

Alexander Hacking

Analyst · Citi

Okay, so on a full year basis. And then the second question is around the timing of potential capital return to shareholders. I guess when are you going to -- how periodically will you assess this? Will this be something that you'll do at the end of the year with excess cash, something you'll do every quarter, every 6 months? I just want to know what's the timing there?

William Oplinger

Analyst · Citi

Alex, we'll be doing the analysis at the end of each quarter, but I believe that it would be best to assume that if we are in a position to make a return to shareholders, it would be in the second half of this year. So we will watch cash flow come in during the course of the year. You know we like to keep $1 billion of cash just for the strength of the balance sheet, so we'll watch it come in during the course of the year. And if we make a return to shareholders, it will be in the second half.

Alexander Hacking

Analyst · Citi

Okay. That's clear. Actually, can I just go back to the first question, if I may? You said that the $400 million is versus full year '17? But then when we were talking about the guide of 3.3 -- sorry, the guide, if you annualize what's in the fourth quarter, right, you then will kind of take off $400 million for cost. But that $400 million increase should be less than versus 4Q, right, because cost was rising all year. Again, I don't know if you -- do you kind of see where I'm going? Like I see sort of an inconsistency there.

William Oplinger

Analyst · Citi

Yes, I see where you're going. So just to be clear, if you take the full year '17 adjust for metal prices, adjust for API, back out the forex impact of rising currencies and then back out the raw materials of $400 million, you should get very, very close to that range of $2.6 billion to $2.8 billion in guidance.

Operator

Operator

Our next question is from Novid Rassouli from Cowen and Company.

Novid Rassouli

Analyst · Cowen and Company

The first one is just on your Slide 23. So it looks like the lion's share of the curtailments are coming from this NDRC curtailed capacity. I just wanted to see if you could walk us through maybe -- you mentioned the permits, the licensing. Maybe if you could just kind of walk us through the procedure for acquiring operating rights and how that might look. If it's even possible, what the time frame is. Just trying to get a sense of how sticky that is there.

Roy Harvey

Analyst · Cowen and Company

Sure, Novid. Let me give a shot at it, and Bill can chime in as well. So essentially what happens -- this is a policy that was originally put into place in 2015, and it was really during 2017 that we started to see real on-the-ground enforcement, and that included real environmental and operational reviews to see what plants were running and whether they were actually permitted. So the real game changer in 2017 was that they took action. And instead of allowing excuses, they actually -- we actually saw all unpermitted capacity come off-line. So that's really the big changer in 2017. Now going forward, let's say, let's take 2 different situations. Let's say that you have capacity that you've already built but that does not have an operational permit. You have two routes in order to find a permit for that as per the rules that have been established. The first route is to go out into the market and actually acquire a permit from somebody else. So that would mean the closure of another Chinese plant that would be willing to sell those rights. Now as you can imagine, you're seeing those rights, those operating rights, increase in price pretty significantly. So the other method that you have would be to curtail your own production. And essentially, what the Chinese government has done is they've established a ratio for aluminum specifically that says in order to gain a permit, you need to close 1.25 tonnes of older capacity. So that ensures that you're not bringing new tonnes online that doesn't have a corresponding curtailment inside your own portfolio or purchasing it on the market and having a curtailment in somebody else's portfolio. So if you have new -- so that's the example of capacity that's come off-line as a result of these curtailments or closures over the course of 2017. If you have a new smelter that you want to bring online, some of the -- there will be some new production that was permitted back in 2015, 2016. And so you will see some growth this year, which is the result of prior actions and prior permits being granted. Any new added capacity would then need to go through that same set of requirements that the curtailed capacity has. So they either need to acquire it from somebody else, or they need to find some way to close their own smelting capacity in their portfolio. So it really is a pretty restrictive process. It ties back to the Chinese government's declaration that aluminum is oversupplied, and therefore, the more that China enforces its policies, the more traction we have to see them start to reduce that surplus and, at some point, get into a balanced condition. Does that make sense, Novid?

Novid Rassouli

Analyst · Cowen and Company

That does. And so clearly the first option is a zero-sum game, someone swaps their permit. The second option, you're saying you cut for every 1.2 tonnes of older capacity, then you can restart -- I'm just trying to get a sense if the second option is also a zero-sum or how that works.

Roy Harvey

Analyst · Cowen and Company

It's also zero-sum with one exception, which is that there's a few smelters that are coming online just now that have permits that were already granted. So it's just a bit of a legacy issue that's coming to bear now. And all that's incorporated into our supply-demand balances.

Novid Rassouli

Analyst · Cowen and Company

Got it. Okay. And then just my second and last question, as far as inventories, we've been seeing aluminum ingot inventories rising in China. And then at the same time, we've been seeing alumina prices, it looks like, stabilizing somewhat on declining port inventories. I just wanted to see if you guys can maybe speak to inventory levels briefly and maybe how we're setting up going into 2018 relative to what -- how we entered 2017 and how you guys are thinking about that.

Roy Harvey

Analyst · Cowen and Company

Yes, Novid, and realistically when you step back and look at it, inventories are following the supply-demand balances pretty close. So when you're running a structural deficit outside of China, then what we're seeing is that inventories have been continuing to decline year-over-year. And so the beginning of 2017, we're already starting to see some relief from those large inventories built up during the great financial crisis. And what we're seeing over -- at the end of 2017 is those inventories have continued to come down. So that's a very welcome story, and that looks at all inventories, whether it's on warrant or off warrant. In China, again running a structural surplus, what we have seen are that inventories are growing. And so particularly over this last period where we had less winter curtailments than were expected, we've continued to see those inventories creep up. So the good news on the inventory story in China is that we're still relatively light when you think about what is necessary in order to support such a large and intricate smelting -- large and intricate aluminum industry inside of China. However, unless they fix their supply versus demand issue and stop generating a surplus, they're going to continue to see those inventories increase.

Operator

Operator

Our next question is from Chris Terry with Deutsche Bank.

Christopher Terry

Analyst · Deutsche Bank

A couple of questions from me. You've talked about this quite a bit on the dividends versus buyback angle. It seems like you're not going to give too many more hints away on that. But just in terms of the spending throughout 2018, I think you said you'd pay the $300 million liability in 1Q. What's the CapEx profile throughout the year in terms of the sustaining business and the value creation $150 million? Is it more two half-weighted? Or how do we think about that?

William Oplinger

Analyst · Deutsche Bank

Yes, it's traditionally more second half-weighted than first half. If you look at how we spent in '17, it's not dissimilar to how it will be spent in '18. So we typically ramp up the projects during the course of the year and spend more in the second half. So to be clear, we're anticipating $450 million of CapEx. $300 million of that is sustaining, $150 million of that is return-seeking. The $300 million that we make in the discretionary contribution to the pension plan won't necessarily all be made in the first quarter. So I don't want you to come away with thinking that we make that contribution in the first quarter. We will look during the course of the year and see when the best time is to make that contribution. But I would anticipate it to be, in the first half, maybe spilling over a little bit into the third quarter.

Christopher Terry

Analyst · Deutsche Bank

Okay. Sure. And then in terms of the other -- the costs for the caustic and the carbon, the additional $400 million, going forward and into future periods, are you going to look at how you negotiate that with suppliers and potentially lock it in a different way to mitigate that? Or is it just going to be more of the same going forward in terms of you'd just be at the mercy more of the market?

Roy Harvey

Analyst · Deutsche Bank

Yes. That's a great question, Chris, but it's not one that I'm necessarily going to answer. To be quite honest, we have a very active procurement group. We are very focused on what we see happening in the market, and our strategy is determined from how we read that. And so we make adjustments as we go along, and to be quite honest, we wouldn't necessarily telegraph that to the market or to our suppliers. I would bring up one very -- a couple very specific points for caustic. Frustrating thing on caustic is that it takes 5 to 6 months for it to flow through our P&L. So we're just seeing the increases that really started about 6 months ago or more coming to our financials right now. That's the unfortunate thing. The positive thing on caustic is that because of our bauxite, because we have a lower reactive silica, it means that our impact in caustic while frankly it's a large impact, what we see is that some of our competitors have an even larger impact because they have a higher caustic usage per tonne. And on the bauxite side, it means that we make a very strong business case for our customers to consider and to pay for the bauxite supplies that we can supply to them. So caustic raw material price increases are never particularly welcome. However, I think it is a competitive advantage that Alcoa has in both our bauxite and alumina businesses.

Christopher Terry

Analyst · Deutsche Bank

Okay, makes sense. And the last one from me, just Becancour. In terms of the two potlines that are off at the moment, will you be able to restart those pretty quickly once the workforce allows it back in? Or how do you keep those in the meantime?

Roy Harvey

Analyst · Deutsche Bank

Yes, so essentially, we've done everything we can to put those two lines into as good a shape for restart as we possibly can. And in fact, that was part of our reasoning behind the lockout, is that we wanted to make sure that the instability in the line that there has been through these negotiations, we control it and we prepare it for restart best we can. That said, Chris, it does take some real effort in order to restart them, and there is some cost involved. So while we can do it as easily as possible, it takes some time, and it does cost some money.

William Oplinger

Analyst · Deutsche Bank

And to bookend it a little bit, we restarted Portland this year. And I think from start to finish, it took us about 6 months in Portland. We're in the process of restarting Warrick. Now I would not compare Becancour to Warrick. Warrick had been down for a while and was in worse shape, but it's going to take us nine months from start to finish in Warrick to restart it. So Becancour is bigger than both of those, but it's also newer.

Operator

Operator

Our next question is from David Lipschitz with Macquarie.

David Lipschitz

Analyst · Macquarie

Two quick follow-ups. Most of my questions have been answered. So in terms of the production guidance for the year, the ABI, you're saying, is not included. It's basically considered the 1 potline and that's it, and that's how you've done your production forecast? I just want to make sure that was clear.

William Oplinger

Analyst · Macquarie

Yes, when we say not included -- we have included running 1 potline at ABI. And so if you see the '17 to '18, there's actually a dip in shipments in aluminum. That is due to the fact that we've taken out a couple hundred thousand tonnes of capacity at ABI.

David Lipschitz

Analyst · Macquarie

Okay, I just want to make sure. My second quickly and following up on a previous question. In terms of either buybacks or dividends, past the second half of this year, I think what he was trying to get at is like we get into 2019, is that something if you do more specials that every quarter you look at it and do it the next quarter? Or is it going to be once a year? Or how will that play out, I think, just the starting of it in the second half of the year?

William Oplinger

Analyst · Macquarie

Yes. So the capital framework that we discussed in the call today is for 2018. We'll reevaluate that as we go into 2019, and that will be based on what market prices look like and what cash generation looks like. So again, in the second half, assuming the cash flows are strong, we'll be making those decisions around capital return, and we will let you know.

Operator

Operator

Our next question comes from Arjun Chandar with JPMorgan.

Arjun Chandar

Analyst · JPMorgan

Just on the capital allocation front once again. You mentioned splitting your excess cash above $1 billion half-and-half between returns to shareholders and delevering. I was wondering if there's a specific leverage target including the pension liabilities closer to today's news around the defined benefit pension plan as to when if you would change that allocation on excess cash above that $1 billion?

William Oplinger

Analyst · JPMorgan

Yes. So we're going to make the $300 million discretionary contribution this year. When we look at our capital allocation framework, the key variable that we're looking at is our weighted average cost of capital. We fundamentally believe that today, with the leverage that we have between the debt and the underfunded pension and OPEB liability, that our WACC is suboptimal, and that it could be further optimized by paying down either the pension deficit or a part of the debt. So the question is how much is enough. And if we were to ballpark it, I would suggest to you that probably $750 million to $1 billion of debt and OPEB -- I'm sorry, debt and pension reduction would be the optimal capital structure for us at this point in the cycle so -- I'm not counting the $300 million towards that. So the $300 million would go towards the $750 million. So it would mean an additional $450 million to $700 million in overall debt reduction over the next few years.

Operator

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Roy Harvey for any closing remarks.

Roy Harvey

Analyst · Bank of America Merrill Lynch

Thank you very much, operator, and I'd like to thank Jim and Bill as well. 2017 was a pivotal year for Alcoa Corporation. It was our first full year as a standalone company. We've made a significant amount of progress on our strategic priorities, and we're in a stronger position today than when we launched just over a year ago. We recognize that there is still lots of work to be done, and we look forward to 2018 and beyond. I appreciate everybody's time today and all the questions. Back to you, Operator.

Operator

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.