Alcoa (NYSE:AA) was down 5.5% as of Friday's close for reasons that The Street has tried to explain. Although The Street admits that there are a few positive items for an investor's consideration, overall the picture released by Alcoa on January 9, 2014 was rather dismal. Zacks continues to rate Alcoa as a hold, but listing a number of negatives such as the negative $2.19 EPS number which probably more then anything has been the cause of this stock dropping recently. It would appear that the general opinion here at Seeking Alpha is positive, with the majority believing that the market has over-reacted to the information recently reported by Alcoa.
There was a rating group that increased their price target after the earnings release, which might indicate that some positives are contained in the report. Deutsche Bank upgraded their target price for the stock on Friday from $5.50 to $7.50. They still have it marked as a sell as they believe the price should come down to $7.50 (at $7.50 the P/E would be roughly a bit over 20). While I do not believe this is the correct valuation of Alcoa, I do believe that it shows us that the earnings report contained some positives that we can capitalize on, especially if the price continues to go down for a little while longer.
As stated above, the reason that Alcoa is down at the moment is clear (negative EPS for the quarter). However, the reasons for being positive are also buried within the report that Alcoa released.
1. Path Towards a Strategy of Differentiation:
Alcoa has moved to strengthen their position with respect to the revenue they derive from their value added activity. From their recent press release:
Engineered Products and Solutions
ATOI was a fourth quarter record of $168 million, down $24 million sequentially and up $28 million, or 20 percent, year-over-year. Sequentially, seasonal cost increases and unfavorable volume and price/mix were somewhat offset by continued productivity improvements. Days working capital improved by 3 days to a new record low.
Once again, as I mentioned in my previous writing on Alcoa, Ford is about to release the new version of their F-150 which was talked about once again on Friday, in the Wall Street Journal. The release of the new F-150 would result in a significant expansion of Alcoa's 'value-added' segment. The amount of revenue derived from their engineered products activity is rather low compared to their main aluminum operation. It currently stands at roughly 25%, however if Alcoa builds this area of their business in the future then it will help smooth out the cyclical difficulties present for any mining company.
I have put together the following chart to show 2013 Revenue by Sector for Alcoa based on their recently released statements:
As you can see, both the Global Rolled Products and the Engineered Products categories represent some 'value-added' activity, and these both represent a fair amount of the companies revenue. The category with the highest profit margin however, is in the area of Engineered products, and fortunately this has expanded slightly during the last quarter.
2. Cash Flows:
Cash Flows might have decreased during the course of the year, however this is mostly the result of payments on maturing notes contained within their Financing Activity. Alcoa's Operating Activity Cash Flows actually increased due to the add-back of both depreciation/amortization and the one-time cost of goodwill impairment.
This is a positive, as the negative Earnings Per Share has not decreased their Cash Flows From operations. This is mostly due to the Add-Back of impaired Goodwill, which is mostly the issue when considering the historically rather large loss for EPS that occurred during this last quarter.
3. Earnings Per Share:
And that brings me to Earnings Per Share. This is not really much of a positive as it comes in at a negative $2.19 per share. This is a considerable decrease over previous quarters. However most of this is due to a 1.7 Billion dollar write-off due to impaired goodwill. There were also several other "one-time" costs written off in the last quarter of 2013 which reflect the resolution of the Alba issue (two court cases with the DOJ and SEC that were settled). If all of these items are taken out of EPS we would find that there is actually a small profit of $0.04 per share for the quarter. This would show a positive increase year over year for Alcoa. I look at this as a good thing as the negative EPS of $2.19 is not due to the regular course of business.
I think that in full disclosure, we should readily admit that Alcoa is always facing special item adjustments for the EPS. And, in the efforts of assisting you with evaluating AA, I am providing the last 2 years (plus the last quarter of 2011) for comparison purposes.
|Quarter of Results:||As Reported:||If Special Items are Excluded:|
4. Alba Issue:
You have already heard me discuss this briefly and I think that another Seeking Alpha contributor has done a nice job explaining the positives attributable to the settlement of this issue for Alcoa.
There were two parts to the Alba Resolution:
Earlier today [January 9, 2014], Alcoa announced the resolution of the investigations by the U.S. Department of Justice (DOJ) and the U.S. Securities and Exchange Commission (SEC) regarding certain legacy alumina contracts with Aluminum Bahrain B.S.C. (Alba).
And then there were the subsequent costs associated with this settlement and resolution:
As part of the DOJ resolution, AWA will pay a total of $223 million, including a fine of $209 million payable in five equal installments over four years.
And more costs:
Under the terms of the settlement with the SEC, Alcoa Inc. agreed to a settlement amount of $175 million, but will be given credit for the $14 million one-time forfeiture payment, which is part of the DOJ resolution, resulting in a total cash payment to the SEC of $161 million payable in five equal installments over four years.
These costs are non-operating costs and not indicative of the overall company's financial health. I look at this resolution as a positive because the resolution of any case involving the DOJ and SEC is a positive.
Alcoa was bound to drop after the earnings statement was released on Thursday of last week. However if one is patient and waits a little bit, I think one can purchase Alcoa for a bargain. On the surface the report seems more negative then it actually is, and at the moment this appears to be what the market is responding to. As Alcoa continues to dip, I think a strong purchasing decision can be made.