Aluminum giant Alcoa (AA: Charts, News, Offers) has long been regarded as one of the most accurate bellwethers of global economic health, due to its sprawling global operations – which are spread over 31 countries – and the nearly universal demand for alumina and aluminum in a wide range of consumer and industrial products. 80% of Alcoa’s revenues are earned from aluminum and alumina sales, so the company’s fate is ultimately tied to the price of the metals, which have steadily declined after a brief rally earlier this year. Spot price for aluminum today is roughly 9% lower than it was a year ago, and 22% off its year high. Alcoa is invested in all aspects of aluminum production – including mining, refining, smelting, fabricating and recycling. Its products are used in aircraft, automobiles, commercial transportation, packaging, construction, defense, industrial, and oil and gas operations.
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Alcoa, a Dow component, kicked off the earning season by announcing earnings of 15 cents per share, far short of the analyst consensus of 23 cents per share, but a vast improvement over the 6 cents per share it posted a year earlier. Revenue increased 21% to $6.4 billion, beating the analyst consensus of $6.23 billion. At first glance, these earnings look mediocre. However, Alcoa’s earnings were littered with so many one-time charges – such as flood damage, and positive ones – such as an income tax benefit, that analysts had a hard time figuring out just how much the company actually earned.
Its adjusted earnings, excluding one-time charges, ended up at $164 million, but still fell short of the expectations of $172 million, but paint a far more positive picture of the company’s potential growth. The company reported steady demand for aluminum in all major markets except for Europe, where demand is expected to decline 13% from the first half of the year. Alcoa received approximately 24% of its 2010 revenue from the troubled European region. The three largest European economies – France, Germany and Italy – are expected to shrink by 0.4% this year. To offset these troubles, Alcoa looks to end fiscal 2011 with a 17% increase in demand in China, up from its original 15% projection. For all global markets combined, Alcoa sees global aluminum demand increasing by 12% by the end of fiscal 2011, down slightly from the 13% it posted in 2010. Alcoa reiterated its lofty claim that aluminum demand will double by 2020.
Alcoa failed to addressed the dropping price of aluminum, which suggests that the market doesn’t agree with Alcoa’s view. Currently, China is the driving force behind aluminum prices. Due to the energy costs of aluminum production, China’s state-owned aluminum producers tend to produce more aluminum when energy costs are low – such as now – and produce less when energy costs are high – when commodity prices spike in times of economic growth. China tends to stockpile the produced aluminum, along with other metals, thus turning the metals market into a cyclical one instead of one that continually trends upwards. However, this swing model only works in times of economic certainty. With the recent report that China’s growth has slowed significantly, the state-owned aluminum producers may still continue producing at lower margins but higher volume in order to raise cash to finance outstanding debt. This keeps aluminum prices low in the short term, which is bad news for Alcoa.
The low spot price of aluminum has been exacerbated by the rising production costs that Alcoa has been grappling with. Since 2008, Alcoa has cut 20,080 jobs and closed down 295,000 tons of capacity at smelters just to stay afloat. Looking forward to the fourth quarter, Alcoa refused to give an exact forecast of its alumina and primary aluminum output. Analysts believe that inevitable cuts in production will drastically change its output for the end of the year. Alcoa is currently the third-worst performer in the Dow after Bank of America (BAC: Charts, News, Offers) and Hewlett-Packard (HPQ: Charts, News, Offers), with shares down 35% for the year. However, with increasing evidence that the market is near a bottom, shares may rebound sharply from oversold levels. Shares of Alcoa currently trade with a forward P/E of 8.45 and a PEG ratio of 0.27.
Other News About AA
Alcoa Profit Trails Estimates as Europe Trims Aluminum Orders
European woes hit Alcoa hard, despite decent results in other markets.
Alcoa Falters in a Fragile Economy
Can Alcoa keep aluminum profitable in these uncertain times?
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Leo Sun is long-time market follower and finance writer. He regularly contributes to the Stock of the Day analysis.
