Wednesday, July 17, 2013

The Winners and Losers From Alcoa's Recent Earnings

Investors always like to look at Alcoa’s (NYSE: AA) earnings and use them as a guide to the rest of earnings season. In the latest second-quarter results, there were some surprising elements which deserve to be looked at in more detail. In this article, I want to examine Alcoa’s end market commentary and discuss the implications for some companies which you might be looking at.

Alcoa changes guidance, but not for China

I’ve tabulated the updated full-year guidance below. The green segments are where numbers were upgraded, and red is for the downgrades.

Probably the most surprising aspect of these results was that Alcoa didn’t reduce guidance in any of its end markets within China.  A number of companies have reported recently and cited specific weakness in the country. For example, FedEx recently spoke of global trade growing slower than global growth, Oracle cited weakness in China, and filtration company Pall (NYSE: PLL) delivered some disappointing numbers in its industrial filtration results.

Pall’s Chinese industrial sales were down 11% in the quarter. The company spoke of the ongoing changes in the Chinese economy and how they are forcing Pall to adjust its sales focus. In general, China is trying to shift towards more domestic consumption and reduce its dependency on export-led manufacturing.  This is presenting challenges to Pall, and given that nearly 60% of its industrial sales are in process technologies and 20% in microelectronics, it is likely to face some difficulties.

Aside from what companies are saying, China’s own economic data has been weaker recently, with the official Purchasing Managers’ Index registering 50.1 in June. A reading above 50 indicates growth, so clearly China’s manufacturing industry is not growing by much.  However, this is not the way that Alcoa sees it! Indeed, it actually cited Chinese demand for aluminum as remaining strong and kept its 11% demand growth forecast. 

The reason why Alcoa may be seeing relatively better conditions is because aerospace and automotives have been the standout performers within the industrial sector this year. Furthermore, beverage can packaging is relatively non-cyclical, and China’s heavy truck & trailer industry is benefiting this year from some regulatory changes. It looks like a case of good news for Alcoa, but not necessarily for the wider economy.

Winners and losers from Alcoa’s report

Aerospace and automotive have been strong this year for similar reasons. The U.S. consumer is starting to benefit from employment increases, and lenders are more willing to expand credit in the form of car loans. North American auto sales have been improving, while China’s remain strong.

Aerospace has been very solid, and the industry has the potential to outperform in a cyclical recovery because its dynamics have changed.  The need for austerity has forced governments to stop subsidizing national loss-making champions, and airlines are getting much better at dealing with high oil prices and outsourcing unnecessary work. The result is increased airline profitability driven by Asian passenger traffic.

This commentary will interest shareholders in a diversified industrial company like General Electric (NYSE: GE) or Ametek (NYSE: AME). Aviation is GE’s largest industrial profit generator, and it needs strength in aviation, transportation, and health care in order to offset some weaker performance in Europe (particularly within its power & water segment). Alcoa spoke of a 40% rebound in growth in its regional jet business and 12% for its business jet segment.  This is great news for GE, but, on a more worrying front, Alcoa also said that it anticipated a weaker demand from Europe for industrial gas turbines. It looks like GE’s weakness in power & water is set to continue, so this is a mixed report for GE.

However, it was a good report for Ametek shareholders. The company has heavy exposure to aerospace, particularly the business jet sector (Textron is a major customer). Ametek also has customers in the North American heavy truck & trailer market. Indeed, in its most recent results, Ametek had cited some softness in its power & industrial business, thanks to softness in the heavy truck market. My point here is that if Alcoa is talking about order rates being up, then this will surely feed through into Ametek in future quarters.

Other stocks worth considering for the aerospace theme are B/E Aerospace, Heico, and Precision Castparts. Finally, the heavy truck & trailer market seems stronger, so stocks like Cummins could see better prospects.

The bottom line

In conclusion, this was a pretty good report from an end-market-demand perspective. There were no downgrades to expectations over China, and if anything, the news on the aerospace and automotive sectors was a little better. There was even some positive news for the heavy truck & trailer market. Overall, it was a favorable report, but investors still need to remain selective about where they invest in the industrial sector, because the sub-sectors within it are reporting some varied performance.

No comments:

Post a Comment