Here’s Why Alcoa is Selling Off After Earnings

Yesterday the perpetual earnings season kicked-off with aluminum producer Alcoa (NYSE:AA). Although Alcoa blew away profit expectations by $0.02 a share ($0.21), revenues came in $59 million less than Wall Street’s desire for $5.71 billion (Thomson Reuters).

So, why are AA shares down ~2% this morning?

Citigroup has downgraded the stock to a “hold” on valuation, citing a $17 price target.

What do we think?

Alcoa is trading at its historical average for P/E. So, it’s not terribly expensive. Also, the company delivered the variables our Earnings Preview covered for a very strong outlook:

The company projects sales to rise another 12% this year, they see global demand for aluminum doubling by 2020, aluminum pricing continues to strengthen, and CEO Klaus Kleinfeld said inventories are declining:

[W]e actually see that inventories are coming down on an absolute basis as well as on a days basis. The days basis is probably the more adequate reflection here, seven days lower than in the third quarter, so now at 52 days.

And if you compare it to the fourth quarter of ‘09, it was actually 66 days. So you’re really talking about two weeks improvement there and that is pretty substantial.

Also, in the first half of 2011 the company plans to reopen three aluminum smelters which have been idle during the economic downturn.

One issue to watch was volumes and costs. The company saw increased costs in a few different segments and lower volumes than expected (hence the lower revenues). We’ll keep an eye on that going forward.

What are the risks going forward?

This quarter Alcoa hit an all-time record for cash from operations and a fourth-quarter record for free cash flow. So, expectations for more of the same may lead to future disappointment. Especially if the global economy cools on the back of China reigning in growth.

Also keep an eye on competition. Competitors may take market share from Alcoa even if global demand does increase as projected.

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