Alcoa Stock – Q3 Earnings Spark Split Concerns

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Just when it looked like Alcoa Inc (AA) shares might finally be pulling themselves out of a multimonth slump, earnings come along and remind owners of Alcoa stock that this company is still in serious trouble right now.

They also remind them that splitting Alcoa up into two organizations next year doesn’t solve the bigger problem — it simply dumps the problem on one of the two companies.

Q3 Earnings Raises Company-Split Concerns for Owners of Alcoa StockAlcoa CEO Klaus Kleinfeld sees reason for hope, of course, noting that the aluminum glut should finally be coming to a close and that the worst-case scenario for China has already been priced into AA stock.

His optimism lacks conviction, though. Or, maybe the market simply sees more trouble ahead that Kleinfeld can’t publicly acknowledge.

Alcoa Earnings

In its third quarter of 2015, Alcoa earned 7 cents per share on $5.57 billion in revenue. Both fell short of estimates, as well as last year’s comparables. Wall Street was calling for earnings of 13 cents per share of AA stock on $5.65 billion in sales, and in Q3 of 2014, the company earned 12 cents per share on a top line of $6.24 billion.

The culprit, of course, is falling aluminum prices. Alcoa said its average selling price for aluminum was 25% lower than they were a year ago.

It’s a figure that jibes with the spot prices for aluminum then and now. A year ago, aluminum was fetching around 87 cents per pound. Now it’s selling for about 70 cents per pound as an economic slowdown in China — the biggest consumer of aluminum — has crimped demand at the same time China itself has ramped up its output of aluminum.

And although the industry as a whole has curtailed production, there’s still some Chinese-driven excess to burn off. Alcoa was previously looking for car production to rise between 5% and 8% this year, but has now whittled that outlook down to growth of only 1% to 2%. Heavy truck output from China is projected to fall 22% to 24% this year, versus a prior forecast of only a 14% to 16% decline.

Looking Ahead

While aluminum prices are falling at the same time crucial Chinese demand is waning, Kleinfeld assures investors that better days are here.

Specifically, between all the production cuts Alcoa and other aluminum companies have made (been forced to make), AA has not only reeled in its 2015 surplus expectation of 762,000 tonnes to 551,000 tonnes, but actually expects a supply deficit next year, which should re-inflate aluminum prices.

Not everyone is on board with Kleinfeld’s optimism, though. Morgan Stanley, for one, is forecasting a surplus of 1.8 million metric tons of aluminum next year, which would keep prices crimped for quite a bit longer.

It’s a disparity that has to concern current and potential owners of Alcoa stock, who will see the company split into two next year. While the “downstream” division that sells finished specialty products to the automotive and aerospace industries is doing fine, the “upstream” unit that smelts and sells raw aluminum is proverbially hanging by a thread.

For perspective, although Kleinfeld touted the fact that the past nine months have been outstanding and highly profitable ones for the alumina division, the primary metals unit outright swung from an after-tax operational profit of $245 million in the third quarter of 2014 to a $59 million loss last quarter.

Moreover, although the success of its rolled products division and alumina division appear as if it could offset the deteriorating aluminum division’s newfound losses, those P&L statements for each division don’t include costs associated with shuttering capacity. If Alcoa wants to stop bleeding money through its aluminum unit, it’s going to have to incur at least more one-time costs elsewhere on the accounting statement.

In other words, if aluminum prices don’t perk up significantly, and soon, the upstream unit that will retain the Alcoa name may begin its journey as a standalone company already facing insurmountable odds.

Bottom Line for Alcoa Stock

With all of that being said, perhaps it’s not the specific metrics of each unit that should concern Alcoa stock owners, but rather, Klaus Kleinfeld’s unwillingness to see — or at least talk — reality.

To his credit, curtailing production of aluminum was the right thing to do in the long run. But, his comment “If (the commodity business) looks this good at these prices, then imagine how it will look when we have higher commodity prices” has to leave the market wondering which market he’s looking at, because there’s nothing particularly attractive about commodities right now, nor was there anything especially compelling about the Alcoa earnings report for Q3.

Perhaps something he said during a CNBC interview better summed up his assessment of the commodity market’s implosion:

“You have to put it into perspective. It’s not like falling off a cliff.”

He’s right … it’s not like falling off a cliff. That’s the problem. It’s that lack of hard landing yet that suggests we may still have farther to fall, which just leaves Alcoa investors wondering who’s going to be left holding the bag next year after the split.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/10/q3-earnings-raises-company-split-concerns-owners-alcoa-stock/.

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