NEW YORK ( TheStreet) -- Alcoa ( AA) delivered on diminished Street earnings expectations for the second quarter, but the jury is still out on the turnaround for the aluminum giant, which has been the biggest Dow dog of 2010.

Alcoa shares are up on the day after its earnings by a little more than 1%, consistent with the broad equity market rally after not just Alcoa, but railroad operator CSX ( CSX) kicked off earnings season on an optimistic note. Nevertheless, the move up in Alcoa shares on Tuesday isn't the kind of lift that represents investor conviction in immediate and significant upside for the aluminum stock.

Alcoa's 13 cents earnings per share bested the worst-case scenario of the Street, which had included analysts lowering earnings forecasts for the quarter to as low as 9 cents in the month leading up to the second quarter earnings. Depending on your earnings consensus source, Alcoa's 13 cents earnings per share was in line, or beat the Street by a penny.

That penny beat isn't really the final word on Alcoa. In fact, the headline micromanagement of earnings meets and beats can obscure the longer-term outlook. How bad will the second half of 2010 be for Alcoa with aluminum prices already dropping steeply? How long will it be before Alcoa is not just on the mend, but propelled by macroeconomic forces to deliver on upside potential in its shares?

What follows are burning questions about the outlook for Alcoa shares going beyond the headlines.

Question No. 1: If the Alcoa beat of the Street by a penny was predicated on diminished expectations, what were the positive notes in the Alcoa earnings report that could be more important to the stock outlook?

There were many positives in the Alcoa report that can be distinguished from the Street earning beat. Above all, Alcoa presented a pretty clean earnings report, eliminating the big restructuring and one-time charges that have bedeviled previous earnings, and demonstrating continued progress on company goals that are achievable regardless of spot metals pricing. Here are a few biggies.

The Alcoa second quarter 2010 EBITDA income of $724 million produced a margin of 14%, the highest EBITDA margin for Alcoa since the third quarter 2008.

Alcoa was free cash flow positive in the second quarter, at $87 million.

Restructuring charges disappeared from Alcoa earnings. That's a big change from the first quarter, when results included restructuring charges of $187 million, or 29 cents per share.

Net debt was $8.5 billion, unchanged quarter over quarter, but looking more manageable due to the earnings recovery and EBIDTA margin improvement.

Bottom Line: Alcoa delivered a clean earnings report, and that's a big step, but many of the Street models have already taken into account a more efficient company, with a better balance sheet and continued execution on cost reductions. For Street models to change significantly ahead of a major change in factors beyond Alcoa's control -- such as the metals pricing environment and macroeconomic growth rate -- Alcoa would need to do still more.

Either a structural change in Alcoa's margin profile or the ability to pay off debt faster than expected could be the type of event that changes the medium to long-term Street outlook on Alcoa, beyond the improvement already modeled by the Street for the depressed Alcoa shares. On the margin front, the highest margin level in EBITDA income since 2008 was notable, but one quarter does not a trend make.

What remains to be seen is how sustainable the Alcoa improvements will be, when faced with short-term pricing pressure and fears that the macroeconomic recovery may not chug, but stumble forward.

Question No. 2 The outlook for China is integral to the global macroeconomic environment. Will China propel Alcoa, or keep Alcoa from making more progress?

If you listen to the comments from Alcoa CEO Klaus Kleinfeld, fears about China are overstated. The Alcoa CEO noted that negativity about China -- which includes talk of a big bubble developing in real estate -- doesn't match the reality. It's true that credit risk has grown for banks and the property sector has seen values rise quickly in major cities, but the government has already responded to these issues, the Alcoa CEO said.

Kleinfeld said when he talks to people negative about China, he always asks what growth rate they are pegging for China, and the pessimists say 8.5%. "That's a pretty substantial number," the Alcoa CEO noted in the earnings conference call, adding that China just raised its growth rate above 9% and the International Monetary Fund expects 10.5% growth. "They are managing the overheating," the Alcoa CEO concluded.

Analysts aren't so sure, however, and think China may be a slow boat for Alcoa to ride to a fuller recovery.

China goes to the root of the distinction between forces within the control of Alcoa, and beyond its control.

Alcoa management reiterated the key theme from U.S. business leaders who are looking to China to make their 2010 numbers.

Alcoa raised its global demand forecast for aluminum from 10% to 12% and China, along with the BRIC bloc of countries, are set to be the primary drivers.

Deutsche Bank analyst Jorge Beristain acknowledged the strides made by Alcoa in the second quarter, but still worries that the tightening of the belt in China is at an early stage and the industrial sector may not yet have experienced the full brunt of China's efforts to slow its economy.

The Chinese restocking of commodities can swing high and low from year to year. If 2009 was a restocking year for China, followed by a pullback in 2010, it would bode well for the outlook in 2011. However, with near-term metals prices a headwind for Alcoa, many believe that Alcoa won't be able to keep the earnings momentum going in the second half 2010.

Bottom Line: Deutsche Bank analyst Jorge Bernstein ranks the metals pricing environment as the biggest headwind for Alcoa in the upcoming quarters, and a slowdown in China as the second-biggest risk, with the ability to push normalized earnings for Alcoa further down recovery road.

Question No. 3: Is there a big threat of sector overcapacity limiting Alcoa's rebound, and led by China flooding the aluminum market?

It's important to remember that while Alcoa has no business directly levered to aluminum sales in China, or smelting operations in China, China is a metals-specific story, and a big one for all the aluminum players in terms of global capacity.

Alcoa said China will be taking 1 million to 1.5 million tonnes of aluminum offline soon. This hasn't stopped the questions about China flooding the market, but Alcoa's CEO Kleinfeld told analysts that it isn't a concern for Alcoa.

The need to become more energy efficient will naturally limit the energy-intense approach of the Chinese aluminum industry. Alcoa talked up its energy-efficient production of aluminum and a more power-conscious aluminum sector limiting the supply. "This is not telecomm equipment," Alcoa CEO Kleinfeld said on the earnings conference call.

Bottom Line: In the end, the energy intensive nature of aluminum production could limit China's production, and that would be a big positive for the aluminum market -- but it may be a matter of timing.

The Alcoa CEO said that the aluminum production in China of 1 million to 1.5 million tonnes will be coming offline "soon."

Analysts note that there have been previous economic cycles during which the trigger for Chinese production controls lagged the market expectation, and this aluminum production trend could be measured in years as opposed to a few quarters.

Question No. 4: Should an investor be excited about Alcoa shares in the near-term?

Probably not, and that's probably why the Alcoa rise on Tuesday after its earnings merely matched the market performance.

The most positive lining on the Alcoa earnings may be the fact that it was executed with the proverbial one hand tied behind its back.

Alcoa is at 70% utilization, therefore, the company can make the argument that incremental volume, as long as can hold costs in check, should be even accretive to earnings.

However, Alcoa didn't change its near-term guidance and expects volumes to be flat quarter over quarter, and the business segments that drove the margin outperformance are in the seasonally weak summer period.

Alcoa executed on certain Street metrics -- the clean earnings and balance sheet improvements among the high points -- but the absolute level of earnings is still low, and the near term headwinds could send Alcoa even lower.

The view on Alcoa shares may still be the wait-and-see approach taken by Deutsche Bank analyst Jorge Beristain, who has a hold on Alcoa. The market is basically giving Alcoa a passing grade, but the near-term outlook is not sufficient to change the fundamental view of the stock. Deutsche Bank has a $14 price target on Alcoa, so the argument can be made there is reasonable upside to the stock.

In fact, Deutsche bank read the volume flatness that Alcoa guided investors to in the third quarter as a trigger to cut second half estimates for Alcoa and reduce its full year 2010 estimate from 30 cents to 18 cents. Though the $14 price target and 2011 and 2012 earnings remain unchanged.

It's not an unequivocally clear message, and catalysts don't seem to be aligning to send Alcoa higher any time soon. The global situation is improving, but at a micro-level, there remain the near-term headwinds for Alcoa earnings. "Given lack of near-term triggers and macro headwinds we continue to maintain our hold rating," Deutsche Bank's Beristain said.

Bottom Line: Alcoa gets a passing grade from the market for this earnings report, but a passing grade isn't necessarily cause to graduate Alcoa shares to a buy.

-- Written by Eric Rosenbaum from New York.


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