Tesla, Dow Are Handling Inflation. Alcoa Shows It Isn’t Easy.

view original post

The cost of caustic soda, which is critical to the process of producing aluminum, is likely to rise, according to Alcoa.

Dreamstime

Inflation is running at 40-plus-year highs, creating a host of problems for businesses and consumers. Managing through it is proving easier for some than others.

Take aluminum maker Alcoa (ticker: AA). Its shares were down 12.5% in midday trading Thursday. The S&P 500 and Dow Jones Industrial Average were up about 0.9% and 0.7%, respectively.

The loss for stock in Alcoa was partly due to its earnings report, released after the close of trading on Wednesday. The company reported earnings per share of $3.06 from $3.3 billion in sales, while Wall Street was looking for $2.88 from $3.5 billion. That doesn’t seem enough for a double-digit loss in the stock, but there were a few points that appear to have worried investors.

For starters, Citigroup analyst Alexander Hacking downgraded shares to Hold from Buy. His price target stayed at $84 a share. Shares are still up about 27% year to date and he calls the stock “fairly valued.”

There are also some cost pressures that could take a bite out of profit margins in the second half of 2022. Management said on their earnings conference call that prices for caustic soda, an ingredient in Alcoa’s manufacturing process, rise after a lag and will be higher by the end of the year. There isn’t much Alcoa can do about it because there isn’t a great substitute for caustic soda in aluminum making.

Dow Inc. (DOW) faced rising costs too, but it had more ability to substitute raw materials, helping the company to better manage the inflation problem. CFO Howard Ungerleider told Barron’s that about 65% of the company’s production capacity can flip between oil or natural gas-based feedstocks. That was valuable as oil prices shot higher in the first quarter.

The oil-to-natural gas ratio, an indicator of which raw material is less expensive, averaged about 19 in the first quarter, meaning a barrel of crude cost 19 times as much as 1,000 cubic feet of gas. The figure is about 20% higher than in the fourth quarter, which means oil is getting more expensive relative to natural gas, and that Dow would likely favor making petrochemicals out of natural-gas feedstock to preserve margins.

Its first-quarter revenue and earnings, disclosed Thursday morning, were better than expected. The stock was up about 6% in midday trading.

Even Tesla (TSLA) got into the substitution game. Like Dow and Alcoa, it beat forecasts on both the top and bottom lines in its first-quarter earnings, disclosed Wednesday evening. The stock was up about 7.3% in midday trading.

Management talked about inflation in discussing the result, but managed to offset the pressure by changing the makeup of its batteries, among other tactics. Tesla said about half the cars it shipped in the first quarter used lithium-iron-phosphate, or LFP, batteries, which don’t contain costly cobalt and nickel.

LFP batteries have less energy in a cell than the more expensive ones, but buyers appear to be happy with standard-range Tesla models that offer 260-plus miles per charge.

Many auto makers are moving to LFP batteries in some of their EV models as they seek to reduce costs. Cobalt and nickel rose about 50% and 20%, respectively, in the first quarter compared with the end of 2021. Iron prices were up more like 10%.

The magnitude of the change isn’t all that matters: Cobalt is about $80,000 a metric ton, while iron is more like $1,000.

Companies will be dealing with inflation for many months to come. For now, investors are rewarding companies that demonstrate flexibility.

Write to Al Root at allen.root@dowjones.com