Aluminum Kingdom: Economic Growth Spurs Demand

Nihar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Aluminum is not exactly science-fiction style gray goo, but for investors it is interesting. Being one of the most commonly used metals means that as our lackluster global economy improves, demand should rise. The time to take a position was a few months ago, but there is still some more time since we are in a slow and sad recovery. The miner is a better choice than the metal itself, since aluminum is more of an industrial metal. Alcoa (NYSE: AA) just reported earnings. Alcoa also smelts and recycles the aluminum, so add one point for diversity.

Productivity Gains Will Continue at Alcoa Says Management... Repeatedly

The earnings call was interesting. There was a lot of positive spin on the next year, and 7% growth is okay, but considering the downturn during the last few years I would expect growth to accelerate. 7% is not bad, but when that goes to 10% for the year Alcoa should really heat up. The number is fairly arbitrary, but judging by the regional breakdown of growth covered in the earnings call it is conservative. North America was mentioned at 4% with Europe at -1%. China picks up the slack at 11%. When the global economy improves, China and similar countries should at least remain at the same levels, while North America and Europe increase a bit.

The real story from the earnings call was all the productivity gains and cost-cutting measures that the company is putting into play. The phrase "productivity gains will continue" or something to that effect is used numerous times in the earnings call though not the whole phrase every time. It was a bookend to any statements about charges and expenses that will be incurred in the future. Management wants investors to be aware that it is for the greater good. It is worth giving them the benefit of the doubt considering the cost-cutting measures already put in place. The company wants to generate free cash flow, and it is on a good path.

The share price could do better than $9, but with a long-term outlook on a growing global economy $9 seems like a nice price to get in on. Flatness might be a concern, but writing some LEAPs could be a solution. The 2014 calls for $12 get 0.20, though waiting for $0.25 might be better. This is after going long of course.

Earnings might be on their way to an uptrend, but it is too early to tell. Half a billion in free cash is a good sign, and the company has more than enough cash available on hand to pay any expenses. There really is not much else in the metrics worth mention. Alcoa is right on the line between good and bad. This seems better as an investment on global recovery from a company that is cost conscientious.

If you really just like the metal you can invest in iPath Dow Jones-AIG Aluminum Total Return Sub-Index ETN (NYSEMKT: JJU), though this is a position in aluminum via futures contracts. This would be an investment based on aluminum demand growth. Alcoa's expectations are useful for this guidance, but there is no option to cut costs to boost returns like a company has. Also, contracts involving aluminum do not allow for the diversity of refined or smelted products. Alcoa is expanding its smelting capacity while lowering costs so overall it is the preferable investment.

Rio Tinto Takes a Whack, but Real Fallout is Elusive

One of Alcoa's competitors, Rio Tinto (NYSE: RIO), just recently announced that its CEO was stepping down now that the company expects a $14B writedown. Apparently the market just didn't care. I am sure the market will care when the earnings reports come out. When HP announced its $8B writedown the stock went up, but the subsequent months were not so kind for various reasons. It could be that Rio Tinto's issue is a one-time thing and everything else about the company is amazing. The risk is probably too great though. You would not go long until a quarter or two after the massive writedown to see the effect, and to see if more trouble comes out of the woodwork. The news was expected and nothing will happen, but it's not worth betting on.

Rio Tinto is a lot bigger than Alcoa though, with more cash and less debt. The bad news might provide an entry if the share price does decline. There is no anticipating if the market will overreact or not so just watch for the fall out. For now, I prefer Alcoa. At least the recent slight earnings beat was followed by some insider buying. Insider buying is a welcome development if you want to go long. Nice to see management believing in the company they run.

Final Thoughts

There is a lot on Alcoa's issues and its recent history, and it is important to acknowledge that Alcoa is a stock on the mend. At least the hope is that it is on the mend. It is right at the line right now so only time will tell for certain. I prefer the turnaround over the huge company that just stubbed its toe. Either the market shrugs it off and the larger company trudges along with possibly acceptable returns, though nothing too exciting, or it declines and lets you enter in later. For now, Alcoa is priced nice and low and the picture is getting brighter not darker.


TheArchivist has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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