UPDATE: AA Reports Q1 Earnings Tonight, Implied Move and A Way to Play

by Dan April 14, 2011 8:31 am • Commentary

UPDATE on Apr 14, 2011:

I am not going to sit hear and tell you that I am some expert on aluminum stocks or for that matter commodities, because I am certainly not.  This story caught my eye for a couple of reasons; first the stock looked very over bought near-term and the second the street seemed to want to disregard what seemed to me to be a very well known fact that regardless of soaring aluminum prices of late, that AA’s execution would be able to mitigate raising input costs……well here is one where the herd wasn’t right, at-least for now.  The stock is off about 6.5% (4/13/11 close 16.55) since reporting Monday and appears to be poised to move towards that previous low of ~15.50 made in March.

-Below are a couple excerpts from analysts on their post earnings reports:

Note from Citi on April 12, 2011 (they have a Hold rating and $17.00 target) :

After incorporating 1Q results and guidance, we are raising our 2011 estimate slightly to $1.27 from $1.24, maintaining estimates for 2012-13 at $1.35.
-Guidance – AA expects production increases of 125k tonnes QoQ for alumina and 50k tonnes QoQ for aluminum. Input costs such as energy, caustic, and pitch/coke should continue to increase, offsetting some of the benefits of high aluminum prices. Downstream Flat-Rolled and Engineered Products are expected to see seasonal and cyclical demand pick-up.
-Downstream Executing Well – Downstream businesses have been the star performers this cycle, helping to de-commoditize AA’s earnings stream. Management provided full year revenue targets for 2011 and reiterated their 2013 target. Margins should continue to expand as revenues grow.
-Cost Pressures Upstream – Alumina refining and aluminum smelting are both commodity input intensive businesses and the benefits of rising aluminum prices are being somewhat offset by cost. Quarterly cash costs are now back at 2008 levels.
-AA Shares Look Fairly Valued – AA shares traded down by 3% after hours despite topping consensus estimates marginally. Investors may have been expecting a larger beat based on recent share performance and revenues of $6.0 bln were light vs
consensus of $6.3 bln. Trading at 13.2x our 2012-2013 estimates, valuation appears inline with historical averages. In US Metals & Mining, we prefer CLF

Note from BMO where they downgrade the stock to Sell, April 11, 2011:

BMO Research is downgrading Alcoa from a Market Perform to Underperform. Reasons mostly have to do with the current share price level and expectations for the industry, rather than with Alcoa itself.

-In terms of the share price, it is currently well above BMO Research’s target price of US$15. Alcoa has been somewhat range-bound for several years, trading up to US$18 and down to US$10, so at present it is near the top of its trading range. In terms of the industry outlook, demand for aluminum is rising in 2011 but so is supply.
-Both Alcoa and BMO Research expect a surplus this year as supply exceeds demand. The 10Mt of total inventory given by Alcoa or 12Mt given by RUSAL suggests potentially significant downwards price pressure whenever the financial structures unwind (due to either higher interest rates or a flattening of the forward curve). This may, however, not occur for several months, at a minimum.
-Lastly, given AA has returned to more reasonable profit levels the financial markets may contemplate what sustainable earnings for the company are, and what multiples the shares should trade on. Based on Q1/11 earnings, Alcoa is earning around US$1.20 a share. It may be possible that the company is capable of earning US$1.60–2.00/share at peak and (perhaps overly simplistically) a P/E of 7–10x suggests little upside. On the positive side, Q2/11 should be higher than Q1/11, which may act to support the share price in the short term.


-As for the July 17 / 14 1×2 Put Spread that I suggested as a Bearish Play that would capture 2 earnings events, It now all depends on your outlook for AA and the overall market.

-If you have this on, you have it right where you want it….The spread Monday before earnings cost ~.50, and is now worth ~.80 and there is plenty more profit potential left in the structure if you remain bearish and are willing to wait it out…..

-The thing that drove me to the trade was that the stock was very extended and if the stock continued to sell off in the days/weeks to come i would look to take some profits as I would expect some sort of re-tracement of the downward move.

FROM APR 11, 2011:

EVENT: AA(~$18.00) reports Q1 earnings tonight after the close.

-Options market is implying about a 6% move which is fairly rich to its average move over the last 4 qtrs at 2.35% and its 3.4% average move over 8qtrs.


-stock is up ~16.5% ytd and up 80% since Sept 1, 2010, vs the ~27% return in the S&P 500 in that same period.

-wall street analysts seem to be fairly mixed on the name with 9 buys, 6 holds and 2 sells with an average 12 month price target of ~$20.

-of the top 10 holders who account for ~28% of the shares in the entire float, only 2 in the last 13f filing actually sold any and 7 of the 10 added to existing positions.


While the 80% rally in 7 months appears to be a bit overdone in the near-term, when you consider the run other commodity related names,  and actual commodities, it doesn’t exactly stick out like a sore thumb. Longer term chart shows a tremendous amount of room overhead and a breakout above these multi-year highs could see a low 20s stock in the offing.

AA 3 year chart        by Bloomberg


-The stock is clearly benefiting from the higher prices that aluminum is fetching these days, but I am not certain that the recent ~10% rally in aluminum is likely to offset rapidly rising input costs and the affects of the weak dollar.

-Near-term the stock looks overbought and will need a beat and raise quarter and guidance to get this thing to even attempt a breach of $20.  The above listed headwinds could keep a lid on the stock near term.



AA (stock ref ~18.00)  Buy the July 17 / 14 1×2 Put Spread for ~.50

-Buy 1 July 17 put for ~.80 and

-Sell 2 Apr 14 Puts for a total of .30 (.15 each)

Break-Evens on July Expiration:

Upside –If the stock is above 17 than you lose the .50 (or ~3% of the underlying).

Downside: if the stock is btwn 17 and 16.50 you can lose up to .50. if the stock is btwn 16.50 (down ~8%) and 14 (down ~22%) can make up to 2.50 (or ~14% of the underlying)….

BEST CASE-stock is 14 and you make 2.50. bwtn 14 and 11.50 pay off trails off,

WORST CASE-stock below 11.00 (down 39%)  and you lose money…..You are essentially put the stock at 14, but you have 3.00 in gains from the July 17 Put you are long, less the .50 premium that you paid……so loses really start at 11.50…..It is VERY unlikely that the stock will be down 39% by July expiration.

TRADE RATIONALE: I want to Look to JULY expiration as it will capture 2 earnings events,  and identify a structure that gives me short exposure while minimizing my premium outlay.  Another way to do this would be too leg into this trade, BUY the July 17/14 Put Spread as if 1 up and if the stock starts heading south after earnings look to sell another of the 14s to lock in some gains……I am using strikes and break-evens that are at what I deem to be significant support levels that also offer considerable profit potential without offering to much added risk.