Alcoa (NYSE:AA) released its third quarter earnings on Tuesday. While the company’s revenues and profits declined on a year-on-year and sequential basis, it reported an earnings of $0.03 per share. As we expected, the decline in revenues was attributed to lower demand for aluminum owing to the economic slowdown in China. To be fair, the loss from continuing operations of $143 million, or $0.13 per share, was due to special items which cost it $175 million or $0.16 per share. Excluding special items, the company had income from continuing operations of $32 million, or $0.03 per share. ((Alcoa Reports Loss From Continuing Operations Of $0.13 Per Share; Income Of $0.03 Per Share Excluding Special Items, Alcoa News Release, October 09 2012))
We currently have a price estimate for Alcoa of $10 and are in the process of revising it in light of recent earnings. Below we take a detailed look at the key highlights of earnings as well as the outlook of the company.
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Earnings At A Glance
Alcoa reported solid revenues of $5.8 billion, despite a 17% decline in realized metal prices year-on-year, and 5% sequentially. This is slightly down from revenues of $5.9 billion in Q2 2012. London Metal Exchange (LME) prices were down 7% sequentially on a 15-day lag basis with realized prices down 5% sequentially and 17% year-over-year. The impact of lower LME prices was partially offset by higher third-party shipments so the adverse impact on revenues was cushioned.
Operating income from continuing operations (excluding extraordinary items) declined to $32 million compared to $61 million in the previous quarter. Surprisingly, Alcoa reported record third quarter results in the Global Rolled Products, and Engineered Products and Solutions divisions. It showed significant sequential performance improvement in Alumina and Primary Metals. The company attributed improved performance in these segments to higher utilization rates, process innovations, lower scrap rates, usage reductions, and reduced contractual spending. 
Alcoa cut its 2012 global aluminum demand forecast to 6% from 7%, but maintained its long-term outlook that aluminum demand will double in 2020 from 2010 levels.
Special items in third quarter 2012 included reserves for environmental remediation, a net discrete tax charge, uninsured losses related to a fire at Massena, the negative impact of mark-to-market changes on certain energy contracts, and restructuring and other charges. 
Long Term Fundamentals
Positive growth continued in the aerospace market where Alcoa sees 13-14% year-on-year growth, and in the automotive market, where it sees an 11-15% growth in the North American market. The automotive demand in Europe, however, continues to decline. Alcoa’s 2012 global growth outlook for packaging (2-3%), commercial building and construction (2.5-3.5%), and industrial gas turbine (3-5%) markets remains unchanged. In the heavy truck and trailer market, Alcoa is lowering 2012 growth expectations (7-9% decline) in anticipation of a slowdown across all major regions.
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 the company’s efforts to geographically diversify its operations. Additionally, vertical integration should help the company maintain healthy margins even with depressed prices.
We believe that Alcoa’s long-term fundamentals are strong while it continues to face near term headwinds. The market sometimes reacts very negatively to macroeconomic factors, even if fundamentals are intact. A lot of events are taking place around the world simultaneously, driving market and investor sentiments. Some notable ones are — the Euro zone crisis, worries over mounting U.S. debt and the hotly debated fiscal cliff situation, and the slowdown in China. The LME prices for aluminum could be reflecting these sentiments, leading to steep price declines over a relatively short period of time.
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.Notes:
- Alcoa’s CEO Discusses Q3 2012 Results – Earnings Call Transcript, Seeking Alpha [↩]
- Alcoa Cuts Global Demand Forecast, Blames China, Business Insider [↩]