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By Ahmed Ishtiaq

Alcoa Inc (NYSE:AA) is the heavyweight in the arena of aluminum. The company is among the world's top producers of alumina (aluminum's principal ingredient from bauxite) and aluminum. The firm's operations include bauxite mining, alumina refining, and aluminum smelting. Alcoa's primary products include alumina and alumina-based chemicals, automotive components, and sheet aluminum for beverage cans. The company caters to markets such as aerospace, automotive, and construction industries. Non-aluminum products include precision castings and aerospace and industrial fasteners. Although a global company, Alcoa does about half of its business in the U.S.; Australia, Brazil, and European countries make up its largest international markets.

The company recently announced its earnings and gave a positive outlook for 2013. Alcoa reported better than expected results, which were welcomed by the market. In our series of quick picks, we recommended Alcoa as a long-term investment. We expect the company to have a great 2013 as we see aluminum demand recovering. The company has now given the outlook in-line with our expectations for the coming year. Let's take a look at the earnings report and how the company is expected to perform in 2013.

Earnings Announcement

Alcoa reported revenues of $5.9 billion, up 1% from the previous quarter. However, revenues were down 2% compared to the fourth quarter revenues of 2011. Furthermore, income from continuing operations was $242 million, or $0.21 per share. Income from continuing operations was $64 million, or $0.06 per share excluding special items. Special items contributed $178 million for the quarter and mainly consisted of Tapoco Hydroelectric Project asset sale, which resulted in a $161 million after-tax gain. Full year income from continuing operations was $191 million, or $0.18 with special items. Income from continuing operations excluding special items was $262 million or $0.24 for the year.

Moreover, the company ended the quarter with a strong cash position. Alcoa generated cash flows from operations of $933 million for the quarter, $670 million more than the previous quarter. Free cash flows for the company stood at $535 million. The company met all of its cash sustainability targets for the fourth consecutive year. Alcoa also improved its productivity and overhead expenses. As a result, the company delivered $1.3 billion in productivity and overhead improvements. At the end of the quarter, the company had $1.9 billion in cash, which puts it in an extremely strong liquidity position.

At the moment, the debt-to-capital ratio of the company stands at 35%. Alcoa has $8.8 billion in debt, however, net debt of the company stands at $7 billion. Net debt in the amount of $7 billion is the lowest since 2006. Furthermore, the company has taken 531,000 metric tons smelting capacity offline to improve its competitive position.

Future Outlook

Aluminum demand is recovering at the moment, and the company expects demand to grow at a 7% rate during 2013. Recovering global economy will drive aluminum demand higher, and Alcoa is well positioned to exploit this increase in demand. The company has a competitive advantage over its competitors. Due to integrated operations, Alcoa is able to achieve synergies and reduce its costs. Furthermore, its operations give it control over the supply and enable the company to manage its output better. The company does everything from the mining, refining, smelting, and recycling of aluminum. Due to control on different levels of supply chain, the company is able to achieve better synergies. Alcoa expects 9%-10% growth in Aerospace, 1%-4% in automotive and 4%-5% in building and construction. Increased demand will help the company improve earnings and cash flows over the next year. There is substantial growth potential for Alcoa.

Comparison with Peers

Alcoa peers include Aluminum Corporation of China Limited (NYSE:ACH) and Century Aluminum Company (NASDAQ:CENX). Below table lists important metrics for comparison.

AA

ACH

CENX

Forward P/E

7.4

N/A

N/A

P/B

0.7

0.9

0.8

P/S

0.4

0.3

0.4

EPS Growth

26.80%

345.20%

N/A

Operating Margin

0.60%

-3.20%

-2.90%

Net Margin

-1.00%

-3.40%

-4.70%

ROE TTM

-1.70%

-10.10%

-5.60%

Debt to Equity

0.60

0.80

0.30

Source: Morningstar

Alcoa is trading at attractive valuation at the moment. The stock provides substantial upside potential on its current valuation. Margins clearly show the overall condition of the industry. All the companies in the industry are operating at negative margins due to low aluminum prices. However, this can change in 2013 due to recovering prices.

Summary

Alcoa is currently trading at attractive multiples. Furthermore, the company is in a great financial position. Global demand for aluminum is increasing, which will provide Alcoa an opportunity to grow. Due to its status as one of the biggest operators in the market, Alcoa will exploit the growth opportunities in the market. I expect Alcoa to have a better year than 2012, and the stock price should move upwards.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: EfsInvestment is a team of analysts. This article was written by Ahmed Ishtiaq, one of our equity researchers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.

Source: Alcoa Will Prove To Be An Astute Investment Now