Ahead of Alcoa’s (NYSE:AA) earnings report this week, there were certainly lots of grim expectations. Since July, the shares have dropped by roughly 37%.
Unfortunately, Wall Street’s fears proved to be spot on. In the latest quarter, Alcoa’s profit came in at $172 million, or 15 cents a share, which was well below the 22 cents a share consensus estimate. As should be no surprise, the company is feeling the pressures from a global economic slowdown.
But for investors looking for good values, is Alcoa now attractive at these levels? To see, here’s a look at the pros and cons:
Pros
Top operator. When it comes to the production of aluminum, Alcoa is the world leader. In fact, it has extensive operations in areas like mining, refining, smelting and fabricating.
While Alcoa has non-aluminum products – like precision casting and industrial fasteners – the fact is that over 80% of revenue comes from aluminum.
Valuation. Alcoa’s shares are trading at only 11 times earnings. Plus, the company pays a fairly decent dividend of 1.2%. And even with the headwinds, Alcoa still forecasts continued profitability for the next year.
Focus on efficiency. During the 2008-2009 recession, Alcoa saw a plunge in its business and the stock price collapsed. But the company took swift actions, such as unloading poorly performing businesses and finding ways to improve efficiencies. Interestingly enough, Alcoa is now highly cost competitive — even against Chinese operators.
Cons
High costs. Alcoa relies heavily on raw materials, transportation and energy, and such commodities have been generally high, which has pinched margins. There have also been pressures from the volatility in currency rates.
The macro environment. In the latest quarter, Alcoa saw a drop-off in demand in Europe because of the agonizing sovereign debt crisis.
The company’s CEO, Klaus Kleinfeld, warned that the world is “very nervous” and it may be “worrying itself into another recession.” If this does happen, it would mean a big hit to the company’s revenue and profit.
Competition. Even though there are only a handful of rivals, they are still fierce. They include companies like Rusal, Rio Tinto (NYSE:RIO) and Aluminum Corp. Of China (NYSE:ACH). It is not uncommon for them to boost capacity too aggressively.
Verdict
Even though aluminum prices plunged by nearly 20% in the quarter, Alcoa was still able to grow its revenue by 21% or $6.4 billion. And the company boosted its demand forecast for China from 15% to 17%. Given that it is the world’s biggest consumer of aluminum, the increase will definitely be a big deal and should help soften the declines in other markets, especially Europe.
In addition, Alcoa has suggested that the aluminum market has come under significant attack from short-sellers. But such things can’t last for long. In other words, there could easily be a snap-back in futures pricing when the speculation trails off.
So for investors who want to hold onto a stock for a couple years, Alcoa does look like a good bet – especially in light of the big pullback. So all in all, the pros outweigh the cons on this one.
Tom Taulli is the author of “All About Short Selling” and “All About Commodities.” You can also find him at Twitter account @ttaulli. He does not own a position in any of the stocks named here.
