Correlative Earnings Outlook: As Alcoa Moves, So Will Century Aluminum

Includes: AA, C, CENX
by: Andrew Sachais
As earning season approaches, it seems as if the market is putting more emphasis on its outcome. After discouraging jobs data on Friday, the VIX showed little upward change. This observation gives way to the inference that the market expects earnings data to provide positive upward pressure.

Leading off the earnings announcements is Alcoa (NYSE:AA). As a major producer of aluminum, its profits rely heavily on its market price. Although AA provides a solid play, more companies may look to move on the announcement, specifically Century Aluminum Company (NASDAQ:CENX), which too is in the business of smelting aluminum. This is where it derives 100% of its revenue, while AA derives 65% of its revenue from the production as well. The correlation exists as the two companies are correlated 71% on a daily basis. Essentially, as AA moves next week, so will CENX, and possibly more in following weeks.

Alcoa’s earnings are dependent on the two variables: The price of aluminum to drive revenues and the cost of production/transportation to aid margins. AA has made it an initiative to increase margins and has been doing so on a steady basis for the past few quarters. Trailing 12 month financials show that they have increased gross and operating margins while decreasing the cost margins, naturally.

However, this quarter provides some uncertainty due to the higher energy costs. Transportation costs are expected to rise, but if management was able to limit its effects, then expectations could be met. On the other side, aluminum demand is expected to stay strong for 2011 as the world economy demands more. The economic slowdown poses a threat, but aluminum had a price run up throughout the early part of the quarter, so hopefully that can be reflected in the revenues.

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That is Alcoa’s fundamental picture, and based on the earnings call, it will provide better insight into what CENX’s earnings will look like. On a technical basis, Alcoa, Century, and aluminum have had a similar run over the past few months. The price target for Alcoa post earnings is $20.5, while the target for Century stands around $19.

Both would result in substantial percent moves. An empirical finding using historical moving average volume indicators shows that on the day of previous AA earnings announcements, CENX traded at higher volumes; it also mirrored the direction of AA’s move. Indicators show that both stocks are in a point of consolidation waiting for a catalyst. They are trading within the upper regions of the range and show signs of breakout on good news. Considering revisions have been downwards over the past few weeks, it may provide AA a better opportunity of beating the estimates.

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