Alcoa, Inc. (AA)

Tracker52 (99.33) Submitted: 2/15/07 1:44 PM : Start Price: $29.96 AA Score: 28.97

The Industry: Aluminum is ultimately a commodity product. It is an important component of nearly every major transportation product, numerous industrial applications, and, of course, the familiar beverage cans. The industry has been consolidating and Russia and China are rapidly increasing their aluminum output.

The Company: I have been following AA since I first began investing seriously. Although I tend to like low P/E stocks, Alcoa has been in a perpetual state of restructuring for years and every time I think they have finally gotten on track, they quickly fall off and announce a new round of "cost-savings". In a commodity industry, the primary advantage comes from being the low-cost producer, and AA is not. Unlike many other industrial commodities, China and Russia are not very good potential markets. These countries both produce large amounts of aluminum domestically and are more likely to be exporters than importers. As the largest aluminum producer, AA is a natural "swing provider" when demand is high, meaning that they benefit disproportionately when the lowest cost producers can't fully meet demand. The downside is that they also stand to lose the most when demand softens.

I see a confluence of several major factors hitting AA. First, the domestic auto makers are scaling back production. Second, the aerospace cycle may be peaking soon. Third, there is increasing competition from substitute materials such as composites and titanium for many of aluminum's traditional uses. The company has over 7 billion in debt and only 1/2 billion in cash. It is free cash flow negative and has consistent ROE/ROA/ROIC well below the S&P 500 average. Steadily deteriorating current (from 1.8 to 1.0 over ten years) and quick (from 1.0 to 0.47) ratios give me significant concern about the health of the company, especially in an environment that may well be about as favorable as it's going to get.

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