Alcoa Posts Encouraging Results

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

On Monday, Alcoa (NYSE:AA) announced its quarterly results to kick-off the earnings season in the after-hours. The company reported a profit of 11 cents per share, which beat the 9 cents per share predicted by the analysts. Alcoa generated $5.80 billion in revenues, which was slightly lower than the $5.97 expected by the analysts. The results were pretty mixed.

Demand for Aluminum

As the automobile and plane industries are improving, the demand for aluminum increases, which drives the aluminum prices higher. For the remainder of the year, Alcoa expects aluminum demand to increase by another 7%. Because Alcoa sells materials to a wide range of industries and it is the first large company to report earnings for the quarter, investors usually pay close attention to the company's earnings report. Alcoa's earnings report can tell us how some industries (e.g., car, plane and canned goods) are performing as well as give us hints about the overall shape of the economy.

A Wild Ride of Roller Coaster

Alcoa's investors suffered so much during the recession of 2008/09 as the company's market cap fell sharply from $47 billion to $5.58 billion. Since then, while many other companies saw their share price recover nicely, Alcoa didn't see much of a recovery. By the end of 2009, Alcoa's market value was nearing $18 billion; however, it fell down to $10 billion in 2011 when the markets saw a correction due to the fears regarding the European economy. Currently, Alcoa's market value is around $9 billion. Considering that Alcoa's annual revenues have fluctuated between $20 billion and $25 billion in the last three years, the company could possibly see a lot of upside if it were to improve its margins significantly.

Encouraging Developments

Alcoa's last quarter represents a lot of positives for the company. For example, in the last quarter, all of Alcoa's business segments were profitable and none of the business units reported a loss. Excluding one-time items, the company posted its best earnings results since 2011. Furthermore, Alcoa's downstream profitability was at all-time high, which is encouraging for the future. Moreover, the company ended the quarter with $1.6 billion of cash, which can serve as a cushion in case the company's turnaround takes a longer time. This also ensures that Alcoa's dividend payments will be sustainable for the foreseeable future even though the relatively low yield of 1.43% might not excite many investors to begin with.

The cost of goods sold as a percentage of revenue continued to fall for the company. Last year in the same quarter, the figure was at 84.9%, whereas it was 84.2% in the last quarter, and it fell to 83.1% in this quarter. As the company continues to do a better job of managing its costs, the margins will improve and the upside potential will be maximized for the investors of the company. In the last quarter, Alcoa's effective tax rate fell from 35.8% to 27.4%, which contributed to the improvement of the company's margins. It is very difficult to predict a company's future effective tax rate; however, it is likely to stay under 30% as long as Alcoa's earnings don't suddenly surge more than expected. If that happened, the tax rate would be a little higher, but I doubt any investors would complain about the effective tax rate if the company is able to improve its earnings drastically.

Guidance by Business Segment

The "Engineered Products and Solutions" segment of Alcoa will benefit from a strong aerospace market and improving U.S. construction market, particularly in the non-residential area while it may be held back by the slowing construction activities in Europe and parts of Asia. The "Global Rolled Products" will benefit from the strong demand for cars, planes and aluminum packaging across the world while it will have to deal with pricing pressures due to competition and a slowing economy in certain parts of the world. In the "Alumina" segment, the company will deal with increased mining costs as it ramps up its production rate. In the "Primary Metals" segment, the pricing remains unpredictable and energy costs usually outweigh the productivity gains made by the company. This segment will be somewhat challenging for Alcoa, even though it will continue to be profitable.

How About the Balance Sheet?

In the quarter, Alcoa's debt increased slightly from $6.96 billion to $7.37 billion; however, debt to capital ratio fell from 34.8% to 34.7% because the company was able to accumulate cash in the quarter. This is a much better percentage than the 42.5% obtained by Alcoa in 2008. For the rest of the year, Alcoa expects to keep its debt-to-capital ratio between 30% and 35% while maintaining positive cash flow. As long as the global economy doesn't enter a major recession or anything, this target is pretty obtainable.

What Do the Analysts Think?

The analysts expect Alcoa to earn 59 cents this year, 88 cents in 2014, 95 cents in 2015 and $1.05 in 2016; however keep in mind that the range of predictions is pretty wide. At the end of the day, all analysts covering the stock expect the company to remain profitable for the next few years, which should be very beneficial for the investors. The average analyst target price for Alcoa is $10, which again comes with a wide range between $6 and $13 (the current price is $8.40 as of the time of writing this article).

In conclusion, Alcoa's earnings report was encouraging for the investors of Alcoa as well as investors in the industries where Alcoa sells materials, particularly the automobile and aerospace industries. I would suggest giving Alcoa a try if you have a long-term horizon and a lot of patience.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AA over 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.