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Alcoa (AA) Q3 Preview: Another Earnings Beat in the Cards?

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Alcoa (AA - Free Report) is set to release its third-quarter 2016 results ahead of the bell on Oct 11.

In the last quarter, the New York-based aluminum giant posted forecast-topping earnings (a positive surprise of around 67%), but lower aluminum prices dragged down its sales and profits. Gains from productivity actions offset headwinds from lower metal prices in the quarter. The company recorded productivity gains of $375 million across all segments in the quarter.

Alcoa, in July, reaffirmed its global aluminum demand growth forecast of 5% for 2016. Moreover, the company revised its a global aluminum deficit forecast for 2016 to around 775,000 metric tons from its prior view of 1.1 million metric tons. Global demand for aluminum is expected to grow faster than supply in 2016.

Alcoa's results are a closely followed event as it is often considered a barometer of the economy as the company’s products are used across a wide gamut of industries. Investors will look particularly for management’s commentary on demand trends and outlook for its key end-use markets, especially aerospace and automotive, and the company’s planned split into two independent companies.

Alcoa has beaten earnings estimates in the last three quarters. Let’s see how things are shaping up for this announcement.

ALCOA INC Price and EPS Surprise


ALCOA INC Price and EPS Surprise | ALCOA INC Quote

Factors to Watch For

Alcoa is on track to complete the separation of its smelting and refining business from those that cater to aerospace and automotive markets. The separation will result in the creation of two standalone entities – Arconic Inc. and Alcoa Corporation.

Alcoa’s board recently approved the completion of the planned separation. The proposed split has been scheduled to become effective before the opening of the market on Nov 1, 2016. The separation will provide shareholders with value-creating investment opportunities. It will also mark the completion of Alcoa’s multi-year transformation.

Post separation, Arconic will be a leading provider of high performance multi-material products and solutions in attractive markets including the fast-growing aerospace market.

On the other hand, Alcoa Corporation will be a highly competitive leader in bauxite, alumina and aluminum production with a world-class asset base including the world’s biggest bauxite mining portfolio. Alcoa, in April, signed contracts worth more than $350 million to supply bauxite to external customers over the next two years.

Alcoa’s aggressive cost-cutting and productivity improvement actions are expected to continue to lend support to its earnings in the September quarter. The company expects Arconic and Alcoa Corporation to deliver $650 million and $550 million in productivity improvement, respectively, in 2016.

Alcoa is also actively pursuing its aerospace expansion strategy. The company, in its second-quarter 2016 call, noted that it sees an improvement in the aerospace market in the back half of 2016 and a strong 2017 based on ramp-up of new platforms.

Alcoa, in June, landed a multi-year supply contract with Brazil-based leading commercial jets maker, Embraer, worth $470 million. The deal makes Alcoa the sole supplier for proprietary wing skins and fuselage sheet to Embraer.

The company, earlier this year, also cut a long-term agreement with Boeing (BA - Free Report) to supply multi-material aerospace parts. Alcoa, last October, also inked a $1 billion deal with Airbus to supply the latter titanium, steel and nickel-based superalloy aerospace fastening systems. The deal marked Alcoa’s biggest fastener contract ever with Airbus.

Demand from the automotive market also remains healthy. Alcoa is making a notable progress with its breakthrough Micromill technology and rolling mill investments to meet rising demand for aluminum intensive vehicles.

However, Alcoa is still witnessing softness across certain end-use markets. Weakness in non-residential building and construction market is expected to persist in Europe. The company also expects a double-digit decline in the heavy duty truck and trailer market in North America in 2016. Weakness is also expected to continue in the North American packaging market.

For the third quarter, Alcoa sees after-tax operating income (ATOI) for its Engineered Products and Solutions (“EPS”) division to increase 5% to 10% year over year. The division is expected to continue to gain from RTI acquisition and productivity gains. However, Alcoa expects pricing pressure and airframe supply chain destocking to affect the EPS unit in the third quarter.

While pricing remains a concern, strong shipments of automotive sheet products is expected to favorably impact the company’s Global Rolled Products ("GRP") business in the September quarter. Alcoa expects ATOI to rise 5% to 10% year over year in the GRP unit in the quarter (barring the impact of Warrick smelter curtailment).

For the Transportation and Construction Solutions (“TCS”) unit, Alcoa envisions ATOI to rise 1% to 3% year over year in the third quarter. Productivity gains and growth in building and construction business is expected to be neutralized by sustained weakness in the North American heavy duty truck market.

While ATOI for the Primary Metals segment is expected to be flat (barring the impacts of pricing and currency) in the third quarter, the same for the Alumina division is projected to rise by $5 million in the quarter.

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 and a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) 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 12 cents.

Zacks Rank: Alcoa currently carries a Zacks Rank #2, which when combined with a 0.00% ESP, 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:

Teck Resources Limited has Earnings ESP of +5% and carries a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.

Pan American Silver Corp. (PAAS - Free Report) has Earnings ESP of +46.15% and sports a Zacks Rank #2.

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