Alcoa: Dead Money Personified

Alcoa (AA) is the world's third largest producer of aluminum and the leading producer of alumina, a white granular material that is chemically defined as aluminum oxide. The Pittsburgh corporation's refinery operation in Western Australia is capable of supplying 15% of international demand. The company manufactures thousands of finished products for the aerospace, automotive, defense, and housing industry. This is a cyclical stock; tied to the boom and bust nature of the global economy and commodities markets.

Despite a commodity boom that was to drive oil to $147 / barrel, propel gold towards $1,000, and deliver aluminum at a July record of $3,380.15 per metric ton on the London Metals Exchange, this stock has returned nothing over the past decade. Shares have actually underperformed the Standard and Poors 500, an index being ravaged by today's credit debacle. Long term, I expect this underperformance to continue. This stock is dead money and is to be avoided.

First, the commodities boom is finished. Although aluminum prices have not enjoyed the spectacular rise of petroleum, gold, and agricultural products - aluminum has already peaked, nonetheless. Prices spiked in July - courtesy of a weak dollar and irrational exuberance pertaining to Asian demand. In Q2, ending June 30th, Alcoa was garnering $3,058 average price per ton of aluminum sold. Going forward, matching this figure will be an impossibility; and $3,000 / ton will be the high water mark for Alcoa.

In spite of these record prices last quarter, Alcoa Q2 income fell from $715 million in 2007 to $546 million in 2008. Cash provided from continuing operations eerily plunged from $1.6 billion over the six month period ending on June 30, 2007 to $719 million in 2008. These statistics are troubling when we consider the fact that aluminum prices actually spiked during the period; and a $46 million cash flow gain is the result of currency changes directly associated with a battered dollar. These gains will be eliminated with continued dollar strength.

This quarter, aluminum has been marked down towards $2,500 on the LME. I am pegging fundamental value of the contract at $1,800. Commodity prices across the board will continue to revert towards the mean, due to the recent global slowdown and renewed dollar strength which is less an indication of U.S. power, than it is a flight to safety. Remember, metals required 25 years simply to match the upward march of inflation and aggregate price levels. It may be another 25 years yet, before the next boom is felt.

The China story must also be put to rest. The Asian export economy will languish as its top customer, the United States, remains shackled underneath a credit crunch of its own. Chinese officials have already confirmed the inevitable - shutting down 350,000 metric tons of aluminum production this year in an effort to support prices.

The trials of the housing and automotive sector, top end users of Alcoa products have been well documented. The housing bust, plagued with oversupply, tight credit, and a stalled economy is catharsis defined. Detroit is on the brink - lobbying the corridors of Washington, hat-in-hand, for bailout money.

Alcoa investors may only bide time with a paltry 3% dividend, and hope for a buyout. The share buyback program is effectively a ruse, merely countering the dilutive additional stock that has already been issued and authorized to compensate top executives.

Alcoa is carrying a lowly market cap of $17 billion, and may be an attractive pawn in the BHP Biliton (BHP) - Rio Tinto (RTP) chess match. Alcoa has been 'in play' for years, attempting to purchase Alcan for $27 billion in order to stave off a hostile takeover. AA was stood up at the altar, thwarted by Rio Tinto's $38 billion 2007 bid. The deal established Rio Tinto Alcan as the world's top producer of aluminum and was a sharp blow to AA's prospects as a standalone company.

I fashion any buyout to be unlikely in the near term with the credit markets reeling. Shareholders will clamor for a valuation north of $25 billion, and in these present conditions, we shall witness swine launch themselves into the heavens before any execution of a $25 billion leveraged buyout. Likewise, BHP and Rio Tinto shares have been decimated from summer 08 highs, devaluing stock currency that could have been offered to finance a deal.

There is no reason to own a stock that has been unable to exploit a once-in-a-generation commodities boom, presently stares into the abyss of a bust, and is an unlikely takeover target.

Comments

[apppro:]

You may be right on the result, but you're way off on the why's. Just look at this chart comparing AA with other large commodity companies:
finance.yahoo.com/echa...?
s=AA#chart6:symbol=aa;...

Look famaliar - they should. All ran up a little too much, but are now ALL being destroyed by gangshorting. Put these stocks on the no short list and they'll stop the short conspired sell off also.

First the monolines>then the big-money banks>then the brokerage houses>now the commodity comanpies> WHO'S NEXT.

www.youtube.com/watch?...

2008 Oct 02 07:10 AM

[apppro:]

Correct chart link (I hope):

finance.yahoo.com/echa...;range=3m;compare=pot+...

2008 Oct 02 07:11 AM

[apppro:]

finance.yahoo.com/echa...;range=3m;compare=mos+...

2008 Oct 02 07:13 AM

[Gumby:]

Are you also meaning that Rio Tinto was a sucker for buying Alcan for $$38 billion? Alcan was half Alcoa size... Cars will no longer be made mostly of steel as you should very well know... Steel is too heavy for cars... We are already hard at work figuring out how to put more aluminium into cars, buses, etc.. besides plastic and composities... Only 350 pounds of aluminium goes in every car... Why isnt PickUps made of aluminum yet?? This would boost gas mileage?? Gasoline prices shot to $4.50 a gallon only recently... It will be a matter of time before we figure out how to put more aluminium in all cars...Our economy went south primarly because of oil prices not foreclosed properties and failed banks.. It was always the OIL OIL OIL OIL OIL PRICES THAT KEEP COMING BACK TO SCREW UP OUR ECONOMY.. It is nobrainer for me to be convinced that Americans is finally fed up with Big Oil!! By the way.,,,, ALCOA is at all times lows, and you are so eager to tell us to avoid ALCOA stock, DUH DUHDUH EH EH DUH EDEEDUHH!

2008 Oct 02 01:17 PM

[Ryan Barnes:]

Kofi, do you read the earnings reports? Study input costs? The spot price of aluminum has barely kept pace with the majority of their input costs. You mention all the "booming" and "propelling" yourself. Just because commodity prices have been universally rising doesn't imply a "once-in-a-generation" opportunity. It's not Hungry Hungry Hippo, where all the marbles must be scooped up before it's too late...It's a global market economy

Alcoa is trading at decade lows in terms of valuation. They earned a profit during the last recession, which is better than many S&P members, and they outperformed the S&P 500 at the same time. If this stock is dead money, than I'll invest with my dying dollars

2008 Oct 02 01:19 PM

[Gumby:]

We are shrinking our cars to save weight and fuel to a point where it is getting so ridiculous!! Putting more aluminium into those shrinking cars will stop the shrinking and reverse the process without any sacrifices in fuel economy.. Remember there is still so many of us that are Big & Tall Men and Women who are in search of small cars that will be comfortable to drive... Aluminium is and will be the answer ! We will have safer small cars that will be bigger than what we have got now.. hell, those small cars are just plain silly!

2008 Oct 02 01:26 PM

[Gumby:]

We will not return to SUVs and Pickups so Big & Tall Men and Women can drive them again... Unless they are made of much more aluminium! Steel is dead! Long Live Aluminium!

2008 Oct 02 01:28 PM

[Gumby:]

We are producing over one billion tons of steel while only 40 million tons of aluminium annually... Steel will have to give a lot ! Aluminium has nowhere to go but UP!

2008 Oct 02 01:29 PM

[Gumby:]

We are already replacing glass beer bottles with aluminium bottles.. yeah yeah! no more broken glass on the pavement, sidewalks and trails!!! Hooray!!! This will encourage more bicyclsts who are sick and tired of flat tires from running over broken glass everywhere. We will save more energy as more of will be more enthusiastic about riding aluminium bicycles.. See ? We are talking about synergy!! ALUMINIUM ALL THE WAY!

2008 Oct 02 01:31 PM

[Gumby:]

America consumes 25% of the world daily output of energy!!! We dont know what to do !!! You are thumbing your nose at ALCOA! Ohhhh! we dont know what to do ?? With idiots like you!!

2008 Oct 02 01:33 PM

[Urbane Gori...:]

Have you noticed that you can't past a link into SeekingAlpha??!!??

jegan

2008 Oct 02 01:40 PM

[Kofi Bofah:]

I cannot think of another era in which commodity prices have sustained such a rally. No, aluminum prices have not kept pace with the basket; but they have risen, nonetheless.

Ryan Barnes: Why buy AA? Are you buying it based on commodity strength / dividends / as a takeover play? Do you believe that aluminum prices are set to spike?

I personally believe the upside cycle in commodities is long dead. But if I were bullish on commodities, I would look at Big Oil or an E&P play. Rails even, would be another alternative. If I were bullish on metals, I would look at BHP.

In terms of valuation, the P-E will spike when the 'E' denominator plunges. Counterintuitively, cyclical and material stocks often trade at low pe's near the peak.

2008 Oct 02 06:42 PM

[svosavvy:]

I find your argument compelling, however, a lack of disclosure is disconcerting. Possibly you thought it was implied through the obvious negative connotation of the article.
I have found this article highly informative. I consider all that is mentioned with much weight. Except the actual price of a share currently is noticeably missing. At its current level I find this share price in the depressed level and a screaming buy in my book. The last time it was this cheap was 2003 when they earned significantly less than what they will earn this year despite all the crisis hullabaloo.
As far as cars go they will have more plastic in the future than anything. I look for the "drive by" media to again start talking about the growth stories in india and china after our "crisis" is resolved. Billions of consumers will make all ships rise. IMO Plastic is a more proper foe than steel in its core demand sectors.

2008 Oct 02 11:04 PM

[svosavvy:]

Very recently long aa, on valuation grounds.

2008 Oct 02 11:04 PM

[Kofi Bofah:]

I have never bought, sold short, or held any options on Alcoa. Honestly, I am evaluating the Dow 30 stocks; and Alcoa happens to be the first.

I have held BHP Biliton before, but liquidated this past summer.

I believe that cyclical stocks can be deceptive on the grounds of valuation. The 'E' denominator can get whacked quickly in a downturn and the P/E will rise accordingly. Hence, valuations often appear cheap - just as the cycle is peaking.

2008 Oct 03 03:49 PM

[greyma:]

If you are in wind then RIO is unlikely to play and we can not expect much action, certainly the Company is badly managed and the last resort is some hedge fund.

2008 Oct 03 08:20 PM