Alcoa Is Poised For A Breakout

Apr.10.14 | About: Alcoa, Inc. (AA)

Summary

Alcoa posted a better-than-expected performance on the back of several tailwinds.

Growth in the automotive and aerospace segments should help Alcoa deliver stronger growth this year.

The forecast for aluminum prices this year is strong due to restricted supply, paving the way for Alcoa to deliver a strong margin performance.

The world's third-largest aluminum producer, Alcoa (NYSE:AA), was expected to deliver solid results, as I had pointed out in my earnings preview article. Alcoa's shares were already soaring before the report, and after the company delivered better-than-expected numbers, I think the stock looks set to scale greater heights.

Alcoa posted revenue of $5.5 billion in the first quarter, a figure that beat consensus expectations of $5.4 billion. On the other hand, excluding special items, its net income came in at $98 million, or $0.09 per share, easily outpacing the $0.05 consensus estimate. Now, looking ahead, Alcoa should continue to improve further, and it looks well-positioned to deliver solid gains on the back of some robust strategies.

The way forward

Going forward, Alcoa will be investing $40 million in its value-add packaging facility in Brazil. Also, it is expanding its proprietary wheel facility in Hungary to cater to the European market. Alcoa has certain major restructuring plans in store for its smelting facility, and is shutting down roughly 420,000 tons of smelting capacity in Australia, the U.S., as well as in Brazil. It is also on a drive to reduce sheet rolling capacity by 200,000 tons by closing its rolling mills in Australia.

In the aerospace segment, Alcoa has increased its growth forecast by 1 percentage point, expecting overall growth of 8% to 9% for this year. The large commercial aircraft segment is expected to deliver a strong performance, and is projected to increase approximately 12.1% this year.

Aerospace on a roll

The aerospace portfolio comprises one of three major components; first are advanced aerospace structures made of aluminum and titanium forging and structural casting, 50% of which is titanium, 30% aluminum, and 20% nickel alloys. Second, is the high-performance engine and engine investment castings segment, with Alcoa being the global leader in the jet engine air force business, and lastly, are the innovative fastening systems, where it is again a global leader. This unique and diversified portfolio gives Alcoa excellent growth opportunities in the aerospace market.

Alcoa is also seeing strong demand from Asia and the Gulf region. In the last three months, the Singapore Air Show saw 90 orders being placed for Airbus aircrafts. Just recently, orders worth $17 billion were generated by Airbus and Boeing (NYSE:BA) in Japan.

In addition, Airline Monitor is reporting an increase in aircraft prices, with average prices expected to be up 2.1% for Boeing and 5.7% for Airbus. The IATA sees strong passenger demand, expected to be up by 5.8%, while cargo demand is expected to increase 4%. Also, smaller segments in aerospace and regional jets have rebounded 13.2%, and now, Alcoa has a backlog of roughly five years for over 1,200 aircrafts.

Automotive is another tailwind

Alcoa is also seeing strong prospects in the automotive segment. In the U.S., automotive growth is believed to be in the range of 2% to 5% for this year, according to management. Alcoa's orders are up and inventory is down by 13 days. Production is also up with 1.39 million units in February, up 4% year-over-year and 7% month-on-month.

In Europe, growth is expected to be in the range of zero to 4%, up from the previous prediction of minus 1% to plus 3%. This is due to an increase in registrations that were up 6.6% this year till February. In addition, the automotive market in China is forecasted to grow in the range of 6% to 10% for this year.

The heavy trucks and trailer market in North America is also expected to see robust demand, with an increase in the production forecast to 5% to 9%. Orders for trucks stood at 90,100 in the first quarter, which is 35.2% up from last year. In addition, inventory is also seeing a sharp decline, with the February number at 47,300 trucks that is much closer to the historic level of 43,000 trucks. Hence, Alcoa is seeing strong tailwinds in the automotive segment as well that should drive its growth going forward.

More catalysts to consider

In addition, North America is expected to see growth in the building and construction segment in the 3% to 4% range. The architectural billings index increased from 50.4 in January to 50.7 in February, and this indicates that Alcoa is enjoying some good tailwinds across its business segments going forward.

In addition, aluminum pricing looks strong this year. Recently, aluminum prices rose to their highest point this year due to concerns that global supplies will be limited, according to Bloomberg. Bloomberg goes on to state that:

In Brazil, aluminum companies producing at the lowest level in 12 years expect authorities to ration power supplies as a drought curbs hydroelectric generation, and Alcoa Inc. said it will cut output at two smelters. Russia's United Co. Rusal, the biggest producer, said its output would fall to the lowest in at least eight years.

Conclusion

Hence, a combination of low supply and strong demand should help Alcoa continue its solid performance this year. The stock has already gained more than 20% in 2014, and I believe that more upside is in store for this aluminum giant, given the positive trends in its different end-markets.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.