What happened

Shares of Arconic (NYSE:ARNC) plunged on Monday after the material engineering company announced first-quarter 2018 results and updated guidance. Management revised full-year 2018 EPS lower, noting that it expects the recent rise in aluminum prices to hold for the remainder of the year and chip away at margins for the company's lightweight metals products. 

Investors headed for the exits after CEO Chip Blankenship noted that "2018 is a transition year during which we are making investments in our future to position the company for long-term success and shareholder value creation."

As of 12:08 p.m. EDT, shares were down 16.7%.

A man wearing a suit holding his hand out flat with a bar chart showing decreases hovering over it.

Image source: Getty Images.

So what

The impact of rising aluminum prices was felt during the first quarter of 2018. Consider how the opening periods for the past two years stack up side by side:

Metric

Q1 2018

Q1 2017

Change (YOY)

Revenue

$3.44 billion

$3.19 billion

7.9%

Cost of goods sold

$2.77 billion

$2.46 billion

12.6%

Operating income

$333 million

$283 million

17.7%

Operating income excluding special items $345 million $390 million (12%)

Net income

$143 million

$322 million

(55%)

Data source: Arconic press release. YOY = year over year.

The increase in cost of revenue outpaced revenue growth, which sapped margins and resulted in less revenue trickling down to the bottom line. Operating income grew as Arconic reduced corporate overhead and is now past large restructuring charges that have been painful in the recent past, but adjusting operating income by excluding special items resulted in a drop of 12%.

Meanwhile, the 55% plunge in net income is a bit misleading. In the first quarter of 2017, the company enjoyed a $351 million gain on the sale of Alcoa stock following its spin-off. If that one-time gain is backed out of the comparison, then Arconic's operational improvement is easier to see.

Nonetheless, the impact of higher aluminum prices in 2018 will be impossible for investors to overlook. Management lowered full-year 2018 EPS guidance to a midpoint of $1.22, compared to the prior expectation for $1.50. Similarly, the business is now only expected to generate $250 million in operating cash flow for the year, which is exactly half of the previously expected level. 

Now what

Arconic will suffer from the margin-shrinking effects of rising aluminum prices. Much of that is due to uncertainty regarding new American tariffs on imported aluminum products. However, some part of the global pricing uncertainty stems from American sanctions on Rusal, the Russian aluminum giant with which the company has a direct relationship. Sanctions have been levied and then walked back. It's still unclear exactly how that will shake out.

Given the many sources of uncertainty in the aluminum market, it's not very surprising that Arconic stock is encountering increased volatility. Unfortunately, without more clarity on prices and business relationships, investors should expect that to continue for the foreseeable future.