Why I Love Alcoa but Hate the Stock

NEW YORK (TheStreet) -- Aluminum giant Alcoa (AA) has always had an excellent management team. Aside from being in a business with excellent long-term prospects -- able to grow commensurately to the world's population -- the company's leadership team has always served as one of Alcoa's most attractive qualities.

However, these days I can't say the same for the stock. It's not because management isn't doing what it can to produce value for shareholders. Right now, Wall Street just doesn't care enough to wait.

In its most recent quarter Alcoa generated no EPS on revenue of $5.963 billion. However, when excluding special items, the company did earn 6 cents a share, topping analyst estimates of 5 cents. It also generated $246 million in free cash flow.

How should investors view this performance? Although the company did register a small beat, it was on estimates that have been revised lower over during the quarter.

The good news is Alcoa is performing as well as can be expected considering what it has had to deal with this year. This includes double-digit declines in aluminum prices that have adversely impacted both its gross margins, down 7 points, as well as operating margins, down 77%.

As it stands, year-over-year prices dropped 18% last year and 4% this year, negatively impacting not only the company's top line, but also its profitability.

So the fact the stock is at $8 is a testament to the respect and trust the company's management team has earned. But at the same time there is no near-term catalyst to suggest the stock should be trading higher from current levels.

By all accounts the valuation appears fair. For now, the company continues to work on productivity as well as efficiency improvements including reducing capacity.

In the long term, these moves will help improve the company's profitability while it waits for aluminum prices to stabilize. Alcoa continues to perform exceptionally well in its mid- and downstream operations while registering 20% operating margin in its Engineering Products and Solutions segment.

But it seems that we've been down this road before since this quarter was not much different from the first quarter.

The current state of the aluminum industry is broadly understood. Because of this, not much is expected from Alcoa. So even as it continues to navigate through extremely challenging macroeconomic environments, all it gets is a shrug from analysts.

For example, just one month ago several analysts were expecting earnings per share to arrive at 9 cents; a year ago, estimates were as high as 38 cents.

In other words, the report was decent, but the worst is far from over. What analysts see is the company's Primary Metals segment swung to a loss -- again, this is highly attributable to feeble pricing of aluminum.

So the fact the stock did not suffer a drastic decline suggests the company is getting the benefit of the doubt due because it is in a business with a reputation for good economics while having a management team with a reputation for brilliance.

Looking ahead, the company's CEO Klaus Kleinfeld offered many glimmers of hope by saying:

"Alcoa maintained revenue strength and solid liquidity by driving high profitability in our mid- and downstream businesses and by reducing costs and improving performance in our upstream businesses. Although aluminum prices are down, the fundamentals of the aluminum market remain sound with strong demand and tight supply, and Alcoa is successfully capitalizing on accelerating demand in high-growth end markets such as aerospace and automotive."

On that note, the company's aerospace segment is expected to grow on the year by 14% as Kleinfeld also indicated an existing backlog with Boeing ( BA) as well as Airbus that will help spur the company's growth.

Will this be enough to consider taking a position in the stock at the moment? Another important question to ask is, how long am I willing to wait?

The company's management deserves a considerable amount of credit here for continuing to make the best out of a bad situation, particularly by focusing on its downstream business where it showed a considerable amount of improvements. But the question is will these improvements be enough to light a fire under the stock? At this point I will have to say no.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Richard Saintvilus is a private investor with an information technology and engineering background and has been investing and trading for over 15 years. He employs conservative strategies in assessing equities and appraising value while minimizing downside risk. His decisions are based in part on management, growth prospects, return on equity and price-to-earnings as well as macroeconomic factors. He is an investor who seeks opportunities whether on the long or short side and believes in changing positions as information changes.

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