In a market that still seems obsessed with finding "China plays", Alcoa (NYSE:AA) might not be the first name that comes to mind. The reality, though, is that China largely calls the tune these days and this giant aluminum company has little choice but to dance to it as best it can.

IN PICTURES: 9 Simple Investing Ratios You Need To Know

The Quarter That Was
Alcoa had a respectable fourth-quarter performance. Sales growth was not exactly robust, as the company produced sequential growth of 7% and annual growth of 4%, but it was good enough to more or less meet the average estimate. Within the numbers there was a relatively normal level of choppiness - Engineered Solutions revenue rose by 11%, while Alumina and Flat-Rolled were laggards with flat revenue and 1% growth, respectively.

To a certain extent, that sales profile worked in the company's favor. Although it is certainly the case that sales performance (both absolute and relative) impacts margins, the company saw the best top-line growth in its highest-margin segments. That helped fuel overall after-tax operating income growth of 14% on a sequential basis and 65% on a year-over-year basis, with Primary Metals leading on both an absolute and relative basis. (For more, see Zooming In On Operating Income.)

Trying to put that into a little more context, the profitability of Alcoa is still a good news / bad news proposition. Looking back through Alcoa's history and trying to craft a "normalized" run-rate, it looks like Alcoa is about 10% below normal in terms of flat-rolled production and maybe 20% below normal in engineered products. Here is why that really matters - the incremental costs involved in those two production profiles are quite small and Alcoa could probably double its profitability in each segment at a "normal" run rate. In other words, there is major positive profit leverage if Alcoa can get back to normal (without a major collapse in prices). (For more, see Alcoa Predicts Aluminum Boom.)

The Road Ahead
The problem for Alcoa is that the new normal may not be like the historical normal. Western economies are using less and less aluminum per person, which makes China an even more important incremental consumer. It also makes Chinese policy decisions all the more important - both on the demand side (in terms of interest rates, sales taxes and so on) and the supply side (the incentives/operating conditions for large smelters like Chalco (NYSE:ACH) and a host of small operators).

Outside of China, there are other concerns, as well. For starters, there is a pretty sizable level of inventory in the market (at least as measured by LME inventories). Moreover, the big consumers of aluminum - transportation, building and packaging - all have their problems. Ford (NYSE:F) and Boeing (NYSE:BA) may be doing better, but the growth forecasts are not scintillating and commercial construction is still rather moribund. (For more, see Aluminum, From Rags To Riches.)

Better Metals Elsewhere
Alcoa has a dicey record of earning attractive long-term returns on its capital, and that is more of an industry-wide issue than a management issue. The fact is, Alcoa management has done quite a lot of good things - exiting unattractive businesses, focusing on cost containment and so forth. Unfortunately, it is just not an appealing business and shareholders have not been all that excited about the sector for a while. In fact, the investment community tends to be pretty unhappy when companies like Vale (Nasdaq:VALE) or BHP Billiton (NYSE: BHP) make any mention of expanding their finished aluminum businesses (as opposed to the alumina/bauxite operations).

The Bottom Line
It is probably true that solid global economic growth would work down the inventories relatively quickly. It seems equally true that Alcoa has quite a bit of positive profit leverage if the company can get close to that "normalized" level of production. That could make the stock an appealing idea for risk-tolerant investors looking to make a high-beta play on the recovery.

More conservative or long-term-oriented investors, though, should probably take the long-term history of the industry to heart, though, and stay away from the aluminum sector. Copper companies like Freeport McMoRan (NYSE:FCX) and steel companies like Nucor (NYSE:NUE) are not exactly widows-and-orphans stocks, but at least they have been able to produce decent long-term returns from their asset bases. (For more, see Aluminum Is Over The Hump.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  2. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  3. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  4. Mutual Funds & ETFs

    ETF Analysis: WisdomTree SmallCap Earnings

    Discover the WisdomTree Small Cap Earnings ETF, a fund with a special focus on small-cap and micro-cap stocks with positive earnings.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares US Regional Banks

    Obtain information and analysis of the iShares US Regional Banks ETF for investors seeking particular exposure to regional bank stocks.
  6. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  7. Technical Indicators

    Key Financial Ratios to Analyze the Mining Industry

    Discover some the most important financial ratios used by investors and analysts to evaluate companies in the metals and mining industry.
  8. Technical Indicators

    Key Financial Ratios to Analyze Retail Banks

    Learn about key financial metrics that investors use to evaluate retail banks, and how the industry is fundamentally different from most other industries.
  9. Technical Indicators

    Key Financial Ratios to Analyze Airline Companies

    Examine some of the most important financial ratios and performance metrics investors use to evaluate companies in the airline industry.
  10. Stock Analysis

    The 5 Biggest Canadian Oil Companies

    Obtain information about some of the largest and most successful major integrated oil corporations that are headquartered in Canada.
RELATED TERMS
  1. Profit Margin

    A category of ratios measuring profitability calculated as net ...
  2. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis ...
  3. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  4. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  5. Net Present Value - NPV

    The difference between the present values of cash inflows and ...
  6. Long-Term Debt

    Long-term debt consists of loans and financial obligations lasting ...
RELATED FAQS
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  4. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  5. What is the difference between the return on total assets and an interest rate?

    Return on total assets (ROTA) represents one of the profitability metrics. It is calculated by taking a company's earnings ... Read Full Answer >>
  6. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!