That Tricky Alcoa

 | Apr 09, 2012 | 7:30 AM EDT
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On Tuesday, Alcoa (AA) -- traditionally the first company to report -- is set to kick off earnings season. But, in recent years, it's been such an inconsistent performer that I've been thinking we should have another company take this role -- maybe one that can report a really strong quarter, just to keep our spirits up during. But, since I can't change the reporting schedule, I thought I would take a look at this name, one of the largest aluminum producers on Earth.

In 2011, Alcoa produced 3.78 million metric tons of aluminum, up 5.3% from the year-earlier period and 16.5 million metric tons of alumina, up 3.7% from 2010. (Alumina is used to make aluminum.) According to Alcoa, the size of world market is some 24.3 million metric tons, and Alcoa accounts for almost 15% of the world's production. The demand for aluminum has grown steadily. From 2001 to 2010, global consumption of aluminum has risen at a compounded annualized growth rate of 6%. The main drivers of demand are airplanes, aluminum trailers for transportation, containers/packaging and construction (think aluminum studs). Together, these drivers comprise about 62% of aluminum demand.

While demand has been steadily rising over the last decade, Alcoa has three major problems. First, the company's earnings are highly correlated with the global economy, and especially the American economy. If the economy sinks, Alcoa goes with it. Second, over the last decade China has become a net exporter of aluminum. By aggressively taking market share worldwide, China has displaced Alcoa in many markets.

The third problem is that there are a lot of moving parts to Alcoa's financials -- currency, volume, demand, price, product mix, energy, raw materials and labor costs. It's very difficult to get all those factors moving in the right direction. Last year, for example, productivity added $632 million to Alcoa's net income. However, higher energy costs of $182 million, higher raw materials costs of $373 million and general cost increases of $496 million all but wiped out the additional productivity the company managed to squeeze out. It's like that every quarter: One step forward, 10 steps back.

Last year, sales rose 19%, but this year the number is forecast to decline 2.2%. Lingering oversupply will make the first half of 2012 difficult. (In January, the company announced plans to shut down 12% of its high cost smelting capacity.)

Will the second half of the year be better? Stay tuned. To be an investor in Alcoa you have to believe the company's long-term efforts to reduce expenses, move to lower cost production methods and higher worldwide demand for aluminum will eventually pay off in 2013 and beyond.

For fiscal 2012, the Street is looking for an operating profit of $1.534 billion, which would be down 13.8% from the $1.779 billion figure from 2011. For 2013, the Street is estimating operating profit of $1.879 billion on revenue of $26.4 billion. If those 2013 estimates come to fruition, the stock could trade as high as $13 a share. If not, investors will be stuck with more disappointment. Investing in highly cyclical stocks like Alcoa is not as easy as it used to be.


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