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Alcoa (AA) Buckles Up for Q1: Another Earnings Beat Coming?

Alcoa AA is gearing up to release its first-quarter 2016 results after the close on Apr 11. In the last quarter, the New York-based aluminum giant swung to a loss on a reported basis, hurt by charges related to restructuring and lower metals pricing. However, its adjusted earnings beat expectations (a positive surprise of 33.33%).  

Alcoa's primary metals business posted a loss in the quarter, hammered by lower aluminum prices and a decline in regional premiums. Headwinds from lower prices more than offset gains from productivity actions in the quarter.

Alcoa, in its fourth-quarter 2015 call, said that it sees 6% global aluminum demand growth in 2016 (to a record 60.5 million tons). The company’s outlook also indicated sustained strong momentum in aerospace, a key end-use market.

Alcoa’s results are closely watched by investors as they put a spotlight on demand trends for aluminum (a major industrial metal) across a vast spectrum of industries, which is closely linked to levels of economic activity. Investors will look particularly for management’s commentary on demand and pricing trends and the company’s planned separation into two independent companies.
 
Let’s see how things are shaping up for this announcement.
 
Factors to Watch For

Alcoa is witnessing strong momentum across aerospace and automotive markets. Healthy demand from these key end-markets coupled with the company’s aggressive cost-cutting and productivity improvement actions is expected to lend support to its earnings in the March quarter. The company achieved around $1.2 billion in productivity gains in 2015, surpassing its target of $900 million.

Alcoa, which continues to grapple with weak aluminum pricing, is actively pursuing its aerospace expansion strategy and has secured roughly $10 billion in aerospace contracts since the beginning of 2015.

The company, in Jan 2016, landed a long-term agreement with Boeing BA to supply multi-material aerospace parts, marking its fourth multi-year contract with the aerospace giant in a series of recent deals. The contract follows Alcoa’s two multi-year aerospace deals (worth more than $2.5 billion) with Boeing, inked in Dec 2015. Alcoa, in Sep 2014, also signed an aluminum sheet and plate deal with Boeing worth more than $1 billion.

In addition, Alcoa cut a $1 billion deal with Airbus in Oct 2015 to supply the latter titanium, steel and nickel-based superalloy aerospace fastening systems. The deal marked Alcoa’s biggest fastener contract ever with Airbus. Alcoa also inked an agreement with Airbus yesterday to supply 3D-printed metal parts for Airbus commercial aircraft.

Alcoa is also taking major steps, including closure of high-cost smelters, to cope with the low aluminum pricing environment. The company is trimming uncompetitive aluminum smelting and alumina refining capacity to move down the cost curve and maintain competitiveness in a challenging operating backdrop.

As part of this move, the company shuttered its Warrick Operations smelter in Indiana in March and will also cut alumina production by 1 million metric tons by the end of the June quarter, including curtailment of refining capacity at its Point Comfort operations in Texas. The completion of all announced curtailments and closures are expected to remove roughly 25% operating smelting capacity and around 20% of operating refining capacity by the middle of next year.

Moreover, Alcoa is seeing healthy automotive demand. While pricing remains a concern, strong demand for auto sheet products is expected to continue to favorably impact the company’s global rolled products business.

However, Alcoa is still faced with a weak pricing environment. Lower realized aluminum prices hurt its primary metals business in fourth-quarter 2015 and is expected to remain a headwind in the March quarter.

Aluminum prices remain under pressure given the oversupply of the metal in the market, exacerbated by high levels of exports of the metal by China (the world’s biggest producer) amid waning domestic demand. Alcoa faced significant headwinds from lower prices of aluminum and alumina which slumped 28% and 43%, respectively, last year. Weak metals prices have taken their toll on the company’s shares which slumped roughly 37% in 2015.

Alcoa also faces headwinds associated with unfavorable currency swings and weakness across non-residential building and construction, and commercial transportation markets. Softness in non-residential building and construction market is expected to persist in Europe. The company also expects a double-digit decline in the heavy duty truck and trailer market in North America in 2016. The North American packaging market also remains weak.

Alcoa, in Sep 2015, said that it is separating its smelting and refining business from those that cater to rapidly growing aerospace and automotive markets in a bid to shore up growth amid the prevailing difficult operating environment.

The separation will result in the creation of two standalone, publicly traded entities – The Upstream Company and The Value-Add Company. The separation, which is expected to close in second-half 2016, will mark the completion of Alcoa’s multi-year transformation. The Value-Add Company will be named “Arconic" while the Upstream Company will operate under the "Alcoa" moniker. We expect the company to provide more color on the planned split in its first-quarter call.

Earnings Whispers
 
Our proven model shows that Alcoa has the right combination of two key ingredients to beat earnings.

Positive Zacks ESP: The Earnings ESP (Expected Surprise Prediction) for Alcoa is +100.00% - the difference between the Most Accurate estimate of 4 cents and the Zacks Consensus Estimate of 2 cents. This indicates a likely positive earnings surprise.
 
Zacks Rank #3 (Hold): Alcoa’s Zacks Rank #3 increases the predictive power of its ESP.
 
Note that stocks with Zacks Rank of #1, 2 and 3 have a significantly higher chance of beating earnings. The Sell rated stocks (#4 and 5) should never be considered going into an earnings announcement.  

Stocks That Warrant a Look
 
Here are some other mining companies you may want to consider as our model shows they have the right combination of elements to post an earnings beat this quarter:
 
Royal Gold, Inc. RGLD has earnings ESP of +38.46% and carries a Zacks Rank #1 (Strong Buy).

Eldorado Gold Corporation EGO has earnings ESP of +100% and sports a Zacks Rank #2 (Buy).

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BOEING CO (BA): Free Stock Analysis Report
 
ROYAL GOLD INC (RGLD): Free Stock Analysis Report
 
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ALCOA INC (AA): Free Stock Analysis Report
 
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