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Alcoa Inc (AA)’s Return To Profitability

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Alcoa Inc (NYSE:AA) is generally seen as a barometer for global manufacturing as airlines, automakers, construction firms and home appliances use its products. Alcoa has seen difficult years, but with the recent better than expected first-quarter results, the company seems to be better positioned for growth.

Alcoa Inc (NYSE:AA)Alcoa Inc (NYSE:AA) focused purely on aluminum rather than diversifying into other materials like copper or iron ore, which other global mining companies did. This continued focus on only specializing in aluminum products and an oversupply of aluminum resulted in the company facing losses and a decline in its share price. During the recession, Alcoa’s market capitalization declined drastically from $47 billion to $5.5 billion. While many companies have seen recovery in its prices, Alcoa Inc (NYSE:AA) has not seen much of recovery.

However, the recent first-quarter result provided a glimpse of hope and a number of positive factors for the company.

Better than expected results

Although revenues declined 2.9% to $5.8 billion versus last year, it reported EPS of $0.13, up 44% versus last year and higher than market expectations of $0.08. Despite weak metal prices, it was able to post strong profitability across all segments. Its net profit was up by more than 50% to $149 million, buoyed by increased demand in aerospace and automotive products.

Further, the company has been able to manage its costs resulting in lower COGS margin, which has improved from 84.9% in 1Q12 to 84.2% in 4Q12 and 83.1% in 1Q13.

Strong profitability across segments

Segment wise, the company experienced growth across all its segments, which were driven by productivity improvements.

Its Engineered Products and Solutions’ (EPS) After Tax Operating income (ATOI) increased 23% sequentially from 4Q12 and reported a record EBITDA margin of 20.9%. It quickly kicked out its Global Rolled Products (GRP) segment and expects its ATOI to increase 15%-20% sequentially. In its upstream business, Alcoa Inc (NYSE:AA)’s alumina division gained from higher spot prices leading to ATOI increasing sequentially from $41 million to $58 million.

The company has been shifting its business mix focus to value-added products over the last few years. This can be seen from the change in the mix of ATOI – EPS and GRP divisions constituted 71% of the total ATOI in 2012 as compared to 25% in 2003. This favorable trend will help the company to improve its margins and reduce its earnings volatility, which is affected by aluminum price fluctuations.

Improved balance sheet

The company is focused on being free cash flow positive in FY13 and it is taking the necessary steps to accomplish the same. It has been able to reduce its working capital days by 27 days since 1Q09, which equates to approximately $1.8 billion in cash. Similarly since 4Q12 it has been able to reduce its days by 4, which equates to approximately $260 million in cash (Source: company earnings call). Further, the company ended with a strong cash balance of $1.6 billion, which can act as a cushion in case the turnaround takes a longer time.

In December 2012, Moody’s placed Alcoa Inc (NYSE:AA)’s rating under review for downgrade, which would cost the company’s investment grade rating. S&P rates Alcoa at BBB-, its lowest investment-grade rating, with a stable outlook. At the recent earnings call, the company mentioned that it intends to maintain its investment grade rating and this can be seen by its lower Debt/Capital ratio, which has reduced from 42.5% in 2008 to 34.7% in 1Q13. It has mentioned that it intends to maintain this ratio between 30-35%.

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