Alcoa (NYSE:AA) brought some much-needed good news to the market when it reported a surprise profit in the first quarter as productivity improved while higher aluminum prices and better product mix translated into strong earnings. Both revenues and profits were up on a sequential basis, while earnings declined on a year-over-year basis. Lower realized alumina prices and higher input costs dented earnings to some extent. 
The general expectation was that the company would record its second consecutive quarterly loss. Alcoa is a world leader in the production and management of primary aluminum, fabricated aluminum and alumina, and competes globally with other companies like ArcelorMittal (NYSE:MT) and US Steel (NYSE:X). Alcoa’s results are closely eyed as it usually is the first Dow company to post earnings.
We maintain our price estimate for Alcoa at $12, implying a premium of close to 20% to the current market price. We have renamed the Flat Rolled Products division to Global Rolled Products to reflect the company’s new nomenclature. We expect that the company’s restructuring efforts coupled with initiatives to develop high-end engineered products and growth from the aerospace sector should drive sales and allow for better operating margins going forward.
Earnings up sequentially, but year-over-year decline
Alcoa recorded revenues of $6.0 billion in Q1 2012, up slightly from Q4 2011 as well as Q1 2011. Net income from continuing operations rose to $105 million compared to a loss of $193 million in the previous quarter. However, income was still significantly down from the $309 million recorded in Q1 2011 as realized prices still have not recovered to levels seen a year ago. With the exception of Europe, the company witnessed growth in shipments in most of its markets, albeit at a slower rate.
When compared to Q4 2011 the company has shown marginal growth, with demand up for most sectors including industrial products, automotive, packaging and transportation. Higher realized prices and strong productivity improvements boosted margins and net income compared with Q4 2011. Compared to the same period last year, industrial, building and construction demand for alumina, aluminum and other related products declined, while transportation, aerospace and automotive were the sectors that saw growth.
Estimates revised to reflect Alcoa’s realigned strategy
Alcoa is increasing its focus on its midstream flat-rolled products and its downstream engineered products, eying the huge demand potential. With falling alumina prices and rising input costs, we have lowered our forecast for EBITDA margins for alumina segment to about 30% over the Trefis forecast period. Consequently, the decline in market prices will affect the Primary Metals margins in the next few years. With demand for global rolled products increasing, we expect margins to increase for that segment. According to our revised estimates, engineered products will witness a robust growth with EBITDA margins above 19%.
On the path to recovery
Alcoa has maintained its forecast for the global aluminum supply deficit in 2012. For 2012, the company estimates that aluminum demand will grow by 7% compared to 10% in 2011 , primarily driven by global aerospace demand and partially offset by a decline in European sales.
We believe the company is on the right path with the help of its midstream (flat-rolled aluminum sheets) and engineered products. However, the primary aluminum and alumina segments are still grappling with oversupply in the market. The company’s recent strategy realignment and capacity cuts for smelters and alumina refining should help it withstand the pressure.Notes:
- Alcoa Earnings Rebound Over Prior Quarter on Higher Productivity, Improved Market Conditions, Alcoa News Release, April 10 2012 [↩]