Aluminum producer Alcoa (NYSE:AA) reported earnings last week that blew past analyst expectations, helped by higher prices for base metals and higher demand in aerospace, transportation, and building materials.
The raw numbers give you the idea that this was indeed a record quarter. Revenues were 20% higher at $7.8 billion, while earnings from continuing operations came in at $0.29 per share, a 21% jump over last year. What the data can't show, however, is that by becoming a low-cost producer of aluminum, Alcoa has positioned itself to take advantage of an excess of capacity that will constrain its competitors.
With more alumina in supply than demand can handle, the spot price drops to a point where higher-cost producers can't remain profitable. Alcoa has taken advantage of smaller, troubled producers in the past by buying them up, though it has also been shedding parts of its own company that don't meet its focus these days. Alcoa remains one of the top three aluminum producers today.
Yet production will also be constrained because smelters, which are used to melt ore to separate impurities, will close due to high energy costs, both here and in Europe. That should sustain the industry in times of excess capacity.
While the demand for aluminum in China is being spurred by its amazing growth rate, it also became a net exporter of aluminum earlier in the decade. But that situation's bound to change because the Chinese government has limited investment in the industry. It has limited approvals for new smelters, tightened financing for new projects, and closed factories that pollute the environment. Even so, the company expects there to be excess capacity ranging from 1.5 million to 3 million tons of alumina.
But Alcoa's business is not all about China. Its performance in 2006 got a boost from aerospace and commercial transportation, but that won't last this year. Orders for heavy trucks jumped last year because of new emission standards that go into effect this year, so Alcoa is anticipating a 40% to 50% fall-off in demand for 2007. And the continuing sad state of the North America automotive market continues to weigh heavily. Airbus and Boeing (NYSE:BA) are placing orders for about 900 planes, so Alcoa expects to get a good piece of the production market.
Look for Alcoa to continue to perform well this year. While there are market factors that could presage a fall, such as the excess capacity and China's position as a net exporter rather than importer of aluminum, Alcoa is also building plants in China to better meet the demand and will reap the benefits of growth in aerospace. Autos remain a challenge in the U.S., but should provide opportunities in the rest of the world. With smelter production slowing, the ability to keep prices at least stable should offset the problem of oversupply.
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Fool contributor Rich Duprey does not own any of the stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.
