Because aluminum is a critical raw material for many industries, the quarterly earnings report of Alcoa (NYSE:AA) is an important barometer of the stock market. Unfortunately, with its latest announcement, things are looking shaky. On Tuesday, the stock lost 6% to $16.70.
Then again, Alcoa had to deal with some headwinds in the quarter. They included things like the weak dollar and a surge in energy prices. As a result, sales came to just under $6 billion, which was below the $6.1 billion consensus. Earnings, however, beat forecasts by a penny.
Keep in mind that Alcoa’s stock price had already posted strong gains. Over the past year, the shares have doubled.
Can they resume their upward trend? Here’s a look at the pros and cons:
Pros
Global leader. Alcoa is the largest producer of aluminum, with operations in 31 countries. It serves a wide array of end markets like aerospace, automotive, construction and beverages. The good news is that the economic rebound is lifting many of these categories.
Healthy pricing. All in all, the global supply-and-demand balance for aluminum is positive for Alcoa. The result is that pricing should continue to increase. Keep in mind that there is roughly a two-month lag time until these changes hit Alcoa’s bottom line. In other words, this should mean stronger momentum in the next quarter.
Cost cutting. A few years ago, Alcoa’s business saw a perilous decline because of the recession. But the company took swift action and engaged in aggressive cost cutting, including halting capital expenditures, improving sourcing for raw materials, selling off assets and lowering headcount. Because of these moves, Alcoa has been able to boost profits as well as pare down debt (the debt-to-capital ratio is 33.6%).
Cons
High materials costs. Alcoa is a major buyer of energy and other key raw materials. There have also been supply problems with caustic soda (which is used for bauxite production) because of the Japanese earthquake and tsunami. But the worldwide surge in commodities creates a problem. While Alcoa has been able to effectively offset the impact with higher productivity and cost reductions, this can only go so far.
The China factor. The BRIC countries (Brazil, Russia, India and China) are key growth drivers for Alcoa. Yet, China remains the most important, as the country continues to invest in its infrastructure. But there are some signs that growth will decline. For example, to combat threatening inflation, China has been increasing interest rates.
Competition. Alcoa has large rivals, which include companies like Rusal, Rio Tinto (NYSE:RIO) and Aluminum Corp. Of China (NYSE:ACH). A big issue is that production can easily turn into an excess glut – and it can take a while for the market to get back into balance.
Verdict
On the company’s latest earnings conference call, Alcoa’s CEO, Klaus Kleinfeld, was upbeat. He talked about the promising long-term trends and believes that aluminum pricing will be healthy. Yes, he thinks China should remain strong.
On a valuation basis, Alcoa’s stock also looks attractive. The forward price-earnings ratio is about 11 (which is based on Wall Street consensus estimates). And again, the next quarter may see a nice lift because of improved pricing.
When adding things up, it looks like the pros outweigh the cons on the stock.
Tom Taulli’s latest book is “All About Short Selling” and his Twitter account is @ttaulli. He does not own a position in any of the stocks named here.
