Alcoa to Kick Off Earnings; Should You Buy?

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Source: Thinkstock

Source: Thinkstock

In 2014 shares of Alcoa (NYSE:AA) have increased by more than 20 percent, and the stock has since become a favorite of retail and institutional investors. However, much of the excitement in shares of Alcoa is in response to its last quarter. Therefore, with Alcoa near 52-week highs and set to report earnings next week, is it a good idea to buy, hold, or sell into the report?

Alcoa is the third largest producer of aluminum in the world, and is always the first major company to report earnings in any given quarter. After years of disappointment and a flat stock, Alcoa’s recent rally has been just as much due to a connection in the bottoming prices of aluminum versus real improvements in its business model. With that said, should you buy it?

To answer that question, here are a few key points you should know ahead of the report:

  • Analysts expect revenue to decline 4 percent to $5.6 billion.
  • After three years of almost continuous declines in the prices of aluminum, it does appear to have bottomed around $0.80.
  • The company’s downstream segment is now driven by aerospace, one of its fastest growing segments and making up 52 percent of sales.
  • Its midstream segment consists of auto sheet, which some analysts think can double in total tons over the next 10 years. This is a major investment point for longs, and a space that’s watched closely.

When those points are considered, Alcoa is a classic cyclical company, depending on the industries that use aluminum and the health of the overall economy to thrive. Therefore, Alcoa is a story of good and bad, and the combined outcome was a 3 percent decline in aluminum shipments during the fourth-quarter and guidance for a 7 percent rise in global demand this year. This is led by aerospace, construction, and automotive, but then the company faces declines in industries like commercial transportation and industrial gas turbines.

Therefore, expectations are relatively low, the long-term guidance from Alcoa remains positive, but the problem is that the stock is no longer cheap. Currently, Alcoa trades at 21.25 times forward earnings, and Normura recently said it expects the company to earn free cash-flow of negative $630 million this year, which is not a positive. Therefore, in comparing Alcoa to another large basic material company like BHP Billiton (NYSE:BHP), it’s really hard to say “buy Alcoa ahead of earnings” following its run higher.

Specifically, BHP Billiton trades at 14 times next year’s earnings, and because it’s most diversified in high margin businesses, it has an operating margin of 30 percent. Hence why, in my opinion, there are far better opportunities than Alcoa, such as BHP Billiton, and I would avoid or sell the stock ahead of earnings, as it could pullback significantly.

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