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Alcoa: Limited Downside, Big Upside in ’12

AA is profitable, streamlined and ready to roll

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Aluminum prices can’t move much lower: The CEO of one of Alcoa’s competitors, Norway’s Norsk Hydro (PINK:NHYDY), recently said aluminum prices are about as low as the industry will allow them to go because many producers risk operating at a loss if aluminum gets any lower than $2,000 per metric ton, or roughly 91 cents per pound. Chief Executive Svein Richard Brandtzaeg said, “If there is a lengthy (low price) situation, the chances for shutdowns are increasing.”

Reports indicate that Chinese aluminum producers already have cut back annual production by about 1.5 million metric tons — showing that even if demand remains weak, producers are going to get aggressive with supplies to boost prices that way. I won’t say prices have nowhere to go but up, since weak demand could persist. But it is clear that aluminum producers are going to act together to ensure they don’t go significantly lower.

Right-sized for hard times, ready for recovery: So why aren’t investors flocking to Alcoa stock if it has all these things going for it? Well, because the primary factor affecting demand for aluminum is economic growth — specifically, production of durable goods like cars and construction projects. But there are reasons to expect baseline aluminum demand won’t drift much lower because car sales and construction already have taken big hits. There’s also Brandtzaeg’s point that the aluminum industry will continue to curtail supplies to ensure prices don’t drift lower, either.

As for Alcoa’s operations, big cost cuts over the past few years, including some 13,500 layoffs handed down in 2009 (a staggering 13% of its work force), have streamlined the company for hard times. Alcoa is is lean and on the defensive — which means if things stay challenging, AA stock should hang tough.

I know what you’re saying. This is all nice — in theory. The reality, of course, is that things can certainly get worse — much worse — for Alcoa and for many stocks on Wall Street.

Auto sales should be up almost 10% in 2011 from 2010 numbers and easily could retreat to those earlier levels in the coming year. Housing starts and other construction statistics indicate marked improvement over 2010 as well, and it’s not unrealistic to think that housing could backslide too. Demand could plummet, aluminum prices could crash and AA stock could take a beating.

That’s a risk I’m willing to take. I think Alcoa has limited downside after its tumble across the past few years and recent return to profitability, and will at worst move sideways in 2012.

As for upside, I think $12 is reasonable. According to Thomson/First Call, 16 Wall Street analysts have an average target of $12.73 and a mean target of $12.25. Most recently, Barclays put a $13 target on a AA stock in November with an equal weight rating.

That’s a 33% upside from here. Maybe not enough to win the Best Stocks for 2012 contest, but certainly returns any investor would be happy with.

Full disclosure: In the spirit of taking my own advice, I purchased 540 shares of AA stock at $8.95 on Dec. 14. I hope that adds a bit of realism to my commentary on the stock across 2012!

Jeff Reeves is the editor of Write him at, follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. Jeff Reeves holds a position in Alcoa, but no other publicly traded stocks.

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