Shares of Alcoa (AAFree Alcoa Stock Report), the first Dow-30 component to report March-period earnings, traded sharply higher today after the aluminum maker registered better-than-anticipated first-quarter results. Strong shipment levels at the Upstream division, as well as an improved product mix within the Midstream and Downstream segments, mitigated a 9% year-over-year decline in aluminum prices, to $2,433 per ton in the term. Strength in certain key end markets, including industrial products, automotive, packaging, and commercial transportation, were instrumental. In all, sales of $6.0 billion exceeded our $5.7 billion estimate.

Alcoa also had share net of $0.09 in the March term, a significant drop from the year-earlier period, when the metals producer notched its second-highest quarterly earnings in recent memory, at $0.27. Nevertheless, the latest term showed encouraging progress on a sequential basis, thanks to productivity improvements across all operating segments, driven by procurement savings and process enhancements. In fact, we had expected the company to suffer a loss of $0.03 a share, which would have matched its 2011 fourth-quarter deficit.

In spite of the uptick in performance, CEO Klaus Kleinfeld acknowledged that challenges remain. For starters, the cost of energy (the second most significant expense in the production of aluminum) remains relatively high, posing a problem for manufacturing and shipping. Another concern is excess global supply. Earlier this year, China declared that it would reduce its projected aluminum output by 1.1 million tons, from a total capacity of roughly 17.1 million tons annually. But that drop has yet to materialize, and production in the world's largest aluminum market reportedly increased sharply in January and February.

Furthermore, there is speculation that state-owned Chinese companies are maintaining production levels in order to protect jobs, in return for favorable rates on power. To make matters worse, newer more-efficient plants are being constructed at a faster rate than the retirement of older facilities. And questions remain regarding that country's plans for the remainder of 2012.

It is becoming more apparent that in order for aluminum markets to firm, capacity reductions will have to come from elsewhere around the world. In fact, industry behemoths Alcoa, Russia's United Company Rusal, and Norway's Norsk Hydro ASA recently announced production cuts. In January, Alcoa shuttered 531,000 tons, or 12% of smelting capacity. More recently, it reduced annual alumina (basic element used to manufacture aluminum) operations by 390,000 tons, or 3% of capacity. These steps are part of an aggressive expense-cutting program in which Alcoa intends to eliminate $800 million from its full-year production costs.

Management's year-ahead outlook for growth in global aluminum consumption, at 7%, may well be warranted. Demand for key metal from the world's two most populous countries, China and India, is on pace to advance at a double-digit pace. Consumption rates also appear poised to show momentum in Brazil and Russia. Overall, the company's top brass is optimistic that such gains, together with industrywide capacity curtailments, will result in excess demand. For alumina, Alcoa is looking for supply and demand to be in equilibrium. Firming market conditions in certain end markets, including aerospace and automotive, drive these expectations.

Regardless, with the industry unable or unwilling to rein in excess capacity fast enough, aluminum's growing usage may not translate into continued momentum for Alcoa. We have lifted our full-year bottom-line estimate by $0.10, to $0.65 a share, but that is entirely due to the strong first-quarter performance. In fact, our share-net forecasts for the remainder of 2012 remain unchanged.

About The CompanyAlcoa Inc., a Pennsylvania corporation, is a global leader in the production and management of primary aluminum, fabricated aluminum, and alumina combined. It supplies the aerospace, automotive, building and construction, commercial transportation, and industrial markets. It has more than 300 operating and sales locations in over 30 countries. Sales of aluminum and alumina account for more than three-fourths of Alcoa’s total revenues. It also produces nonaluminum products, such as precision castings and fasteners for the aerospace and industrial markets. Alcoa’s operations consist of four worldwide reportable segments: Alumina, Primary Metals, Flat-Rolled Products, and Engineered Products and Solutions.

At the time of this writing, the author did not have positions in any of the companies mentioned.