What to Expect From Industry Peers After Alcoa's Earnings Beat
Zain is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Aluminum companies have been plagued by the problem of overcapacity as supplies haven’t been matched by demand levels, leading to surplus stocks that have led to sharp declines in aluminum prices. Alcoa (NYSE: AA) announced its earnings on July 8, after the market closed.
The shares popped up 2% in the after-market hours as the company reaffirmed 7% growth in aluminum demand for the year. However, investors seem to be discussing whether the growth in supplies will be more or less than the growth in demand. Let’s have a look at what the Street has to say.
Earnings season on a go
For the time being, the Street seems to have a pessimistic outlook on these companies. Recently, the Street lowered Q2 estimates for the three U.S. aluminum companies, all primarily due to a lower underlying aluminum price versus the consensus estimate for the quarter. Specifically, the Q2 estimate for Alcoa was lowered from $0.13 to $0.07, for Century Aluminum (NASDAQ: CENX) from -$0.08 to -$0.11, and for Noranda Aluminum (NYSE: NOR) from -$0.13 to -$0.15.
However, Alcoa’s EPS of $0.08 topped the Street’s estimate and clearly showed that the sentiment for the industry was at its worst. The top line, however, remained below estimates at $5.8 billion. Two important factors to be considered in an aluminum company's earnings release are: a.) average realized price for aluminum and b.) shipments of aluminum products.
Alcoa announced that the average realized price for aluminum was $2,237/metric ton (which came in -4% on a year-over-year basis). Shipments of aluminum products declined 2.8% on a year-over-year basis. As already mentioned, the company reaffirmed FY 2013 projections of 7% global aluminum demand growth, particularly for use in automobiles and airplanes.
Most of the EPS beat came from stronger-than-anticipated results from two of Alcoa’s segments that are alumina and engineered products. Alumina is a key ingredient in production of aluminum and is extracted from bauxite through a refining process. The engineered products segment continues to benefit from strong aerospace and automotive demand, and Alcoa expects profitability for the segment to continue to improve as it enters new, higher margin products.
Given a declining demand environment, investors were also wary of cash reserves with the company. Alcoa generated $228 million in free cash flow for the quarter. The days' working capital was a Q2 record low of 27 days. Goldman remains negative on the supply-demand fundamentals of aluminum. While a significant amount of global capacity is operating below cash-cost levels (excluding regional premiums), aluminum fundamentals could keep pricing under pressure. With flattish aluminum prices in 2013, Alcoa is expected to generate negative free cash flow of $1.1 billion.
Shares of Century Aluminum and Noranda also popped up 3% a piece after this news. Despite persistently low aluminum prices, Noranda has been able to maintain profitability in its primary-aluminum business due to second quartile cash costs of its facilities. Nonetheless, the Street remains negative on the near- to medium-term outlook for aluminum prices and believes low prices will keep earnings and margins depressed.
The company could see some upside from improved non-residential construction demand in its primary-aluminum and flat-rolled divisions, but the non-res recovery is expected to continue to be slower than widely expected.
As far as liquidity is concerned, Noranda is not expected to face near-term liquidity concerns as its revolver is un-drawn and no significant debt payment is due for several years. However, the high debt level will remain an additional overhang on the stock, particularly if aluminum prices remain at current depressed levels.
The best aluminum player
Century Aluminum is best placed among the US aluminum producers in terms of: 1.) company-specific growth; 2.) company-specific cost savings potential from renegotiating power contracts; and 3.) relative valuation, with shares trading at 6.4x 2014 EBITDA estimates versus the other two US aluminum producers trading at 6.8x 2014 EBITDA.
Along these lines, subsequent to Q1 earnings, Century announced the acquisition of the Sebree aluminum smelter and a tentative power agreement at its Hawesville smelter, both located in Kentucky. I estimate the combined impact on Century EBITDA to be at least ~$70 million to $90 million, implying 2014 EBITDA potential now approaching $200 million (based on $0.93/lb aluminum price assumption) and a share price approaching $12 based on ~5.5x this potential 2014 EBITDA.
Overall, the aluminum industry remains an uninteresting space unless incremental demand increases hit the industry and defeat the current oversupply issues. On a company-to-company basis, however, we do find some interesting stories. Century is seen as the best stock given its cheaper valuations and cost-reduction strategy, while a neutral stance on Alcoa and Noranda is predicated on declining aluminum prices balanced by improving end markets.
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Zain Abbas has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!