This earnings season just kicked off with a major surprise from Alcoa. It wasn’t what Alcoa (AA) did – it’s what it said. Although last quarter’s earnings came in under analysts’ already reduced estimates, management kept its sales growth forecasts virtually unchanged. “Kept” implies a passive, do-nothing attitude. Actually, it's an active statement founded on management’s convictions.
There are two components of this growth projection, and each could fuel stock market gains, particularly the latter.
First, they forecast growth
Management sees continuing increases in global demand, driven by improvements in key industries. We’ve seen recent reports of this growth: auto sales, aircraft orders and the reliable beverage containers. International growth is a good driver as well (China’s is expected to be 17%).
With growth, any worries about a Great Recession #2 may be discarded.
Second, they didn’t lower their growth forecast
Following on, management maintained its projected 12% rate. So, what happened to slowing growth? Did the reduced rate end on September 30? Was it all due to Japan’s tsunami after all? This forecast is completely contrary to everything we’ve read and heard – and what many of us have internalized. Therefore, if it is a more accurate reading of the economy’s dynamics, then there is likely a dramatic stock market rise coming.
Personal note: I am not trying to make a “Dow 40,000!” type of statement. We don’t even know if Alcoa is close to being right. That said, IF they are generally correct, the reality will be so much better than currently expected that there would need to be a large upwards adjustment to match the new, higher valuations. And, as we know, a nice market rise can beget increased interest (and buying). Hence, “dramatic” is an appropriate description.
Is Alcoa’s management overoptimistic?
Alcoa’s surprising growth outlook appears rational and reasonable. It’s not created from management’s hopes but from the company’s “inside” information. Alcoa gains insight into the economy’s dynamics from working with a broad spectrum of large industrial companies. Its understanding and foresight can be significantly better than any economist studying past statistics.
The company is in a competitive, global industry (currently with excess capacity) that is buffeted by generally uncontrollable costs and prices. It doesn’t have the luxury of being unrealistic. (To get a sense of Alcoa’s management quality, check out the 2010 annual report. It describes the recession measures management took to ensure the company’s long-term survival and success.)
It’s also hard to believe that 123-year-old Alcoa has suddenly put on rose-colored glasses. With an executive team composed of 50+ year-olds and the board having two (!) 76-year-old senior advisers, management must answer to history.
Does the market see the same favorable picture?
Today’s (Wednesday’s) stock market seemed to focus on the growth message and not the earnings deed.
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(Stock charts courtesy of StockCharts.com)
Even Alcoa, itself, shook off the initial negative reaction to the undersized earnings.
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The bottom line
Alcoa’s results substantiate the stock market’s initial pause and moderate decline. However, management’s outlook runs contrary to the warnings of worse to come. It appears that the August-September market travails, based on those warnings, are now being reversed. In addition, Alcoa’s maintaining their forecast sales growth rate, if seconded by other company reports, could squelch the widely accepted expectations of slower economic growth. That would be a major up-market catalyst.
Next up: The finance industry, starring JPMorgan Chase (JPM)
For the Dow Jones Industrial Average companies, we have twenty-nine more earnings reports to come. They will furnish additional information about both the past quarter’s slower growth effect and, more importantly, corporate insiders’ outlook for future growth. Next up tomorrow (Thursday, pre-opening): JPMorgan Chase. The combination of “major bank” + “Wall Street” + sour stock market has lowered expectations, so it will be interesting to get CEO Jamie Dimon’s review and, especially, outlook.
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Disclosure: I am long JPM. Positions held: U.S. stocks and U.S. stock funds
