Why You Should Be Optimistic About Alcoa's 4Q

Alcoa (NYSE: AA  ) reported its 4Q and full-year 2012 results yesterday. Although they more or less met expectations, there was enough in the company's report for to cheer formerly gloomy investors. In the last few years, Alcoa's results and its stock have been hammered by market oversaturation, low commodity prices, and costs that were too high to make a meaningful profit. This most recent quarter and the company's outlook provide good reason for optimism about Alcoa, albeit of the cautious variety.

Welcome back to profitability
Alcoa posted sales of $5.9 billion for the quarter, for a convincing beat on the $5.6 billion expected by analysts. To everyone's relief bottom line was safely in the black at $242 million, against a loss of $191 million in 4Q 2011. Even when counting one-time gains, the company still made a profit of $64 million.

It's particularly good when a materials giant like Alcoa brings in more revenue than anticipated. That's because it's so completely entwined with the prices of its chosen material; if demand is weak, no one's going to pay much for the good and results will suffer. That was the case with aluminum producers over the past few years, particularly when the aluminum-hungry Chinese economy started to cool.

For 2012, aluminum was on the down side of its cycle; 3Q of last year saw the metal hit a nearly three-year low, and not coincidentally Alcoa's revenues were the most depressed they had been in quite some time. Meanwhile, costs didn't exactly follow that trend, instead they moved higher, so the company ended up with a net loss of $143 million for the quarter.

Those first nine months of last year weren't cozy for anyone involved in the business; it was a period of slicing expenses and surviving, not growing. Alcoa's management promised a reduction in production capacity and overall costs. It made good on that commitment, finalizing the closure of an expensive smelter in Italy and selling its Tapoco Hydroelectric project, a set of dams and related assets located in Tennessee.

It wasn't alone in its actions last year. Rivals also put the brakes on their operations, with Rio Tinto (NYSE: RIO  ) taking an $8.8 billion charge on its aluminum assets, and BHP Billiton (NYSE: BHP  ) nixing an ambitious plan to build a new smelter in Congo.

The batten-down-the-hatches approach was the right one for the time; now, life seems to be getting better. Prices crept up in the final quarter of last year, nearly touching an average spot price of $1,999 per metric ton, or almost 4% better than in 3Q. It doesn't look like there will be as desperate a need to close smelters or book steep writedowns on inventory in the near future.

Charge of the Chinese
This has much to do with the recently improving economy in China. That country really matters for the aluminum business because it's far and away the top consumer of the metal -- it was responsible for 41% of the world's entire consumption in 2010, for example, more than three times the percentage figure for the United States.

When Chinese aluminum buyers smile, the industry gets happy. Alcoa is expecting grins this year; in a conference call announcing the company's results, CEO Klaus Kleinfeld said demand in that nation will grow by 11% this year, a nice improvement from the 9% of 2012.

On a global scale, the firm expects demand will advance 7% over the course of this year. Global prices should march along more or less in step with this; a poll of 20 industry analysts quoted by Bloomberg has it that the selling price will average $2,150 per metric ton in 2013. Those analysts are quite bullish on the immediate future, anticipating $2,292 the following year, and an even $2,400 in 2015.

Rapacious rivals, degraded debt
Alcoa has good reasons for optimism, but there remain some areas it's got to keep an eye on. That China market is big, juicy, and growing, but the company is hardly the only kid on that block. Among others, it's got a competitor in that nation's large Aluminum Corporation of China (NYSE: ACH  ) , which boasted nearly double the revenue of its American rival in its 3Q.

Speaking of balance sheet items, some of Alcoa's could be better. Last month, Moody's put the firm's debt under review for a downgrade, which means its rating might be cut to junk. The ratings agency was worried particularly about aluminum prices and their impact on the firm, so maybe that downgrade is less of a possibility now. Still, it's a concern, particularly in a business that needs so much capital and that typically borrows robustly to help fund it.

Nevertheless, investors were thirsty for some good news on the company and they got it. The industry's trying circumstances had been holding back Alcoa and its stock for quite some time, and for now it looks like those conditions are improving. That's reason enough to be be bullish on the company in this fresh new year.


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