Caution Is Needed When Considering These Aluminum Stocks

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It’s no secret that aluminum stocks have been under pressure. The financial woes aluminum manufactures are experiencing stem from a global decline in aluminum prices.

Prices are on the decline largely due to China pretty much flooding the market with the metal, despite there being a considerable supply glut globally.

Dow component leader Alcoa (NYSE: AA) has been affected particularly hard. A spotlight was shined on its finances last week when Moody’s Investors Service downgraded its outstanding debt to junk status.

Other manufacturers in this space that are trying to weather the fallout of declining aluminum prices include Kaiser Aluminum (NASDAQ: KALU) and Century Aluminum (NASDAQ: CENX).

Focusing on things it can control

Alcoa is the industry leader when it comes to aluminum production. In fact, its dominance is one of the reasons it is a Dow component. Its earnings results kick off earnings seasons and have traditionally given investors an idea of what’s to come from other companies because so many of them rely on aluminum in the goods they produce.

When Alcoa released its first quarter earnings report for 2013, company executives acknowledged the pressures of declining aluminum prices. However, execs boasted of improved performance in aluminum products, despite lower prices.

Its chief executive, Klaus Kleinfeld, said the quarter was “strong” due to the record profits posted from its downstream business. Those businesses include production of goods used in the aerospace, automotive, building and construction, commercial transportation and power generation markets.

“Our mid and downstream businesses now account for 72% of our total after-tax operating income while our upstream business continues to move down the cost curve,” Kleinfeld said. “We achieved these results by focusing on the things we can control and by pressing Alcoa’s innovation edge, scale, and strength in end markets.”

Alcoa continues to project 7% global aluminum demand growth this year. This is up from the 6% it had projected for 2012. This optimism flies in the face of indications that point to the oversupply problem not easing in the short term. This gives me pause and makes me leery of the stock being a worthy investment at this point. Investors seem to share the same sentiment--so far this year, Alcoa’s share price is down roughly 2.1%.

A stronger buy

Another player in the aluminum space that may be a better buy than Alcoa is Century Aluminum (NASDAQ: CENX). So far this year, its stock is up 13.11%. Also, its total returns to investors is up almost 40% over the last year, which is higher than the S&P’s total return increase of 30.48%. That compares to Alcoa increase of just 3.83%.

One of the areas where you can see improvements in Century Aluminum is in its bottom line. For the first quarter, its earnings per share improved to $0.09 from -$0.05 during the first quarter of 2012. Its chief executive, Michael Bless, said that weakness in the Chinese economy and in the Eurozone challenged its earnings, but in the U.S., end markets were “generally strong.”

“Overall, we continue to expect medium and longer-term global trends to be favorable, and are thus executing our strategic plans,” Bless said.

Net income increased by a whopping 287.5% during the first quarter of 2013, compared to the first quarter of 2012. It was $8.25 million. Sales for the quarter were $321.3 million, compared to $326.2 million for the first quarter of 2012. Shipments of primary aluminum for the 2013 first quarter were slightly higher than they were during the first quarter of 2012.

As noted by Motley Fool blogger Masam Abbas, Century Aluminum has undertaken a number of projects to reduce costs and improve earnings. I agree with Abbas that while these projects are expected to benefit the company, they will likely fall short of supporting the current stock price.

All things happen for a reason

Several years ago, Kaiser Aluminum was dogged by several lawsuits, including some from people charging that its aluminum products contained asbestos, which has been linked to mesothelioma. It was also defending itself in a labor dispute, the mounting legal costs of which contributed to its filing for bankruptcy protection in 2002.

This turned out to be the best move, allowing the company to implement significant changes as part of its restructuring. The restructuring entailed the company's shedding its non-strategic bauxite and alumina operations as well as most of its primary aluminum holdings. Since emerging from bankruptcy proceedings, the company is more focused on developing the high-quality, fabricated aluminum products for major suppliers and manufacturers in the aerospace, general engineering, automotive, and custom industrial markets.

Considering Kaiser Aluminum focuses on producing fabricated products, it is an ideal pure play. This has allowed it to be somewhat shielded by the decline in aluminum prices. Kaiser Aluminum says it expects the weak demand from the fourth quarter to continue into the first quarter, citing slowing manufacturing demand in North America.

During its first quarter of 2013, the company beat analysts’ estimates. Its net income was $34 million or $1.73 per share. That is higher than the roughly $27 million, or $1.38 per share it reported during the same quarter of 2012. Year-to-date, Kaiser Aluminum’s stock is up 2.84%.

So, if you are on the hunt for a metal stock, you may want to steer clear of Alcoa. It is disconcerting that it has painted a rosy picture for the aluminum industry, especially considering that observers say there will be no meaningful improvement over the next few quarters.

Century Aluminum and Kaiser Aluminum are better plays, mainly due to the restructuring initiatives they have invested in, which help them be well-positioned to handle the increase in demand for aluminum. This is going to be key, as uncertainty remains about when prices for the metal will increase and, if they do, whether they will increase enough to affect these companies' top and bottom lines in a substantial manner.

Materials industries are traditionally known for their high barriers to entry, and the aluminum industry is no exception. Controlling about 15% of global production in this highly consolidated industry, Alcoa is in prime position to take advantage of growth that some expect will lead to total industry revenue approaching $160 billion by 2017. Based on this prospect and several other company-specific factors, Alcoa is certainly worth a closer look. For a Foolish investment perspective on this global giant simply click here now to get started.

Tedra DeSue 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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