Alcoa - Wait For Green Shoots Before Considering A Long Position

Apr. 9.13 | About: Alcoa, Inc. (AA)

Shares of Alcoa (NYSE:AA) are trading unchanged in Tuesday's trading session. The aluminum producer reported a mixed bag of first quarter results for 2013 after the close of the regular trading session on Monday.

First Quarter Results

Alcoa generated first quarter revenues of $5.83 billion, down 3% on the year before, and down 1% compared to the fourth quarter of 2012.

Revenues were down as aluminum prices fell back on lower metals production in Europe. Yet, Alcoa continues to project a 7% increase in global aluminum demand for 2013, driven by a strong demand from the aerospace industry. Yet, revenues fell short of consensus estimates of $5.88 billion.

Profitability increased compared to last year as cost of goods sold fell 180 basis points compared to the same period last year, partially offset by a 30 basis point increase in selling, general and administrative expenses. The company aims to find further efficiencies in its cost structure, to boost its operating margins.

Net income came in at $149 million, or $0.13 per diluted share. This compares to last year's earnings of $94 million, or $0.09 per share. Note that earnings excluding a $28 million one-time benefit, came in at $0.11 per share.

Comparable earnings comfortably beat consensus estimates of $0.08 per share.

CEO and Chairman Klaus Kleinfeld commented on the results, "This was a strong quarter led by record profitability in our downstream business, improved results in our midstream business and remarkable upstream performance in the face of weak metal prices."

Valuation

Alcoa ended its first quarter with $1.55 billion in cash and equivalents. The company operates with $8.8 billion in short and long term debt, for a sizable net debt position.

For the full year of 2012, Alcoa generated annual revenues of $23.7 billion. Net income attributable to shareholders came in at just $189 million, or $0.18 per diluted share. While revenues will be stagnant, earnings could improve into 2013.

The market currently values Alcoa around $8.9 billion. This values the firm at roughly 0.4 times annual revenues and 47 times last year's annual earnings.

Alcoa pays a quarterly dividend of $0.03 per share, for an annual dividend yield of 1.4%.

Some Historical Perspective

Shares of Alcoa have notoriously underperformed over the long term, as the company essentially failed to differentiate its products from its main competitors, thereby having little pricing power.

Shares peaked at $50 back in 2007 and fell all the way to $5 in 2009. They did manage to bounce back to $18 in 2011. From that point in time, shares have lost half their value again as the company failed to benefit from the global economic recovery.

Over the past four years, Alcoa increased annual revenues by nearly 30% from $18.4 billion in 2009, to $23.7 billion over the past year. After reporting a billion dollar loss in 2009, the company did manage to become profitable again in the years following.

Change In Strategic Focus

Shareholders in Alcoa getting tired of the waiting for a better day. The change in the company's strategic focus has been good, and should be applauded. Alcoa wants to focus on the downstream business, which has higher and more stable margins. Furthermore the company holds nice market positions in key long term growth markets, including the car and aerospace markets.

This strategic plan is accompanied by an aggressive target of $750 million in productivity gains. At the same time, the company's earnings remains closely tied to aluminum prices. Alcoa estimates that a $100 price drop in aluminum per ton costs the company up to $240 million per year.

With a recent decline in aluminum prices to just $1,900 per ton, a tougher second and third quarter ahead is to be expected. The company expects a stabilization of aluminum prices, as Alcoa saw its surplus projection for the global aluminum market fall. The company saw a surplus of just 155,000 metric tons over the past quarter, compared to 535,000 metric tons just three months ago.

Investment Thesis

Yet Alcoa is making some progress in tackling its large debt position, although the pace of debt reduction has not been that high, and has been driven by a reduction in "days working capital", rather than reporting decent operating profits.

At these historically low levels, shares act as a call option given the strong operating leverage and the high degree of balance sheet leverage. Yet one has to wonder how much upside there is, as management called the past quarter "a strong quarter". Furthermore it is worrying that Alcoa achieves sub-optimal profitability given the still decent shape of the world economy.

How much better can it get before Alcoa will significantly increase its earnings?

The lack of a structural higher, and less volatile earnings and cash flows, make me hesitant to invest. While I realize the potential and applaud the strategy and cost saving measures which management has taken, I don't give them too much credibility given the historical performance.

I will wait for some green shoots, thereby missing the first stage of the rally, before considering a long position.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.