Alcoa (AA) Up Prior to Earnings, Buy the Rumor?

It is probably a bit simplistic to call it “buying the rumor”, but Alcoa (AA) is trading about 5% higher the day before they kick of second quarter earnings season. The stock was given a major boost when Klaus Kleinfeld, Alcoa’s CEO, made optimistic remarks during an interview on Bloomberg television. Kleinfeld said that he is encouraged by the rebounding economies of the United States and particularly China. He said, “China is clearly out of the woods…It’s economy has come back and is growing.” The “green shoots” of the U.S. economy are also positive for his business, which should get a boost from the automobile industry as sales trends suggest is beginning to rise from the ashes.

Alcoa is America’s largest producer of aluminum and their stock has been hammered by the downturn in the world economy. It was less than a year ago that the company’s stock was over $30, but slacking demand and falling prices of base metals sent the stock reeling to a low of just below $5. Year to date aluminum prices have seen a slight up-tick of about 5%, but Alcoa’s stock is off by about 9% over the same period. As Kleinfeld said, much of the increased demand that is driving the price of metals up is coming from China. Of course, most of the Chinese demand has been absorbed by Aluminum Corp. of China, aka Chinalco (ACH), which has seen their stock rise by two-thirds so far this year. However, the fact that demand is starting to return is still important news for the struggling Alcoa.

Alcoa is expected to report another dismal quarter tomorrow, which will in all likelihood be its third straight quarterly loss. Consensus analysts’ estimates are expecting a loss of $.37 on revenue of $3.9 billion, which would be a decline of about 48.5% in sales. Because of the destruction of Alcoa’s fundamentals we downgraded the stock to Overvalued when the stock rose into the $10 range in early May, and it has yet to break significantly above that. If Mr. Kleinfeld is correct and the company shows encouraging results then the stock will get a boost from it, but we will still not advocate buying until the fundamentals are much stronger. We are hopeful that the results tomorrow will show an improved operating environment, but it would be nothing short of a miracle for the company to return to profitability this quarter. Of course, that is a major strike against any stock we value, and with Chinalco absorbing much of the increased demand from China and the dollar’s recent strengthening, there are still significant headwinds for Alcoa.

Alcoa may be cheap compared to historical norms, but it is no longer cheap enough to warrant our attention given its crumbling fundamentals. It is of course interesting to see the market gravitate to the optimistic tone of the CEO, and we would be pleased to see the company beat expectations. However, this company is not strong enough yet to get our stamp of approval. This may be a classic case of “buy the rumor, sell the news” as the CEO has lifted expectations, perhaps unintentionally.

“Alcoa will be one of the first to report. The stock is counter-cyclical it has 3% pop to the up side. Why do you think that’s happening? What is the buzz on Alcoa?…

The buzz is that they are likely to lose 36 cents a share versus gain of 67 cents a share last year. We expect the company to be hit by the lower aluminum costs or prices as well.” Fox Business Network 7/7/2009

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