Shares of Alcoa Corporation (AA) declined 13.4% in October, according to data provided by S&P Global Market Intelligence. Although the company gave generally well-regarded earnings in the middle of the month, the stock failed to break the general downtrend of major industrial stocks in the month.
It didn't matter if companies like United Technologies or Honeywell International raised full-year guidance on the back of good results, nor that Caterpillar merely maintained its full-year outlook and 3M Company lowered its 2018 guidance. All the major industrial stocks sported double-digit declines in the month.
Alcoa was actually one of those that raised guidance -- management now sees full-year 2018 adjusted EBITDA excluding special items in the range of $3.1 billion to $3.2 billion, compared to a previous range of $3 billion to $3.2 billion. No matter, the key issue with Alcoa in October was the changing outlook for economic growth in China.
Listening in on the third-quarter earnings call, CEO Roy Harvey's comments repeated the themes that others have said about China during earnings season. "Data released over the past two months have shown that in China, the transportation and electrical sectors particularly had weaker year-over-year growth than projected," he said. There's the smoking gun.
Indeed, Harvey lowered the company's estimate for aluminum demand growth from China in 2018 to 4.75%-5.25% from a previous range of 5.75%-6.25% and global aluminum demand growth is now seen in the range of 3.75%-4.75% compared to a previous range of 4.25%-5.25%.
That said, it isn't just about demand. There's also the supply side to consider.
Starting with alumina, Harvey outlined that global supply disruption in alumina production (the starting material derived from bauxite that's used to smelt aluminum) in Brazil would create a larger deficit in the global market than previously expected -- good news for Alcoa.
On a more negative note, Alcoa now expects China to be a net exporter of alumina, whereas three months ago the expectation was for it to be a net importer. However, Harvey argued that "China is building new smelters that are expected to increase alumina demand and rest of world supply disruptions are likely to be resolved at some point" and concluded by pointing out that "while increased alumina prices represent an added cost for our smelters, Alcoa benefits overall due to the strength in the third party alumina sales."
Alcoa is also one of the largest producers of bauxite in the world, and here Harvey sees a market with a larger surplus than previously expected -- not good news for Alcoa and the outlook for bauxite pricing. There are no problems with bauxite supply.
Finally, while the supply of aluminum from China is forecast to be lower due to "curtailments and delayed expansions," Harvey argued that "supply reduction has been matched by a reduction in demand growth" and the demand/supply imbalance is expected to be less favorable than previously anticipated.
All eyes are on China and the forthcoming trade negotiations between President Donald Trump and Xi. Despite the slightly better earnings outlook and some positives from supply side considerations, Alcoa needs the outlook for demand from China to improve. That's what's likely to drive the stock price in the near and mid-term.