Monday, August 27, 2012

How Alcoa's Results Read Across the Market

The symbolic start to the earnings season kicked off as usual with Alcoa (NYSE: AA) giving results. Investors will be pouring over the numbers and outlook in order to discern where the economy is headed. Whilst it’s easy to pour scorn on the idea that one company can set the tone for a whole economy, Alcoa does give very useful and detailed commentary on its end markets. In addition Aluminum is widely used across a range of industries and markets. It’s time to look into what Alcoa said.


Alcoa’s End Market Guidance

These days what Alcoa doesn’t say is almost as important as what it does. The market has been fretting about China’s growth prospects for some time and, since it is the key driver of hard commodities demand, what Alcoa has to say matters. I’ve summarized the latest outlook below with reference to previous reports.

SegmentQ2 2011 vs. 2010Q3 2011 vs. 2010Q4 2011 vs. 2010Q1 2012 vs 2011Q2 2012 vs 2011Trend
Aerospace76 to 710 to 1113 to 1413 to 14Stable
Automotive4 to 83 to 53 to 83 to 74 to 8Slightly Stronger
Heavy Truck & Trailer7 to 120 to 22 to 51 to 5-3 to 1Weaker
Beverage Can Packaging2 to 32 to 32 to 32 to 32 to 3Stable
Comm Building & Construction1 to 31 to 34 to 52.5 to 3.52.5 to 3.5Stable
Industrial Gas Turbine5 to 105 to 1001 to 23 to 5Stronger

Before breaking down the outlook by industry segment I will focus on where the changes were on a geographic basis.


Geographic Summary of Alcoa’s Results

North America saw a stronger Automotive outlook and this ties in with the extra production shifts planned at Ford (NYSE: F) and others. Heavy Truck & Trailer was weaker but this is coming of some strong numbers and the average age of a US truck is approaching historic highs. Beverage Can Packaging was weaker and this is pretty much in line with what Coca-Cola (NYSE: KO) and Pepsi are reporting in soft drinks and what some of the food companies are saying about canned food. Conditions remain weak in commercial building & Construction but interestingly, there was no change from last quarter.

Somewhat surprisingly there was no change in the European outlook. Although this just means conditions remain negative (apart from in Beverage Can Packaging which has 5-7% growth forecast in Europe) it does imply that things haven’t quite fallen off a cliff in Europe in the way that some technology companies are trying to argue.

Turning to China, the only downgrade to expectations came in the Heavy Truck & Trailer segment where growth is seen as turning negative by 3-8%


Aerospace and Automotive

The aerospace was seen as being particularly strong and, as ever with proponents of the industry, the back log of order at Boeing (NYSE: BA) and Airbus were cited as ensuring strong growth for years ahead but I would urge a note of caution here. Aerospace may well be a long cycle industry but it is still cyclical and when the going gets tough airlines will suffer. They go bust, they cut back on routes, and then ultimately airplane orders get cancelled or delayed.

Alcoa were quick to talk about commercial aerospace (particularly business jets) picking up the slack from the decline on the military aircraft side. However, business jets are the most cyclical of all orders and a large part of the growth in aircraft demand at Boeing has come from European budget operators and emerging market airlines. If the BRICS are slowing then their airlines are likely to see lower passenger miles growth.

The main bright spot was in automotive where there are real signs that North America car sales are expanding. The US car manufacturers are seeing increased orders and provided the US recover remains on track (albeit a slow recovery) Alcoa should see good demand. The average age of the US car has been rising with the economic weakness and is now at a level that suggests that consumers should start to purchase again.


Heavy Truck & Trailer  and Beverage Can Packaging

Heavy Truck & Trailer was seen as weaker in both China and North America. The former has now turned negative whilst the latter is moderating from very strong growth. Alcoa think that China stimulus spending may well increase demand in the second half but again I would urge a note of caution. China is still a communist country and its local Governments have a reputation for corruption and spending for the sake of hitting central Government targets without particular concern for efficiency. In other words, China may find it hard to get stimulus spending filtered down into the real economy. Europe is seen as weak.

I found the Beverage Can Packaging to be the most interesting segment from these results. North America was seen as weaker but Europe and China remain on track. Indeed, I notice that Ball Corporation (NYSE: BLL) was up the day after the results in an otherwise down market. Can packaging is a relatively recession proof industry and perhaps Ball, Crown, Rexam and others are set for margin expansion as Aluminium prices abate but end demand remains stable. The problem I have with the likes of Ball is that the evaluation does not look cheap. These businesses require a lot of ongoing capital expenditures and keeping capacity utilization high is paramount. In other words, they are strategically tied to their customers with little ability to cut costs in any downturn.


Commercial Construction and Industrial Gas Turbines

Rather surprisingly, there was no change to the Commercial Building & Construction markets. This is despite some signs of recovery in North America and weakness in China. Architectural Billings have been weaker in recent months but they were expansionary for a while in the US and construction hiring was strong in the US. I suspect the US will get stronger so perhaps the forecast 5% decline is the low point? As for China the forecast 7-8% growth is probably the tail end of existing fixed asset investment. There are real signs of a slowdown in new developments in China. Need I mention that Europe was weak?

And finally, industrial gas turbines saw its growth prospects pick up. There is secular growth from the increase in market share taken by gas in terms of producing energy. It is interesting that this is causing growth prospects to accelerate and investors should look at some of the parts manufacturers as being potential beneficiaries.