Industrial bellwether Alcoa (AA: Charts, News, Offers), the largest domestic aluminum producer, has always been a leading indicator of the global economy’s health. Despite current speed bumps with the debt crisis in the United States and Europe, bullish analysts believe the company’s profit could double in the second half of 2011, due to rising demand from Asia, international automakers and aircraft manufacturers. However, we’ve heard this story before – with iron ore and molybdenum also being hot commodities in a recovering global economy. Can Alcoa live up to expectations, or is it destined to fall short as global growth slows?
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Alcoa is the world’s third largest producer of aluminum, after Rio Tinto Alcan and Rusal. The company is based in Pittsburgh, Pennsylvania, and operates in 31 countries. The company is diversified across all aspects of the industry, with operations in technology, mining, refining, smelting, fabricating and recycling. Aluminum accounts for three-fourths of the company’s revenue; the remainder comes from non-aluminum precision casings and industrial fasteners. The company has a diversified customer base in aircraft, automobiles, commercial transportation, packaging, building and construction, oil and gas, defense and industrial applications. Competition has been fierce among the top three aluminum producers – in 2007 Alcoa attempted a $27 billion hostile takeover of rival Alcan, hoping to create the world’s largest aluminum producer. The attempt failed after Rio Tinto took over Alcan in July 2007. As with the large miners, market consolidation is inevitable, and with a market cap of nearly $17 billion, the company is destined to be one of the last men standing.
For the most recent quarter, Alcoa reported net income of $322 million, or 28 cents per share on revenue of $6.59 billion. A year ago, Alcoa posted net income of $136 million, or 13 cents per share, on revenue of $5.19 billion. Excluding one-time items, the company’s EPS came in at 32 cents per share. Despite these strong numbers, the company missed the lofty analyst consensus of 33 cents per share, but beat the projected revenue of $6.28 billion.
Analysts believe that China will be the great catalyst to the company’s future prospects, and will offset weakening demand in Europe and the United States. Aluminum prices increased 6% this quarter, while alumina (a raw material used to process aluminum) increased 7%, boosted by Chinese demand. Alcoa CEO Klaus Kleinfeld has forecast a 12% increase in global demand in 2011 and a doubling of shares at the end of the decade as Asian countries increase commercial construction and purchase more aircraft, cars and trains. In addition, a rebounding General Motors (GM: Charts, News, Offers) and Ford (F: Charts, News, Offers), along with recovering Japanese automakers Toyota (TM: Charts, News, Offers) and Honda (HMC: Charts, News, Offers), should fuel demand for aluminum and keep prices high. Alcoa expects auto sales to increase by 9% worldwide while the aluminum content of vehicles will increase by 1.5%. Leading aircraft manufacturers Boeing (BA: Charts, News, Offers)and Airbus, the latter with which Alcoa holds a $1 billion contract, are also forecast to increase their orders of Alcoa-produced aluminum parts. American Airlines is expected to order as many as 280 new narrow-body jets, an industry record, from Boeing and Airbus. Aerospace shipments are expected to increase 15% in 2011. Alcoa’s aerospace revenue was $2.9 billion in 2010, out of its total sales of $21 billion.
Despite these positive catalysts, investors are concerned with the company’s increased production costs, which it observed in the second quarter of 2011. In particular, the cost of coke and pitch, two vital raw materials used in aluminum production, increased, and electricity costs in the United States increased. The weakening dollar has also made raw materials more expensive across the market, increasing costs in foreign markets by as much as two cents per share. Smelting costs increased from $1.04 to $1.07 per pound. Although these rising costs threaten operating margins in the short term, Deutsche Bank believes that the company should be able to offset these increased costs and decreasing margins by increasing its sales volume in the next few quarters.
Alcoa currently trades with a cheap forward P/E of 10.49, a PEG ratio of 0.35 and a price-to-book ratio of 1.24. The company also pays a slim quarterly dividend of 3 cents per share.
Other News About AA
Alcoa Profit May Double on Aluminum Demand
The bullish case for Alcoa.
What Rising Aluminum Prices Could Mean for Alcoa’s Earnings
Aluminum prices will buoy Alcoa’s earnings.
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Leo Sun is long-time market follower and finance writer. He regularly contributes to the Stock of the Day analysis.
