Click to EnlargeAlcoa (NYSE:AA) reported earnings after the bell on Tuesday night — marking the unofficial beginning of third quarter earnings season — and the results weren’t pretty. Earnings came in at 15 cents per share, well below analysts’ expectations for 22 cents. While the miss was wide enough on the headline level, worse still is that estimates already had fallen sharply from 32 cents 90 days ago and 29 cents just 30 days ago.
AA shares were down over 5% after hours, and the miss threatens to take the steam out of the nascent broader-market rally of the past few days.
This high-profile disappointment provides a few important broader-market insights for investors:
Earnings Estimates Might Need to Come Down Further
Even though Alcoa’s earnings estimates had fallen 24% in a month, this wasn’t nearly enough for the company to “beat” lowered numbers. This calls into question the potential for further misses not just by companies in the materials sector, but also across the entire market. According to a Factset report released Oct. 7, third-quarter estimates had only fallen 3.9% since June 30. Much of this decline came from the financial sector, and a large portion of that stemmed from the plummeting estimates for Goldman Sachs (NYSE:GS).
Granted, Alcoa is just one company — and it’s one that happens to be exposed to the large decline in the price of aluminum. Still, this indicates the rest of the market might be vulnerable to sharp estimate cuts as analysts try to play catch-up in the weeks ahead.
A Lowered Bar Doesn’t Provide Total Safety
Like most materials companies, Alcoa’s plunging estimates were matched by an equally sickening downturn in its stock price. At Tuesday’s close, AA shares were off nearly 43% from their high of early April. Typically, the combination of falling earnings estimates and huge stock price losses sets up the potential for a rally following the actual earnings report. But that won’t necessarily be the case this quarter if the after-hours reaction in Alcoa shares is any indication. Investors should be on high alert that the usual “sell the rumor, buy the news” trade is dangerous in the current environment.
Europe Worse, China Better Than Thought
Alcoa’s earnings provided good news and bad news about the world economy. On the negative side, AA cited slowing demand from Europe as an important reason for its third-quarter shortfall. Weakening growth in Europe is hardly news, but Alcoa’s miss indicates that the stocks of companies with a high European exposure may need to discount an even worse scenario than they already are.
In the good-news department, Alcoa noted that global demand is much more robust now than it was at the depths of the recession three years ago. AA’s presentation cited continued strength in demand from the emerging markets in general, and from China in particular. While part of this positive outlook stems from the increasingly favorable supply-and-demand picture for aluminum in China, it also might indicate that the market’s recent concern about slowing Chinese growth might be exaggerated.
As for Alcoa itself, the stock might be a long-term buy, but there isn’t compelling reason to step and buy the stock just yet. There’s a long way from Tuesday’s regular-session close of $10.30 to the $8.45 intraday low AA established earlier this month, and all of its rallies since the April high-water mark have proven shallow and short-lived. As long as macro concerns are driving market performance, investors will be best served by looking elsewhere for opportunities.
As of this writing, Daniel Putnam did not own a position in any of the aforementioned stocks.
