Alcoa No Better Than Coin Flip as Market Bellwether Status Fades

Alcoa No Better Than Coin Flip as Market Bellwether Status Fades

Alcoa Inc. (AA), the first Dow Jones Industrial Average member to report results each quarter, is losing its accuracy as a bellwether for the U.S. stock market.

The Standard & Poor’s 500 Index has usually followed Alcoa’s lead since 2002, rising 2.5 percent in quarters when the aluminum producer beat the market after earnings, less when it didn’t. That relationship has broken down since 2011, when the S&P 500 posted even bigger gains, about 3 percent, when Alcoa’s results hurt its stock, according to data compiled by Bloomberg.

Overtaken in size and market clout by diversified commodities companies such as BHP Billiton Ltd. (BHP) and Glencore International Plc, Alcoa has struggled to make a profit with aluminum prices sagging as production outpaces the metal’s use. Investors are looking beyond the New York-based producer, which announces results after the close of trading today, to companies such as International Business Machines Corp., which reports in ten days, according to Bespoke Investment Group.

“We don’t consider it much of a bellwether,” said Edward Dewees, who helps oversee about 3 million Alcoa shares among the $2.7 billion managed by New York-based Douglas C. Lane & Associates. “As far as did Alcoa beat or meet earnings, that’s a meaningless headline. Any investor who’s going to make a decision about other companies’ earnings based on Alcoa’s headline earnings, that’s silly.”Expected Profit

Alcoa is expected to report a 8-cent a share profit today, according to the average of 18 analysts’ estimates compiled by Bloomberg, two cents less than the results the company delivered in the first quarters of 2010 and 2012.

Monica Orbe, a spokeswoman for Alcoa, declined to comment on the company’s earnings or its position in the market.

Since 2002, the S&P 500 gained an average of 2.5 percent in the 90 days following Alcoa’s earnings in instances where Alcoa outperformed the market on the day after its results, according to data compiled by Bloomberg. When Alcoa underperformed, the benchmark gauge for U.S. equities only added 0.5 percent in the next 90 days, the data show.

In the seven quarters during the past two years in which Alcoa has underperformed following its earnings results, the S&P 500 has still climbed an average of 3 percent in the following 90 days, including one rally of as much as 8 percent, the data show. The S&P 500 fell 0.5 percent the one time the company outperformed.

Since 1959

Alcoa was added to the Dow Jones average in 1959. The company is now the gauge’s least-influential member with a price-weighting of 0.4 percent, compared with 11 percent for IBM and 6.4 percent for Chevron Corp.

Alcoa, the world’s most valuable materials company in 2002, no longer ranks in the top 89. Its market capitalization has slumped 74 percent to about $9 billion, according to data compiled by Bloomberg.

The decline has threatened the company’s status as a bellwether, a term which originally referred to a bell-wearing sheep that leads the flock and indicates to the shepherd where to find his animals as they graze.

When Alcoa’s shares fall after it reports — which happened 20 times in the past eight years — the S&P 500 had had negative returns through the two months of earnings season 50 percent of the time, according to Ryan Detrick, a Cincinnati-based analyst at Shaeffer’s Investment Research. An increase in Alcoa shares after earnings was correlated with positive returns 69 percent of the time.

Coin Flip

“With this upcoming earnings season we wouldn’t put nearly the same confidence that we would just five or six years ago,” said Detrick. The company’s results now predict the direction of the market about as well as a “coin flip.”

“A $9 billion company is clearly not as significant as one of the top 30 blue-chip names,” Detrick said.

The number of large institutional shareholders owning Alcoa has dropped by 47 percent in the past 10 years, according to data compiled by Bloomberg. In the first quarter of 2003, 390 investment managers controlling $100 million or more said they held Alcoa shares. In March, only 208 such firms reported owning Alcoa shares.

Alcoa’s debt may be downgraded to junk level, Moody’s Investors Services said Dec. 18.

New Indicator

IBM is a better indicator because its products and services are more ubiquitous even than the metal used in beer cans, airplane wings and some pick-up trucks, Paul Hickey, co-founder of Harrison, New York-based research firm Bespoke, said in an interview.

“If IBM trades up on the day after earnings, the rest of earnings season will be positive 75 percent of the time,” Hickey said. “Their services unit is in every Fortune 500 company and practically every government of the world.”

Mining companies such as Xstrata Plc, BHP and Rio Tinto Group have grown through acquisitions and building new capacity for several commodities, while Alcoa focused resolutely on aluminum. Russian and Chinese competitors have taken market share, leaving the company that invented modern aluminum processing as the world’s third-largest producer.

“The fundamentals for metals and mining equities have certainly delinked from other sectors,” Andrew Cosgrove, an analyst at Bloomberg Industries in Princeton, New Jersey, said in an interview. “That’s principally due to the fact that the aluminum markets are in oversupply. That’s what’s been driving the disconnect between metals and mining and the market as a whole.”

Global Output

Global aluminum output exceeded demand by 906,440 tons last year, according to data compiled by Bloomberg. That surplus has kept prices from rising and contributed to warehouses accumulating about 7.2 million tons of inventories, about eight weeks’ use, according to March 14 estimates by Barclays Plc.

A price-taker for the unprocessed metal that accounts for the largest share of the company’s revenue — 32 percent in 2012 — Alcoa’s profitability has suffered even as demand has improved with a recovering U.S. economy.

Alcoa Chief Executive Officer Klaus Kleinfeld now expects China, the country that churns out the most aluminum, to supply 350,000 tons more than it will consume, causing a surplus this year.

Facing Surplus

Kleinfeld’s goals include completing work on a $11 billion mining, smelting and rolling complex in Saudi Arabia, which will be among the world’s cheapest to operate. He is trying to expand the profit margin in the company’s businesses that make engineered products such as fasteners used on aircraft and the blades that turn jet-engine and electricity-generating turbines.

Alcoa grew at the beginning of the 20th century to dominate U.S. industry as an integrated monopolist alongside John D. Rockefeller’s Standard Oil and Andrew Carnegie’s U.S. Steel Corporation, according to George David Smith, a professor of business history at New York University’s Stern School of Business who has consulted for Alcoa.

Protected by patents on the industrial process that founder Martin C. Hall discovered independently and concurrently with French chemist Paul Heroult, Alcoa operated as a U.S. monopoly through 1940.

By the time Paul O’Neill came to the Aluminum Corporation of America as CEO in 1987, the company faced competition from peers trying to outgrow it in the U.S. and Europe.

Aluminum Focus

When O’Neill departed in 1999, he had made new bets that Alcoa could profit from focusing purely on aluminum rather than diversifying into other materials such as copper or iron ore as other global mining companies did. He bought Spain’s state-owned aluminum producer, Inespal SA, and Alcoa’s biggest U.S. competitor, Reynolds Metals Co.

His successor, Alain Belda, spent a decade specializing in aluminum products and cutting costs. In 2000, he paid $2.9 billion for Salt Lake City-based Cordant Technologies Inc., a maker of engine parts and fasteners for aircraft, expanding the business that is now Alcoa’s most profitable.

As these transactions and an oversupply of aluminum reduced the company’s power as a market indicator, Bespoke’s Hickey said Alcoa has “become less and less relevant.”

Alcoa’s earnings aren’t the bellwether they once were, Hickey said. “It’s a serial underperformer.”

To contact the reporter on this story: Sonja Elmquist in New York at selmquist1@bloomberg.net

April 7, 2013, 6:17 p.m. ET
Alcoa Plagued by Aluminum Glut

PITTSBURGH—The world’s biggest aluminum maker by revenue wishes there were less aluminum in the world, but it says there is only so much it can do about it.

Alcoa Inc., AA +0.24% traditionally the first out of the earnings season gate, is witnessing a seventh consecutive quarter of falling or flat raw aluminum prices on the London Metal Exchange, despite its own moves to curtail production.

The depressed raw aluminum price, which chiefly dents profit in the company’s primary metals division, is the main reason company profit in the first quarter, to be announced on Monday, is expected to fall one cent to eight cents a share, even though many of Alcoa’s biggest customers—makers of airplanes, cars and beverage cans—are either doing just fine or thriving.

And it might get worse before it gets better.

Speculators are busy shorting aluminum, part of a wide selloff in commodities, causing turmoil in the broader mining and metals sector. More than 20 mining CEOs have lost their jobs over the past 18 months. Massive mining projects are being suspended or put on hold. Inventories in warehouses are at record highs. Production in China, the chief source of global oversupply, is expected to increase a whopping 9% to 24.3 million metric tons this year. The LME price has dropped to under $1,900 per ton, down from over $2,500 two years ago, and more than $3,000 before the financial crisis.

Klaus Kleinfeld, Alcoa CEO since 2008, isn’t sitting on his hands. He closed smelters and production lines, slashing annual production capacity by 531,000 metric tons in 2012, or 12% of the company’s total. “We focus on the things that we can control to maximize value,” he told analysts.

With low raw aluminum prices persisting despite these moves, Mr. Kleinfeld is trying to bolster profit by improving Alcoa’s portfolio of products like screws, bolts and other high-value parts for the booming global aerospace industry, and sheets of metal for automobile makers looking to make vehicles lighter so that they consume less fuel. Income in its “engineered products and solutions” division rose 14% to $612 million in 2012, while income at its primary metals division, which makes raw aluminum, fell 36% to $309 million, a pattern expected to repeat itself in Monday’s results.

The emphasis on making and selling more value-added products for cars and planes has helped Alcoa hold its own compared with its peers.Rio Tinto, another top-three aluminum maker, has announced total write-downs totaling $25 billion on Alcan, the Canadian aluminum business it bought in 2007.

Alcoa has been reducing production at its higher-cost facilities. One idea floated by shareholders and endorsed by some analysts as a way of maximizing value is selling its $10 billion raw aluminum business, whose profits are largely dependent on LME prices. But analysts say the company would have a hard time finding a buyer willing to pay what it wants, while prices are so low, which could lead to a fairly long wait.Prices aren’t expected to rise until Europe, Japan and other pillars of the global economy get back on their feet, propelling global demand upward.

“For now, commodity funds in London are liquidating and dumping positions,” says Lloyd O’Carroll, an analyst with Davenport & Co. of Richmond, Va., who has advocated selling off the raw aluminum division. “The chatter is quite negative, and it’s hitting gold, oil, aluminum, everything.”

Still, long term, some are optimistic. “The long-term future of aluminum is very strong,” says Jorge Vazquez, an analyst for Chicago-based Harbor Intelligence. The aerospace industry is still growing as China, India and other emerging countries stock up on passenger jets. Around the world, governments are mandating better fuel-efficiency standards. The best way to achieve that is with aluminum, which is 25% to 35% lighter than steel. Sales of sheet aluminum are increasing 25% a year, says Mr. Vazquez.

For now, however, buyers fear overstocking, while supply remains plentiful. Companies—like Alcoa—have tried to cut production, but that’s never enough, say analysts. “When there’s oversupply, it always gets solved by higher demand, always, never by cutting supply, because not enough companies actually do it,” says Mr. Vazquez.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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