The forward-looking Valuentum Dividend Cushion is a ratio that gauges the safety of a dividend over time. Most dividend analysis that we’ve seen out there is backward-looking – meaning it rests on what the firm has done in the past. Although analyzing historical trends is important, we think assessing what may happen in the future is even more important. After all, investors are looking to the future, not using a rear-view mirror to pick the best dividend-growth stocks.
In the case of a company like Alcoa (AA), the forward-looking Valuentum Dividend Cushion and historical trend analysis come together to explain what we see happening with the dividend today. According to our dividend-growth methodology, a ratio below 1 for the Valuentum Dividend Cushion signals that the dividend may not be safe – that management may choose to cut its dividend or may not have the funds to continue paying or raising the dividend. As of December 2011, this ratio sits at 0 for Alcoa (yes, 0), indicating “very poor” dividend safety as well as “very poor” dividend growth potential. As such, we’re not tempted at all by Alcoa’s dividend, as we believe there are much better dividend risk/reward profiles out there. As such, you won't find us adding Alcoa to our Dividend Growth portfolio anytime soon.
Faced with this score of 0, what do you think Alcoa's management will attempt to do going forward? You guessed it: boost cash flow. And that's exactly what management is focusing on in 2012. The Valuentum Dividend Cushion helps to not only protect investors against dividend cuts, but also to anticipate management's actions (we make the Dividend Cushion score available for all firms in our coverage universe). Here's our earnings note on Alcoa that explains their uncomfortable cash-flow situation:
Similar to the third quarter, Alcoa kicked off fourth-quarter earnings season with a whimper. The aluminum giant posted a fourth-quarter loss on charges associated with cutting high-cost smelting capacity, lower aluminum prices, and general market weakness. We continue to be comfortable with our fair value estimate and do not expect to make any changes to it at this time. In the spirit of transparency, we make available our full 16-page report on Alcoa here.
Revenue fell 7% sequentially thanks to weakness in Europe and weak alumina and aluminum pricing, but increased 6% from the same period a year ago. Revenues in packaging, industrial products, and building and construction each fell at a mid-to high-teens pace on a sequential basis, with only the aerospace and industrial gas turbine markets revealing continued growth. On a year-over-year basis, aerospace, automotive, and commercial transportation markets all showed greater than a 20% increase in revenue. Alcoa’s loss from continuing operations came in at $0.18 per share for the period, which compares to earnings of $0.24 per share in last year’s quarter. Adjusted for restructuring charges, earnings per share was $0.03 per share during the quarter.
Cash from operations during the fourth quarter jumped sequentially thanks to record-low working capital days, while free cash flow came in at over $650 million (over 10% of sales) during the period. The free cash flow earned during the fourth quarter was notable, as the firm pulled in just over $900 million for the entire year (or about 3.6% of sales). The company ended the year with $1.9 billion in cash on hand, and we will continue to pay close attention to the aluminum giant’s financial health, particularly as the firm cuts back on system smelting capacity. Alcoa is targeting positive free cash flow in 2012, as it remains focused on maximizing cash during the year as opposed to capacity expansion.
Looking ahead to 2012, Alcoa is forecasting 7% growth in global aluminum demand and a global aluminum supply deficit, which may provide some support for aluminum pricing in the months ahead. Specifically, the company expects a global aluminum industry deficit of 600,000 metric tons in 2012, assuming market-related production cutbacks (namely in China) and demand growth forecasts are achieved. Alcoa, itself, will close or curtail 531,000 metric tons, or 12%, of its system smelting capacity.
Importantly, the 7% aluminum demand growth in 2012, while ahead of Alcoa’s long-term annual projections, is below the 10% expansion experienced in 2011 and the 13% growth seen in 2010. However, the firm projects global growth in its aerospace end market of 10%-11% and automotive end market of 3%-8% during the year, which reinforces our overweight exposure to aerospace suppliers Precision Castparts (PCP), Astronics (ATRO), and EDAC Tech (EDAC) and automaker Ford (F) in our Best Ideas portfolio. The decisions by Boeing (BA) and Airbus (OTCPK:EADSY) to stick with an all-aluminum narrowbody plane for their next-gen 737MAX and A320neo, respectively, bodes particularly well for the aluminum giant. Commercial transportation, packaging, and building construction end markets are expected to advance as much as 5%, 3%, and 5%, respectively.
Interestingly, like all other firms in our coverage universe (except Marriot, which subsequently raised it above pre-cut levels), the Valuentum Dividend Cushion would have predicted Alcoa's dividend cut in 2009. In that year, the aluminum producer slashed its quarterly dividend – from 17 cents per share to 3 cents per share – in order to preserve cash in the downturn. Reconstructing the ratio from historical data gives a result below 1 as well, signaling trouble on the horizon for the dividend and the company’s inability to cover their future dividend expense. We'd steer clear of Alcoa's shares.
Alcoa’s Comments on Aerospace:
"Aerospace for 2012, we believe the positive momentum is going to continue. We expect 10% to 11% growth, driven strongly by large commercial aircraft. We now have an increased confidence in the delivery rates because 2011 net orders came out to be 2,183 of our large commercial aircraft. That's obviously Boeing and Airbus together, which is the second highest in aviation history. The combined backlog of both firms now is 8.2 years. So I think there is good reason to be optimistic about that market."
Alcoa’s Comments on Automotive:
"Automotive, another pretty good story, with the exception of Western Europe. We expect on a global basis to have growth between 3% to 8% so let's look in some of the major regions. North America. It looked in the summer as though we would see a slowdown but then the fourth quarter came on strong with 13.4 million vehicles. We expect this momentum to continue into 2012 and driven very strongly by the average vehicle age. That's currently at 10.6 years whereas the 10-year average is 9.4 years, so we anticipated growth here between 5% to 10% in 2012."