Could This Be Bad News for AA Stock?
Alcoa Inc (NYSE:AA) stock did not have a good start on Tuesday morning. In pre-market trading, Alcoa stock tumbled as much as five percent. Why? The company just reported earnings.
For those not familiar with the company, Alcoa is a manufacturer of lightweight metals. It operates in 30 countries and is the largest aluminum producer in the world.
At first glance, Alcoa’s Q1 earnings report (first quarter 2016) doesn’t look that bad. Net income excluding special items totaled $108 million, translating to adjusted earnings of seven cents per share. This turned out to be much better than Wall Street’s expectation of two cents per share in adjusted earnings per share (EPS). (Source: “Alcoa Reports First Quarter 2016 Results,” Alcoa Inc, April 11, 2016.)
Revenue was the disappointing factor. In the first quarter of 2016, Alcoa’s revenue declined 15% year-over-year to $4.9 billion.
Of course, with metals prices being what they are, the downturn in Alcoa’s business shouldn’t really come as a surprise. Aluminum prices have taken a hard hit in the last five years. In the past 12 months alone, the aluminum spot price plunged more than 15%.
Alcoa is running a giant business with many segments. In order to separate its upstream operations from its value-add services, the company announced last year that it would split into two public companies. (Source: “Alcoa to Separate into Two Industry-Leading Public Companies, Completing Successful Multi-Year Transformation,” Alcoa Inc, September 28, 2015.)
Last month, Alcoa said that the value-add segment will be named “Arconic.” The segment would focus on manufacturing multi-alloys for the aerospace and auto industries. For instance, both the fastening systems for the Airbus “A380” jet and sheets for Ford’s “F150” pickup truck come from Alcoa’s value-add segment. (Source: “Alcoa’s Future Value-Add Company to be Named ‘Arconic’,” Alcoa Inc, March 15, 2016.)
Arconic is the more resilient segment of Alcoa. Even with the downturn in metals prices and foreign exchange headwinds, Arconic revenue only slipped 2.2% year-over-year. The segment’s after-tax operating income actually surged eight percent year-over-year to $269 million.
The upstream segment, as you would expect, took the hardest hit. In particular, third-party revenue dropped a staggering 32.2% compared to the same quarter last year. Lower pricing, currency headwinds, and closed operations were responsible for the decline. Still, the upstream segment remained profitable despite those obstacles.
Going forward, the outlook is undoubtedly brighter in the company’s value-add segment. Alcoa predicts that global aerospace sales would grow between six and eight percent this year. Moreover, it expects global automotive production growth to be in the range of one to four percent. At the same time, Arconic is streamlining its operations. The segment achieved $179 million in productivity savings in the first quarter and is targeting total savings of $650 million this year.
Last month, Credit Suisse initiated coverage of Alcoa stock and gave it an “Outperform” rating. The investment bank has a $13.00 price target on AA stock, implying a more than 40% upside in the company. (Source: “Credit Suisse Starts Alcoa at Outperform,” Street Insider, March 10, 2016.)
Curt Woodworth, analyst at Credit Suisse, said that the firm saw “significant upside earnings potential over the next several years.” The firm’s sum-of-the-parts analysis points to a value of between $15.00 and $17.00 per share for AA stock.
The Bottom Line on AA Stock
Alcoa is on track to complete its separation in the second half of this year. When that time comes, the name Alcoa will refer to the upstream company, while Arconic will be the value-add company. If conditions improve in the metals market, Alcoa’s upstream business could stabilize.
Despite Alcoa stock’s recent downturn, the company seems to know a way out. AA stock investors need not panic.