Alcoa Inc (AA), Rio Tinto plc (ADR) (RIO): A Great Way to Play Industrial Recovery

Since the market crash of 2008 and 2009, shares of Alcoa Inc (NYSE:AA) have plummeted more than 80%, while aluminum prices in the U.S have dropped by nearly 45%. Alcoa Inc (NYSE:AA)’s shares have under-performed almost all the major U.S. indices, which leaves little interest for growth investors.

Alcoa Inc (NYSE:AA)But with the recovering infrastructure and automobile sectors in the U.S, China and India, aluminum is again gaining traction. Since Alcoa Inc (NYSE:AA) is the largest aluminum manufacturer in the U.S, it’s one of the prime beneficiaries of rebounding industrial indices. In fact, I believe that it could be one of the most undervalued contrarian plays in the market.

More reasons to buy Alcoa

Alcoa Inc (NYSE:AA) recently reported its quarterly results. Its quarterly revenue stood at $5.8 billion, which declined from $6 billion in last year’s quarter due to lower alumina prices and fewer days of production. Despite the stressed top-line performance, Alcoa Inc (NYSE:AA) reported quarterly EPS of $0.11 compared to $0.06 in last year’s quarter.

Its management explained that aerospace, automobile and packaging volumes were up, which added $15 million to its net income. Meanwhile, the favorable price-to-volume mix in the U.S and Europe added another $21 million. Since the mentioned sectors are showing robust growth, it’s highly probable that Alcoa also continues its growth momentum.

On the fundamental side, Alcoa currently operates with a debt-to-equity ratio of 67% and $1.6 billion in cash. Its debt-to-capital ratio stood at 34.7%, and the company’s management is working toward lowering the debt metric to 30.5% this year. That calls for a significant amount of extinguished debt, which should lower its annual interest expenses by around 14%.

Currently, Alcoa Inc (NYSE:AA) has a total smelting capacity of 4.2 billion tonnes per annum, which makes Alcoa the world’s third-largest aluminum manufacturer, behind only Rio Tinto plc (ADR) (NYSE:RIO) and Rusal. Alcoa’s management expects annual aluminum demand to increase by 7% in FY13, and lowered the aluminum surplus estimate from 535,000 tonnes to 155,000 tonnes.

But last year, Alcoa lowered its overall production by 12%, which hasn’t been recouped yet. This puts Alcoa in a sweet spot, as it can ramp-up its production with the rising demand without expanding its current facilities. That’s an optimistic picture, which should be beneficial to most of the aluminum manufacturers but not all of them.