With the first quarter of 2013 winding down, it's time to look towards the start of earnings season in April. Alcoa will be the first out of the gate to report, and there are a few glaring issues not only with Alcoa but the basic materials sector as a whole. With the Federal Reserve keeping interest rates locked at a 0-.025 range, the entire basic materials sector is feeling the constraints.
Alcoa needs to achieve an $0.11 EPS to meet expectations. Looking back over the last three years shows that the highest EPS Alcoa has achieved in that time is $0.10 per share. While expecting just a one cent per share growth, keep in mind that represents a 10% EPS growth. For a mature materials company to achieve 10% YOY growth while federal and state governments are aggressively cutting costs, that could prove to be unattainable. Currently, Alcoa (AA) has a P/E of 48.67, a Forward P/E of 9.90, a P/S ratio of 0.39, and a PEG ratio of 2.21. Out of all of those metrics, the only fundamental that looks solid in comparison to the S&P 500 average is the 0.39 P/S ratio. The S&P 500 has a P/E of 20.4, the basic materials sector has a P/E of 19.7. Neither of those comparisons work out favorably for Alcoa, with a P/E more than double both the S&P 500 and the basic materials sector.
Also, take in to account the revolving level of short interest broken down by sector. After going through the numbers, the basic materials sector is exactly "par for the course" matching the average of 2.6 days to cover. The S&P 500 average short interest is 2.38 with a float ratio of 2.33. The materials sector has a short interest of 3.61 and a float ratio of 3.55, over 50% higher than the S&P 500 average respectively. To put it plainly, that type of short position just isn't attractive for any investor looking to enter the materials space.
The Federal Reserve's low interest rate policy also plays a factor. The longer interest rates stay exceptionally low, the less inclined banks are to make loans to businesses. Banks can make a better return by investing those funds. So long as banks are less inclined to make loans, the harder it is for businesses to expand. If businesses aren't expanding, that means fewer jobs. Fewer jobs means less people are able to afford new cars, homes, and other big ticket items. That means Alcoa's aluminum won't be in as high of demand to produce car parts, packaging materials, or building and construction.
The other adverse macro economic demand side constraint is the infamous "Sequester" manufactured by the federal government. With massive budget cuts, $10 trillion over the next decade, being made to programs across the board, that means less demand for Alcoa's business. Alcoa's aluminum is used by the Navy, Army, and Air Force. Each part of the military is slated to suffer budget cuts due to the Sequester. Also, government projects to help build and maintain roads, bridges, and railways are going to be scaled back as part of the budget cuts. All of these cuts directly effect Alcoa.
Alcoa is poised to miss earnings based off of past performance, and adverse macro economic events out of the company's control. To make matters worse, the fundamentals of Alcoa are weak when compared to the S&P 500 and the basic materials sectors respectively. Until interest rates rise, and this Sequester is resolved I would steer clear of Alcoa. If Alcoa does somehow meet expectations, I would expect them to revise forward guidance downward with all of the macro economic pressure coming their direction. My personal 52-week price target: $9.03.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Always consult with a registered financial professional before considering adding a new position to your portfolio. Investing involves a significant risk of loss, as such never invest more than you can afford to lose.