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Earnings Confirm Bearish Case for Alcoa Stock (AA)

There's no reason to rush into AA ahead of its split into two businesses

Alcoa Inc (AA) managed to beat Wall Street estimates, and yet weak guidance ensures more weakness in AA stock, at least until the aluminum giant splits in two later this year.

Alcoa stock upstream AAAlcoa stock plunged more than 10% in the first two hours of Tuesday trading despite assurances from AA management that global demand for aluminum will show reasonable growth this year.

But with prices for aluminum and other metals prices in freefall, it’s little wonder that the market won’t give Alcoa the benefit of the doubt.

After all, aluminum prices are off 25% over the last year and show no signs of pulling out of their downtrend. The macroeconomic situation almost guarantees it: Global economic growth is weak and China’s economy is slowing at a faster-than-expected pace. Even after slashing production, there’s too much aluminum out there to stabilize prices.

Indeed, if the outlook weren’t so bleak, Alcoa wouldn’t be looking to cleave itself in two.

True, spin-offs and disposals are especially fashionable these days. Alcoa’s plan to split off the slow-growth, low-margin upstream business from the faster-growth, higher-margin downstream business is a sensible move. But in normal times CEO’s are usually loathe to reduce the size of their domains.

Alcoa Stock Has More Headwinds Than Catalysts

The split also underscores how unattractive Alcoa stock is these days. It’s not like investors need to be hasty in order to get in on the split. The downstream business isn’t going to pop like a hot initial public offering when it starts trading independently from the upstream operations. It will simply have clearer characteristics of a growth stock rather than a value or hybrid play.

Besides, the most recent earnings report and outlook gives investors little reason to be excited about either side of Alcoa.

In the final quarter of the year, Alcoa — as expected — swung to a loss of $500 million, or 39 cents a share, compared with a year-earlier profit of $159 million, or 11 cents a share.

After stripping out restructuring charges, earnings dropped to 4 cents a share from 33 cents in last year’s fourth quarter. On that basis, profits exceeded analysts’ average estimate by 2 cents a share, according to a survey by Thomson Reuters.

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Revenue, however, fell short of the Street’s forecast, coming in at $5.25 billion vs. an outlook for $5.29 billion.

What’s most damaging at this point is that the Alcoa earnings report didn’t do enough to give investors confidence in either side of its operations.

Alcoa can keep cutting costs in its upstream smelting business, but what it really needs is higher commodity prices. Meanwhile, the much more promising upstream division that makes value-added products for the automotive and aerospace industries has its own blemishes. Demand for aircraft and cars is expected to grow, but demand from truck manufacturers is going in the other direction.

Furthermore, as Citigroup analysts note, AA’s forecast for the upstream business fell short of its estimates.

Alcoa stock has lost half its value over the last year (see the chart courtesy of S&P Capital IQ), and it’s reasonable to keep tabs on it as a potential bargain buy.

But with no catalysts in sight and persistent macro troubles, there’s no reason to buy Alcoa stock right now.

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

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