Alcoa Inc. Earnings Reveal a Remarkable Story

Alcoa (NYSE: AA  ) investors who held their nerves through weak commodities markets are watching their patience pay off. After jumping more than 10% last month, shares of the aluminum company tacked on another 6% yesterday, riding on a handsome set of second-quarter numbers.

While trampling Street estimates, Alcoa's earnings report revealed some facts that ensure greater potential gains for its shareholders. Here are three key takeaways every investor should know.

All-round growth
Despite flattish year-over-year revenue, Alcoa swung to a profit of $138 million during the second quarter from a loss of $119 million in the comparable period last year. What's notable is that each of Alcoa's business segments contributed to its bottom line growth, thus confirming the company's turnaround. Before I delve into the details, here's a quick look at what those three segments are:

  • Upstream, comprising of alumina and primary metals.
  • Midstream, comprising of global rolled products or GRP segment. It produces sheets, plates, and foils that are primarily used in aerospace, automotive, construction, and transportation industries.
  • Downstream, comprising of engineered products and solutions, or EPS business. It deals in products like fasteners, wheels, and forgings that again cater largely to the above mentioned industries, particularly auto and aerospace.

Alcoa turned in an after-tax operating income, or ATOI of $97 million from its primary metals business versus a loss of $32 million last year, thanks to higher shipments and improved prices. In case you're wondering why ATOI, Alcoa uses the metric to measure its segment performances. Since ATOI excludes nonoperational expenses like interest and restructuring charges, it is a good measure of the company's operating efficiency.

ATOI from GRP was flat year over year, but improved 34% sequentially to $79 million as robust demand for beverage can and auto sheets helped offset pricing pressures. Alcoa's downstream business continues to act as a solid support in turbulent times. Q2 ATOI from the segment improved 6% year over year to hit a quarterly record, driven by strong demand from aerospace and auto industries.

While the midstream and downstream businesses have been adding good value to Alcoa in recent quarters, its primary metals division's stellar performance stands out. With this core business turning around, Alcoa should move faster up the profitability curve, which is great news for investors. Better yet, the good days may have just begun.

Back to business
Thanks primarily to wide aluminum production cuts in China and lower output from India, Alcoa now projects the global aluminum market to end 2014 with a deficit of 930,000 metric tons versus its earlier projection of 730,000 metric tons. That number tops the world's leading aluminum company, Rusal's projection of 1.2 MT of deficit for the year.

Aluminum markets are recovering. Source: Alcoa

Meanwhile, surplus in the global alumina -- key raw material for aluminum – market slipped substantially to 824,000 metric tons in Q2 from 2.3 million metric tons in the first quarter, indicating robust demand for the metal.

Rising demand, coupled with improved prices -- Alcoa realized an average of $2,291 per metric ton of aluminum in the second quarter, up 2% and 4% year over year and sequentially, respectively -- paves the way for greater top and bottom line growth for the company in the near future.

Until now, the market was pinning hopes on Alcoa's high-margin downstream business. But this quarterly report confirms the reversal of its core business as well, which is something investors have long waited for.

Going stronger by the day
Alcoa's second-quarter report also brought with it another piece of good news: The company now projects the North American commercial transportation market to grow between 10% and 14% this year versus its earlier projection of 5% to 9% growth. So I wouldn't be surprised if this end market ends up adding more than 10% to Alcoa's total value-add revenue this year.

Aerospace: Driving Alcoa's growth. Source: Alcoa

More importantly, healthier transportation and construction markets should provide good support to the already strong aerospace market, which also happens to be the most important end market for Alcoa's midstream and downstream businesses.

Aerospace alone contributed 30% to the company's value-add revenue in 2013, and it's poised for another strong year, with Alcoa projecting it to grow at 8% to 9% clip. Alcoa now expects ATOI from its EPS business to jump 5% to 10% year over year in the next quarter. The trend should continue, especially with the company making huge strides in the aviation market, with investments spanning new facilities and acquisitions.

There's more to the story
Even as end markets grow stronger, Alcoa is slashing costs and resizing operations to boost its margins. So while exploiting growth opportunities, the company is also turning its weaknesses around. A prudent strategy like this one should only ensure greater returns to shareholders in the years to come.

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