By David Silver
Wednesday after the closing bell, Alcoa (AA) started off earnings season with a bang, reporting a quarterly profit of $0.04 (consensus was a loss of $0.10 per share) and revenues of $4.62 billion that beat the Street’s expectations (consensus was $4.55 billion). CEO Klaus Kleinfeld announced that revenues fell 33% year over year but improved 9.0% sequentially. So much has changed since the third quarter of last year that year over year comparisons are really comparing apples to oranges. Since taking office back in May of 2008, Mr. Kleinfeld has slashed production, jobs, and capacity and has tried to concentrate more on the Company’s core businesses. During the quarter, the Company announced it ended a joint venture and received $276 million of cash, which helped give the Company a cash balance of $1.1 billion at quarter end.
In previous quarters, the balance sheet had been a sticking point as the Company was overleveraged and was struggling to generate positive cash flow. Alcoa still has $9.07 billion of long term debt (up from $8.51 billion at the beginning of the year), but its balance sheet has improved dramatically over the past six months. Despite reporting losses in two of the first three quarters of 2009, Alcoa generated $241.0 million from operations. It is still down dramatically from the $626.0 million generated in the first nine months of 2008, but it is a step in the right direction.
The Company indicated that it expects demand to increase 11% in the second half of the year compared to the first half of the year, mostly as a result of increased demand from countries such as China, India, and Brazil. Inventories remain at elevated levels, but continue to decrease. There have been some concerns, however, that purchases from China are more the result of stockpiling than an actual increase in demand. We believe the 11% demand growth is a bit on the bullish side, but management’s expectations could bode well for other companies as well.
The Company’s end markets, namely the aerospace, auto, and construction industries have been extremely weak over the past nine months, and any improvement will be seen as a positive. Automakers are increasing production following the cash for clunkers program, and Boeing’s (BA) Dreamliner 787 is on the verge of its maiden voyage and production beginning in earnest. If auto sales continue as automakers expect and the Dreamliner proceeds without another hitch, the 11% increase in demand is definitely within the realm of possibilities.
During the second quarter, the Company broke a five quarter streak of delivering earnings per share results that were below the Street’s expectations and reported a profit (beating top line estimates). Earnings season from the first two quarters were littered with so-so earnings releases as companies were able to beat on the bottom line by cutting costs (think slashing production and jobs) but fell short on the top line. This quarter, Alcoa started the ball rolling with a beat on the top line and bottom line. Aluminum prices are up about 50% from the lows back in March, but have pulled back in recent weeks. The Company said that it saw an 18.2% increase in the average price per metric ton to $1,972 per metric ton from $1,667 per metric ton in the second quarter.
So Alcoa broke the string of so-so earnings, but can other companies pick up where Alcoa left off? Eventually, the market is going to need to see better results for the rally to continue. Companies will need to show some pricing power and demand growth, not just inventory replenishing. On top of that, management’s expectations for the next six to twelve months are important (just as always). Companies have been able to side step the “normal” fundamental hurdles that resulted from the weaker economy, but that won’t work forever.
Alcoa saw higher aluminum prices during the quarter, and while we don’t expect another 18% sequential improvement through the end of the year, we do expect the price of aluminum to continue moving higher. The real canary in the coal mine for us is copper. Prices for that metal have followed a similar path of weakness in recent weeks as the strength and speed of the economic recovery was questioned following a string of less-than-stellar economic releases.
Written by David Silver, a Research Analyst for Wall Street Strategies (wstreet.com) covering companies in the Transports, Autos, and Beverage sectors. For more information about Mr. Silver, refer to the company’s website, wstreet.com.