Should I Buy Alcoa? 3 Pros, 3 Cons

by Tom Taulli | July 10, 2012 1:38 pm

Aluminum major Alcoa (NYSE:AA[1]) kicked off earnings season Monday, and its results were hardly anything to scream about[2].

The company posted a net loss of $2 million or less than a penny per share, with revenues of $6 billion, versus earnings of $322 million (28 cents per share) and revenues of $6.59 billion a year ago. Alcoa did manage an operating profit of 6 cents per share, however, besting Thomson Reuters estimates by a penny.

That wasn’t enough for investors, however, who were driving Alcoa down roughly 3% on Tuesday, continuing the company’s nearly 50% slide over the past year.

But after this much bloodletting, there’s no doubt Alcoa is looking more and more like a bargain. So should you buy Alcoa? To decide, let’s take a look at the pros and cons:

Pros

Global Leader: Alcoa is the No. 1 producer of primary aluminum and fabricated aluminum in the U.S. The company plays in the key areas of the industry, such as technology development, mining, refining, smelting and even recycling. Just some of the end-markets include aerospace, construction, consumer electronics and packaging. Alcoa also has other businesses, which include precision casting and industrial fasteners.

Aluminum Demand: While things might seem bleak, Alcoa insists this will improve. The company currently forecasts a rise of 7% in global demand this year. A key driver is the auto industry, which looks to increase the levels of aluminum in cars to improve both cost-efficiency and energy-efficiency. Alcoa serves big-time customers like Ford (NYSE:F[3]) and Toyota (NYSE:TM[4]). Another strong source of demand is the airline industry, which needs to upgrade aging fleets.

Cost Advantages: After the 2009 recession, Alcoa took extreme actions to restructure operations[5], such as unloading divisions and finding ways to improve efficiencies. For the most part, the efforts have paid off, as Alcoa now is more cost-competitive than even Chinese manufacturers.

Cons

Aluminum Prices: The blame behind the pain. Aluminum prices have been bleak, falling 23% in the past year. Worse yet: The world still has excess capacity, and it’s unclear when that will dissipate.

Macroeconomics Environment: All signs point to a continued global slowdown, especially in Europe. The U.S. recovery is on shaky ground, and even China is showing some strains. Should China experience a “hard landing,” it would further put the hurt on Alcoa.

Competition: While the aluminum industry is fairly consolidated, the competitive environment remains intense. Alcoa must deal with rivals like Rusal, Rio Tinto (NYSE:RIO[6]) and Aluminum Corp. Of China (NYSE:ACH[7]), not to mention other emerging competition from Russia and the Middle East.

Verdict

While demand looks promising, the excess supply of aluminum is likely to be a problem. Alcoa CEO Klaus Kleinfeld said the situation will get better — but he was light on specifics. Unfortunately, it has been tough for the major producers to cut back on production.

So even though Alcoa’s stock is fairly cheap — trading at 0.37 times sales — there’s no hope for Alcoa without better pricing in the aluminum market. And it’s far from clear when that improvement will come.

So should you buy Alcoa stock? No — for now, the cons outweigh the pros.

Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He is also the author of the upcoming book How to Create the Next Facebook: Seeing Your Startup Through, from Idea to [8]IPO[9].  Follow him on Twitter at @ttaulli[10] or reach him via email[11]. As of this writing, he did not own a position in any of the aforementioned securities.

Endnotes:
  1. AA: http://studio-5.financialcontent.com/investplace/quote?Symbol=AA
  2. hardly anything to scream about: http://investorplace.com/2012/07/lackluster-alcoa-earnings-cant-take-shine-off-this-stock/
  3. F: http://studio-5.financialcontent.com/investplace/quote?Symbol=F
  4. TM: http://studio-5.financialcontent.com/investplace/quote?Symbol=TM
  5. Alcoa took extreme actions to restructure operations: http://investorplace.com/2011/12/alcoa-aa-stock-limited-downside-high-upside-stocks-to-buy-in-2012/
  6. RIO: http://studio-5.financialcontent.com/investplace/quote?Symbol=RIO
  7. ACH: http://studio-5.financialcontent.com/investplace/quote?Symbol=ACH
  8. How to Create the Next Facebook: Seeing Your Startup Through, from Idea to : http://goo.gl/RVJL9
  9. IPO: http://goo.gl/RVJL9
  10. @ttaulli: https://twitter.com/ttaulli
  11. email: mailto:tom@taulli.com

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