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Published: June 22, 2010
By the end of Monday’s trading, investors
began to question whether China will really follow through with
plans to boost its
currency. Earlier in the day,
we opined that change is coming, albeit more slowly than
many would like.
Even after the dust settled and many China-related stocks gave
back their gains, shares of metals makers - especially aluminum
producers - held onto sharp advances. Both Alcoa (NYSE: AA)
and Century Aluminum (Nasdaq: CENX) rose more than +10%
on intra-day basis on Monday, and were holding most of those
gains in Tuesday trading. For both of these firms, investors
need to brace for some short-term pain but real long-term gains.
A Tough Start to Earnings Season
Alcoa, which always kicks off
earnings season, will likely set a somber tone. Analysts
have been lowering their second-quarter profit forecast from
$0.28 to $0.16 during the past few weeks, and that still looks
too high. Spot pricing for aluminum has been steadily dropping,
and that could push Alcoa’s per-share profits closer to the
$0.10 mark. In a similar vein, Century Aluminum may also be on
track to miss analysts’ second-quarter forecasts when they are
released later in July. That’s why share prices have been in
freefall for these aluminum producers prior to Monday’s
China-related spike.
The weakening outlook is due to a global aluminum glut. The
London Metals Exchange (LME) has been carrying about 4.5 million
tons in its inventory. But Chinese inventories have doubled in
the last six months to around 500,000 tons. Taken together,
those two locales carried more than five million tons on hand,
an industry record. (Inventories have since fallen four straight
weeks and now stand at about 4.97 million tons). Prior to the
economic slowdown, there were typically about one million tons
of aluminum in inventory.
And with so much inventory on hand, spot pricing for aluminum
has been falling sharply, from $1.11 a pound in late April to a
recent $0.88.
As that analysis
shows, it is the
increase in Chinese
inventories that has
made all the
difference. And that
factor is likely to
reverse as the yuan
slowly builds
strength. Even
before any move in
the yuan, a number
of Chinese producers
are said to be
operating at
negative cash costs
(which means that
their operating
expenses are higher
than the sales
prices they can get
for smelted
aluminum). While
firms such as Alcoa
and Century Aluminum
operate much more
inexpensively
(thanks to better
vertical integration
and smelters in
regions where power
is cheap), they had
to give up profits
as their Chinese
rivals ramped up
output.
Energy is expensive
in China. And
Chinese officials
have repeatedly
stressed that the
nation’s energy
resources shouldn’t
be frittered away on
money-losing
industries. So even
though a stronger
yuan will lower the
cost of imported oil
and gas, it won’t be
enough to turn these
money losers into
money makers. Which
is why many analysts
think China will
start to curtail
aluminum production.
Action to Take
--> As
noted earlier,
aluminum now fetches
less than $0.90 a
pound. Some of these
money-losing Chinese
smelters are likely
going off-line as we
speak. Aluminum
would have to move
back up above $1.05
a pound before
production
re-starts. Yet right
now, analysts are
tweaking their
models to account
for $0.90 aluminum.
Goldman Sachs, for
example, just cut
its 2011
EPS forecast for
Alcoa from $1.20 to
$1.05. (As a point
of context, Alcoa
earned an average of
$2.50 a share from
2005 through 2007).
On the upcoming
earnings reports,
look for estimates
to fall to reflect a
sobering pricing
outlook. Ironically,
that lowered view
will be arriving
just as the changing
industry dynamics
should enable
pricing to rise back
up. So wait for
these stocks to
digest the bad news,
and then pounce.
Alco is scheduled to
report quarterly
results on July 12.
-- David Sterman
Staff Writer
StreetAuthority |
