Is Alcoa a buy at 52-week lows?

Despite several positives, the aluminum giant is not without risks.

By Wall St. Cheat Sheet Jul 19, 2012 9:57AM

By Robert Kohut

 

Alcoa (AA) is blessed, or cursed, with the honor of being the first Dow component to report earnings each quarter. The aluminum giant kicked off the summer earnings season with a modest beat on drastically lowered estimates, and the stock price fell to a new 52-week low during the trading week and closed at a share price not seen since the early 1990s.


Lowered guidance, commodity price jitters and general palpitations over the state of the global economy all serve as likely culprits. However, while CEO Klaus Kinsfield noted strong demand for aluminum from both the automotive and the aircraft sectors, not even an announcement of a $1.4 billion deal with European aircraft manufacturer Airbus could stem the flow of red.


The question is whether Alcoa, near a 20-year low, is a buy. Is there opportunity, or should we all stay away? Let's analyze the stock with the relevant sections of our CHEAT SHEET investing framework.

 

C = Catalyst for a stock's movement

The Airbus announcement serves as potential evidence Alcoa is stuck in a rut and the only catalyst that could propel this stock is solid evidence the European debt crisis is not going to bring the entire global economy to its knees.

 

H = High-quality pipeline

You don't think of a base metals producer like Alcoa as having an ongoing pipeline of new products like a tech or pharmaceutical company. Yet Alcoa invests 1% of its revenue into research and development. In reality, Alcoa's "pipeline" does not consist so much of new products but of new technologies.


The company has a technological organization spanning research centers and universities around the world working on improved processes and services, and some new forms of aluminum products as well. These enhancements and innovations fall off the radar screen of most investors since you can't rollout a process the way Apple (AAPL) rolls out a new iPhone or Microsoft (MSFT) a new operating system. (Microsoft owns and publishes Top Stocks, an MSN Money site.)


The Alcoa Technical Center outside of Pittsburgh is the world's largest light metals research center. In a world going increasingly green, Alcoa's management expects the demand for lighter metals like aluminum to nearly double by 2020.

 

E = Equity-to-debt ratio is close to zero

Here is where Alcoa gets problematic. Its debt-to-equity ratio is 0.69, or 69%, which is not good. In context, its total debt is about $9.5 billion with cash on hand of only $1.7 billion. Its cash position has been badly hurt by metal prices, which are currently approaching two year lows. However, the company's cost control efforts may be kicking in as it reported positive free cash flow of $246 million, compared to last quarter's negative $506 Million, an improvement of $752 million.

 

A = A level management runs the company

A level management is quick to recognize when issues arise beyond its control, and it takes action to control what is within its power to control. Alcoa has been tossed about by lowered commodity prices and higher input costs from oil prices and other materials. Rather than hope for the best, Alcoa management has reacted with aggressive cost-cutting measures and restructuring its business segments for greater operational efficiency and enhanced productivity. So far management appears to be doing the best it can in difficult circumstances.

 

T = Trends support the industry in which the company operates

The need for greater fuel efficiency is driving demand for lighter metals and Alcoa is the world's leading supplier. Despite current macroeconomic conditions, Alcoa's management reiterated its forecast of 7% growth in global aluminum demand this year, with 11% growth in China. CEO Klaus Kinsfield said the company is seeing "13 percent to 14 percent growth in aerospace this year, 4 percent to 8 percent growth in automotive, and 2 percent to 3 percent global growth in beverage cans."

 

Conclusion

The verdict on Alcoa is wait and see. The numbers just won't be there if the company is wrong about demand forecasts and increasing metal prices. Like many stocks today, Alcoa's future is in doubt until some kind of certainty regarding global growth emerges. However, for the riverboat gamblers out there, it is hard to ignore an established Blue Chip company trading at a price nearing 20 year lows.

 

Using a solid investing framework such as this can help improve your stock-picking skills.

 

Robert Kohut is an writer at Wall St. Cheat Sheet. As of this writing, he did not own a position in any of the aforementioned stocks.

 

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