Business Risk Cash Flow Cushion Solvency Score Distance To Default Economic Moat Industry Group Sector

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1 Alcoa is poised to recover with an improved cost base amid higher aluminum prices and demand. Morningstar Credit Committee Committee members voting on rating do not own securities issued by the company. Credit Analysis as of 16 Jul 2010 Business Analysis as of 16 Jul 2010 Estimates as of 03 Aug 2010 Currency amounts expressed with $ are in U.S. dollars (USD) unless otherwise denoted. Contents Summary Credit Analysis Business Analysis Outstanding Issues Analyst Notes Methodology Credit Perspective 02 Aug 2010 Alcoa is one of the largest independent aluminum producers in the world. Its expansion in low-cost production-- particularly in Brazil and Saudi Arabia--helps usher the company into a mid to low tier on the global cost curve, solidifying its global leadership position in alumina, primary aluminum, and fabricated aluminum products. However, its highly leveraged balance sheet, large dependence on financial markets for funding needs, large unfunded pension and healthcare liabilities, and its volatile end markets offset its operational strength. We feel this is ultimately detrimental to its credit quality. Alcoa is vertically integrated, and mines 85% of its bauxite needs and produces 100% of its alumina needs. Its upstream assets generate over 40% of total revenue. Alcoa's smelting and refining facilities vary in quality, but the most high-cost ones have been idled since Going forward, we expect Alcoa to continue investment in upstream quality assets, while carefully monitoring its financial leverage. Although capital investment in upstream assets is beneficial in the long term, we feel this expansion will put additional strains on its free cash flow generation. Alcoa had a challenging year in 2009, primarily due to a drastic drop in the aluminum price over the course of a few months. It ended 2009 with adjusted debt of $12.9 billion, and $120 million in earnings before interest, taxes, depreciation, and amortization, or EBITDA. Looking ahead, we expect credit metrics to improve gradually during the next few years, but this would not merit a significant upgrade to an investment-grade rating. Credit Metrics (USD Mil) (E) 2011(E) Cash And Equivalents 762 1, Total Debt 10,578 9,819 10,279 11,346 Interest Expense EBITDA 3, ,923 4,022 Debt to Book Capital Quick Ratio Debt to EBITDA EBITDA to Interest Expense Operating Summary (USD Mil) (E) 2011(E) Sales 26,901 18,439 20,669 22,150 % Change EBIT 1,140-1,189 1,228 2,471 % Net Sales Net Income -74-1, ,161 % Net Sales Free Cash Flow -1, , % Net Sales Capital Structure Current Prior Quarter Prior Year Equity Bil Bil Bil Preferred 55 Mil 55 Mil 55 Mil Debt 9.8 Bil 9.76 Bil Bil Source: Morningstar Issuer Profile Alcoa is the largest player in the global aluminum market, producing 20% of the world's alumina and 10% of its aluminum. Alcoa's upstream segments involve bauxite mining, alumina refining, and aluminum smelting. Downstream businesses produce beverage cans, aerospace components, gas turbines, auto and building products, and telecom parts. The company has operations on every content and mining activities in the U.S., Australia, Brazil, Guinea, Jamaica, Trinidad, and Suriname. Page 1 of 10

2 Credit Analysis Five Year Adjusted Cash Flow Forecast (USD Mil) 2010(E) 2011(E) 2012(E) 2013(E) 2014(E) Cash and Equivalents (beginning of period) 1, Adjusted Free Cash Flow 1,205 1,029 1,455 1,309 1,189 Total Cash Available before Debt Service 2,686 1,529 1,955 1,809 1,689 Principal Payments ,171-1,171 Interest Payments Other Cash Obligations and Commitments ,129-1, Total Cash Obligations and Commitments -1,941-2,411-2,471-2,666-2,666 Cumulative Annual Cash Flow Cushion Cash Flow Cushion Possible Liquidity Need Financial Health Alcoa's debt/capital ratio has risen to 44% from a historical average of 33%, yet the company has improved its liquidity position through cost-cutting initiatives and we expect it to have no trouble meeting its debt obligations. However, there is a near-term possibility that Alcoa's bonds could be downgraded to junk, given the higher leverage at a time when the company has been losing money for six consecutive quarters. Moody's, Standard & Poor's, and Fitch previously downgraded Alcoa to the lowest investment-grade rating in February More than a year later, the losses continue while the debt level rises, and we believe this could prompt another rating cut. A downgrade would raise the company's financing costs and limit access to capital. Alcoa is targeting a debt/capital ratio of 30%, which would keep the firm squarely in investment-grade territory. Adjusted Cash Flow Summary % of USD Millions Commitments Beginning Cash Balance 1, Sum of 5-Year Adjusted Free Cash Flow 6, Sum of Cash and 5-Year Cash Generation 7, Revolver Availability 3, Asset Adjusted Borrowings (Repayment) Sum of Cash, 5-Year Cash Generation, Revolver and Adjustments 10, Sum of 5-Year Cash Commitments -12,154 Credit Rating Pillars Peer Group Comparison AA Sector Universe Business Risk Cash Flow Cushion Solvency Score Distance to Default Credit Rating B B Source: Morningstar Estimates Note: Scoring is on a scale 1-10, 1 being Best, 10 being Worst Capital Structure The balance sheet is relatively healthy. While the current debt/capital ratio is relatively high at 44%, Alcoa has a strong liquidity position, and we expect it to approach its target debt/capital ratio of 30% over the next several years as the recovery of the aluminum market and recently completed capital projects improve cash-flow generation. Current net debt of $8.5 billion is about 2.2 times our estimate of Alcoa's 2010 EBITDA, but we expect this ratio to fall to 1.5 by 2013, consistent with the company's historical average, which we believe is a comfortable amount of leverage. Alcoa's interest coverage ratio fell below 1 in 2009, but the company had adequate cash flow to meet its debt obligations. There are no significant debt maturities in the next several years, and the company also has an undrawn revolving credit facility of $3.25 billion. Enterprise Risk Aluminum is a cyclical commodity business that can experience high price volatility. The company has struggled with managing energy costs and unfavorable currency Page 2 of 10

3 Credit Analysis movements to limit the effect price swings have on earnings. Alcoa's exposure to the struggling construction and aerospace industries will probably continue to hurt the bottom line, and the company's growth depends on global economic recovery. High fixed costs will weigh heavily on profitability if aluminum market recovery is slower than expected. Page 3 of 10

4 Business Analysis Thesis Alcoa has struggled with high costs and falling demand as the aluminum market was severely injured by the global recession. However, improving industry fundamentals and a reshuffled operating structure should help the company regain its footing. Alcoa is one of the top players in the aluminum industry, as the largest producer of alumina, a major smelter of aluminum, and a leading manufacturer of aluminum products for beverages, cars, aircrafts, and building construction. The company's size and vertical integration enable strategic advantages such as lower input costs, greater efficiency, and access to financial resources. But like all commodity industries, aluminum is a challenging business as profitability is linked to cyclical demand and volatile price movements. The selling price of aluminum is based on the London Metal Exchange price, which historically moved in tandem with operating costs such as power and raw materials, leading to relatively consistent margins. When the recession hit in 2008, the LME price plunged 56% in five months, faster than the decline of other inputs, yielding a sharp hit to Alcoa's earnings. As we begin the global economic upturn, Alcoa's recovery will be magnified by its recent divestiture of certain slow-growing, less profitable downstream assets while investing in high-performing businesses such as the upstream operations of mining and producing alumina and smelting aluminum, as well as flat-rolling aluminum operations in lower-cost regions. The company expanded its refinery and built a new bauxite mine in Brazil, as well as a new can sheet and tab line in Russia, both areas where energy costs are about 35% lower than in the United States and Europe. Alcoa also purchased an interest in bauxite mines and a refinery in Suriname from competitor BHP Billiton BHP and entered into a joint venture with Ma'aden to develop a fully integrated aluminum complex in Saudi Arabia. The new complex will capitalize on Saudi Arabia's fully developed infrastructure and low-cost natural gas supply while granting entry into the fast growing Middle East. All of these initiatives strengthen Alcoa's portfolio, and we expect the company to regain its pre-recession margins as demand for aluminum improves. Strengthening in the automotive and commercial transportation industries should overcome currently weak market conditions in the aerospace, construction, and industrial gas turbine markets. Aluminum prices are relatively healthy and have been on an upward trend since early 2009, supported by rising production costs in China and recovery in global demand. The main driver for future growth of the aluminum market will be economic expansion in developing markets, namely China. China has been the largest producer and consumer of aluminum in recent years, and the Chinese automotive and aviation markets are poised for further strength. Alcoa is in a good position to capture this growth, as its costs are about 25% lower than the Chinese competition, given the high-cost energy sources in that region. Plus, Alcoa has steadily expanded its sales presence in the Pacific over the past few years by capitalizing on the strong demand growth in the region, particularly in China. China's production capacity has increased fivefold in the past decade, but limited bauxite resources and lack of access to cheap power supplies could inhibit the long-term viability of Chinese smelters. The primary obstacles Alcoa faces include stiff competition from other sizable aluminum players as well as new entrants in smelting, particularly in the Middle East, Russia, and China. The attractive fundamentals of the mining and refining businesses have prompted Alcoa's primary competitors to pursue a similar strategy of investing upstream, which may weaken Alcoa's competitive position. The growth of aluminum demand in China has decoupled the value chain in recent years, creating a sizable spot Page 4 of 10

5 Business Analysis market for alumina and inviting more entrants into the less capital-intensive smelting business. If aluminum demand growth is unable to absorb the new capacity, this could put downward pressure on prices. Rising energy prices and unfavorable currency movements are also a concern, somewhat mitigated by the company's success in shifting production to lower-cost regions. Economic Moat We believe Alcoa operates with a narrow economic moat. While its products are largely undifferentiated commodities sold into cyclical end markets at exchange-based prices, the company operates with considerable scale as the largest producer of alumina and has one of the largest global aluminum operations. Alcoa's size enables the company to lower its costs by optimizing its energy usage and improving the efficiency of procurement, distribution, and overhead. Alcoa's upstream operations each generate operating margins in excess of 20%. Arabia and the continued ramp-up of the recently completed upstream growth initiatives in Brazil. However, other large aluminum players are pursuing a similar strategy, and this competition will probably reduce the availability of greenfield expansions and lessen their returns. Therefore, while the business mix shift toward these opportunities and away from Alcoa's no-moat segments should increase the moat of the company as a whole, the value of these opportunities may erode over time and the company's competitive advantages relative to its closest competitors should remain constant. Alcoa also has significant cost advantages from its vertical integration (mining 85% of its bauxite needs and producing almost 100% of its alumina needs), as it not only sources a significant share of its raw-material needs at cost, but the mining and refining businesses are attractive assets themselves, generating the highest operating margins and the highest return on assets among Alcoa's segments. Large barriers to entry in the upstream operations stem from high initial investment and fixed costs, the somewhat low value/weight ratio of aluminum, and the importance of proximity between the refinery and the raw-material source. Moat Trend We believe the moat trend is stable. Alcoa has recently expanded its upstream operations, which now make up about 40% of revenue from 25% just a few years ago. This trend is expected to continue as the company's growth plans include developing a fully integrated complex in Saudi Page 5 of 10

6 Outstanding Issues Outstanding Issue By Maturity Date and Yield Issue Information Name Currency Maturity Coupon Yield Modified Date (%) Price (%) Callable Convertible Duration Alcoa 6.5% USD 01 Jun Yes No 0.7 Alcoa 6% USD 15 Jan Yes No 1.3 Alcoa 5.375% USD 15 Jan Yes No 2.2 Alcoa 6% USD 15 Jul Yes No 2.6 Alcoa 5.55% USD 01 Feb Yes No 5.3 Aluminum Co Amer 6.5% USD 15 Jun Yes No 6 Alcoa 6.75% USD 15 Jul Yes No 6 Alcoa 144A 5.72% USD 23 Feb Yes No 6.9 Alcoa 5.72% USD 23 Feb Yes No 6.6 Alcoa 6.15% USD 15 Aug Yes No 7.3 Alcoa 5.87% USD 23 Feb Yes No 8.2 Alcoa 5.9% USD 01 Feb Yes No 10.3 Aluminum Co Amer 6.75% USD 15 Jan Yes No 10.2 Alcoa 5.95% USD 01 Feb Yes No 12.7 Source: IDC and Finra A maximum of 33 issues is displayed. Page 6 of 10

7 Recent Notes from our Credit and Equity Analysts New Credit Rating: Alcoa 02 Aug 2010 Morningstar is initiating credit coverage of Alcoa AA with an issuer rating of. Alcoa is one of the largest independent aluminum producers in the world. Its expansion in low-cost production--particularly in Brazil and Saudi Arabia--helps usher the company into a mid to low tier on the global cost curve, solidifying its global leadership position in alumina, primary aluminum, and fabricated aluminum products. However, its highly leveraged balance sheet, large dependence on financial markets for funding needs, large unfunded pension and healthcare liabilities, and its volatile end markets offset its operational strength. We feel this is ultimately detrimental to its credit quality. Alcoa is vertically integrated, and mines 85% of its bauxite needs and produces 100% of its alumina needs. Its upstream assets generate over 40% of total revenue. Alcoa's smelting and refining facilities vary in quality, but the most high-cost ones have been idled since Going forward, we expect Alcoa to continue investment in upstream quality assets, while carefully monitoring its financial leverage. Although capital investment in upstream assets is beneficial in the long term, we feel this expansion will put additional strains on its free cash flow generation. Alcoa had a challenging year in 2009, primarily due to a drastic drop in the aluminum price over the course of a few months. It ended 2009 with adjusted debt of $12.9 billion, and $120 million in earnings before interest, taxes, depreciation, and amortization, or EBITDA. Looking ahead, we expect credit metrics to improve gradually during the next few years, but this would not merit a significant upgrade to an investment-grade rating. Alcoa Raises Demand Outlook After Strong 2Q 12 Jul 2010 Alcoa's AA second-quarter results rebuffed any signs of weakness in the aluminum sector with sales of $5.2 billion and adjusted earnings of $0.13 per share. Shipments rose 4% sequentially, and the company increased its outlook for 2010 demand growth to 12% from its previous forecast of 10%. However, aluminum prices have come down in the past few months; we believe this will offset any impact of stronger-than-expected shipments for the rest of the year. We are concerned about the downward trend in aluminum prices, which are now 12% lower than the start of the year, but we expect improving demand and production curtailments in China stemming from higher energy costs will support a price recovery. We are leaving our fair value estimate unchanged for now, but we'll revisit should aluminum prices remain sluggish. Alcoa Reports 1Q 12 Apr 2010 Alcoa AA reported first-quarter earnings from continuing operations of $101 million (excluding restructuring and special charges of $295 million), a significant improvement over the fourth quarter's $9 million due to higher average selling prices for alumina (up 13%) and aluminum (up 8%), as well as $86 million generated from continued cost reduction efforts. These gains were partially offset by higher energy costs and LIFO expenses, (as rising raw material costs start to flow through the income statement), as well as a drop in shipments. Even with the higher realized prices, revenue fell 10% sequentially, to $4.9 billion due to lower alumina, aluminum, and sheet can volume. After-tax operating income increased from the fourth quarter across all segments except flat-rolled products, where the loss of a significant contract in the sheet can business impacted North American sales volumes. We expect 2010 volumes to improve over the prior year, with further strength in the automotive and commercial transportation markets, and slight improvement in the aerospace and industrial sectors. Alcoa should also begin to see the benefits of its 2009 growth projects as the upstream Juruti and Sao Luis facilities ramp up, and the upgrades at its Russian can sheet mill and Bohai mill in Page 7 of 10

8 Recent Notes from our Credit and Equity Analysts China become fully operational in the next year. Page 8 of 10

9 Morningstar s Approach to Rating Corporate Credit 3 Offers a proprietary measure of the credit quality of companies on our coverage list. 3 Encapsulates our in-depth modeling and quantitative work in one letter grade. 3 Allows investors to rank companies by each of the four underlying components of our credit ratings, including both analyst-driven and quantitative measures. 3 Provides access to all the underlying forecasts that go into the rating, available through our institutional service. Purpose The Morningstar Corporate Credit Rating measures the ability of a firm to satisfy its debt and debt-like obligations. The higher the rating, the less likely we think the company is to default on these obligations. The Morningstar Corporate Credit Rating builds on the modeling expertise of our securities research team. For each company, we publish: 3 Five years of detailed pro-forma financial statements 3 Annual estimates of free cash flow 3 Annual forecasts of return on invested capital 3 Scenario analyses, including upside and downside cases 3 Forecasts of leverage, coverage, and liquidity ratios for five years 3 Estimates of off balance sheet liabilities These forecasts are key inputs into the Morningstar Corporate Credit Rating and are available to subscribers at select.morningstar.com. Methodology We feel it s important to perform credit analysis through different lenses qualitative and quantitative, as well as fundamental and market-driven. We therefore evaluate each company in four broad categories. Business Risk Business Risk captures the fundamental uncertainty around a firm s business operations and the cash flow generated by those operations. Key components of the Business Risk rating include the Morningstar Economic Moat Rating and the Morningstar Uncertainty Rating. Cash Flow Cushion Morningstar s proprietary Cash Flow Cushion ratio is a fundamental indicator of a firm s future financial health The measure reveals how many times a company s internal cash generation plus total excess liquid cash will cover its debt-like contractual commitments over the next five years. The Cash Flow Cushion acts as a predictor of financial distress, bringing to light potential refinancing, operational, and liquidity risks inherent to the firm. Morningstar Research Methodology for Determining Corporate Credit Ratings Competitive Analysis Cash-Flow Forecasts Scenario Analysis Quantitative Checks Rating Committee BB A C CC BBB AAA D B CCC AA Analyst conducts company and industry research: Management interviews Conference calls Trade show visits Competitor, supplier, distributor, and customer interviews Assign Economic Moat Rating Analyst considers company financial statements and competitive dynamics to forecast future free cash flows to the firm. Analyst derives estimate of Cash- Flow Cushion. Analysts run bull and bear cases through the model to derive alternate estimates of enterprise value. Based on competitive analysis, cash-flow forecasts, and scenario analysis, the analyst assigns Business Risk. We gauge a firm s health using quantitative tools supported by our own backtesting and academic research. Morningstar Solvency Score Distance to Default Senior personnel review each company to determine the appropriate final credit rating. Review modeling assumptions Approve company-specific adjustments AAA AA A BBB BB B CCC CC C D Extremely Low Default Risk Very Low Default Risk Low Default Risk Moderate Default Risk Above Average Default Risk High Default Risk Currently Very High Default Risk Currently Extreme Default Risk Imminent Payment Default Payment Default 2010 Morningstar. All Rights Reserved. The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security. Redistribution is prohibited without written permission. For licensing or permission to use this information, call Page Page 9 of 710of 8

10 Morningstar s Approach to Rating Corporate Credit The advantage of the Cash Flow Cushion ratio relative to other fundamental indicators of credit health is that the measure focuses on the future cash-generating performance of the firm derived from Morningstar s proprietary discounted cash flow model. By making standardized adjustments for certain expenses to reflect their debt-like characteristics, we can compare future projected free cash flows with debt-like cash commitments coming due in any particular year. The forward-looking nature of this metric allows us to anticipate changes in a firm s financial health and pinpoint periods where cash shortfalls are likely to occur. Morningstar Solvency Score The Morningstar Solvency Score is a quantitative score derived from both historical and forecasted financial ratios. It includes ratios that focus on liquidity (a company s ability to meet short term cash outflows), profitability (a company s ability to generate profit per unit of input), capital structure (how does the company finance its operations), and interest coverage (how much of profit is used up by interest payments). Overall Credit Rating The four component ratings roll up into a single preliminary credit rating. To determine the final credit rating, a credit committee of at least five senior research personnel reviews each preliminary rating. We review credit ratings on a regular basis and as events warrant. Any change in rating must be approved by the Credit Rating Committee. Investor Access Morningstar Corporate Credit Ratings are available on Morningstar.com. Our credit research, including detailed cash-flow models that contain all of the components of the Morningstar Corporate Credit Rating, is available to subscribers at select.morningstar.com. Distance to Default The Distance to Default rating is a quantitative, marketbased measure of a company s current financial health. (Distance to Default serves as the basis for Morningstar s Financial Health Grade.) The underlying model treats the equity of a firm as a call option on that firm s assets. Based on estimates of asset volatility and the Black- Scholes option-pricing model, we can estimate the likelihood that the value of the company s assets falls below the value of its liabilities, implying likely default. For each of these four categories, we assign a score, which we then translate into a descriptive rating along the scale of Very Good / Good / Fair / Poor / Very Poor Morningstar. All Rights Reserved. The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. This report is for information purposes only, and should not be considered a solicitation to buy or sell any security. Redistribution is prohibited without written permission. For licensing or permission to use this information, call Page Page 10 of 810 of 8