Earnings Preview: Alcoa (AA)

by Dan October 8, 2012 12:53 pm • Commentary

Event:  AA reports their Q3 after the close Tuesday Oct 9th.  The options market is implying about a 3.75% move vs the trailing 4 qtr & 8qtr avg moves of ~3.25% and ~3.38% respectively.  

Price Action/Technicals:  AA is up 6.3% ytd vs the SPX which is up about 16%, and sorely lags behind the  XLB (the Materials Select SPDR) of which it makes up 2.18% of the the etf’s weight.   The stock currently sits about 15% off of the 2012 high made in Feb and about 15% about 15% above the 2012 lows made in July, but now basically right in the middle of the 3 month range of $8 to $10.

The 2 year chart shows the recent break above the downtrend that has been in place from the April 2011 top above $18, but apparently stuck inside a fairly wide range of about $11 to $8 since the Sept 2011 break-down.

[caption id="attachment_17580" align="aligncenter" width="490" caption="AA 2 yr chart from Bloomberg"][/caption]


Sentiment:  Wall Street analysts remain fairly mixed on the stock with 6 Buys, 11 Holds and 4 Sells, and an avg 12 month price target of about 10.62.  Short interest sits at about 7.75% of the float.

Fundamentals:  Wal Aluminum prices have seen a bit of a QE3 rally in the past couple months, but is still languishing near the low end of its 3 year range, as Chinese demand has slowed in the last year.  3 year price chart of Aluminum on the London Metals Exchange:



The real problem for Alcoa stock though, over the past 3 years, has been its low margins.  The company’s revenues are actually similar to 2005, but the stock is down more than 60% from those days.  One look at the gross margin chart explains why:



Expenses and capex have simply been too high.  Progress on that front likely means more than the revenues front going forward.


Volatility:  Alcoa realized and implied volatility are near 2 year lows, as the stock has remained in that $3 range since the start of 2012, and is basically unchanged on the year.  Not exactly price action to excite option buyers.  Here is the chart showing 60 day realized vs. 90 day implied volatility in AA:


[caption id="attachment_17590" align="alignnone" width="605" caption="from LiveVol Pro"][/caption]


 IN SUM:  Whatever your thoughts on AA’s future direction, it’s unlikely that AA implied volatility is likely to drop much below 30 based on history.  As a result, buying 3 month or further out options financed with shorter dated premium might make sense, especially if you have a strong directional view on the name.