Alcoa (NYSE:AA) will kick off this quarter’s earnings season when it announces its Q2 results after the market closes on Monday. Alcoa’s results are closely eyed as it usually is the first Dow company to post earnings. We expect the company to record soft earnings. The company’s restructuring efforts should pay off even as aluminum prices and demand remain sluggish due to global economic conditions. Earlier in January, Alcoa had realigned its strategy and closed down some of its smelters in an attempt to remain profitable and to strengthen its product portfolio going forward. Last quarter, the company surprised everyone with a profitable quarter as opposed to an expected loss. It will be interesting to see, if Alcoa once again surprises everyone to trigger an upside in the company’s stock, which has been heavily battered in past one year.
While we currently have a price estimate for Alcoa at $12 or a premium of close to 35% to the current market price, we will update our price estimate to reflect the dwindling aluminum prices post earnings release.
Aluminum price decline in Q2
We expect average realized prices to decline across the segment as aluminum prices are hovering at two years low on London Metal Exchange (LME). The resurgence of the European debt crisis, slowing Chinese growth and mixed reports about the U.S. economy, all have contributed to the decline in aluminum demand and prices. Further, oversupply from Chinese smelters at below cost levels, has also depressed the prices. Aluminum prices have declined approximately 15% from $2100 per ton at beginning of Q2 2012, to nearly $1800 per ton at end the quarter. 
However, an ease in input costs coupled with a reduction of about 12%, or about 531,000 tons, in its smelting capacity, should help the company remain profitable for the quarter even as earnings will decline on a year-over-year basis. 
Long term fundamentals intact
We believe that Alcoa’s long-term fundamentals are strong while it continues to face near term headwinds. The company’s restructuring efforts coupled with initiatives to develop high-end engineered products and growth from the aerospace and automotive sector should drive sales and allow for better operating margins going forward.
Further, vertical integration should help the company stay healthy even with depressed prices. Alcoa is a fully integrated producer of aluminum; it mines bauxite, refines it into alumina, makes primary aluminum and also produces midstream products like flat rolled sheets and downstream engineered products.
But, the company’s stock may continue to remain under pressure, should there be no reprise from Chinese oversupply.Notes:
- LME Alunimum Price, LME, July 5 2012 [↩]
- Alcoa Plans to Curtail Smelters in Italy and Spain as part of Global Primary Restructuring, Alcoa News Release, Jan 9 2012 [↩]