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Alcoa Inc. (Alcoa) is engaged in the production and management of primary aluminum, fabricated aluminum, and alumina combined. The Company’s products are used worldwide in aircraft, automobiles, commercial transportation, packaging, building and construction, oil and gas, defense, and industrial applications.

Alcoa is a global company operating in 31 countries. It has investments and operating activities in Australia, Brazil, China, Iceland, Guinea, Russia, and the Kingdom of Saudi Arabia. Alcoa’s operations consist of four worldwide segments: Alumina, Primary Metals, Flat-Rolled Products, and Engineered Products and Solutions. In June 2009, Alcoa completed the divestiture of the wire harness and electrical portion of the EES business to Platinum Equity effective June 1, 2009. In December 2009, the company completed the divestiture of the electronics portion of the EES business to Flextronics Inc. (NASDAQ:FLEX).

At a glance:

  • Monday's Closing Price 12.10

  • 52 Week High 17.60

  • 52 Week Low 8.70

Investment case

Does AA make for an intelligent investment or intelligent speculation today? Starting with a base estimate of annual Free Cash Flow at a value of approximately $500,000,000 and the number of shares outstanding at 974,000,000 shares; we used an assumed FCF annual growth of 7 percent for the first 10 years and assume zero growth from years 11 to 15. Review the Free Cash Flow record here.

The resulting estimated intrinsic value per share (discounted back to the present) is approximately $8.02.

  • Market Price = $12.1

  • Intrinsic Value = $8.02 (estimated)

  • Debt/Equity ratio = .77

  • Price To Value (P/V) ratio = 1.51

Before we make a purchase, we must decide ( filter #1 ) if AA is a high quality business with good economics. Does AA have ( filter #2 ) enduring competitive advantages, and does AA have ( filter #3 ) honest and able management. It 's current return on capital is -2.11. Using a debt to equity ratio of .77, AA shows a 5-year average return on equity = 8.1

Some industries have higher ROE because they require no assets, such as consulting firms. Other industries require large infrastructure builds before they generate a penny of profit, such as oil refiners. Generally, capital-intensive businesses have higher barriers to entry, which limit competition. But, high-ROE firms with small asset bases have lower barriers to entry. Thus, such firms face more business risk because competitors can replicate their success without having to obtain much outside funding.

Growth benefits investors only when the business in point can invest at incremental returns that are enticing. Only when each dollar used to finance the growth creates over a dollar of long-term market value. In the case of a low-return business requiring incremental funds, growth hurts the investor. The greatest companies sustain a competitive advantage, produce free cash flow, and use debt wisely.

Does AA make for an intelligent investment or speculation today? Time is said to be the friend of the wonderful company and the enemy of the mediocre one. Before making an investment decision, seek understanding about the company, its products, and its sustainable competitive advantages over competitors. Next, look for able and trustworthy managers who are focused more on value than just growth. Finally ask: Is there a bargain relative to its intrinsic value per share today?

Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misapraised. In terms of Opportunity Cost, is AA the best place to invest our money today?

How will AA compete going forward? Keep in mind that a financial report like this is a reflection of the past and present. It may be used to project a future, but it may not account for factors yet unseen. Therefore, pay attention to competitive and market factors that may affect changes in profitability.

In summary, using a debt to equity ratio of .77, AA shows a 5-year average return on equity = 8.1 . Based on a holding and compounding period of 10 years, and a relative FCF growth of 7 percent, then the estimated effective annual yield on this investment may be greater than 3 %. Going forward, are there any tranformational catalysts or condition indicators imaginable on the horizon?

Disclosure: No positions

Source: Is Alcoa a Value Investment?