Are the Shorts Right About Alcoa?

With shares of Alcoa (NYSE:AA) trading at around $8.70, is AA an OUTPERFORM, WAIT AND SEE or STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

C = Catalyst for the Stock’s Movement

Alcoa is the most shorted stock on the Dow, and that short position has steadily increased. Are the shorts correct about the future direction of Alcoa’s stock?

Alcoa has been around since 1888. It’s the world’s leading producer of primary aluminum, fabricated aluminum, and aluminum. It’s also the world’s largest miner of boxite. Alcoa has 60,000 employees in 31 countries.While it has underperformed the market recently, it’s not going anywhere.

Investing should be about choosing quality companies and ignoring the timing aspect. However, it can’t be denied that investing in Alcoa is all about timing. When the economy is beginning to show improvement, it’s a superb investment. When the economy is beginning to slow, it’s a poor investment. This doesn’t pertain to central bank action propping up the markets.; it pertains to the actual economy.

Revenue has been declining for Alcoa, which makes the bottom line imperative. Alcoa recently announced that it might cutback aluminum production – its reviewing 460,000 metric tons of smelting capacity. Cutbacks are most likely to take place where there are high energy costs and potential for regulatory changes.

Alcoa is still seeing strength in aerospace and autos. Aerospace might continue to see growth, but anyone predicting strong growth in autos is highly optimistic. Consumer discretionary industries aren’t likely to perform well in the economic environment ahead.

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The chart below compares fundamentals for Alcoa and Aluminum Corporation of China Limited (NYSE:ACH).

Trailing P/E 37.99 N/A
Forward P/E 11.92 118.89
Profit Margin 1.05% -5.41%
ROE 1.36% -14.78%
Operating Cash Flow 1.66B 328.83M
Dividend Yield 1.40% N/A
Short Position 8.90% N/A

Let’s take a look at some more important numbers prior to forming an opinion on this stock.

T = Technicals Are Mixed

Alcoa has performed poorly over three-year and one-year time frames. However, the stock has performed respectably over the past month. The stock is also now trading above its 50-day SMA and 200-day SMA.

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1 Month Year-To-Date 1 Year 3 Year
AA 5.83% 0.56% -2.98% -28.06%
ACH 8.66% -13.60% -4.63% -55.19%
50-Day SMA 8.37
200-Day SMA 8.60

E = Equity to Debt Ratio Is Normal

The debt-to-equity ratio is close to the industry average of 0.60. Revenue is the big concern here, not debt.

Debt-To-Equity Cash Long-Term Debt
AA 0.53 1.56B 8.92B
ACH 1.84 1.96B 16.61B

E = Earnings Have Been Inconsistent

The good news is that Alcoa has been in the black over the past three years. The bad news is that there was an earnings setback in 2012. Revenue also suffered a setback in 2012. On a quarterly basis, revenue declined while earnings improved year-over-year. Revenue and earnings both declined sequentially.

Fiscal Year 2008 2009 2010 2011 2012
Revenue ($) in billions 26.90 18.44 21.01 24.95 23.70
Diluted EPS ($) -0.10 -1.23 0.24 0.55 0.18
Quarter Mar. 31, 2012 Jun. 30, 2012 Sep. 30, 2012 Dec. 31, 2012 Mar. 31, 2013
Revenue ($) in billions 6.01 5.96 5.83 5.90 5.83
Diluted EPS ($) 0.09 0.00 -0.13 0.2188 0.13


Now let’s take a look at the next page for the Trends and Conclusion. Is this stock an OUTPERFORM, a WAIT AND SEE, or a STAY AWAY?

T = Trends Do Not Support the Industry

Aluminum prices have declined 33 percent since their peak in 2011. Global demand is questionable at best. As mentioned earlier, aerospace and autos are showing strength, but it would be difficult to see continued strength in autos.

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Shorts aren’t shorting this stock because they think it’s going BK. They’re shorting the stock because they don’t think it’s the right environment for Alcoa. While shorting a stock like Alcoa isn’t recommended, the shorts are correct in regards to their analysis. Simply put, Alcoa performs well when the economy is beginning to strengthen and demand is on the rise. That isn’t the case at this point in time.

Alcoa is a WAIT AND SEE.

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All content posted should not be considered professional advice. Please do your own research and consult with a professional financial advisor before making any investment decisions.