Alcoa Results Raise More Questions Than Answers
10/12/2011 3:46 pm EST
As indicators go, this one is sure tough to read. It’s not clear exactly what Alcoa’s (AA) quarterly earnings say about the global economy—except that it’s tough out there.
Yesterday, Alcoa announced third-quarter earnings of 15 cents a share. That was short of the Wall Street consensus forecast of 23 cents a share…but with so many special items, it’s not clear to me exactly how short of estimates earnings were.
After taking out the positive items (such as an income tax benefit) and the negative (including flood damage), it looks like Alcoa’s adjusted earnings of $164 million were short of Wall Street estimates of $172 million.
But what interests those of us who own other stocks—but no shares of Alcoa—is the “Why?” of the miss. That’s where we’ll find clues to the prospects for the global economy.
The company said that demand for aluminum held up everywhere except Europe. Alcoa actually raised its projections for demand in China to 17% for 2011 from an earlier 15%. That should be enough, the company said, to offset falling demand in Europe.
The company kept its projections for growth in global aluminum demand at 12% for 2011. That’s down just slightly from the 13% growth in 2010.
I have some trouble, though, putting that demand forecast together with the company’s reported drop in the price of aluminum, which has been falling since May. Yesterday’s price on the London Metal Exchange was about 22% below the May high.
That could be a sign that others in the aluminum market see demand as softer than Alcoa does—which, if true, wouldn’t be great news for the global economy. Or that those speculators that built stocks of aluminum, thinking the price would go higher, have been selling.
On the other hand, the drop in price could simply be a reflection of the structure of the global aluminum industry.
In the global industry, China’s aluminum companies are the swing producers. But they have high energy costs, so when aluminum prices fall, they tend to cut production. That would then, normally, lead to a reduction in supply that would result in prices climbing again.
The key here is “normally.” When China’s big state-owned aluminum producers are pressed for cash to service debt, they will typically keep producing even if they have to cut prices to sell their output.
That may be what’s happening now—since China’s big state-owned companies have loaded up on debt and banks are desperate for the cash flow that will demonstrate that these loans haven’t turned bad.
In this situation, although it may make no sense to sell aluminum at a loss in the long run, in the short-run keeping production high is a sound business proposition. (After all, if you’re current on your loan, a state-owned producer can always get a new loan from a state-owned bank.)
Reminds me of one of my favorite radio ads of my childhood. The breathless announcer’s spiel went “We lose money on every sale and make it up on volume.”
Unfortunately, if you’re an Alcoa and actually have to worry about showing a profit, that kind of logic from competitors can be extremely painful.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did not own shares of Alcoa as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio here.