Time for the Dow to Drop Alcoa

Updated from 7:01 a.m. EST

Who thinks Alcoa(AA Quote) is still one of the 30 best representatives of U.S. business?

The index folks at Dow Jones do, apparently. Last month, they yanked Altria (MO Quote) and Honeywell (HON Quote) from the Dow Jones Industrial Average, but they neglected to give Pittsburgh-based Alcoa the boot, too.

There are plenty of reasons why the aluminum giant should have been chopped from the index, which tracks 30 leading U.S. public companies, but they all come down to one thing -- poor management.

"Alcoa was the only major metal producer whose share price went nowhere during the greatest sustained commodity boom of all time," writes Don Coxe, a global portfolio strategist at Chicago-based BMO Financial Group, in a recent report. "That is such a fascinating accomplishment that the company deserves to become a fixture in [business]-school textbooks."

Time to Boot Alcoa From the Dow

Coxe has a point. Over the past year, Alcoa's share price has barely moved. During that same period, metals firm Freeport-McMoRan Copper & Gold(FCX Quote) gained more than 50%, while diversified miners Rio Tinto(RTP Quote) and Companhia Vale do Rio Doce(RIO Quote) have approximately doubled.

At first glance, looking over a longer period might seem to make Alcoa's stock performance look better. But in reality, it looks even worse. That's because although Alcoa doubled since 2003, the others in the group grew between four- and fivefold.

Clearly something is wrong with Alcoa, when not even sky-high metals prices across the complex -- and that includes aluminum -- could help them keep up with the pack.

What exactly is the problem? Victor Lazarovici, a recently retired Wall Street metals analyst with two decades in the business, says Alcoa seemed to "choose a strategy of acquiring second- and third-tier assets, and expanded into manufacturing and casting," which he says is "a bear-market strategy."

He points to the purchase of Reynolds Metals in 2000 as an example of bad judgment. The deal originally was to have included the Worsley alumina plant in Australia, which was the crown jewel of the transaction, Lazarovici explains. Along with that came some packaging businesses, a line he says "has no place in a smokestack industry."

Then, regulators insisted that Alcoa promise to dispose of the alumina plant in order to get the necessary antitrust approvals. "Alcoa still went through with the deal," adds Lazarovici.

Alcoa was left with Reynolds, minus the key plant, but with the misfit packaging businesses. That isn't so good. During an up-cycle in the metals business, the commodity products like ingots, billet and alumina tend to do better than manufactured or semifabricated lines.

(Alcoa did announce recently that it had sold its packaging business to New Zealand firm Rank Group.)

Chuck Bradford, an analyst at Soleil in New York, has another issue -- the prevalence of unusual items in the firm's earnings. For instance, in the first nine months of 2007, restructuring and other charges totaled $413 million. That comes on the back of $543 million for the whole of 2006 and $292 million in 2005.

The underlying point being, what is the quality of earnings at Alcoa?

Bradford also says management seems to be tripping up on its current expansion plans in Trinidad. "They were hoping to have a new smelter up late this year or next year," Bradford says. "Now they haven't even broken ground and have to find a new location."

And then consider the recent decision to appoint former Merrill Lynch(MER Quote) chief Stan O'Neal to its board of directors.

"[O'Neal's] most notable achievement [was] buying a large subprime mortgage issuer when the housing bubble had already begun to shrink," writes BMO's Coxe. "Given that Alcoa's failure to participate in a record run of profitability for metal companies could be called sustained destruction of shareholder value, maybe Mr. O'Neal's record of doing it better and faster made him noteworthy."