Alcoa's (NYSE:AA) share value has climbed a whopping 97% in one year. The company has given a lot of importance to transforming its product portfolio into one that commands a higher premium. A major reason why this is happening and why it will benefit investors is the ongoing economic calamity surrounding the world. The European debt crisis and slowing Chinese growth have contributed to the decline in aluminum demand, which is directly correlated to industrial growth. Therefore, prices for aluminum, which are Alcoa's major sales component, have fallen over the last few quarters.
Due to this reason, the change toward value-added or processed products is a wise choice as it allows greater pricing premiums and provides higher margins compared to the upstream business. In this article, we will be going through Alcoa's latest quarterly results. I will then shift your attention to the near-term future value the organization has to offer.
Recent Quarterly Highlights
As mentioned above, Alcoa is aggressively transforming its portfolio to capture profitable growth while lowering costs. The strategy explains why sales for the second quarter rose 7.2% sequentially to $5.8 billion. The sequential improvement was the result of stronger volumes in the mid and downstream businesses, improved metal pricing, and higher energy sales. A sequential comparison for metal companies is justified since economic growth and macro factors prohibit year-over-year comparison.
The company is now beginning to experience higher demand for products such as can and brazing sheets, together with industrial and commercial transportation products. Volumes across the Engineered Products "EP" segment are also on the rise. This is due to recovering economies in Europe and the US. As a result, operating income for EP rose 8% sequentially last quarter with Rolled Products "RP" bringing a much greater increase of 34%. The RP segment also captures automotive demand, which is another plus.
Primary metals operating income became positive during the first quarter of fiscal 2014, reaching $97 million as the realized price for metal was $2,291 per metric ton, increasing 4% sequentially and 2% year-over-year. Higher London Metal Exchange "LME" pricing and regional premiums contributed toward the positive news. This partially explained why the upstream segment continued to improve for the 11th consecutive quarter.
With regard to the bottom line, cost savings continued to be on track as productivity gains totaled $302 million for the second quarter, spread across all segments. The gains came from process improvements and procurement savings enabling Alcoa to save $556 million compared to its annual savings target of $850 million. Since the company is already ahead of its previously set targets, the current target set by Alcoa is satisfactory and we can expect it to be achieved without any reduction.
Gross margin improved by 80 bps due to these gains. With SGA falling as well, Alcoa was able to deliver diluted earnings per share of 18 cents after adjusting for special items. This was double the figure provided in the previous quarter. Even if we leave special adjustments in place, the company turned negative earnings into positive earnings through its new strategy and improving economic climate.
I would like to add a very important note regarding the company. Alcoa is acquiring Firth Rixson, a leader in jet engine components. Firth Rixson has the largest seamless rings with a full range of engine disks with different diameters. This will allow Alcoa to double the engine content on its key programs immediately.
Moreover, the main technology that Alcoa will be adding relating to the specialized isothermal process will allow for higher operating temperature in jet turbines. The 70 degree Celsius temperature will lead to a 40% improvement in combustion efficiency, which is a major contributor to the 15% fuel efficiency in jet engines. In financial terms, the prospect holds an additional $1.6 billion revenue and $350 million EBITDA beginning two years from now through 2016. The company also is investing $125 million in Alcoa Power and Propulsion "APP" to expand its advanced jet engine component offerings allowing APP revenues to reach $2.2 billion in 2016.
Global aluminum demand is expected to stay at 7% this year. The aerospace industry is expected to grow between 8% to 9% this year as demand for large commercial aircraft soar. Automotive is expected to grow 1% to 4%, packaging 2% to 3%, and building and construction 4% to 6%. The macro environment is favorable for Alcoa at the moment. With the lowest debt since 2007, Alcoa is well positioned to gain in the present climate since it can leverage to extend its operations if needed. The restructuring shows that results are achievable. Based upon these factors, I think long-term investors should continue holding the stock and interested investors should consider buying. It holds a strong buy rating.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.