Aluminum may be stronger than bricks and mortar, but this global aluminum supplier can't escape the very foundation that it's built upon.
Alcoa (NYSE: AA ) inaugurated earnings season this week for an equity marketplace that's eager to convert uncertainty and trepidation over the global economic outlook into relevant, observable data. Without question, Alcoa achieved impressive operational results during a third quarter that saw aluminum prices dive to a 34-month low!
After adjusting for some pricey one-time charges -- including a $40 million charge relating to the $85 million settlement of a civil suit brought in 2008 by Aluminum Bahrain alleging racketeering and fraud-- Alcoa delivered adjusted net income of $32 million ($0.03 per share). Alcoa absorbed the brutal spot-price environment through sweeping productivity gains, production curtailments at higher-cost smelting facilities, and also some regional and index-based price premiums. Of course, external market dynamics like the 6% growth in global aluminum demand for 2012 that Alcoa now forecasts are critical to understanding not only Alcoa's particular business outlook, but also the condition of the global economy at large.
A foundation of bricks and mortar
In the aftermath of the 2008 financial crisis, Fools will recall that resilient emerging-market commodity demand was instrumental in restarting the global industrial engine that still drives a significant portion of global economic activity. The BRIC nations, and China in particular, provided the world economy with a timely foundation of good old-fashioned, brick-and-mortar industrial demand. Previously, a hopelessly bloated financial sector had claimed its throne as the vanguard of a new global economy. But when that sector collapsed into panic and disarray, the act of building things -- and the materials required to do so -- offered a robust pillar of support upon which a fragile period of recovery has since been built. But what if those BRICs start to crumble, and the next chapter of this ongoing financial crisis finds no such foundation of resilient emerging-market growth?
Considering the sheer gravity of near-term challenges facing the economies (and currencies) of Europe and the United States, the prospect of seriously faltering growth in the East and elsewhere certainly presents an unsettling set of macroeconomic scenarios. In the past week alone, investors have fielded some decidedly disappointing indications of weakening business conditions not only from Alcoa, but also from diversified miner Rio Tinto (NYSE: RIO ) and the International Monetary Fund (IMF). Rio Tinto CEO Tom Albanese indicated that his company is "more cautious on the outlook for the next few quarters for our business than we would have been a couple of months ago,"and the IMF cut growth forecasts for both China and India while warning that: "Risks for recession in the advanced economies are alarmingly high."
Fortunately, we have also some encouraging signs to discuss, but the uncertainty surrounding current outlooks makes it an absolute imperative that investors continue to scrutinize the bellwether earnings results like those just released by Alcoa.
First, the good news
In addition to being profitable, investing is meant to be fun! So let's not permit ourselves to lose sight of the many hopeful indications that are still shining through the muck. For starters, China recently unveiled a $150 billion stimulus package that will focus heavily upon major infrastructure projects. In addition, some of China's major municipalities have mapped out their own aggressive investment plans that could potentially augment the national initiative in substantial ways. Although it's difficult to ascertain what portions of these plans will ultimately be realized, the headline numbers call for total investment of more than $1.1 trillion over the next several years.
Also, some of Alcoa's end markets have shown considerable strength of late. Alcoa is forecasting 13%-14% production growth in the global aerospace industry for 2012, and growth of 4%-8% overall for the auto industry. These industries are significant drivers of industrial demand for aluminum and other metals, and must be noted as substantial indicators for some degree of resilience in industrial demand. And finally, please note that while lamenting continued weakness in China -- where manufacturing actually contracted in September -- Rio Tinto did add the caveat that China's "deceleration is probably bottoming out."
And now for the warning signs
Despite the company's positive operating results, Alcoa shares slipped by as much as 5% Wednesday, with some sobering assessments of select end markets sneaking in to spoil the party. The big shocker for me was Alcoa's revised estimate for China's production of heavy trucks and trailers. Three months earlier, the company forecasted a slide of up to 8% for 2012, but Alcoa's latest estimate sees that production decline potentially reaching a dastardly 21%! This Fool will be eagerly awaiting earnings results from Caterpillar (NYSE: CAT ) on October 22 to gauge whether similar weakness has affected that bellwether's operations in China.
From Alcoa's prior forecast for 20% growth for 2012 in China's aluminum end-market relating to cans and packaging applications, the company issued a revised forecast for growth of only 8%. Here again, while canning demand is not exactly a core economic indicator, the important takeaway here is in the surprising extent of the forecast revision this late in the calendar year. Collectively, the data coming out from Alcoa, the IMF, and others suggests a rather severe additional weakening of industrial business activity in China during the third quarter that is likely to reverberate through the impending flurry of corporate earnings. Furthermore, the ongoing diplomatic impasse between China and Japan over disputed islands in the East China Sea could spell trouble for Japan's already fragile economic condition. Japanese automaker Toyota Motor (NYSE: TM ) saw sales in China plummet by 49% in September, while U.S. counterpart Ford Motor (NYSE: F ) booked a corresponding 35% gain!
While this discussion has focused quite intensively upon China as the dominant mover and shaker among the world's emerging markets, please recall that Europe and the United States remain at the epicenter of a global financial crisis that simply has not abated since exploding onto the world stage already more than five years ago. With the IMF estimating an 80% likelihood that the eurozone will suffer a recession next year, and also issuing stark warnings regarding the potential for global recession if policymakers on either side of the Atlantic fail to rise to their respective challenges, the prudent Fool will continue to carefully monitor emerging market industrial demand from the likes of Alcoa for signs that China and the BRICs may once again offer some foundation -- if even a partially crumbled one -- of brick-and-mortar support to a world in continued financial crisis.