Monday, October 10, 2011

Kaiser Aluminum Can Help Construct Your Portfolio, Not Alcoa

Alcoa (NYSE: AA) is generally the first big company to kick off the quarterly earnings season. And with expectations tepid for its third quarter report on Tuesday, should you invest in Alcoa or is Kaiser Aluminum (NASDAQ: KALU) a better bet on the sector?

Alcoa is expected to report a 28% plunge in its earning per share (EPS) from 2010's third quarter. This means that if Alcoa can do better than the 23 cents a share that 11 analysts on average are forecasting, Alcoa stock will pop after it announces its earnings -- especially if Alcoa raises its revenue and profit forecast.

Why is Alcoa profit expected to plunge? Concern about the slowing economy has slashed aluminum prices 19% this year. And Alcoa stock has fallen 46% since April -- more than twice the 22% plunge in the S&P 500's materials index, according to Bloomberg.

Meanwhile, analysts' estimates for Alcoa's third quarter have contracted 41% from 37 cents a share in July as bets on Alcoa's stock decline -- in the form of put options -- have increased in value. Alcoa put options priced 10% below the share price rose to 7.61 points above calls to buy the stock on Oct. 4 -- the biggest gap in the price relationship (called the skew) since April 2009, according to Bloomberg.

But news in the sector is not all bad. That's because despite a drop in its second quarter earnings, Kaiser Aluminum beat expectations substantially in that quarter. Specifically, Kaiser reported second quarter 2011 EPS of 63 cents a share that were down 11% from the year before although 18.8% better than expected.
The good news for Kaiser is what it perceived as demand from its aerospace customers. As Kaiser said in its second quarter 2011 earnings announcement, the company is benefiting from a "strong aerospace order book and [is] well positioned to meet the growing demand with previous investments in plate capacity and with the recently announced expansion of [its] Kaiser Alexco aerospace extrusion facility."
So should you shun Alcoa and buy Kaiser? You should consider doing just that. Here's why:
  • Kaiser: growing, barely profitable company; cheap stock. Kaiser revenues were up 9.3% to $1.2 billion in the last year while its net income fell 80% to $21 million yielding slim 1.8% profit margin. But its Price-earnings-to-growth ratio (PEG) -- 1.0 is fair value -- is a cheap 0.92 with a P/E of 39.8 on earnings forecast to grow 43.1% to $3.41 in 2012.
  • Alcoa: growing, profitable company, fairly priced stock.  Alcoa's revenues are up 14% in the last year to $23.5 billion and its net income rose 127% to $950 million while it earned decent 4% net profit margin. And its PEG is reasonable 0.95 on a P/E of 11.2 with earnings forecast to grow 11.8% to $1.19 in 2012.
Kaiser looks cheap and well-positioned to grow along with aerospace demand. Although I would like to see wider profit margins, the company has beaten expectations substantially in recent reports -- boding well for the stock if that trend persists.

Alcoa also looks good if the 2012 earnings forecast is right -- but the wide skew suggests that Wall Street knows some bad news.


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