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Should You Buy Beaten-up Alcoa?

Alcoa (NYSE: AA  ) , the largest producer of aluminum in the U.S., was once a bellwether with a $40 billion market capitalization whose quarterly performance gave us a real sense of economic conditions at home and abroad.

Today, however, the company's market cap has plummeted to $8.5 billion, and its chief function as an economic gauge relates to its traditional role as the first component of the Dow Jones Industrial Average to tell us about its quarter. Following the market close on Monday it again performed that function, providing some optimism about what may be in the offing for others that will report behind it.

The numbers
Alcoa recorded a quarterly loss of $119 million, or $0.11 a share. However, excluding items, the company earned $0.07 per share, a penny higher than the consensus expectation among the analysts who follow it. Total revenue was $5.85 billion, down slightly from the $5.96 billion for the second quarter of 2012.

A portion of the one-time items -- $62 million -- involved reserves related to Department of Justice and Securities and Exchange Commission investigations into alleged corrupt payments in the sale of alumina in Bahrain. Management noted that a settlement of the Justice Department's charges could cost another $200 million. Beyond that, in an attempt reduce its costs, Alcoa took charges associated with shuttering a smelter in Italy and closing a pair of lines in Quebec.

As to the company's segments, far and away the pack horse for the company was its engineered products and solutions business. The unit turned in $193 million in operating earnings, up 23% from the second quarter of 2012.

High demand, but higher supply
Management continues to anticipate solid 7% growth in overall global demand for its products for 2013. Specifically, the aerospace market is expected to require 9%-10% more aluminum, while automotive demand will likely be up by 1%-4%, commercial transportation by 3%-8%, packaging by 1%-2% building and construction by 4%-5%, and industrial gas turbine manufacturing by 3%-5%.

Despite this relatively rosy demand scenario, Alcoa's average prices realization slid by 4% year over year. The culprit: increased worldwide production, including a doubling of output from China during about the past half-dozen years.

Alcoa has wrapped up -- or is completing -- expansions of facilities in the U.K., outside Pittsburgh, and in Indiana. In addition, it has announced planned three-year expenditures of about $275 million to expand and upgrade capacity at its Alcoa, Tenn., rolling mill. That project relates to demand from increased automotive production.

In summing up his company's quarter, CEO Klaus Kleinfeld said: "Our business showed remarkable operating performance in the quarter with solid free cash flow. In our value-add businesses we reached another milestone with record profitability in our downstream business, while acting decisively to defy the headwinds of falling metal prices in our upstream businesses."

Better approaches to aluminum
With its quarterly results out of the chute, then, the question becomes whether Alcoa's shares constitute appropriate additions to Foolish portfolios. My reading, despite admittedly owning the stock, is that they do not.

Were I looking at the company anew, I'd be put off by product price declines, the ongoing federal investigations, the likely need for additional downsizing and cost cutting. And then there's the substantial expansion in global aluminum supply.

Conversely, smaller Kaiser Aluminum (NASDAQ: KALU  ) produces more specialty products, is close to being debt free, and generates an operating margin nearly four times that of Alcoa. Further, the California-based company has been accorded a consensus buy rating by the analysts who follow it, against a hold for Alcoa.

Alternatively, I'd look closely at Rio Tinto (NYSE: RIO  ) , the Anglo-Australian mining giant, which is nearly nine times the size of Alcoa, and generates an operating margin more than seven times Alcoa's. In addition to being a major factor in aluminum production -- having snatched Canada's Alcan from Alcoa's grasp several years ago -- Rio produces an array of minerals and metals, including copper, molybdenum, diamonds, iron ore, coal, and precious metals.

It thereby enjoys some protection from sliding copper prices. The company's PEG ratio is a compelling 0.47, and its indicated forward annual dividend yield currently is and attractive 4.60%.

Foolish takeaway
So, while Alcoa kicked off earnings season by slightly topping the analysts' expectations, there clearly appear to be more appropriate options for Fools with an interest in aluminum manufacturers.

Maybe your interest in focusing on high-yield stocks relates to concern about the currently volatile market. If so, as is discussed above, you may have more reason to examine attractive mining giant Rio Tinto. Indeed, if you're even remotely on the lookout for high-yielding stocks, The Motley Fool has compiled a special free report outlining our nine top dependable dividend-paying stocks. It's called "Secure Your Future With 9 Rock-Solid Dividend Stocks." You can access your copy today at no cost! Just click here.

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Related Tickers

9/28/2016 4:00 PM
AA $9.88 Up +0.23 +2.38%
Alcoa CAPS Rating: ***
KALU $88.22 Up +2.78 +3.25%
Kaiser Aluminum CAPS Rating: ****
RIO $33.74 Up +1.51 +4.69%
Rio Tinto CAPS Rating: ***