Earnings season unofficially began yesterday with the former bellwether Alcoa (AA) reporting third quarter earnings results after the closing bell. The results beat the Street's expectations on both the top and bottom lines. The company had a third-quarter net loss of $143 million, or $0.13 per share, compared with net income of $172 million, or $0.15, a year earlier. Excluding costs related to some domestic environmental remediation and an international legal settlement, Alcoa earned $0.03 per share. Total revenues declined to $5.83 billion from $6.42 billion during Q3 last year, but beat Wall Street's average estimate of $5.54 billion in sales.
The results beat the Street, but they are not the big issue with Alcoa these days, it is management's expectations for a few items that the Street then tries to extrapolate to other companies and industries: A) China, B) direction of AA's end markets (aerospace, automotive, etc.), and C) the supply/demand variable, which has a huge effect on prices. Let's first start with China. CEO Klaus Kleinfeld indicated that AA's expectations for Chinese demand would be lower than previously thought. Now many would think this would send the stock into a tailspin, however, the expectation was only slightly lower, down to 6% growth from 7% growth that was previously expected. Management still expects demand to double by the year 2020. Chinese demand right now is dependent on stimulus spending, and until there is organic growth, expansion will be relatively limited.
Now, we look at its end markets. Aerospace and autos were extremely strong. Autos were stronger than I thought they would be considering the weakness in Europe and the slacking demand in China. However, it seems that the strength in the North American auto markets, particularly the United States is able to (at least partially) offset that weakness. One of the more worrisome tidbits from the company's conference call was Mr. Kleinfeld's comments about the heavy truck industry. He indicated that demand from heavy-truck and trailer manufacturing will decline in 2012, and that the company now estimates truck and trailer output may decline as much as 21%. Just three months ago, Alcoa forecast that truck and trailer related demand would decline by a mere 8%.
Finally, we talk about prices. As much as Alcoa is trying to "alluminate" and innovate, the company's fortunes are still tightly tied to the price of aluminum. Prices have been weak for most of 2012, while supplies remain abundant. During the third quarter of 2012, prices averaged approximately $1,950, compared to $2,800 in 3Q11. (During 3Q11, aluminum was trading for roughly $2,800, while the stock was trading at $18; today, aluminum is trading around $2,200 per ton, but AA is trading around $9.00.) Prices should be even lower than they currently are as central banks' monetary policy actions caused a recent spike. Over a two week period during the third quarter, aluminum prices increased more than 20% as the European Central Bank announced its Outright Money Transaction, also known as OMT, program where it would purchase an unlimited amount of sovereign debt, the Federal Reserve announced QFinity, China announced another round of stimulus, while the Bank of Japan, Bank of England, and the Bank of Korea also announced formative monetary easing programs.
We have China demand slowing, end markets are a mixed bag at best (auto and aerospace offset by slower heavy truck demand; construction is a wash), and prices that appear to have room to the downside. Despite the all the Central Banks' concerted effort to pump cash into the system, I think the supply/demand fundamentals win out over the next few months. Eventually, inflation is going to hit, but I think we are a few years out from that. I wouldn't be buying shares of AA at this level. The stock is trading with a forward PE ratio of 12.68 (a trailing twelve month PE ratio of 132.3), but a PEG ratio 3.32. Price to book is below one, 0.72, and the stock has solid cash flow, but I see the stock being relatively range bound over the next few months. There will be opportunities to trade the stock, but I would not be purchasing for a longer term investment.