Alcoa Is Worth $10 With Long Term Fundamentals Intact
Alcoa (NYSE:AA) released second quarter earnings on Monday which were mostly in line with our expectations as lower realized aluminum and alumina prices offset growth in downstream engineered products and gains from productivity improvements. Revenues and profits declined on both a sequential and year-over-year basis. [1] Below we take a detailed look at the key highlights of earnings as well as the outlook of the company.
We have revised our price estimate for Alcoa to $10, a premium of close to 15% to the current market price, to reflect the lower aluminum prices. We believe that the company’s restructuring efforts coupled with initiatives to develop high-end engineered products lend support to our price estimate.
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Earnings at a Glance
In the quarter, lower realized prices took a toll on earnings even as demand was up sequentially for most sectors including aerospace, distribution, industrial gas turbines and packaging. 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.
Alcoa recorded revenues of $5.9 billion in Q2 2012, down slightly from Q1 2012 as well as Q2 2011. Operating income from continuing operations (excluding extraordinary items) declined to $61 million compared to $105 million in the previous quarter. Operating income was significantly down from Q2 2011 as realized prices were significantly down from the prior year’s levels.
Midstream and Downstream Products to Lead Recovery
In the near-term, we are cautious about the primary aluminum and alumina segments as they continue to grapple with oversupply in the market even as the company has maintained its forecast for the global aluminum demand-supply deficit in 2012. Chinese mills continue to supply alumina at below-cost levels as opposed to the initial expectations of capacity cuts. Further, dwindling economic confidence and the European debt situation have suppressed prices that are hovering around two-year lows on the London Metal Exchange. Accordingly we have lowered our forecast for average realized prices and EBITDA margins for the alumina and primary metal segments as alumina and aluminum prices continue to remain under pressure. Should there be no immediate cut in supply from Chinese mills, we expect no respite in the near term.
We remain optimistic about the company’s midstream global rolled products and its downstream engineered products. We maintain our robust growth expectations for the engineered products and global rolled products divisions as pent-up demand from the aerospace, automotive and transportation sectors should drive growth and allow for better operating margins going forward.
The company’s recent strategy realignment and capacity cuts for smelters and alumina refining should continue to drive productivity improvement. Further, its Saudi Arabia project is on track and is expected to start operations in early 2013. This will help in the company’s efforts to geographically diversify its operations. Additionally, vertical integration should help the company maintain healthy margins even with depressed prices.
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Notes:- Alcoa Reports $0.00 Per Share From Continuing Operations; Income Of $0.06 Per Share Excluding Special Items, Alcoa News Release, July 09 2012 [↩]