Alcoa (AA), the once-iconic aluminum producer, and now former Dow 30 component, is scheduled to report its calendar 4th quarter earnings after the bell on Thursday, January 9th, 2013.
Consensus analyst expectations for Q4 13 are for $0.05 in earnings per share (EPS) on $5.426 billion in revenue for expected year-over-year declines of 17% and 8%, respectively.
Since Q3 13 was reported in early October, EPS has seen a slight downward revision from $0.06 to now $0.05 per share, while the consensus revenue estimate has fallen from $5.444 billion to $5.26 billion.
The price of aluminum remains stable at the low end of its 6-month range near $0.80 per pound, according to this chart from InvestmentMine.com. All the recent rule changes around aluminum and warehousing and what was uncovered in this NY Times articles in the summer and fall of 2013 still (in my opinion) has not had much of an influence on price. (To be frank, I never understood the whole warehousing issue. "They" said it inflated aluminum prices, but the charts of aluminum prices show otherwise. I don't get it.)
The Q3 13 results were actually pretty decent: AA produced upside EPS and revenue surprises as 80% of operating income came from the stronger downstream business. Even though aluminum pricing was weak in Q3 13, the downstream segment managed to compensate for upstream weakness. In addition improved forex from "producer" country currencies like the Aussie dollar helped the bottom line.
It is easy to paint a dire picture of the aluminum producer, given the market price of aluminum and the rather public humiliation of being dumped from the Dow Jones Industrial Average after 50 years (?), but the stock is trading close to a 52-week high as this is being written and was up 10.5% in December 2013 and 30% in the 4th quarter of 2013 alone, after being in the red most of the year.
A Tale of Two Companies: To understand Alcoa, you have to understand the upstream and downstream businesses. Right now, demand for aluminum (downstream) is on fire as cars and the aerospace industry look to lighten auto and truck frames, and airframes to extend gas and fuel mileage. Ford recently announced they were looking to construct an "all-aluminum" truck, (I believe to be part of their Ford F-150 line), which should further improve aluminum demand. AA's downstream businesses are cooking on all cylinders.
The upstream businesses are the issue as Klaus Kleinfeld details in his quarterly conference calls, basically saying that the Chinese are not acting rationally, and keep producing aluminum below the cash cost of the commodity, which no doubt is helping to stimulate the upstream demand, but is making it tough for AA and the sector to operate profitably.
The key tell for AA shareholders (not a good one) was the global reduction in smelting capacity AA had to shutter both in 2012 and then again in early 2013 to deal with the inventory glut.
So far, we haven't heard much about Alcoa needing to make additional reductions, which is perhaps what the stock price is reacting to in calendar Q4 13.
Signs of Life in the stock: Whether it was a "dash to trash" in late 2013 or just the hunt for underperformers, AA caught life early in October '13 trading from $7.82 to $9.63, up 23% in just 30 days. Pricing hasn't changed, and neither has earnings estimates, so is this just a head fake, or the start of something greater ?
The fact is that Basic Materials and aluminum should benefit from a return to global growth in 2014, as Japan, Western Europe and China start to recover, not to mention the US.
Our sleeper sector for 2014 is Basic Materials, and our sleeper stock within the sector is Alcoa.
Valuation: With 2013 almost in the book, consensus EPS of $0.33 - $0.34 per share is probably a lock, with 2014 and 2015 consensus of $0.41 and $0.53 per share, leaving AA trading at 26(x) and 20(x) forward earnings, for expected growth of 21% and 29%.
While that may make AA look attractive from a PEG perspective, the fact is downward pressure still continues on forward EPS estimates. That is the one fundamental element that makes me nervous about the stock. Forward revenue estimates too continue to be revised lower.
The next leg up for the stock needs to be driven by stabilizing or improving forward revenue and EPS estimates.
Trading at 10(x) cash flow and 37(x) free-cash-flow and 5% free-cash-flow yield, AA isn't a screaming buy, but at today's $10.50 trading level, it is trading just a smidge above tangible-book of $9.93 per share.
What has impressed me is that since mid-2010, Alcoa has been able to generate free-cash-flow (on a 4-quarter trailing basis) every quarter, sustaining their modest dividend, despite weak pricing, shuttered capacity and margin pressure.
Although our spreadsheet tells me AA is paying out just 30% of free-cash in the form of the dividend, and no share repurchases, the shuttering of capacity no doubt has kept management nervous, and thus it is unlikely they will make any changes from a "capital allocation" standpoint.
Alcoa management is creating operating leverage for the next up cycle, if and when it ever appears.
Technical analysis: With the recent 30% rise in the stock price in Q4 13, AA is coming up on what should be tough resistance at the 200-week moving average of $11.06 and then the 50-month moving average at $11.22. If the stock can clear these two hurdles, it could run nicely, with the next stop being the April, 2011 high near $18.30.
Summary: Far more could go right in 2014 and 2015 for Alcoa, (than could go wrong, that hasn't already) but this still remains a stock where global growth needs to be robust, global central banks need to be stepping on the monetary brakes with both feet and there is a real threat of commodity inflation, which has been the exact opposite "macro" environment that we have seen in the last 5 years.
Alcoa peaked near $50 per share in 2007 after earnings close to $3 per share. Granted we may never see those days again, but I still think the April '11 high of $18 is feasible, with global demand and better aluminum pricing.
The company is being left for dead, which I think is too negative.
We've been long and wrong on the stock since late '09. Up until Q4 13, it has been one of, if not the worst portfolio performers we own. It was the wrong stock and sector, with the wrong fixed cost base and the wrong commodity at the wrong time.
We think that could change in 2014.
However, what we don't want to hear:
a.) More capacity being shuttered;
b.) Weaker aluminum pricing ahead;
c.) Any signs of caution around downstream businesses;