Alcoa Puts Show Earnings Risk After 46% Plunge

By Cecile Vannucci, Jeff Kearns and Kaitlyn Kiernan - Oct 11, 2011 3:21 AM GMT+0700
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A worker inspects a roll of aluminum during processing in the Alcoa Warrick Operations plant in Boonville, Indiana. Shares of the largest U.S. aluminum producer lost 46 percent since April. Photographer: Tom Strickland/Bloomberg

The price of bearish contracts on Alcoa Inc. (AA) jumped to the highest level since May 2009, as traders speculate this week’s earnings report won’t stem a plunge that has erased $9 billion of equity value.

The cost of New York-based Alcoa put options 10 percent below the share price rose to 7.61 points above calls to buy the stock on Oct. 4, according to data compiled by Bloomberg. That was the biggest gap in the price relationship known as skew since April 2009, the data show.

Analysts have cut estimates for Alcoa’s third-quarter profits to 23 cents a share from 37 cents in July, data compiled by Bloomberg show. Shares of the largest U.S. aluminum producer, which begins earnings season tomorrow, lost 46 percent since April, more than double the 22 percent drop for materials companies in the Standard & Poor’s 500 Index, as concern about the slowing economy sent the metal down 19 percent.

“It’s hard to be bullish on a company that provides a product that’s so linked to the broad global industrial economy,” John Stephenson, who helps manage $2.7 billion at First Asset Management Inc. in Toronto, said in a telephone interview Oct. 7. The firm reduced its Alcoa holdings to 2.2 million shares from 10 million at the start of the year. “People aren’t buying metals because they’re worried about the economy.”

Michael Belwood, a New York-based spokesman for Alcoa, declined to comment on the company’s options or earnings.

Single-Day Move

Implied volatility, the key gauge of options prices, for three-month puts to sell Alcoa shares should they drop 10 percent is 64.68 versus 58.79 for calls to buy if it climbs 10 percent. The spread reached 7.61 points on Oct. 4, the widest in 30 months.

The rise in skew and volatility for Alcoa comes after two months in which equities saw unprecedented volatility, whipsawed by concerns including S&P’s downgrade that removed the U.S.’s AAA credit rating, speculation Greece may default on its debt, reports showing rising inflation in countries such as China and India.

Alcoa options are pricing in a 5.4 percent one-day gain or loss after its quarterly report tomorrow. The implied move is calculated from a comparison of implied volatilities for two options maturities closest to expiration.

‘Downside Move’

“The market is definitely assigning a greater probability to a downside move than upside,” Max Breier, a senior equity derivatives trader at BMO Capital Markets Corp. in New York, said in a telephone interview Oct. 7. “Even if you solve the problems in Europe we’re still going to be in a world where growth in the developed world is less than 2 percent.”

The Chicago Board Options Exchange Volatility Index, also known as VIX, slumped 16 percent to 36.20 last week after advancing for the previous two weeks. It dropped 8.8 percent to 33.02 today. In Europe, the VStoxx Index, which measures the cost of Euro Stoxx 50 Index options, fell 13 percent to 40.56 last week. The gauge slid 6.5 percent to 37.91 today.

The S&P GSCI Index of commodities has tumbled 20 percent from this year’s peak six months ago. The global primary aluminum surplus through July reached 614,180 metric tons, a yearly high as production gained and demand fell, according to Bloomberg Industries data. The surplus, equal to about 1 percent of global demand, helped push prices down 9.8 percent this year. Global producer inventories rose in July to the third-highest level since April 2009.

Analyst Estimates

The International Monetary Fund cut its forecast for worldwide growth next year to 4 percent from 4.5 percent on Sept. 20, predicting “severe” repercussions if Europe can’t contain its debt crisis or U.S. policy makers deadlock over a fiscal plan. U.S. GDP is forecast to rise 2.2 percent in 2012, a Bloomberg survey of economists shows.

While analysts have reduced their estimates, Alcoa’s earnings are forecast to be more than double last year’s. Then, the company reported profit of nine cents a share, topping predictions, and raised its 2010 global consumption forecast to a 13 percent increase on higher demand in China, Brazil and India. Alcoa’s shares rose 1.5 percent last week after falling 20 percent over the previous two weeks.

This year’s decline may mean that Alcoa shares are poised to rally if the company exceeds analyst estimates with a “decent quarter,” according to Mark Demos, who helps oversee $18 billion at Fifth Third Asset Management in Minneapolis.

‘Pretty Good Shape’

“They’re still in pretty good shape,” Demos said in a telephone interview Oct. 7. “The industry has slowed significantly but it’s still growing.” Alcoa’s revenue rose for the past five quarters, reaching $6.59 billion in the most recent three-month period.

Bond investors are also becoming more bearish on Alcoa. The cost to protect Alcoa debt for five years has more than doubled since the end of July. Credit-default swaps tied to the bonds, which typically decline as investor confidence improves, rose to a two-year high of 4.73 percentage points on Oct. 4, up from 1.95 at the end of July.

“Industrial commodities have been under a lot of pressure,” John Kattar, chief investment officer at Eastern Investment Advisors in Boston, which manages $1.7 billion, said in a telephone interview Oct. 7. “A lot of that is centered on fears of a slowing global economy, but more specifically on fears of slowing in China.”

To contact the reporters on this story: Cecile Vannucci in Amsterdam at cvannucci1@bloomberg.net; Jeff Kearns in New York at jkearns3@bloomberg.net; Kaitlyn Kiernan in New York at kkiernan2@bloomberg.net

To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net; Andrew Rummer at arummer@bloomberg.net