Alcoa rides aluminum prices to profit

Alcoa shares could gain as the strengthening economy boosts aluminum demand.

By TheStreet Staff Apr 6, 2010 10:22AM

By David MacDougall, TheStreet.comTheStreet.com

 

Alcoa (AA) will be the first Dow component to report first-quarter earnings next week. The aluminum producer is expected to earn 15 cents a share after losing 59 cents a year earlier. The Pittsburgh-based company said yesterday it would have a $180 million charge for closing plants and an $80 million charge for health care expenses.

 

Still, analysts expect the company to increase revenue 18% this year. Much of the improvement in performance came from the rebound in aluminum prices, which have gained 70% during the past year. Alcoa has become an attractive opportunity as inflation fears grow and the metal regains the value it lost in the crash.

 

Aluminum prices and Alcoa are tightly correlated. In fact, changes in the spot price of aluminum during the past five years account for about 60% of the stock's movement. If aluminum continues to gain in the coming months, so will Alcoa shares.

 

Many economists say inflation is on the way after the government has spent more than a year trying to jolt the economy with aid. That should boost prices for commodities denominated in dollars, such as aluminum, and the share prices of their producers.

 

Alcoa shares plunged 69% in 2008, when aluminum prices sank 36% and the S&P 500 lost 38%. The company felt the added pinch of debt obligations when revenue for 2009 was nearly cut in half due to falling prices and demand. Debt always exacerbates a problem because obligations aren't always linked to the company's performance. As demand returns and prices increase, the company should rise above the cost of debt to earn a healthy profit.

 

Dow companies such as like General Electric (GE), Caterpillar (CAT), United Technologies (UTX) and Boeing (BA) can be hurt by increasing prices for commodities, which raise the cost of the materials they use. However, Alcoa thrives on it, which makes it a good stock for diversification when commodity prices rise.

 

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Alcoa has lost 8.4% this year, making it the worst-performing member of the Dow Jones Industrial Average, which has gained 6%. The best-performing stock is Boeing, up 33%.

 

Investors that have held Alcoa during this time period may be kicking themselves for missing out on better-performing Dow components, but Alcoa won't be a laggard for long. Alcoa's worst-case scenario would involve a sinking economy, which would hurt aluminum demand.

 

Now that employment numbers have turned positive it seems like the threat of a so-called "double dip" recession is abating. Economic growth, no matter how small, is a positive sign for commodity producers that have been hurt by falling prices in recent years. Growth should lead to beefed up demand, boosting metal prices.

 

When Alcoa releases results next week, investors should listen carefully for forecasts about the rest of 2010. If management expects demand to continue and aluminum prices to rise, that would bode well for Alcoa.

 

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