Deceleration, Not Destruction for Alcoa
We don't think the firm's third-quarter results suggest an impending deep recession that the market is essentially pricing in.
Market Update
Alcoa reported adjusted earnings of $0.14 per share in the third quarter, but we hesitate to label the results as disappointing. Aluminum prices have declined on the London Metals Exchange (LME) some 20% since May, and the company continues to battle higher prices for raw materials and energy, causing the earnings to decline from $0.32 per share in the second quarter. However, we don't think the results suggest an impending deep recession that the market is essentially pricing in, with the stock down about 35% year to date. Volumes were roughly flat sequentially, with stronger-than-expected consumption in China offsetting weakness in Europe. Even with the drastic drop in the price of aluminum, the company's sales only declined 3% sequentially. Alcoa also confirmed their prior forecast for a 12% increase in aluminum consumption in 2011, suggesting that volumes are unlikely to be off materially in the fourth quarter, either.
We think the drop in aluminum prices has more to do with the market's fears regarding global economic growth than a true deterioration in the demand for aluminum. While we concede that Alcoa's fourth-quarter earnings are likely to also decline sequentially, as aluminum prices are currently at a low point for the year and we're heading into a seasonally weak quarter, we think prices will find support, as costs have yet to recede, putting the current LME price below the marginal cost of production. The year-over-year comparison for the second half of 2011 should appear favorable, as aluminum consumption patterns are still quite healthy relative to 2010. Visibility is low, but we do not yet see the signs of a contraction in aluminum demand, and we think Alcoa's shares look very compelling at current levels.
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