If You Like Alcoa’s Outlook, You’re Going to Love This Little Brother
James is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
2012’s fourth quarter earnings season is officially here now that Alcoa Inc. (NYSE: AA) has kicked things off by sharing its recent fiscal results. As usual, all eyes were on the company’s numbers, since how this major name fared last quarter is an omen of how the entire earnings season will pan out.
That’s the theory anyway. In reality, however, the theory doesn’t hold water. There’s still something ‘bigger picture’ to be gleaned from Alcoa’s numbers, though.
While the aluminum icon may or may not be a proxy for the overall market any longer, at least it’s a proxy for the aluminum industry. And, there are other aluminum names that are likely to be in the same boat, including relative unknowns Century Aluminum (NASDAQ: CENX) and Kaiser Aluminum Corp. (NASDAQ: KALU). So, if you liked what you heard from Alcoa, you may love what you hear about one of the others.
No need to beat around the bush -- Alcoa lost money last quarter. It lost $191 million to be exact, or $0.18 per share, but only took a $0.03 loss on an operating basis. Still, that’s a pretty drastic step backwards compared to the $258 million profit it generated in the same quarter a year earlier, when it earned $0.25 per share.
The swing to a loss materialized despite the 6% bump in revenue, to just under $6 billion.
How’s that happen? A major dip in aluminum prices between the middle of the year and the end of the year. Aluminum fell from $1.25/lb in June to $0.87/lb in December, reflective of fading demand. The cheaper it is, the more the company can sell, but the more margins are crimped. That much most all of you know.
What was less touted is perhaps the more important detail included with the announcement: Alcoa sees better days for aluminum ahead. In fact, the company expects demand to grow by 7% this year, simultaneously suggesting the aluminum market will see a supply shortfall.
Those are pretty bold outlooks. Scratch that -- those are huge cojones outlooks, especially given that aluminum prices are still under $1.00/lb, and the $1.13 level is generally regarded as the make/break price. And, one has to wonder if the optimism was the usual -- almost obligatory -- puffery normally seen from companies that want to talk their stocks higher.
The thing is, Alcoa isn’t the only interested party looking for a better aluminum market in 2012. Harbor Aluminum feels aluminum prices are going to bottom in the current quarter. In December, Goldman Sachs (though reeling in its original forecast) still said aluminum prices were on pace to swell by 26% this year. Other reputable names agreed. Indeed, enough agreed that we can reasonably take Alcoa’s optimism as face value.
What’s Good for the Goose…
Great, but what’s this got to do with an aluminum company that isn’t Alcoa? Quite a bit actually. If Alcoa has nothing but brighter days ahead -- and investors are giving it a break after a couple of shortfalls and the first loss in six quarters -- just think how well the market would applaud a smaller, nimbler company that’s on the verge of producing more, and more reliable, success.
Enter Century Aluminum, stage right.
To be fair, Century has seen better days. It’s also seen worse. Since 2010 it’s waffled in and out of the red, though the recent hit and miss results are much more enjoyable than the disastrous numbers from 2007 and 2008.
Century Aluminum has earned $1.05 per share for the last four quarters, translating into a P/E of 8.8. A low P/E isn’t everything. In fact, it’s often misleading. In this case though, it’s unusual in a good way ... it signals hesitation from the market to get behind a shaky stock. If it’s not as shaky as the market presumes, however, other investors’ lack of confidence may actually mean a bargain has been created for you.
At the heart of the worth-it/not-worth it debate is -- ta-da -- that nagging price of aluminum. When it’s above the $1.00 level (the $1.13 level is a nice target, but not a profitability requirement for a smaller company with modest overhead), Century does well. When it’s below $1.00, Century struggles. And if the metal can get back up to $1.13 ... well, let’s just say Century can squeeze more out of that price than Alcoa can.
Ergo, if you’re betting on the same aluminum price recovery that Goldman Sachs, Harbor, and a bunch of other pundits are, then CENX may be a higher octane way to play it than AA.
As of the last look, Century was expected to turn last year’s per-share earnings of $0.27 into $0.64 this year. While odds are Q4’s numbers will end up being a let-down thanks to the surprising slide in aluminum prices, any pessimistic fallout may be a capitulatory dip that ends up being a long-term blessing. The fact that analysts dislike it more than they like it is in many regards a contrarian bullish cue -- the stock’s just primed for the analytical community to change its mind at the first sign of stronger numbers. (It would be nice if analysts were proactive rather than reactive, but that’s usually not how it is.)
All that being said...
In the interest of being savvy, stepping into a small-cap materials name isn’t a low-risk activity. If it works out though, and aluminum has indeed seen its worst days, this is a name that could pack a little extra bullish punch as a cyclical rebound play. Best of all, few others are even thinking about it yet.
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