Like it or Not, the World Is Looking Up

 | Apr 09, 2014 | 7:48 AM EDT  | Comments
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The needle movers are all going in the right direction. That's the real takeaway from last night's Alcoa (AA) conference call. The biggest drivers of worldwide growth -- the huge end markets in aerospace, trucks, autos, and non-residential construction -- are all looking up. With just a couple of exceptions, notably in some European construction, every single end market is improving. It's the most bullish worldview Alcoa has given us since the Great Recession ended. No wonder the stock's been running so hard.

Now, there's always a lot of confusion about Alcoa and its importance as an indicator of anything, anything at all. The aluminum maker has had its share of ups and downs -- and it's been mostly downs, for sure. In large part this is because there is too much aluminum being produced in the world, but it's also because the company is so incredibly sensitive to worldwide growth.

That's because aluminum is used in pretty much everything, from cars and trucks to large office building construction to cans and bottles and turbines and, most importantly, aerospace.

Plus, there are two Alcoas. There's the non-value-added Alcoa that makes the raw materials that it and others can use to manufacture pretty much everything that needs strength and lightness, and then there's what Alcoa keeps itself and puts into its own value-added food chain.

The first is hostage to both the world price on the top line and to the production costs on the bottom line. The second, the value-added, is dependent upon both the demand side and the share taken from other materials because of innovation.

That's a huge number of moving parts, and it can explain why critics initially looked at Alcoa's flat revenue and decided, "Oh well, no expansion in the economy worldwide, another ho-hummer, it's all done with cost-cutting."

Unfortunately that couldn't be more misleading. In truth, the price of the metal keeps falling in part because of too much inventory and excess production, even as demand is on the increase. Meanwhile, Alcoa is producing less high-cost aluminum because of closed manufacturing capacity -- 420,000 tons in all, with another 200,000 coming. That makes for lower revenue but higher profit, which is pretty much the name of the game. What's the point of continuing to produce high-cost aluminum that loses you money just so you can show some revenue growth?

So, from the outside, it looks as if sales haven't increased at all. That's a totally wrong read. Sales have increased nicely in lower-cost metal -- the higher-costs mills being shut down -- which is one reason the earnings are going higher, not lower. To conclude that sales are weak, but that earnings are strong, is fatuous logic at its worst.

But, more important, the company has graciously given us a breakdown of each line item -- and, like it or not, the world's looking up.

Let's start with aerospace. If you want to know when the beginning of the decline in Boeing's (BA) stock came, it wasn't with Boeing's quarter. It was when Alcoa lowered the boom on its aircraft numbers, with CEO Klaus Kleinfeld saying there was a small inventory glut. He might have well have said, "Short Boeing."

Whatever inventory glut there might have been, it has since disappeared, though this transpired as Alcoa took its aerospace outlook up from 7% to 8% to 9% -- which is very important, because many Alcoa watchers thought this number was coming down. Klaus outlined an eight-year backlog of 10,675 large jet orders, with pricing up 2.1% for Boeing and up 5.7% for Airbus. Airline profitability is at a record $18.7 billion and climbing, and there seems to be no reason to think these gains will reverse. Also helping things? The regional jet market has gotten strong, with a 13.2% growth number. That, too, had been previously stalled.

Remember, two million Alcoa fasteners go into each jet, so there's a lot of business on the line. Those aren't pure aluminum numbers, either. A lot of those fasteners are value-added with titanium mixed in.

Your takeaway? Buy Boeing, United Tech (UTX), Honeywell (HON) and Precision CastParts (PCP), all of which had been dinged by the results of the previous Alcoa quarter. Also consider buying Allegheny Technologies (ATI), the big allow producer, on any pullback -- because, when you hear "titanium," you should think, "Allegheny."

As for the auto market, it's just plain strong. Despite what you've heard from the various auto dealers, inventories are back to normal -- the time needed to clear them is down 13 days from earlier this year -- and production growth is rising. Alcoa's looking for a 2%-to-5% growth number here, and that's for the overall fleet, not the switching from steel to aluminum that's going on behind the scenes. Europe is not as strong, and is expected to grow at 0% to 4%, but that's up from negative 1% to plus 3%. China is staying at 6% to 10%.

Takeaway: You can buy Ford (F) or General Motors (GM) off of this, and I would buy GM right into the ridiculous downgrade from hold to sell by Morgan Stanley today. Where was that analyst when the stock was at $41?

Trucks were a gigantic part of the call, too. I was shocked at the growth here, and it might have been the real standout of the evening. Heavy trucks are now expected to grow 5% to 9% in the U.S. Last quarter, Alcoa predicted just 1%-to-5% growth, and that caused Paccar (PCAR) and all of its derivatives to hiccup. Alcoa's orders were extremely strong here, up 35% from the first quarter of 2013, and backlog is now at 114,000 trucks, up 36% year over year. Commercial trucking building in Europe has improved -- from expectations of down 6% to 9% to negative 1% to 5%. China remains strong at 16.3% production.

These figures amount basically to a re-accelerating truck bull market. The takeaway? Buy Paccar, Cummins (CMI), Eaton (ETN) and Wabco (WBC).

Finally, building and construction showed a nice lift, up 3% to 4% in the U.S. It was down 2% to 3% in Europe -- a new negative -- but China was steady at 7% to 9%.

There are no real takeaways here, but orders for aluminum did pick up with the better weather in the U.S., as it was too cold to pour concrete for much of this country in the first part of the quarter.

There are other elements of the quarter to consider, as well. For instance, cans declined in the U.S. -- that's the decrease in carbonated beverages -- but they remain strong in both Europe and China. Buy Coca-Cola (KO), perhaps? Turbine construction continues to weaken as natural gas prices rise around the world, making coal much more economic. Takeaway? Continue to buy Norfolk Southern (NSC), Union Pacific (UNP) and the recently uber-downgraded CSX (CSX), precisely the best way to play this trend.

All in all, there is so much like here, both in worldwide growth and in share take from steel to more highly value-added aluminum. That latter item is, besides the closing of inefficient mills, the biggest reason for Alcoa's truly gigantic earnings surprise of $0.09 per share vs. the $0.05 consensus.

Moreover, Kleinfeld predicts that the price of aluminum can finally start rising because of the supply curtailments worldwide. If that actually does happen, who knows how high the stock can go?

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