Are the Airlines a Value Play? Alcoa Suggest They Are

Parsing through Alcoa's (NYSE:AA) earnings call, several items caught my attention as being inconsistent with what we're seeing in the charts.  For longer term investors, the clues provided by AA suggest that the airlines industry may be a hidden value gem with serious growth potential over the next 18-months.  Take a quick look at the Airlines Industry Index weekly chart (XAL) and you'll see that, after a very nice run that started in early October, 2011, the entire industry entered a correction in January 2015 and that correction has been in progress ever since. 

XAL Weekly Chart

The industry did find support at its 200-period moving average.  That's especially significant because it is a long-term level that large institutions and mutual funds track.  They not only use it to determine if a long-term investment is in an uptrend (above its 200-period) or downtrend (below the 200-period) but they will also use that level to place automated buy or sell orders.  Remember, only the large players have sufficient capital to move the price, so when you see an industry like this bouncing off its 200-period average not once but three times, you can be sure that the major investment firms are buying at that level.

In their earnings call yesterday, Alcoa told us that large commercial aircraft deliveries were down in the first half of 2016.  While that sounds like a negative, it really isn't.  There's an oversupply in the market right now, with Airbus reporting that they have 36 wide-bodies sitting idle just waiting for engines.  This is also a transitional period within several of the major providers as airlines are adjusting their fleets between narrow and wide-body aircraft.  Read some of the trade press exchanges between Airbus and Boeing for more insight into that tug-of-war.

Alcoa also referenced a "careful ramp up of new models" and lower orders for legacy technology.  This is due to a shift within the industry to new jet engine technologies that experienced some significant technical problems in the first half of the year.  Those problems at this point have been overcome, however, and the forecast through 2017 is for double digit growth.

Most telling of all is a single line in the Alcoa slide presentation that accompanied their earnings call.  They said, "Airline profitability is at an all-time high."  Now, as a major supplier of product within that industry, Alcoa would be in a great position to know the inside scoop.  The charts for the airlines are all in correction mode, oil and fuel prices remain depressed, and the International Air Transportation Association (IATA) continues to report strong passenger demand into 2016.

This divergence between the stock trends and the underlying industry data suggest that the airline industry as a whole may be undervalued.  Delta Airlines (NYSE:DAL) reports earnings before the open this Thursday (July 14) and we will be closely monitoring their earnings call for confirmation of Alcoa's assessment.

The other major players that we'll want to watch are General Electric (NYSE:GE) reporting July 22nd, and Boeing (NYSE:BA) reporting July 27th.  GE is a major jet engine supplier and Boeing, obviously, is one of the major aircraft manufacturers.  Remember, it's not their earnings that we're interested in, per se, but rather their assessments of the overall industry. 

By the end of July, we should have a very good idea as to where the airline industry is headed in 2016 and the first half of 2017.  If Alcoa's assessment is accurate, however, it would appear the industry is number one on the runway and ready for takeoff.

Alcoa Kicks Off Earnings Season After the Bell on Monday

The Brexit vote is behind us, the UK's selection of a new Prime Minister is still two months away, the US election is still four months away, the Italian banking crisis is simmering, but not boiling over (yet,) and yesterday's jobs report has put both the specter of recession and of interest rate hikes on the back burner, at least for now.  So what's next?  Why, earnings season, of course, and right on queue, Alcoa (NYSE: AA) is poised to kick it off after the close on Monday, July 11th.

Alcoa is one of the companies we closely follow, not just to understand the commodity landscape, but because their earnings calls typically provide an outstanding view of most industries in the industrial sector.  They are heavily dependent, not just on commodity prices, but on the performance of major players in Aerospace, Transportation, Mining, Automotive, and a score of other industries that all contribute to orders of aluminum or aluminum based products.  Getting a bead on Alcoa's outlook on the first day of earnings season provides a tremendous amount of insight into how the remainder of the season will go for most other industries. 

This quarter's earnings call will be even more interesting, however, due to the impending split of Alcoa into two companies.  We expect to hear more regarding the timing of the split and additional details as to the quarterly and annual outlook for the new company, named Arconic and trading under the symbol ARNC. 

Since Arconic will be focused on the Aerospace and Automotive industries, ARNC will be added to our short list of quarterly earnings calls to study.  Remember, there are a handful of key earnings calls that you should follow to give a broad overview of each sector and the market as a whole, and AA (as well as ARNC when they go public) are in that category.

So, what can we expect on Monday?  Well, AA is traditionally pessimistic in their outlook, however this quarter they appear to have good reason to be.  In the first quarter of 2016, AA experienced a significant drop in after tax operating income both in alumina (40% y/y drop) and primary metals (26% y/y drop.)  Revenue year over year was down 15%, and you can expect those struggles to continue.

What's worse for AA, however, is that China - the world's leading supplier of aluminum - is gearing up to increase year-over-year production by 4%, and that increase is expected to begin in the second half of this year.  According to Goldman Sachs, that will drive the overall commodity price of aluminum down from $1692 per metric ton as of yesterday's settlement price to as low as $1350 over the next twelve months.

The value-added business, however, is expected to see a boost, and it's that area in which we'll focus our attention since it will tell us the health of other industries. Sales to aerospace and automotives have been growing at a healthy pace and that is expected to continue with some reports looking at 5% to 8% growth in that division.

Overseas, expect the strength of the US Dollar - especially following the post-Brexit surge against the Euro and the British Pound - to produce negative headwinds for the remainder of the year.  The strong dollar hurts exports and also hurts earnings exchanges as goods and services flow globally.  Expect the impact of the strong dollar to be referenced in the reports of most companies in the S&P 500, as most have significant exposure overseas.

Towards the end of the week, we'll gain insight into the Financial sector when J.P. Morgan Chase (NYSE: JPM) reports before the bell on Thursday, however that's a topic for another post.  Stay tuned.