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Summary

  • Alcoa is set to report earnings this week.
  • Alcoa's cost-cutting initiatives should prove to be profitable in the long-run.
  • Alcoa’s transformation of itself into a value-added, technologically advanced manufacturing company will play a key role in its future growth.
  • Aluminum prices are expected to cross $2,000 per ton mark, which is great news for Alcoa.
  • Alcoa has a lot more upside and is a good buy at current price.

Aluminum producer Alcoa (NYSE:AA) is set to report its second-quarter earnings tomorrow. The stock has been on a terrific run in 2014, gaining in excess of 40% so far. But, will Alcoa be able to sustain its terrific run after the results? Let's check.

The expectations

Analysts expect Alcoa's revenue to drop 3.6% year over year to $5.64 billion in the second quarter. However, on the back of aggressive cost-cutting moves, its earnings are expected to increase to $0.12 per share from the year-ago quarter of $0.07 a share. Moreover, Alcoa's revenue drop will be less than what the company had experienced in the first quarter.

Alcoa had reported first quarter revenue of $5.45 billion, down from the prior year's revenue of $5.83 billion. Although the company had beaten analysts' EPS estimates of $0.05, it was unable to meet the revenue expectations of $5.56 billion. The primary reasons behind the 6% drop in revenue from the first quarter of last year were capacity reductions in primary metals and an 8% year-over-year decline in realized aluminum prices.

However, Alcoa had reported a record adjusted quarterly EBITDA margin of 22.2%. Moreover, Alcoa expects demand for aluminum products to grow by 7% in 2014. As a result, the company's prospects should improve this year, and since it is making investments to grow the business, its outlook should remain strong going forward.

Positive moves

Alcoa is investing $40 million in its packaging facility in Brazil, while it is also expanding the proprietary wheel facility in Hungary to feed the European market. The company is also working on restructuring, primarily its smelting capacity. The company has already taken out around 420,000 tons of smelting capacity in Australia, U.S., and Brazil. Along with changing its portfolio, the company announced that it is taking down its can sheet rolling capacity by 200,000 tons by closing its rolling mills in Australia at the end of the year. Alcoa is cutting costs by shutting down its high-cost smelters and is adding new low-cost capacity.

Alcoa expects aluminum demand to exceed supply in 2014. As a result, the seven-year surplus in the aluminum market would come to a halt. The aluminum market has been in surplus since 2007 because of large capacity increases in China and the Middle East. However, analysts expect Chinese production to grow at the same rate as demand this year.

The improving demand and the self-help actions being taken by Alcoa to create value for shareholders also look impressive. Alcoa's transformation of itself into a value-added, technologically advanced manufacturing company will play a key role in its future growth. It now helps provide innovative solutions to its customers, and commands a leading position in many of its key end markets.

Alcoa also entered into a joint venture with Saudi Arabian Mining Company, Ma'aden, to build the largest and the lowest cost integrated facility in the Middle East, producing 1.8 million tons of alumina, 740,000 tons of aluminum, and 380,000 tons of rolled aluminum products. Not only Alcoa, but other leading companies have also announced capacity cutbacks. These capacity shutdowns, along with increasing demand, will definitely boost pricing and help Alcoa issue a strong outlook.

Alcoa is also improving productivity to bring down costs in the upstream business. The company has already benefited from its productivity enhancement measures and has attained around $6 billion of savings in the last five years. It plans on additional cost savings of $850 million this year, of which $250 million has already been achieved in the first quarter.

End-market demand is strong

Aerospace growth is rising and the two aircraft original equipment manufacturers, Boeing (NYSE:BA) and Airbus Group NV are increasing the intensity of production as airlines order new, more fuel-efficient planes, thus allowing Alcoa to cash in on the boom in commercial aircraft orders. The company plans to expand its downstream market by entering the large commercial jet engine market by building a new $100 million facility in La Porte, Indiana.

Also, Ford (NYSE:F) has made a move to use more lightweight aluminum in its cars and Alcoa will be the aluminum supplier. This will potentially provide Alcoa with yet another significant revenue stream as the market is expected to be worth $10 billion in a decade.

Alcoa is also investing $25 million in its Virginia plant to beef up the production of the facility. Reuters reported:

"Alcoa Inc plans to invest $25 million at its power and propulsion facility in Hampton, Virginia, to start production of lighter-weight jet engine blades and meet growing demand from the aerospace sector," it said on Tuesday.

"As part of a project starting this month and lasting until the fourth quarter of next year, the company will add equipment for a new production line and modify existing machinery to produce blades made of nickel-based super alloys for next-generation aircraft engines."

The value-added business has offset the effects of the falling aluminum prices and the increased focus on automobile and aerospace industry will aid Alcoa's growth. But the aluminum prices are expected to inch closer to the $2,000/ton mark in the upcoming months. Overcapacity has been the primary cause of the increasing aluminum prices, however recently, French financial-services firm Natixis reported:

"In Russia and the West, producers continue to curtail unprofitable smelting capacity. In China, the growing influence of the price mechanism is likely to limit overcapacity."

China is the world's largest aluminum producer and the loss making Chinese producers are expected to cut 3.5 million tons of output this year, which will ultimately give aluminum prices a much-needed boost.

Conclusion

Although the company has reported two direct quarters of EPS declines and eight direct quarters of lower revenue, its stock price has moved higher this year and is trading at its highest point in around three years. However, the trends in the industry are positive and Alcoa looks all set to improve its performance going forward. Its focus on cutting costs and positive end-market prospects will help Alcoa sustain its solid stock price gains.

Source: Up 40% This Year, Will Alcoa Continue Its Rise After Earnings?