Alcoa: What You Must Realize

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About: Alcoa Corporation (AA)
by: Quad 7 Capital
Summary

Gabelli just reiterated Alcoa a top pick.

Evaluating our buy call in light of Q1 performance.

Expectations for Q2 are discussed which will drive momentum one way or the other.

Alcoa (NYSE:AA) was just reiterated as a top pick at Gabelli, with analysts there citing value and a sizable discount based on performance. This call was welcomed as you know Alcoa was named one of my top picks for 2017. As you probably know, Alcoa unofficially kicks off earnings each reporting season and has scheduled its Q2 earnings for July 19th. While a handful of other companies will of course report prior to Alcoa, the sentiment still stands. The question is whether Gabelli’s call will hold water following earnings. You see, this year is a bit special with Alcoa now reporting as a new, standalone company. Over the last few years, we have seen the commodities market display weakness which led to Alcoa having struggled. Some of those pressures have subsided, but Aluminum prices are far from strong. Regardless, the fact is that this long-standing bellwether company has been operating under some tough conditions the last few years. However, the company has strong cost management and earnings have been on the mend.

The fundamentals are still under pressure, but Alcoa continues to weather the storm and appears to have brighter days ahead. This was evidenced in Alcoa’s most recent report. What do I mean? First, Alcoa was earnings positive, and was significantly so. This year it has swung from a huge loss in Q1 2016 to net income of $225 million or $0.63 per share. The good news is that it beat consensus estimates by $0.10. That was a wide margin. While the bottom line beat is great news, we need to dig a little deeper.

Let's discuss the sales figures, which have been consistently under pressure. Well, once again, Alcoa saw weakness. The company posted a revenue miss of $80 million. Revenue came in at $2.65 billion, and this was actually up 5% sequentially and was up markedly year over year. Now, the key reason for this increase was of course rising alumina and aluminum pricing. However, the company is not out of the woods yet.

While things are certainly looking more positive and support the bull case, we need to watch cash flows and the balance sheet. In the first quarter, Alcoa’s cash from operations was $74 million and free cash flow was $3 million. Alcoa ended the first quarter of 2017 with cash on hand of $804 million after transferring the net proceeds received from the Yadkin sale to Arconic Inc. It is also important to note that in order to streamline future operations, the company reorganized itself to have three clear lines of business, which include being focused on bauxite, alumina and aluminum, respectively.

Looking ahead, for 2017, Alcoa sees balanced global bauxite and alumina markets and a modest global aluminum surplus of 400,000 to 800,000 metric tons. Alcoa is projecting 2017 global aluminum demand growth of about 4% over 2016 and expects to ship 2.3 million tons of aluminum and 0.6 to 0.7 million tons of rolled products. The company also estimates that it will see adjusted EBITDA of $2.1 billion to $2.3 billion. For the upcoming quarter, which will help drive momentum in share prices, analysts are looking for a consensus of $0.61 per share in earnings. Analyst estimates for Q2 earnings vary widely, with the most conservative analyst looking for $0.45 in earnings, while the most bullish seeing $0.88 per share in earnings. Sales, which Alcoa has struggled to meet, are estimated to be $2.85 billion on a consensus basis, and this is a number we will closely be watching.

As we move forward, it is important to realize results are strongly driven by prices of alumina and aluminum. Further, volumes appear to be setting up to be positive as global aluminum demand is expected to double between 2010 and 2020, so this is a positive for pricing. I continue to like Alcoa long term, and look forward to Q2 results.

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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.