Alcoa Kicks Off Earnings: Some Numbers That Don't Add Up

An interesting, mostly-positive earnings report - with a few unexplained quirks.....

Let's dig in a bit and see what we got (the aftermarket loved it!)

Strong points include the fact that the bottom line was a beat; top-line questionable - everyone is claiming "beat" but I had the same number on my screen as they reported, so take your pick - if it's a beat, it's not a big one (and might not be one at all.)

Cost-cutting and improved prices for aluminum products are the story here. Here's the top-line reality: Revenues were $4.6 billion vs. $4.2, up 9.52% sequentially. Good, right?

Weeeeeellll... aluminum prices went from $1,667 per ton to $1,972, an 18.3% increase.

Now we got a wee problem. This rather strongly implies that the actual shipped volume was down sequentially. Does it prove this? No, as we don't have product mix shifts in the report, but this sure as hell suggests a decrease in shipped tonnage sequentially, not just year/over/year, and is a big fat flashing yellow light that I bet you don't see talked about.

What makes no sense here is this statement in the release:

Due to low inventories at distributors and rising shipments, regional premiums are improving and global aluminum consumption is expected to increase 11 percent in the second half of 2009.

I don't believe it, to be blunt. You don't have a 9% increase in gross sales on an 18% increase in prices and tell me that shipments are rising, unless you're somehow magically making product appear at customers for which you're not being paid. The internals of the report and the breakdown don't help me come up with a reconciliation either.

Something doesn't add up.

Oh wait! Here it is! Right at the bottom of the report (missed it first pass; thanks to the guy who emailed me!): 1,230,000 metric tons shipped this quarter, 1,288,000 metric tons last quarter.

BINGO!

SHIPMENTS WERE IN FACT DOWN SEQUENTIALLY!

The conference call says they're looking for a 4% rise in demand in China and 6% worldwide, but a 15-20% decline in automotive sales for the full year 2009 and 30-35% decrease in heavy trucks (indeed, there was a report out this afternoon on Class 8 truck sales - horrifyingly bad doesn't even begin to describe it.) But wait! The release also says:

global aluminum consumption is expected to increase 11 percent in the second half of 2009.

Uh.... those numbers don't add up either. What am I missing here guys and dolls?

The rest of the report seems to make sense - the only other area of trouble I see is in engineered products, which is Alcoa's highest-margin business and is in serious trouble, down 15% sequentially. That's mostly aerospace - read "airplanes." Not exactly a growth industry at present......

I'm disturbed, however, by the apparent discrepancy in claimed numbers in two different places and the consolidated result statement saying that in fact shipments didn't increase, they fell.

That is hardly the picture of "improving demand" claimed to be experienced in the reported quarter and forecast - especially when that forecast is for an increase that would simply reverse the 3rd quarter tonnage decline implied by pricing and revenues (that is, take us back to second quarter tonnage-shipped levels.)

Finally, there's the matter of P/E. Assuming we could get to a normalized 12 month leading expectation of 70 cents in fully-diluted earnings by the middle of 2010 (and I believe that's damn aggressive) you're paying 21x on those earnings 12 months out - too darn rich for me for an industrial concern on any reasonable set of forward expectations.

I liked AA in the $5s in March, but I wouldn't go anywhere near it at $15 today.

Sorry, no $ale.

Disclosure: No position; I sold out of my spring long at what was obviously early, but if I still had it, I'd be selling into this strength.

Comments

[Michael Clark:]

Very good, Karl. Have corporations always been lying in their financial reports like they are today -- or are these 'special circumstances'?

Oct 08 12:42 PM

[stay strong:]

Another bear who missed the boat!! that's what you get for being pessimistic

Oct 08 01:17 PM

[ebworthen:]

Karl,

This seems to be more of the same, massaging bad news to make it look better, then putting some spin on it and saying "less worse than expected" so there is no short term pain for the stock.

In Alcoa's case, I'm certain that the can they are kicking down the road is an aluminum one ;-)

stay strong - a bear who missed the boat eh? I'm sure there were passengers who missed the Titanic's last voyage whose feelings changed.

Cheers

Oct 08 01:53 PM

[Shishir Nigam:]

Interesting observation you make Karl, about the declining shipments at Alcoa. Revenue growth, seems to be the holy grail this earnings season, and for good reason. Q1 and Q2 earnings have resulted purely from "above expectations" cost-cutting measures...which are by definition, unsustainable in the long-run. To improve earnings from this point on, revenues will have to rise.

To add another point to your analysis, a big chunk of Alcoa's rise in aluminum demand was attributed to the increased demand for cars, which of course got a one-time boost from cash-for-clunkers. Car sales since then have fallen 41% month-on-month, that's not very encouraging for Alcoa. Whether the other big blue chips can provide/show revenue growth next week, will determine whether the prices come crashing down along with the P/E ratios.

For more analysis, check out my blog: youngandinvested.com

Oct 08 10:55 PM

[sethmcs:]

Actually selling price is much more important to profitability than volume. Why? Because you make more on less sales. The surprising thing here is AA should have no pricing power at all. Didn't read the report but I recall reading that AA was running at 65% capasity last quater. What does their order book look like and what is the source of the pricing power? Weak dollar? Manufacturing orders?

Oct 08 11:05 PM

[ryanclarke:]

Good and careful scrutiny of the numbers. With revenue up about 9% from last quarter and aluminum prices up 18% from last quarter .... shipments should be about the same ... which they were ... not alot difference of shipments of ... 1,230,000 metric tons shipped this quarter, 1,288,000 last quarter. What's of greater concern to me is following AA debt levels and the ability to service that debt level long term. Also, in order to beat the street AA cut to the bone ... about a 25% reduction in head count is what I read in the news. Much of what AA earns on the top line in the next few quarters will get eaten away by AA's debt problem. By this time next year AA's is probably cut to junk ... just like GM ... along with another industry taken over by the secured bondholders and Uncle Sam ... which makes complete sense because AA was a monopoly just like Boring is just like Microsofty is just like Exxon is .. etc.

Oct 09 01:26 AM

[ryanclarke:]

All the boobleheads in the news are going to be wondering why AA posts improving positive earnings quarter over quarter for the next two quarters but the stock price doesn't move back to $40 ... ... because everyone who looks at the AA's 10-Q knows the long term viability of a company waist deep in debt ... is unlikely ... unless AA can get revenue, THE TOP LINE to above $30 Billion a year ... and do it next year ... no matter what.

Oct 09 01:52 AM

[Karl Denninger:]

Uh, that's a roughly 6% volume decline. I wouldn't call that insignificant, given that its a sequential decline.

I do agree on the debt issue, although they're trying in that regard.

On Oct 09 01:26 AM ryanclarke wrote:

> Good and careful scrutiny of the numbers. With revenue up about 9%
> from last quarter and aluminum prices up 18% from last quarter ....
> shipments should be about the same ... which they were ... not alot
> difference of shipments of ... 1,230,000 metric tons shipped this
> quarter, 1,288,000 last quarter. What's of greater concern to me
> is following AA debt levels and the ability to service that debt
> level long term.

Oct 09 08:01 AM

[surgcare:]

Sounds like inflation to me .

Oct 09 09:30 AM

[TeresaE:]

Facts?

Real analysis?

Come now Karl, this is the "new century" and the old rules no longer apply.

Just like it is a "win" that we are going to insure less than half the uninsured for over $1 trillion in costs, including more taxes (windfall taxes, bwaaahaaahaaa) on medical insurers and goods makers.

I'm sure that in our new century, raising costs and mandating expenses for struggling citizens is going to create more money to spend on things like vacations and cars.

So, Alcoa will be just fine, we just have to hold on until the government gets 99% of every dollar we touch and by gawd the economy will just fly high and all us rich middle class Americans will be spending cash like there is no tomorrow.

The only wish I have is that I realized the fallacy of earnings seasons in May. Other than that, hang on folks we ain't seen anything yet.

And thanks again Karl for trying to bring reality into this brave new world.

Oct 09 11:02 AM

[po folks:]

Shipments usually don't rise a lot in most recessions I've seen, so that is no surprise.

Basic material companies usually take it on the chin during downturns and have to cut employment, and also have to squeeze working capital to the absolute minimum to sustain operations. Although this is a reactive solution, it is called good operations management, and that is what we partially see in this earnings report.

Prices usually don't rise in a recession either, which is the puzzle, to me at least. This industry is prone to big oversupply from sovereign nations that run smelters at full capacity to generate foreign exchange, whatever the market conditions. The world price has improved and LME stocks have shown some reductions, but there is still a large overhang.

Could it be that these nations now see this as folly? Is it the weak dollar? Could aluminum be a new "stable store of value" like precious metals?

Oct 09 11:22 AM

[Mark Anthony:]

Karl:

Your article suggests that there are some numbers in AA's quarterly report that are inconsistent and hence suspicious or untruthful. Questioning the numbers of a company's quarterly report "does not add up" is a serious accusation. However your article fails to point to any single number in AA's quarterly report that is inconsistent or suspicious.

So exactly which ones of AA's numbers do not add up?

The only thing that does not add up is your article. The content of your article does NOT add up to its title. AA's quarterly report is truthful and consistent within itself, with no ground for suspicion.

You have been very wrong on US dollar and on the direction the equity market is moving, by "short the phone book". The world does not want our dollars. But the world want US products. The world economy, leading by the China recovery, will thrive. The world wants basic materials. AA produces aluminum, a base metal traded and wanted the whole world around. It does not matter where AA is located, in the USA or in China or in any where. The aluminum is the same aluminum regardless who produces it. So as long as the world wants to have aluminum, AA will have value. And that valuation has nothing to do with the demise of the US dollar. AA's valuation could only go higher measured in US dollar, as the value of dollar moves lower.

I have no position in AA as I have better long plays. But I just find Karl's thesis completely wrong. Bottom line is that the world reject certain things from the USA but want certain things from US. Read the comment section here to understand why:
seekingalpha.com/artic...

Oct 09 03:15 PM

[Mark Anthony:]

It is also wrong for Karl to judge AA, or any manufacturing company's valuation purely based on current P/E ratio. What about book value? What about future profit potentials?

AA's latest quarter reports sales revenue of $4.6B and income of $73M. So the income of selling aluminum is merely 1.6% of the sales proceeding. That's a very insignificant percentage not much higher than roughing or statistics error or even the fluctuation of foreign exchange rates. Just think about what if instead of 1.6%, but rather 16% of the sales proceeding goes into profit, how much should AA's P/E be then?

The price of aluminum itself goes up or down more than 1.6% a day. So it is rather insignificant to argue that only 1.6% of the sales proceedings goes into profit. This number could change very drastically by the next few quarters.

I am not quite interested in aluminum play because the earth has a virtually unlimited natural resource for aluminum production. It's all a matter of turning electricity into the aluminum metal, with no company owning the dorminant technology.

So the up side of aluminum is limited comparing with other, more scarce natural resource play, like my favorite palladium and tellurium. This is why I always maintain holding SWC position at at least 50% of my portfolio. That's how strongly I feel about scarce natural resource plays.

Oct 09 03:32 PM