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Alcoa Inc (AA): Searching for Great Stocks in Basic Materials

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Basic-materials companies with operations engaged in commodities, such as chemicals, steel, and aluminum, provide the resources needed to build and maintain our society. Since these materials go into everything from homes to automobiles, the underlying stocks are tied to the health of the global economy — for better or for worse.Alcoa Inc (NYSE:AA)

It can probably go without saying that the past few years have been extremely volatile for stocks in the basic-materials sector. A slew of headwinds, including lingering unemployment and various debt crises, both in the U.S. and abroad, have resulted in the most unreliable corporate financial results since the Great Recession ended.

Many stocks within the materials sector haven’t rallied nearly to the extent of the broader market over the past few years. Therefore, now might be a perfect time to see if there are any stocks in the sector that are attractively priced.

One aluminum giant and Dow component

Alcoa Inc (NYSE:AA) has had its share of struggles in the wake of the 2008 recession. As the financial crisis set in, global demand for aluminum quickly dried up. Since Alcoa Inc (NYSE:AA) is tied so closely to the health of the global economy, the recession took a huge bite out of its business — a setback from which the company is still recovering.

Worse, 2012 was yet another difficult year, and Alcoa’s performance in recent years has taken investors on a roller coaster ride. Sales fell 5% in fiscal 2012 year-over-year, although the company faced tough comparisons. In 2011, Alcoa registered sales growth of 19% versus 2010.

Last year, Alcoa’s diluted earnings per share collapsed 67% to $0.18 per share. Based on 2012 figures, the stock looks to still be overpriced, trading for more than 40-times trailing diluted EPS.

However, the task for investors considering Alcoa is to predict the company’s likely earnings this year and into the future. Based on the company’s volatile results these past few years, that’s a more difficult task than meets the eye.

For its part, management has a fairly rosy outlook for 2013. Alcoa expects a 7% increase in global demand for aluminum this year, fueled mostly by emerging market demand that continues to outpace that of developed economies. Specifically, demand stemming from China and India is projected to grow 11% and 9%, respectively.

A hidden gem

Air Products & Chemicals (NYSE:APD) is not only a shareholder-friendly company in the materials sector but also when compared to the market as a whole. Very recently, the company raised its dividend by 11%, representing the thirty-first consecutive year for dividend increases. The new annual dividend of $2.84 per share amounts to a 3.2% yield at recent prices.

The company derives 60% of its revenue from outside North America, and reported full-year 2012 sales fell by about 1% year-over-year. Operating income and net income from continuing operations also fell 1% for the year.

Air Products, however, still achieved an 11.5% return on capital and an 18% average return on equity. While sales declines are rarely indicative of an investment-worthy stock, it’s worth noting that 2012 was an extremely challenging year for global-materials companies. Air Products showed resilience in a year in which global manufacturing continued to slow.

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