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Alcoa Draws Back the Curtain

Alcoa draws back the veil on the inner-workings of its business during its quarterly earnings conference call.
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PITTSBURGH (TheStreet) -- Alcoa (AA) - Get Alcoa Corporation Report drew back the veil on the inner-workings of its business during its quarterly earnings conference call Monday evening.

Frustrated that Wall Street had consistently misinterpreted the cyclicality of its business -- that analysts' forecasting models were, at bottom, flawed -- Alcoa's top executives provided a raft of figures, breaking down cost curves and margin trends in each of its segments going back 10 years to the year 2000.

The metals bellwether, which reported in-line first quarter numbers after Monday's market close, also offered rare detail on how fluctuating metals prices and currencies impact its profits.

All in all, Alcoa's detailed hand-holding on Monday, led by CEO Klaus Klienfeld, suggested the gap that often exists between management teams and the professional Wall Street experts paid to analyze corporate business models. Though neither side will admit it publicly, C-Suites executives often say analysts do an uneven job in attempting to understand their companies, while analysts say executives aren't transparent enough.

Said one analyst who participated in Monday's conference call: "I think this is probably what every company needs to do a better job of: 'Here's our business model. This is what drives profitability in this segment. Pay attention.'" Executives at the Pittsburgh-based multinational had previously complained that the range of Wall Street's revenue and profit estimates "was extremely wide," this analyst said.

Media reports on

Alcoa's first quarter

reflected the confusion: "Alcoa outstrips earnings forecasts," read a headline in the

Financial Times

. "Alcoa posts loss, but matches Wall St. estimates," said


. "Stocks fall after Alcoa falls short," reported the

Associated Press

on Tuesday morning.

Alcoa's basic argument during the conference call was that the cyclical nature of its business, although cruel to its bottom line during downturns, will result in sharply growing profit once the broader global economy rounds back into form. It's also known as a "

classic bullwhip effect

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," as

Morgan Stanley

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analyst Mark Liinamaa has pointed out, due in large part to the vicious cost-cutting Alcoa has pursued since the recession began. Going long on Alcoa is thus a kind of market call.

For some analysts, the fresh detail trotted out by Alcoa executives Monday brightened their outlook for the company. "This is clearly an inflection point for me," said Anthony Rizzuto, the metals and mining analyst at Dahlman Rose. He hasn't recommended Alcoa stock in five years. Now, however, "The earnings power would be a lot higher than what is reflected today in the share price."

For others, it did not.


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Brian MacArthur downgraded Alcoa stock to neutral from buy and slashed his earnings predictions for the next three years, through 2012. Of course, MacArthur was well above consensus to begin with, so his revisions bring him closer to the conventional wisdom.

Rizutto believes the company's "normalized" annual EBITDA -- that is, the figure Alcoa would earn before interest, taxes, depreciation and amortization during an average year -- is about $4.4 billion.

In 2009, a down period in its cycle, and thus not normal, Alcoa's EBITDA was $869 million. At the last peak in the cycle, in 2006, the company's EBITDA was about $5.66 billion.

Much of what Alcoa's Kleinfeld discussed served to reinforce what is already widely known: that the company's profits largely depend on where aluminum prices and energy costs stand.

To deal with the former, Alcoa has started trying to convince its alumina customers to move away from the traditional contract system that links the raw material's price to the commodity price of aluminum as it fluctuates via trading on the London Metals Exchange. (Aluminum is smelted out of alumina, which in turn is produced from bauxite).

If you see parallels between Alcoa's efforts and the recent changes in the way miners and steelmakers price iron ore, you'd be right. "I think it's fairly clear that Alcoa is taking a lesson" from

BHP Billiton

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Rio Tinto

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, said Rizutto, referring to the world's biggest ore miners, who recently pressed home the changes.

As it stands under the contract system now, for example, Alcoa is selling its alumina to customers at 15% of the LME price of aluminum one quarter ago.

Alcoa and other miners argue that the current system is unfair, since the costs associated with smelting aluminum are much higher than those associated with producing alumina. The LME-linked contracts thus keep the raw material's price artificially low, miners say.

The cost of smelting aluminum is so high for a single reason, of course: Power. Each day, an average-sized smelter uses as much electricity as a city of one million people. That's why Alcoa is building its multi-billion-dollar facility in Saudi Arabia, where power is cheap. Called Ma'aden, the smelter will come online in 2014, Alcoa has said.

High energy costs also led to Alcoa's plan to shutter two smelters in the U.S. and idle two others in Italy, where European Union rules have forced the country's utilities to charge more for energy than they'd otherwise want to. Alcoa is appealing the rule.

Among the company's so-called "downstream" businesses, such as sheet metal used in beverage cans, Alcoa has cut off two major customers --


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The soda and beer companies had long-term supply contracts with Alcoa that ended last year. Because of rising costs, Alcoa had been losing money under those contracts, selling can sheet for 30 cents a pound. The market price for can sheet is around 45 cents to 50 cents a pound. When Alcoa tried to raise prices, there was sticker shock. Alcoa then walked away -- at least for the time being -- from Pepsi and Anheuser-Busch, willing to take the short-term hit to its revenue instead. Negotiations are ongoing.

Shares of Alcoa were trading late Tuesday at $14.20, down 2.5%, on volume of 87 million shares, more than double the daily average. Though the stock nearly doubled from its recession-induced trough near $8 a year ago in May, its price remains well below the $25 to $40 range it traded within throughout much of the last decade.

-- Written by Scott Eden in New York


>>Alcoa Posts Another 'Noisy' Quarter

>>Alcoa Looks for Downstream 'Bullwhip'

Scott Eden has covered business -- both large and small -- for more than a decade. Prior to joining, he worked as a features reporter for Dealmaker and Trader Monthly magazines. Before that, he wrote for the Chicago Reader, that city's weekly paper. Early in his career, he was a staff reporter at the Dow Jones News Service. His reporting has appeared in The Wall Street Journal, Men's Journal, the St. Petersburg (Fla.) Times, and the Believer magazine, among other publications. He's also the author of Touchdown Jesus (Simon & Schuster, 2005), a nonfiction book about Notre Dame football fans and the business and politics of big-time college sports. He has degrees from Notre Dame and Washington University in St. Louis.