Alcoa: It's All About the Aluminum Outlook

Alcoa's earnings are more important for the outlook on aluminum pricing and demand than the earnings number printed quarter to quarter.
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) -- Analysts have been busy in recent weeks lowering expectations ahead of


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earnings, but the bigger issue for investors is the Street divide over whether the situation will get worse before it gets better for the U.S. industrial bellwether.

Alcoa is the first of the Dow stocks to report, and has also been the biggest loser on the Dow in 2010, the first time Alcoa has had this dubious distinction since 1998.

Several analysts have slashed Alcoa earnings estimates by as much as 50% in the past few weeks as second quarter aluminum pricing final data made the wide range of Street expectations for Alcoa earnings out of date. There is still a high of 20 cents among analyst estimates for Alcoa earnings, but the Street consensus of 12 cents reflects the recent spate of Alcoa earnings revisions. The analyst lowest estimate for Alcoa is 9 cents.

Charles Bradford, an analyst with Affiliated Research Group, lowered his second-quarter Alcoa estimate to 12 cents per share from 19 cents.

Anthony Rizzuto, managing director of Dahlman Rose, reduced his second-quarter estimate to 10 cents from 15 cents because of the lower aluminum prices.

Tony Robson, analyst at BMO Capital Markets, recently dropped his second-quarter Alcoa earnings' estimate to 10 cents a share from 19 cents.

Some analysts indicated that the high end of Alcoa earnings estimates, at 20 cents, simply reflects an analyst who has not updated Alcoa estimates based on readily available aluminum market pricing data for the second quarter.

RBC Capital Markets analyst Fraser Phillips expects currency gains to offset the aluminum pricing at result in earnings of 15 cents in the second quarter. Affiliated Research analyst Bradford said he expected currency to be a tailwind in the second quarter too.

Expectations for the second quarter earnings, though, may be less significant than fears of what the recent drop in aluminum prices will do to Alcoa's third quarter. Over the past three months, the price of aluminum has declined from over $2,400 per tonne in April to roughly $2,000.

Affiliated Research Group's Bradford said he was more concerned about the third quarter since Alcoa's aluminum business is always operating with a lag related to metals market pricing. Bradford said with two months of data already in for the third quarter, the Alcoa pricing lagging the spot markets, his concern is not the earnings number printed in the second quarter, but "whether they will make money or not in the third quarter."

Alcoa's earnings are often judged a bellwether for the U.S. economy, however, analyst were more intent on the Alcoa earnings guidance as it relates to pricing pressure in its core aluminum and alumina markets.

Additionally, analysts will be looking for guidance on global inventory levels that could create downward pressure on pricing. Affiliated Research Group analyst Bradford said stocks may typically react more on whether earnings comes out above or below expectations, but in the case of Alcoa investors should be keyed into how convincing Alcoa management is in providing an outlook for aluminum pricing, and a forecast for how much China is going to produce in the coming year. Continued cost reductions by Alcoa to offset the pricing trends will also be a key earnings issue, analysts said.

The global supply is an issue over which the Street remains divided, and analysts seem to have moved onto 2011 in terms of thinking about Alcoa. "I'm not paying much attention to this year," said Affiliated Research analyst Bradford, who expects a bad third quarter but is more positive on the longer-term outlook.

RBC Capital Markets' Fraser Phillips said the aluminum market continues to labor under the excess inventory and capacity, and aluminum prices will face a headwind.

The RBC analyst wrote, "refinancing and cost reductions in 2009 reduced the pressure on Alcoa's balance sheet and the shares responded positively. The outlook depends on Alcoa's ability to continue to meet its cost-reduction targets on a timely basis, and the aluminum market outlook. However, aluminum continues to labor under the weight of significant excess inventory and capacity and we expect aluminum prices to continue to suffer as a result, limiting any upside potential for the share price over the next 12 months."

Dahlman Rose analyst Rizzuto has written that near-term pricing pressure will remain on aluminum.

BMO Capital markets is expecting aluminum prices to recover over the medium- to long-term, and the industry should receive pricing support as inventory is better controlled.

Analysts said Alcoa has made significant cost reductions and capped its own production to help reset the supply/demand balance. Alcoa has also done a reasonable job of forecasting the overall market conditions, Bradford said.

Last quarter, Alcoa went out of its ways to try to help the Street understand how its business reacts to short-term pricing and currency fluctuations.

>>Alcoa Draws Back the Curtain

Alcoa has stated that it expects a robust outlook for growth in the next decade. Analysts, if no longer focused on the rest of 2010 as a positive stock catalyst for Alcoa, aren't willing to go out as far as a decade either.

Alcoa shares were down a little over 1% on Monday and under $11. Both BMO Capital Markets and Affiliated Research put fair value of Alcoa at $15, while RBC Capital Markets has a $13 price target on Alcoa shares.

-- Written by Eric Rosenbaum from New York.


>>Alcoa Draws Back the Curtain

>>Alcoa Posts Another Noisy Quarter

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