Stocks

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.

4 thoughts on “Valuation: Alcoa Incorporated (AA)

  1. Your analysis of Alcoa is based on laggard price of aluminium as related to today metal prices. The supply and demand balance has yet to be played out as aluminium has been stuck at very low prices for a couple of decades since the lowering of the Iron Curtain. Russia flooded the market with aluminium during the nineties, then every continent start building new aluminium smelters regardelssly about profitability. We are still swimming in surplus and we will have to grab the towel before too long. Aluminium is destined to hit $3 a pound. Translation: ALCOA $200 a share or higher…depending on the cost of electricity in the future.

  2. Gumby brings up a good point. If the price of Aluminium goes up, it is likely to affect the level of revenue that Alcoa receives. Thus, the net income would be affected and the intrinsic value would be greater.

    This just makes it even more attractive from a value investor’s standpoint.

  3. I could not agree more with the analysis and commentary. This is a NO BRAINER!
    I was in after the price drop a couple of months ago! You just can’t pass this up. They are earning heaps of money in a down market!
    Most people are focused on oil and gas and other commodities, not aluminum. Although it’s not rational to do a direct comparison, you can compare human reactions to down markets. Most people forgot when the oil companies were hemorrhaging cash and laying people off in 2000. If you go back farther in time, almost everyone forgot the mile long lines around the employment offices in 1987 in downtown Houston.
    Just like the above example with the oil companies, if this company can do this well in a down market, it’s going to do amazing in an up market. Take Oxy for example. Although not nearly as vertically integrated as AA, if you had bought when it was 10 dollars a share, what would it be worth now after the market split? 173.99 in five years time!
    Aluminum is always in high demand. It’s not a matter of if, it’s a matter of when. Also – if you want to add a little Buffet in with the Graham analysis, you need to look at castles and moats as he likes to explain it. Aluminum transportation costs are high while the costs of the commodity are low. When the market returns, the preferred seller in the whole of North and South America will be this company. This is especially true after further transportation is linked South of the border no matter what is going on in Russia, India or China. Whilst judging the ability of this company to handle political risk in international markets, it’s a good idea to point out that this company has survived over 100 years through two world wars.

    Thus you buy this company with a forever holding period in mind.

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