Alcoa Continues To Be A Risky Play

Jan.10.14 | About: Alcoa, Inc. (AA)

In the after-hours of Thursday, Alcoa (NYSE:AA) kicked-off the earnings release season with its results for the fourth quarter as well as the full-year of 2013. There were several positives and negatives in the earnings, and the investors generally viewed the results as "worse than expected" as we saw a sell-off in the minutes following the announcement. For the fourth quarter of the year, Alcoa reported a loss of $2.19 per share or a net income of $0.04 per share after removing one-time items. The company's revenue for the quarter was $5.60 billion, which was slightly better than the analyst estimates of $5.43 billion. For the full-year, Alcoa generated $0.33 per share in net profits (excluding one-time items totaling $2.47 per share) on revenues of $23.0 billion.

In order to progress with its transition and move on from the legacy issues, Alcoa wrote down $1.7 billion in non-cash good will related to two separate acquisitions that were made more than 10 years ago. These write-downs were involved in aluminum-smelting operations. Furthermore, the company's discrete tax items totaled $361 million and legal costs totaled $243 million for the legacy matters. While these numbers are pretty large, Alcoa will be able to move on and look forward rather than worrying about the mistakes of the past. This is very important for the company's ongoing transition.

Compared to the same period of last year, the average realized aluminum price was down from $2,325 to $2,157, representing a drop of $168. This affected the company's revenues negatively as it fell from $5.90 billion to $5.60 billion. Despite demand being higher than the previous year, the average aluminum price was down by 7% which was explained by an increase in available supplies. In order to have more control over its supplies, Alcoa decided to reduce its production by about one sixth.

The company sees demand for aluminum rising by another 7% in 2014 after increasing about that much in 2013. The main drivers of this growth will continue to be the aerospace, car and construction industries worldwide. The industrial gas turbine market is expected to produce weaker demand for aluminum; however, this effect will not be large enough to offset the increases in the industries mentioned above. The price of aluminum, which is determined by supply-and-demand dynamics will continue to be uncertain for the foreseeable future but there is not that much Alcoa can do about this.

In the quarter, Alcoa was able to improve its balance sheet by generating free cash flow of $498 million. After paying $108 million in pension contributions, the company generated $920 million from operations. The company currently has $1.43 billion in total cash and $7.61 billion in long term debt, compared to $1.86 billion in cash and $8.31 billion in long term debt exactly a year ago. Unfortunately, the company's book value suffered as it fell from $16.52 billion to $13.51 billion between last year and this year. Of course, the large write-down by the company played a strong role in this reduction (even though the write-downs are non-cash events, they can still lead to a reduction in a company's total assets). Alcoa still has a lot of road to travel and a lot of work to do in terms of fixing its balance sheet, and the company has to be highly profitable in the long term to accomplish this goal.

In order to remain sustainably profitable, Alcoa is working towards reducing its operating costs. The company plans on reducing the cost of production for aluminum so that it is not so badly affected by the price decreases in the material. Compared to the past year, the role of value-add business in Alcoa's total revenues and profits have increased, as it now claims 57% of the company's total revenues and 80% of segment profits. The company needs to keep this trend going in order to remain competitive.

Alcoa announced that it would be willing to pay $384 million to settle a bribery case related to a joint venture it runs in Bahrain. Many investors were not very happy to hear this and the company's shares were already selling off during the regular trading hours before the earnings announcement was made. Alcoa currently owns 60% of the joint venture in Bahrain and it will have to pay the settlement in 5 installments.

For the time being, Alcoa is expected to generate about $23-24 billion in revenues and 40 to 50 cents per share in net income for the next year. Of course, in the coming days and weeks, some analysts will be changing their estimates in the light of today's announcement. As of the after-hours of Thursday, Alcoa's market cap is $10.94 billion, which gives us a price to forward revenue of 0.43 and a forward price to earnings ratio of 20-25. Alcoa will have to increase its margins greatly in order to justify its current price. Some of this will depend on aluminum prices and some will depend on the company's cost-reduction program. Alcoa still trades for a value below its book value; so, investors can still keep this company in their portfolio as a contrarian play. On the other hand, this is still a risky play due to low margins and volatility of aluminum prices. Investors should do extensive research and determine their short term and long term goals before investing in this stock.

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.