Why Alcoa Inc Is Actually Starting to Turn Around

Alcoa’s earnings surged past Wall Street’s expectations as its key investments are paying off.

Apr 10, 2014 at 9:55AM

Alcoa

Earlier this week Alcoa (NYSE:AA) reported first-quarter results that surged past analysts' expectations. After stripping out special items the company earned $0.09 per share, which was nearly twice the $0.05 per share analysts expected the company to earn. It was a sign that the company was actually starting to turn around as investments at its higher-margin businesses are really paying off.

Shifting gears
CEO Klaus Kleinfeld was quoted in the company's earnings press release saying that Alcoa's "transformation is accelerating." Specifically he noted that the company was "powering growth in our value-add business and aggressively reshaping our commodity business." That transformation is having dramatic results.

While the company took $276 million in special items on the quarter, those charges were largely related to reducing the capacity of its commodity-based smelter and rolling mills. In fact, since 2007 Alcoa has reduced smelting capacity by 28%. That said, while the company has reduced its investments in its commodity-related segment, it has shifted those investments to grow its value-add segments.

One of the segments receiving investment dollars is its automotive business segment. These investments are paying off as the company saw record auto revenue in the first quarter. That revenue is only expected to keep growing as the company commissioned its new $300 million Davenport, Iowa, automotive expansion, which will supply aluminum sheet products to the automotive industry.

Looking ahead Alcoa sees overall demand for aluminum in vehicles to nearly double by 2025, while the amount of aluminum body-sheet content is expected to quadruple by 2015 and increase tenfold by 2025. This is because automakers like Ford (NYSE:F) are increasing the amount of aluminum in order to bring down vehicle weight. Ford's 2015 F-150, for example, will be 700 pounds lighter thanks to extensive usage of aluminum. That weight reduction is critical to improving the fuel efficiency and performance of Ford's next generation F-150. Because of demand growth from companies like Ford, Alcoa's auto sheet sales are expected to surge from $330 million this year to $1.3 billion by 2018.

Images

Photo credit: Ford Motor Company 

A growing value-add portfolio
Last year Alcoa produced $13.1 billion in revenue from its value-add segments. That revenue is only expected to grow in the future. While the automotive segment will be a big driver, it's just one of four segments Alcoa sees driving revenue growth. As the following slide shows, aerospace, commercial transportation, and packaging will all enjoy single-digit compound annual growth through the next few years.

Alcoa Value Add

Source: Alcoa Investor Presentation (link opens a PDF

Aerospace is particularly exciting given the 7.5% compound annual growth Alcoa sees that segment delivering over the next few years. Its balanced portfolio of innovative fastening systems, high performance engine investment castings, and advanced aerospace structures has the company well positioned to capture the growth in aerospace.

In addition to aerospace, Alcoa is literally reinventing the wheel for its commercial trucking customers. Its new Ultra ONE wheel is 47% lighter than the average steel wheel and 18% lighter than the average aluminum wheel while still being 17% stronger. It will help rigs save 1,400 pounds, which will enhance fuel efficiency as well as enable rigs to increase the payload. Best of all, replacing 18 steel wheels will reduce the carbon dioxide emissions of a rig to the point where it can offset the annual carbon footprint of an average family of four. In addition to the Ultra ONE, Alcoa's Dura-Bright EVO wheel is another important innovation. It never loses it shine as it is a 10x improvement in corrosion resistance. Needless to say, these innovations will be driving Alcoa's transportation segment for years to come.

Investor takeaway
Given aluminum's strength and its lightweight properties it looks like the perfect metal to lighten everything from vehicles to aircraft in order to increase performance and fuel efficiency. The company's focus on investing in its value-add segments that take advantage of aluminum is really beginning to pay off as the company is starting to deliver stronger profits. Because of that, Alcoa's business really looks like it's heading in the right direction.

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Matt DiLallo has the following options: long January 2016 $10 calls on Ford. The Motley Fool recommends Ford. The Motley Fool owns shares of Ford. 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.

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