Alcoa (AA) Q3 Preview: Will Weak Prices Dent Earnings?

AlcoaAA is set to release its third-quarter 2015 results after the close on Oct 8. In the last quarter, the New York-based aluminum giant logged a 17.39% negative earnings surprise as lower aluminum prices hit its legacy aluminum smelting business. But Revenues rose year over year on strength across aerospace and automotive businesses, and beat expectations.

Despite its removal from the Dow Jones Industrial Average in 2013, Alcoa's results still matter as it provides color on demand trends for aluminum across a vast range of industries, which is closely linked to levels of economic activity.

Alcoa, in July, backed its expectation of 6.5% global aluminum demand growth for 2015. Investors will look particularly for management's commentary on aluminum demand and pricing trends and expectations for key end-use markets including aerospace.

Let's see how things are shaping up for this announcement.

Factors at Play

Alcoa, last month, said that it is splitting into two independent, publicly-traded companies in a bid to shore up growth amid a difficult operating backdrop. The separation will result in the creation of two standalone entities - The Upstream Company (consisting of bauxite, alumina, aluminum, casting and energy business units) and The Value-Add Company (includes global rolled products, engineered products and solutions, and transportation and construction solutions businesses).

The transaction, which is subject to specific conditions including final approval by Alcoa's board, is expected to close in second-half 2016. Upon transaction closure, shareholders of Alcoa will own all of the outstanding shares of both the companies. The separation marks the completion of Alcoa's multi-year transformation. We expect the company to shed more light on the separation in its third-quarter call.

Alcoa continues to grapple with weak aluminum pricing. Lower realized aluminum prices hurt earnings in its primary metals business in second-quarter 2015 and is expected to remain a headwind. Weak aluminum prices have taken their toll on Alcoa's shares which are down roughly 33% this year.

Aluminum prices, which sank to a six-year low in August, remain under pressure given the oversupply of the metal in the market, exacerbated by surging exports of the metal by China (the world's biggest producer) amid weakening domestic demand. Alcoa, in its second-quarter call, said that it now sees 2.2 million metric tons of aluminum surplus in China versus 1.8 million metric tons expected earlier.

Moreover, weakness across non-residential building and construction, and commercial transportation markets is expected to sustain in Europe in the third quarter. The North American packaging market is also expected to remain sluggish.

However, Alcoa should continue to gain from strong demand across aerospace and automotive markets. Healthy demand from key end-markets coupled with the company's aggressive cost-cutting and productivity improvement actions should lend support to its earnings in the September quarter.

Alcoa continues to look for expansion opportunities beyond its legacy primary aluminum business and diversify into other materials such as those (nickel and titanium-based) used to make aircraft parts.

The company is actively pursuing its aerospace expansion strategy. The purchase of U.K.-based leading jet engine components maker Firth Rixson has strongly placed Alcoa to capture additional growth in the growing aerospace market through a broad spectrum of high-growth, value-add jet engine components. The buyout of RTI International has also broadened Alcoa's titanium offerings and added advanced technologies and materials to its portfolio.

Alcoa also cut a $1 billion deal with Airbus yesterday to supply the latter titanium, steel and nickel-based superalloy aerospace fastening systems. The deal marks Alcoa's biggest fastener contract ever with the aircraft maker.

Moreover, Alcoa is ramping up production to address 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 in the third quarter.

Alcoa recently landed a joint development agreement with Ford F to make next-generation aluminum alloys for automotive parts using the former's breakthrough Micromill technology. Micromill alloy produced by the Micromill technology is 40% more formable and 30% stronger than the legacy automotive aluminum. The expected use of Micromill material on Ford vehicles is anticipated to more than double from 2016 to 2017.

Alcoa also remains on track to move down the cost curve and is actively repositioning its portfolio, including closure of high-cost smelters. The company has cut 33% of its smelting capacity since 2007.

Earnings Whispers

Our proven model does not conclusively show that Alcoa is likely to beat the Zacks Consensus Estimate in the third quarter. That is because a stock needs to have both a positive Earnings ESP (Expected Surprise Prediction) and a Zacks Rank #1, 2 or 3 for this to happen. That is not the case here, as you will see below.

Zacks ESP: ESP for Alcoa is 0.00%. This is because both the Most Accurate estimate and the Zacks Consensus Estimate are pegged at 15 cents.

Zacks Rank #5 (Strong Sell): Alcoa's Zacks Rank #5 when combined with an ESP of 0.00% makes surprise prediction difficult. We caution against stocks with Zacks Ranks #4 and #5 (Sell-rated stocks) going into the earnings announcement, especially when the company is seeing negative estimate revisions momentum.

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:

Agnico Eagle Mines Ltd. AEM has earnings ESP of +50% and carries a Zacks Rank #3.

Kinross Gold Corp. KGC has earnings ESP of +50% and holds a Zacks Rank #3.

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ALCOA INC (AA): Free Stock Analysis Report

FORD MOTOR CO (F): Free Stock Analysis Report

KINROSS GOLD (KGC): Free Stock Analysis Report

AGNICO EAGLE (AEM): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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