One Thing Could Save Alcoa

| About: Alcoa, Inc. (AA)

Summary

Alcoa is down almost 25% since I called for a buy.

Q4 earnings are out and I discuss the results which were mostly rather weak but are driven almost exclusively by alumina and aluminum prices.

What can save the company.

Alcoa (NYSE:AA) officially kicks off earnings each reporting season. When I last highlighted the stock it had delivered a solid report for Q2, and I recommended it was time to buy. I thought shares were undervalued. Simple as that. And I discussed why. Well, the commodities market has led to my call being down 25%. Ouch. The fact is that this long-standing bellwether company has been operating under some tough conditions. First, an economy that limps along. I mean honestly, since 2009. We have simply just meandered forward. There has not been REAL growth since the Great Recession. Slow, step-by-step growth. It's unlike any rebound in history.

That said, the company and the stock is struggling because it relies heavily on metal prices in conjunction with a robust construction economy. This is due to the fact that it produces and manages primary aluminum, fabricated aluminum and alumina. One reason I like the name overall is that it has little competition, which is a big plus but at the same time, it can be tough to be competing with the global economy. As such Alcoa stock continues to limp along. I made the buy call after three quarters of decent results. Sales were rather strong and I had been waiting for a chance to pull the trigger. I called for a buy at $10.50. The stock is at $8. What do we do?

Well, it doesn't take a genius to see that expectations for the company have diminished in the last few months with the stock falling. Thus, I was not surprised to see Alcoa delivered a rather weak quarter. I'm disappointed overall and believe it may be a warning sign for corporate earnings, especially for those in the materials sector. That remains to be seen. But one thing we do know is that the prices of metals have not improved since last quarter. So, Alcoa has once again kicked off earnings, and this tone was not the best.

What do I mean? Well, Alcoa saw a net loss of just $500 million or $0.39 per share. This is down from net earnings of $159 million, or $0.11 per share last year. If we exclude special items, net income was still down to $65 million or $0.04 per share. Just how bad is this? Well the good news is that it beat consensus estimates by $0.02. That's a plus. And so the stock is rising after hours. This quarter follows a quarter where earnings turned for the worse. I thought that the company would be rather weak, although the beat surprised me. While the earnings figure is nice, overall, I believe this start to earnings season is telegraphing weakness, particularly in construction and other materials names.

This is because earnings aren't everything. Let's talk about sales. The company posted a revenue miss of $110 million. Revenue came in at $5.25 billion, and this was down 17.7% year-over-year. The company also missed estimates. Now, the key reason for this decline was a 25% decrease in impact from lower alumina and aluminum prices as well as some costs associated with divestitures and closures. One good piece of news is that sales were up 7% when looking at aerospace and acquisitions.

But perhaps the headline number is misleading. Let's turn to the segment-specific performance. Perhaps there is positive news here? For starters, the Engineered Products and Solutions segment delivered record revenues of $1.4 billion, while aerospace revenue was up 34% year-over-year. The Global Rolled Products segment saw positive developments. In fact, year-over-year auto sheet shipments grew 18% while adjusted EBITDA per metric ton increased 19% year-over-year. The company saw $865 million in cash from operations, with free cash flow of $467 million. That is not terrible and is far better than historically weak Q3 2015. Could it be stronger? Absolutely, if we were in a better operating environment. But the key is these are positive numbers. The company ended the quarter with $1.9 billion cash on hand.

But the earnings tell us where the company has been and not where it's going. Is there hope? Well, Alcoa projects another strong year for global aerospace sales. It sees 2016 global aerospace sales jumping 8% to 9% over 2015 on continued robust demand for large commercial aircraft and jet engines. In automotive, the company forecasts global production growth of 1% to 4%. Alcoa expects the building and construction market to continue to improve in 2016, with global sales growth of 4% to 6% as well as 2% to 4% growth in turbines.

But it's not all good news. Automotive is going to be a drag, particularly in the heavy duty truck and trailer market, where Alcoa projects production to most likely fall year-over-year. I will point out that in North America, the heavy duty truck and trailer market is expected to decline 19% to 23% this year after a strong end for 2015.

But at the end of the day, the results are driven by prices of alumina and aluminum. The company can't control prices, but one strong piece of news that COULD save the company by supporting prices of the commodities is the fact that the supply/demand curve is working in the company's favor. In fact, in 2016, Alcoa expects a global aluminum deficit of 1.2 million metric tons and a global alumina deficit of 2.8 million metric tons due to global curtailments. Further, Alcoa also projects record global aluminum demand in 2016 of 60.5 million metric tons, up 6% over 2015. On top of that, global aluminum demand is expected to double between 2010 and 2020. If there was ever a setup in the fundamentals to support pricing, it is exactly what is shaping up here with supply and demand. However, time is the unknown factor. The metals sector had been weak for a long time, and it may continue. But at just $8 a share, with the expectations of low supply high demand, I would think that anyone in the name should consider adding on below these levels while waiting for a rebound in prices. That said, tread carefully.

Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles that are time sensitive. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."

Disclosure: I/we 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.