Did This Stock Leave You Cold? Read This

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The bellwether has given its verdict – it’s gloomy, weak and slow. China continues to ail Alcoa (NYSE: AA), compelling the aluminum giant to cut its full-year demand forecast by a percentage point.

So what? Surely you weren’t expecting the company to get all upbeat suddenly, did you? Many thought Alcoa would cut forecast in its second quarter, but it did in the third – that’s about it. And what about the earnings beat it managed to pull off? Okay, I know there’s not much to celebrate, but there’s no reason to panic either.

How low can it go

Alcoa suffered a net loss of $143 million, a significant downside from profit of $172 million it earned in the year-ago quarter. Can’t blame the company – metal and alumina prices slumped by almost 20% from their last year’s levels. But take off a massive $175 million one-time charge related mainly to the settlement of a lawsuit with Aluminum Bahrain (which has finally been settled after a four-year long fight), and the company’s numbers brighten up to a profit of $32 million, or $0.03 per share, which topped analyst forecast of $0.01 earnings per share.

Revenue dipped 9% to $5.8 billion from the year-ago quarter as sagging metal prices hit sales hard. Alcoa’s average realized price for aluminum came in at $2,222 per ton, down 17% from the third quarter of 2011. Expect the bad news to keep rolling, because things seem to be getting worse by the day -- aluminum traded at $2,054 per metric ton on the London Metal Exchange yesterday. Anything below $2,000, and producers could scramble to idle more plants triggering panic in the already shaky industry.

Isn’t the worst over yet?

Mining giant BHP Billiton (NYSE: BHP) dropped a bomb in August by putting on hold ambitious expansion plans to the tune of over $50 billion and deciding not to go for any new project until at least the middle of next year. That came after it reported a 35% drop in annual profits. Its alumina assets face the risk of further write downs if prices crash. Rio Tinto (NYSE: RIO) has just added to the woes by announcing plans to lay off and delay decisions on new projects. Its profits for the first half of the year slumped 22% as metal prices kept going downhill. The main culprit: China and its looming concerns that are showing no signs of easing. The World Bank and IMF have just cut their growth rate forecasts for the nation.

Going by these numbers and facts, one would need a nanosecond to write the company off. But for a company like Alcoa, mere glimpse of top or bottom line figures don’t explain the real thing. Alumina and primary metals make up only a part of Alcoa’s business, or its upstream business, and present a very dismal picture currently -- after-tax operating income (ATOI) for alumina was a negative $9 million in the third quarter, a huge setback from an income of $154 million a year ago. Likewise, the figure for primary metals division swung to a $14 million loss from a positive $110 million last year.

(Alcoa only uses ATOI to measure and report the performance of its segments, which is calculated by simply deducting taxes from operating income. It is very similar to the commonly used metric net operating profit after tax, ATOI thus gives us a good idea of the company’s operating efficiency as it excludes expenses that are not related to the day-to-day continuing operations of a business such as interest, restructuring charges, non-recurring expenses, discontinued operations and so on.)

Now this is where it becomes essential to understand that Alcoa has a downstream business, which actually is doing well, and which is also where the company is going to find growth in the near future till metal prices stabilise. 

Downstream, but up!

Alcoa’s global rolled products division stole the show with a whopping 63% jump in ATOI on a year-over-year basis. This unit makes sheets which have wide applications ranging from beverage cans to auto and airplane parts (I can sense you’ve already started guessing why this segment did so well). Its engineered products and solutions segment was the second-best performer with a 16% jump in ATOI. This segment mainly deals in fasteners, wheels, tooling products, blades and other such items, again catering largely to the auto and aerospace industries.  

Clearly, Alcoa’s projection of 6% higher demand this year comes on the back of automotive and aerospace markets. That’s not odd, considering that two of the biggest players in each of these sectors are Alcoa’s customers, and both are increasingly showing interest in having more of aluminum in their most popular offerings – that’s Ford (NYSE: F) and Boeing (NYSE: BA) for you.

It’s bonding with the metal!

Ford’s F-150 pickup trucks will have aluminum body that could reduce weight by as much as 15% -- the lighter a vehicle, the better the fuel efficiency. These trucks are slated to hit the roads in 2014, and will be fit to meet tougher emission standards. If you think the story about Ford ends here, wait: The auto giant aims to triple its production capacity for electric vehicles within a year. Given how the metal can offset an electric battery’s weight while improving fuel efficiency, Alcoa’s relationship with Ford could go a long way. And that’s just Ford. Fool analyst Rex Moore just got bowled over after test-driving Tesla Motor’s Model S sedan, which, you must know, is an all-aluminum car. And just last month, General Motors invented a unique welding technology that will enable better use of the metal quicker and at low cost. Does that ring a bell?  

A + B works out well

What about Boeing? Its 777-300 ER planes already use aluminum wing panels sourced from Alcoa, and all eyes are on the revamped 777’s that Boeing is seriously considering working on. What’s the biggest speculation doing the rounds? The new model is likely to sport aluminum body with "plastic composite wings." Now if its aluminum, you know where that will come from! Anyway, Boeing’s current backlog itself is so huge it could take at least another five years to clear it. A tidbit: Alcoa’s aluminum also sits on Airbus’ sharklets, the modified wings that improve fuel efficiency.

Packaging, construction and electronics are some other industries Alcoa’s products cater to. Here’s another tidbit: Alcoa also has some big customers in the electronics industry, which means a lot of ways to get into more tablets and smartphones (by the way, iPhone 5 too adorns an aluminum case).

Oh, and did you know Alcoa also made it to Mars through the Curiosity?

Keep track

Clearly, growth areas are many, and Alcoa’s downstream business once again proved to be the savior in its third quarter. But as long as its primary business doesn’t revive, a lot depends on how Alcoa can exploit opportunities in key end markets. If it manages well, it could be one of the greatest turnaround stories once stimulus’ at home and elsewhere start rolling and bring back the shine on economies and metals. To make sure you do not miss any signs of opportunity, stay updated by adding Alcoa to your stock watchlist. Click here to do it.

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Neha Chamaria has no positions in the stocks mentioned above. The Motley Fool owns shares of Ford. Motley Fool newsletter services recommend Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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