Alcoa Passes This Key Test

There's no foolproof way to know the future for Alcoa (NYSE: AA  ) or any other company. However, certain clues may help you see potential stumbles before they happen -- and before your stock craters as a result. Rest assured: Even if you're not monitoring these metrics, short-sellers are.

A cloudy crystal ball
In this series, we use accounts receivable and days sales outstanding to judge a company's current health and future prospects. It's an important step in separating the pretenders from the market's best stocks. Alone, AR -- the amount of money owed the company -- and DSO -- the number of days' worth of sales owed to the company -- don't tell you much. However, by considering the trends in AR and DSO, you can sometimes get a window onto the future.

Sometimes, problems with AR or DSO simply indicate a change in the business (like an acquisition), or lax collections. However, AR that grows more quickly than revenue, or ballooning DSO, can also suggest a desperate company that's trying to boost sales by giving its customers overly generous payment terms. Alternately, it can indicate that the company sprinted to book a load of sales at the end of the quarter, like used-car dealers on the 29th of the month. (Sometimes, companies do both.)

Why might an upstanding firm like Alcoa do this? For the same reason any other company might: to make the numbers. Investors don't like revenue shortfalls, and employees don't like reporting them to their superiors.

Is Alcoa sending any potential warning signs? Take a look at the chart below, which plots revenue growth against AR growth, and DSO:

Source: Capital IQ, a division of Standard & Poor's. Data is current as of last fully reported fiscal quarter. FQ = fiscal quarter.

The standard way to calculate DSO uses average accounts receivable. I prefer to look at end-of-quarter receivables, but I've plotted both above.

Watching the trends
When that red line (AR growth) crosses above the green line (revenue growth), I know I need to consult the filings. Similarly, a spike in the blue bars (DSO) indicates a trend worth worrying about. As another reality check, it's reasonable to consider what a normal DSO figure might look like in this space.

Company

LFQ Revenue

DSO

 Alcoa

$6,585

28

 Century Aluminum (Nasdaq: CENX  )

$326

23

 Rio Tinto (NYSE: RIO  )

$15,684

24

Source: Capital IQ, a division of Standard & Poor's. DSO calculated from average AR. Data is current as of last fully reported fiscal quarter. LFQ = last fiscal quarter. Dollar figures in millions.

Differences in business models can generate variations in DSO, so don't consider this the final word -- just a way to add some context to the numbers. But let's get back to our original question: Will Alcoa miss its numbers in the next quarter or two?

I don't think so. AR and DSO look healthy. For the last fully reported fiscal quarter, Alcoa's year-over-year revenue grew 27%, and its AR grew 7.5%. That looks OK. End-of-quarter DSO decreased 15.3% from the prior-year quarter. It was down 4.8% versus the prior quarter. Still, I'm no fortuneteller, and these are just numbers. Investors putting their money on the line always need to dig into the filings for the root causes and draw their own conclusions.

What now?
I use this kind of analysis to figure out which investments I need to watch more closely as I hunt the market's best returns. However, some investors actively seek out companies on the wrong side of AR trends in order to sell them short, profiting when they eventually fall. Which way would you play this one? Let us know in the comments below, or keep up with the stocks mentioned in this article by tracking them in our free watchlist service, My Watchlist.

Seth Jayson had no position in any company mentioned here at the time of publication. You can view his stock holdings here. He is co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (14) | Recommend This Article (4)

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  • Report this Comment On August 05, 2011, at 11:18 AM, Brettze wrote:

    Seth, It is also important to know who is buying aluminium to make what... As you know , aluminium was invented just merely more a century ago. Copper was discovered thousands of years ago. Ditto for iron, gold, silver . I dont know about nickel . Molybdenum was discovered during the sixteenth centruy or something.. So from there, everyone should be aware that aluminium is among the newest metals in the block. Not only that, metallurgical research help find new uses for aluminium with new metallurgical processes. Take jet wings , The center portion of the wing , that is hidden in the fuselage is made by pressing aluminium with a huge press capable of exerting tens of thousand tons of pressure to squeeze aluminium into incredible strength. Recently, ALCOA discovered and patented Durabright that treat aluminium surface to make it so shiny and mirror like. You can find Durabright wheels in those 18 wheelers . Truckers love them for ease of cleaning without any need for polish agents.. All you need is water and soap and it shines like new . Durabright can be used for solar thermal energy which is still a dawning solar technology with great promises. As matter of factly, ALCOA already developed its own solar parabolic trough (apparently with use of Durabright) and have it tested and completed at NREL (National Renewable Energy Laboratory) www.nrel.gov. Automakers facing new requirements on CAFE (fuel efficiency) toward 2025 will start speeding up convering many steel parts to aluminium or other lightweight materials . As of now, just about 300 pounds of aluminium can be found in an average new automobile rolling off plants . If you add another 100 pounds, this should be more than enough to empty the warehouses of excess aluminium littering all around the world just for that. So if you choose to examine numbers in ALCOA balance sheets alone, you are still as clueless as ever.. Not to mention that it is a very dull and boring ( Warren Buffet style) exercise... I prefer to look at more colorful and storyful information on stocks over the dry numbers.. No wonder, our economy really sucks because investors are too focused on numbers. Get out and see the world and figure out what we really need to improve our own lot ... Just stop being coin snatchers , please!! Bzzzzz!

  • Report this Comment On August 05, 2011, at 11:30 AM, Brettze wrote:

    ALCOA IS MENTIONED AS HAVING PENSION LIABILTY ISSUES OF LATELY. It is already huge. General Motors chose bankruptcy to get around similiar issues . ALCOA had set aside hundreds of millons for pensions in recent years which is already troubling.. Unless aluminium prices climb sufficiently to help cover it, ALCOA will keep running into earning disruptions or eventual bankruptcy . Industrial heavyweights are manipulating aluminium prices mightly to keep aluminium producers under thumbs.. China was apparently encourged to remain self sufficient in aluminium with imports of American produced coal from Australia and Wyoming. Most of China aluminium operations are not making money but China know that if it shut them down, aluminium prices will skyrocket. Now, China is complaining about lending money to us... We borrow money from China because we are not able to sell aluminium to China because coal companies beat us to it.. how is that for a really interesting story????? Numbers?? blaahhh!

    Dirty business tricks , yeah!!

  • Report this Comment On August 05, 2011, at 11:41 AM, Brettze wrote:

    Also, if you remember Jack Welch and General Electric .. Those years !! General Electric exploded with earnings year to year ,, how?? Cheap metals!! Molybdenum were stuck at $3 a pound for years and years , so were nickel and copper... You know about aluminium, too.. Aluminium is used to make gas turbine blades which GE is famous for making gas turbines.. GE used copper to make motors and generators. Nickel and molybdenum can be found in almost everything GE makes and sell. Jack Welch is no genius ... Even that, Jack Welch sold Utah International , a very profitable mining company during the 1980's because he apparently knew that metal prices were going to be fixed which is very good for industrial heavyweights like GE itself... It had been a great merry go round for years and years until around 2000 when copper prices finally skyrocketed along with moly and nickel. there were take overs and acqusitions.. Freeport swallowed Phelps Dodge who just swallowed Cyprus Minerals who swallowed AMAX in a span of a decade or so.. INCO disappeared somewhere! ALCOA used to be the biggest metal company in America but no longer , thanks to low prices for aluminium still stuck in the still waters.. Now, you still bother to examine 45 year old balance sheets of ALCOA that is in need of upgrading to today's real inflation rates.. It is like buying gasoline at $1.20 a gallon , heck, how we wish we still can.... How much higher should aluminium prices go? it is such that supply and demand no longer apply to aluminium these days.. It no longer matter that there is still 5 millon tons of excess shiny aluminium ingots lying aroundin warehouses...It is the cost of making new aluminium that is being hidden and taken away from the balance sheets somehow.. ALCOA is sitll a big liar's story so far... How I really love aluminium and the stuff it is made in. It is a great metal . Our economy can really grow again with aluminium.. Warren Buffet , is it really hard to understand aluminium?? I am so ashamed of you, WB!

  • Report this Comment On August 05, 2011, at 11:43 AM, Brettze wrote:

    Now,, I have good reasons to believe that you with your accounting acumens, should begin examining ALCOA for possible bankruptcy.... instead of making fake glowing stories about ALCOA

  • Report this Comment On August 05, 2011, at 11:50 AM, Brettze wrote:

    ALCOA SKIDDED 10% YESTERDAY.. as if everyone is cringing the neck of ALCOA in efforts to make it die and taken off DJIA!! Enviromentlaists incessentaly lambasted ALCOA for the huge amounts of electrical juice it takes to make new aluminium while ignoring China still producing close to half of the world aluminium annually... We are exporting coal to China to enable China tokeep operating its vintage pre WWII aluminium plants.. All of sudden, carbon emissions is all forgiven and forgotten for China .. Did I use any numbers ??? none whatsoever... The question is whether you and others are prepared to allow aluminium to catch up with the rest of the metal pack already gone up in prices inflation wise.. So, if ALCOA can get a modest $3 for every pound it makes ... Revenues and earnings will skyrocket . It isnot hard to figure how far ALCOA stock can go.. The trouble is that ALCOA is a huge aluminium company churning out close to 10 billon pounds of sparkling aluminium no body wants... even at $1.20 a pound... Now everyone is complaining about jobs yet not knowing what to do with the idle aluminium inventories lying all over !! 5 or 10 millon tons or 20 billon pounds .... Iam really stratching my head so hard , I have open wounds on my temple already!!

  • Report this Comment On August 05, 2011, at 12:01 PM, Brettze wrote:

    Did you know that ALCAN, now a Rio Tinto subdivision, used to be part of ALCOA back in the 1950's before anti trust ligations that forced ALCOA to break up like ATT was later on... We had ALUMAX, REYNOLDS METALS that ALCOA bought back recently. ALCOA sought after ALCAN only to be beat by Rio Tinto by 10 billon dollar difference in bid. Rio Tinto lavished billons on ALCAN shareholders while ALCOA shareholders got nothing but a lousy high of just $45 a share back in 2006. now analysts are circling ALCOA as a potential take over company at $22 a share.. whatever happens its old high of $45???? Is it because of looming pension liablities or is it because of DEPRESSED ALUMINIUM PRICES ?? 99 out of 100 investors would not want to see aluminium prices catch up with the rest of the metal pack becaue of what the other metals already did to the industrial heavyweights like GE, Boeings, Ford Motors, Coca Cola... GE is limping along not because of Jeff Immelt but because of $5 copper, $12 nickel, $20 molybdenum and despite $1.20 aluminium... I can imagine how higher aluminium prices can easily tank the industrial heavyweights earnings...Whether ALCOA get bankrupted or not, aluminium prices is going to go up , anyway. So why treat ALCOA sharehlders so rottenly?? Are we trying to outwait them orwhat?? Sure our economy sucks but we continue to take aluminium prices for granted... It skewered every industrial heavyweight 's balance sheet.. Unions based their unreasonable demands on cheap metal prices .. Looknow, all messed up as metal prices skyrocketed.. Aluminium has been America's saving grace long enough ... Time to jack up aluminium prices now... and be noted!

  • Report this Comment On August 05, 2011, at 12:04 PM, Brettze wrote:

    UAW are talking about profit sharing withautomakers while ignoring the depressed aluminium prices that are being unfairly taken advantage of... UAW lose jobs becuase they built up toomuch demands based on cheap metals even steel ... China used to dump steel here in America to the delgiht of automakers and UAW themselves until Presiodent Bushsigned inlaw to limit orhalt China steel dumpings and Koreas, too. This is what led Detroit down intothe cesspools. People dont appreciate the real values of metals especially aluminium... Aluminium is a big metal market with 80 billon pounds in annual production towering above all other metals... Because of depressed prices, aluminium isnot noticed as muchas supposedly.. Once prices triple or quadruple, we will notice aluminium !!

  • Report this Comment On August 05, 2011, at 12:06 PM, Brettze wrote:

    I couldnt care any less about financial consquences for the industrial heavywieghts of the world because aluminium prices isstill too depressed at 2011 prices. same as in 1980 or before even less if taken in real dollars... Come on, dont bohter with your accounting ... just (expletively said) buy ALCOA!

  • Report this Comment On August 05, 2011, at 12:06 PM, Brettze wrote:

    YOU ARE ALL BIG LIARS IN OPEN BLUE SKY!!

  • Report this Comment On August 05, 2011, at 12:13 PM, Brettze wrote:

    depressed alumiium prices is a big lie that we are led to believe and love... We foolishly avoid creating jobs that will consume aluminium out of sheer fear that aluminium prices will skyrocket. How many jobs are not created is never mentioned .. or ignored... We are watching monthly reports on jobs or unemployment and fret about how bad they are.. Industrial heavyweights avoid creating more jobs that will do nothing but hurt their bottom lines.. due to skyrocketing aluminium prices that is certain tohit.. We are in a constant paralysis when it comes to create jobs because aluminium is way underutilized and we want to leave it that way to great costs to job creation... We chose to consume more gasoline than to conserve gasoline and energy withincreased usage of alumiium that can do that.. We still are too paralyzed to start thinking about reallocating some of our investments away from fossil fuel assets toward far more sustainable alternate energy assets that willalmost certainly require increased aluminium consumption.. we still see no reason to do so as long as we still consider fossil fuel assets to be very ultra conservative investments sowhy risk ourselves for sake of creating new jobs ? We are walking around with missing heads lying somewhere.. fretting around.. It is not politics,, it is the stupid economy as ususal...

  • Report this Comment On August 05, 2011, at 12:22 PM, Brettze wrote:

    We chose to increase coal productin to help sooth the irriating threats of gyrating oil and natural gas prices at great costs to global climate issues.. We are still not solving the global climate issues at all. Pretty apparent to my eyes!! We dodge global clmate issues despite what Al Gore tried to accomplish with his film "Inconventional Truth".. We were excited aboutthe film yet we donothing about China and India consuming ever more coal every year... Coal plants are still built every week... We were quick toforget aboutcoal ... We are still sokeyed up about aluminium and how much electricity it requires to make aluminium while ignoring how much less electicity it requres to recycle aluminium going forward.. Aluminium will save us far more energy than steel because steel uses as much energy to make new or to recycle... Steel melts at much higher temperatures than aluminium, yet aluminium can replace steel is so many products .. We still fail to replace ... We are so shortsighted about the future sustainable benefits of aluninium while Rio Tinto and BHP is still making obscene profits on iron and steel it mines and sell tothe world While ALCOA is still struggling along without giventhe chance to make great contribution to our economy... ALCOA is intentionlally restricted for very wrong politcal intentions.. Enviormentalists are very misguided about aluminium. Solar energy can grow and prosper with aluminium yet we chose to stick to obsolete and inefficient silicon to make photovoltaics which will never contirbute as much solar energy as aluminium can ... We are not going to help our economy wtihout increased aluminium consumpiton, simple as that... Aluminium is a very verstalile metal!! Why the delay tactics ??

  • Report this Comment On August 05, 2011, at 12:24 PM, Brettze wrote:

    Our economy is already geting worse and worse while we leave aluminium lying unused... See the parallel?? What a disgusting story!!

  • Report this Comment On August 05, 2011, at 12:25 PM, Brettze wrote:

    Our economy is doomed withoutaluminium! period!

  • Report this Comment On August 05, 2011, at 12:27 PM, Brettze wrote:

    If my comments above really turns you all off and make you stop considering buying ALCOA shares. This is still fine with me... Chances are that youwill getsucked into other bad unrelated events simply because of your stupidness..

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Related Tickers

4/23/2014 4:00 PM
AA $13.63 Up +0.12 +0.89%
Alcoa, Inc. CAPS Rating: ****
CENX $13.80 Down -0.20 -1.43%
Century Aluminum C… CAPS Rating: **
RIO $54.67 Down -0.30 -0.55%
Rio Tinto plc (ADR… CAPS Rating: ****

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