Valuation: Alcoa Incorporated (AA)

Over the next few weeks, I hope to do an individual valuation of each of the components of the Dow Jones Industrial Average.  For a brief overview of the Dow, please see our Glance at the Dow – a snapshot of the valuations on March 10.  When I have completed the individual valuations, I will put together another overview. 

Company Profile:  Alcoa Incorporated (AA) (obtained via Google Finance)

Alcoa Inc. (Alcoa) is a producer of primary aluminum, fabricated aluminum and alumina, and is active in all aspects of the industry, including technology, mining, refining, smelting, fabricating and recycling. Alcoa is a global company operating in 44 countries. In addition, the Company has investments and activities in Australia, Brazil, China, Iceland, Jamaica and Russia. Its operations consist of six business segments: Alumina, Primary Metals, Flat-Rolled Products, Extruded and End Products, Engineered Solutions, and Packaging and Consumer. The Alumina segment primarily consists of a series of affiliated operating entities referred to as Alcoa World Alumina and Chemicals (AWAC). Alcoa owns 60% and Alumina Limited owns 40% of these individual entities. In November 2007, the Company announced the sale of its automotive castings business to Compass Automotive Group, LLC, a portfolio company of Monomoy Capital Partners, L.P.

 Business and Management Review 

1) Is the business simple and understandable?

Alcoa’s business would be a great example of simple and understandable.  Alcoa produces aluminum and could be used in a case study in business schools looking to learn about a vertically integrated business.  Alcoa strives to be involved in every portion of the process of the production of aluminum, from the mining to the sales, to the recycling. 

 2) Does the business have a consistent operating history?

The company traces its roots to Charles Martin Hall, who discovered the process of smelting aluminum in 1886.  Since then, the company has been involved in aluminum and anything related to it.  I’d say that’s a consistent operating history.  Financially, the company has achieved a positive net income for over 10 years, and has been paying a dividend for over 10 years.

 3) Does the business have favorable long term prospects?The company remains active in bringing aluminum products to other parts of the world and has recently become more involved with the aerospace industry which bodes well for the future as the world begins to explore opportunities in space.   4) Is management rational?

Alain Belda has been the Chief Executive Officer of Alcoa since 1999 and has been with the company since 1969.  Having seen Alcoa’s results and agreeing with the company’s strategies moving forward, we see no reason to think Mr. Belda and the rest of the management is irrational.

 5) Is management candid with its shareholders?

The company has a standard investor relations page, with earnings reports, webcasts, etc.  A look at the latest annual report indicates a clear and detailed explanation of the company’s goals and strategy for the coming year.

  Financial and Value Review 

Defensive:

1) Size of firm

The market cap of Alcoa is $30.84 billion.  Pass.

 2) Strong financial condition

The company’s current ratio is about 1.14, below the 2.0 requirement.  Fail.

 3) Earnings stability

The company has had a consistently positive net income for over 10 years.  Pass.

 4) Dividend record

Alcoa has consistently paid a dividend for over 10 years.  Pass.

 5) Earnings growth

Earnings have grown more than 1/3 over the last 10 years.  Pass.

 6) Price to earnings analysis

With a PE ratio (using our Methods) of 16.33, the requirement of under 20 is met.   Pass.

 7) Price to assets analysis

The Price to Book ratio for Alcoa is 1.91, lower than our 2.5 limit.  The multiple of PE to PB is lower than our requirement of 50.  Pass.

 Overall

Having passed 6 of the required 7 tests for the defensive investor following Benjamin Graham’s value investing strategy, we believe Alcoa may be suitable for the defensive investor.

  Enterprising:

1) Strong financial condition

The company’s current ratio is below 1.5 and debt to net current assets is greater than 1.1.  Fail.

 2) Earnings stability

The company has achieved a positive net income for over 5 years.  Pass.

 3) Dividend record

The company currently pays a dividend.  Pass.

 4) Earnings growth

Earnings are greater today than they were 5 years ago.  Pass.

5) Price

The price is not less than 150% of the net tangible assets.  Fail. 

Overall

While the company did not pass the requirements of the enterprising investor, since it passed the defensive investments, we find the company may be suitable for the enterprising investor also.

 Valuation:

Our valuation model finds a fair value to be around $85.  

Opinion:Since the company is currently trading at about $38, we feel it is undervalued at the present time and may be a suitable investment for the defensive or enterprising investor.None of the staff of ModernGraham.com held a position in Alcoa at the time of publication.  Also, please read our disclaimer and Our Methods.