An Opportunity in Alcoa Before it Strikes Monday?

By Neha Chamaria - July 6, 2012 | Tickers: AA, CENX, TSLA, BA | 0 Comments

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The Street, and that includes me, is waiting with bated breath for Monday when Alcoa (NYSE: AA) reports its second quarter numbers. And I can’t help but wonder-- can, and what if the world’s largest aluminum producer surprises us yet again? If you ask me, chances of the company beating consensus estimates aren’t too far- fetched. The way its end markets have been performing in the past few months tell me this.

So is there an opportunity to grab before Alcoa strikes Monday? You might have an answer by the time you come to the end of this piece.

The keys to recovery

Alcoa’s top line is likely to have suffered badly in the second quarter because of the way alumina prices have shed nearly $400 per ton within 3 months. Having said that, no one can really predict where prices are headed to. But the fact that key end markets seem to be breathing a little easy now means Alcoa might not be in as bad a situation as it seems.

Consider the aerospace and automobile sectors, both of which are big drivers of demand for aluminum.  The perfect example here would be that of the aerospace giant Boeing (NYSE: BA) which posted a stellar first quarter as demand remained firm. So huge is the company’s order backlog that it is ramping up production by nearly 60% to meet it. The French giant Airbus is also setting up new plants in anticipation of higher demand. New designs of both Boeing and Airbus aircrafts would entail higher aluminum content. If this doesn’t speak of a flying aerospace sector (thus aluminum), what does?

From planes to cars

Coming to automobiles, 2012 could turn out to be the best year of in last 5 years. After rising in April and remaining subdued in May, U.S. auto sales have again surpassed estimates in June. While low gas prices seem to be reviving pent up demand, the race to improve fuel efficiency is further triggering demand for metals like aluminum. Case in point: The recent launch of Tesla Motors’ (NASDAQ: TSLA) much awaited all-aluminum electric stunner Model S sedan. The auto maker, not surprisingly, got a green thumbs up for the feat from Alcoa. With more and more automakers gearing up for a lighter vehicle, aluminum is becoming a ‘wanted’ metal.

If that’s not enough, the U.S. housing construction spending has been on the rise in recent months, which is excellent news for aluminum makers since construction industry is another important end market for them.

Is China rising?

But the fate of the aluminum industry depends a great deal on China-- the world’s largest producer as well as consumer of the metal. China’s economy has slowed down, no doubt. But Chinese traders are reportedly waking up to the attractive prices of aluminum, evidenced by the 5% rise Shanghai aluminum posted this week after hitting a ‘three-year low’ last week. That apart, Chinese smelters are curtailing production by as much as 20%, joining the league of many global producers who have already resorted to cut backs.

Interestingly, demand from the nation—which accounts for more than a third of total global aluminum consumption— isn’t really slowing down. By April, the country had imported nearly double the amount of aluminum it had during the same period last year. The net effect of all this would mean good chances of a bounce back in metal prices if supply continues to remain under pressure while demand catches up.

Attractive, is all I can say

That China isn’t the biggest dampener was proved when the aluminum players threw up huge surprises during the first quarter. Alcoa proved it has what it takes to weather trying conditions, thanks largely to responsive cost cutting measures (read: capacity curtailment) which gave the company a leg up. Later, Century Aluminum (NASDAQ: CENX) managed to beat estimates on both top and bottom lines, leaving the Street wondering if it was being overly pessimistic.

Alcoa’s second quarter will be a squib (I am not over the Euro fever yet) on a year-over-year basis, but the pullback in aluminum prices got factored in Alcoa’s shares when they plummeted to multi-year lows recently. Today, the stock is trading at a P/E of 24.38, but one look at how dramatically its forward P/E falls off to just 9.67 tells me there’s good upside potential in the stock.

My Foolish takeaway

Aerospace, automotive, and China should drive Alcoa’s recovery. If the company manages to beat estimates on Monday, it might be a strong signal of bottoming out. But personally, whether Alcoa misses or beats, its current price level seems pretty compelling to me. I’d love to know your views on this. Shoot off your comments below. Fool on!

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