Alcoa: Brace Yourselves, Now

| About: Alcoa, Inc. (AA)
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Earnings season for Q3 is officially underway.

I discuss the results of Alcoa's Q3 miss.

The outlook for the name is considered as is the tone for earnings season.

Brace yourselves. Earnings season for Q3 is officially underway. As I have said in the past Alcoa (NYSE:AA) unofficially kicks off earnings each reporting season. The commodities market weakness, as well as general the stock market looking like it is frothy, has led to Alcoa having struggled. The fact is that this long-standing bellwether company has been operating under some tough conditions. First, an economy that limps along. Growth that is simply non-existent. Despite the markets being at all-time highs, the economy is not strong. Since the Great Recession, have we come back? Yes, but not nearly as strongly as we would have expected say 5 years ago. In short, we have simply just meandered forward. Alcoa relies heavily on metal prices in conjunction with a robust construction economy. Of course the company produces and manages primary aluminum, fabricated aluminum and alumina, which has been a tough sector to operate in for some time. 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. Last summer I called for a buy and the stock hasn't moved really, so what do we do?

The fundamentals are under pressure but Alcoa continues to weather the storm. I was of course surprised to see Alcoa delivered a pretty weak earnings report following the last two quarters which were pretty decent. Of course, considering the pressure the name is under I should not be surprised. But is this a negative sign for corporate earnings reports this fall, especially for those in the materials sector? That remains to be seen, however one thing we do know is that the prices of metals struggled, but have begun to rebound compared to years past. Alcoa set the tone here

First, Alcoa was earnings positive. This is a good thing. This year it has swung from a breakeven quarter in Q1 to net income of $135 million or $0.09 per share in Q2 and now is up to $166 million of $0.33 per share this quarter. Making some adjustments, earnings per share was $0.32 per share. The bad news is that it missed consensus estimates by $0.03. While the miss hurts, we need to dig a little deeper.

Earnings aren't everything. Let's talk about sales. The company posted a revenue miss of $120 million. Revenue came in at $5.21 billion, and this was down 6.5% year-over-year. Now, the key reason for this decline was the closing of several operations as well as a negative impact from lower alumina and aluminum prices. There was a positive 4% impact to revenues thanks to acquisitions and organic growth. One good piece of news is that there were very strong productivity gains across all segments year-over-year, amounting to $377 million in productivity gains.

That is a nice lead-in for the segment-specific performance. For starters, the Engineered Products and Solutions segment delivered record revenues of $1.4 billion, while year-over-year this revenue was up 1%. A large chunk of this improvement came from the RTI acquisition. The Global Rolled Products segment saw positive developments. In fact, year-over-year auto sheet shipments grew 49% while after tax operating income was $58 million in the quarter, reflecting some volume declines in aerospace, but strong productivity gains. The Transportation and Construction Solutions segment saw after tax income of $47 million, up 2% year-over-year. This was a result of continued strong productivity but was partially hampered by costs increases and slightly lower volumes.

One thing I noticed that was buried a bit was balance sheet improvement. What do I mean? Well, the company had sales of assets that should total over $1.2 billion in 2016. So far, the company has received $935 million, strengthening the balance sheet. Cash from operations was $306 million; free cash flow for the quarter was $31 million. Cash used for financing activities totaled $154 million in Q3, while cash used in investing was $220 million. Altogether, 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 revised guidance lower, which is about to crushed the stock. Alcoa projects another strong year for global aerospace sales, but still lowered expectations. I want to point out that it sees 2016 as a year of transition. We cannot forget that there is the pending separation of the company to consider as well. As far as an outlook, the company sees global aerospace sales jumping 6% to 8% over 2015 on continued robust demand for large commercial aircraft and jet engines. Global rolled products revenue was revised downward to $4.8 billion to $5.0 billion, versus $5.0 to $5.2 billion. Engineered Products and Solutions revenues were revised lower to $5.6 billion to $5.8 billion for 2016, down from $5.9 to $6.1 billion. Transportation was also revised significantly lower, with expected revenues coming in at $1.7 billion down from $2.1 billion.

As we move forward I want to caution the outlook of course for the revenues and earnings not only depends on volumes but the results are strongly driven by prices of alumina and aluminum. The revisions reflect sales of assets as well. Be mindful that global aluminum demand is expected to double between 2010 and 2020, so this is a positive for pricing. We are already seeing the growth in demand. Prices haven't caught up yet, but it is more a matter of when, not if. The supply and demand curve is setting up nicely, and as such it is just a matter of time. I continue to like Alcoa under the $30 range (recall there was a 1 for 3 split), long-term.

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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.