Alcoa's Earnings Preview: What Ugly Looks Like

Jul. 1.13 | About: Alcoa, Inc. (AA)

Alcoa (NYSE:AA), the Dow's one and only aluminum producer, is scheduled to report 2nd quarter 2013 financial results after the bell on Monday, July 8, 2013.

If there is a "punch me right in the face" stock we hold in client accounts, and by that I mean every time I look at the stock in client portfolios I think, "What the bleep was I thinking?" it is by far and away Alcoa.

The stock is down 10% year-to-date and about 10% over the last 12 months, underperforming the S&P 500 by about 20% as continued supply of aluminum out of China has kept pressure on the price.

Looking at the charts on, the price of aluminum per pound (in dollars) has fallen below $0.80 to $0.79, taking out the low end of its trading range over the last 12 months.

This has kept consistent downward pressure on earnings per share (EPS) and revenue estimates for AA, as revisions continue to be lower for the aluminum producer:

AA's 2013 and 2014 consensus revenue and EPS estimates

Qtr end 2013 EPS 2014 EPS 2013 Rev 2014 Rev
7/1/13 $0.41 $0.66 $23.6 bl $25.0 bl
4/30/13 $0.44 $0.73 $23.8 $25.4
1/31/13 $0.61 $0.87 $24.6 $26.2
10/31/12 $0.68 $1.01 $25.0 $26.6
7/31/13 $0.74 $1.06 $25.2 $26.8
6/30/12 $0.92 $1.12 $26.0 bl $27.1 bl
Click to enlarge

* Source: ThomsonReuters as of 7/1/13

* These figures are "estimates" of expected EPS and revenues for the 2013 and 2014 calendar years.

Both the 2013 and 2014 EPS have been reduced by 50% over the last year, and within the last two months, the credit rating agencies have reduced Alcoa's debt rating to the BB area, or the higher end of the high yield rating spectrum.

Aluminum, copper, steel, gold, silver and just about any other base or precious metal has seen serious price pressure the last 12 months, which has left the sector in deep value territory.

So what is the upside ?

Trading at 80% of tangible book value (TBV) today, the stock is looking like it is getting washed out, but the only sure way to tell is to see how it trades in the face of more bad news.

With the Fed beginning to taper and Europe looking like it is really stabilizing, if China could stop slowing and there would be a real prospect of a return to global growth, I think Alcoa would benefit from a global economy that was similar to what we saw in the late 1990s.

Alcoa's peak earnings were $3.00 in 2007 and the stock peaked at $48 per share in July 2007. Granted that was a very different economy and financial landscape (read leverage), as China was growing at 15%, but even if we return to half that global growth and China would stop smelting, AA might have a fighting chance.

AA has announced it was shuttering a smelter in Italy last week, which was 44,000 metric tons, on top of the potential curtailment of another 400,000 tons announced earlier in 2013.

It is clear that this is all about supply.

Our internal valuation model puts an intrinsic value on AA near $11, given the current earnings profile, while Morningstar rates AA near $19 per share. AA did trade as high as $18 in March 2011.

AA's CEO has his hands full although he is stuck being eternally optimistic in a situation where he is totally controlled by the Chinese supply picture. Klaus did guide to 7% global aluminum demand growth in 2013, which has been stable now for about a year and a half.

Can the board spin-off a segment of the business? There was a rumor the hot-rolled metals segment might get spun-off to drive shareholder value, but that was just a rumor.

At 6(x) cash-flow and 9(x) enterprise value (EV) to cash flow, the stock could trade lower. The early March '09 low was $4.97.

Deep value investors are no doubt taking an interest in Alcoa, and probably in the basic materials sector in general, these days. But with "deep value" an investor has to be very patient. We are starting to lose ours.

One other point that was picked up off of a brokerage report (can't recall the source): Alcoa is now the smallest Dow component by market cap. There is a risk it could get kicked off the index, which would trigger another wave of selling of the stock and more downward pressure on the price.

Disclosure: I am long AA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.