Why Alcoa Inc's Positive Momentum May Just Be Getting Started

Even though Alcoa's stock price is at multi-year highs, its prospects for future growth mean the rally is entirely justified.

Jul 10, 2014 at 2:22PM

Shares of aluminum giant Alcoa (NYSE:AA) rallied after posting better-than-expected quarterly earnings. The stock has been on an absolute tear, nearly doubling in price over the past year. This includes a roughly 5% jump after reporting second-quarter earnings that handily beat average analyst estimates. Management's sharp focus on cost controls is clearly paying off, and there are positive business developments that bode well for the future.

One promising catalyst for Alcoa is an emerging partnership with Ford Motor Co. (NYSE:F) that could very well pave the way for better days ahead.

Still, with Alcoa's stock price sitting at a level not seen since 2011, there may be reason to curb your enthusiasm. After all, these are far from glory days for the aluminum industry. While some key markets, like automotive, are recovering along with the global economy, others, like housing, are taking longer to recover.

Add it all up, and it might seem like Alcoa faces a mixed picture. But the company is doing all the right things, like cutting costs and strengthening the balance sheet. The end result is that while Alcoa's not fully out of the woods yet, it's getting closer by the day.

Cost controls key for the quarter
First, the details of Alcoa's earnings beat. The company posted a quarterly net profit of $216 million, or $0.18 per share. This handily beat estimates, which called for just $0.12 per share in quarterly profit. Revenue was about flat versus the same quarter last year. What really paid dividends for Alcoa is its ongoing cost reduction program. Every one of Alcoa's business segments were profitable last quarter, which reversed the $178 million loss the company posted in the same quarter of 2013.

Management has taken great strides to transform Alcoa's cost structure and dramatically improve the balance sheet. The focus on cost reductions delivered $302 million in productivity gains just last quarter. As a result, the company is ahead of schedule to meet its full-year forecast for $850 million in productivity gains.

Alcoa is also busily fortifying its balance sheet by paying off debt and raising cash. The company ended the quarter with the lowest net debt since 2007. And, Alcoa now has $1.2 billion in cash on the books, which will provide a nice margin of safety. This is nearly double the amount of cash Alcoa had on hand just at the end of the last quarter. That's especially important for a cyclical company such as Alcoa.

Looking ahead, management had good things to say about the economic conditions of the industry. Aluminum prices recently hit a 13-month high. And, Alcoa expects global aluminum demand to rise 7% this year, thanks to strength in several key markets. One such market is automotive, where car makers are increasingly turning to aluminum.

Green shoots are budding
For example, earlier this year Ford announced its new line of pickup trucks will feature an aluminum alloy that results in lighter vehicles and greater fuel efficiency. Its 2015 F-150 line will employ what Ford labels a 'military-grade aluminum alloy' in the body and bed. The 2015 model will weigh 700 pounds less than its predecessor, and the new aluminum alloy is more easily recycled. This means greater fuel efficiency and minimized waste.

This should be a direct benefit to Alcoa, which projects aluminum use in automotive parts will double by 2025.

It seems as though Alcoa's momentum is unstoppable. Since getting booted from the Dow Jones Industrial Average, Alcoa is having the last laugh as its share price has almost doubled in just the past year. Management's laser-like focus on cost controls is really paying off, and several of the company's key markets are looking strong. In addition, higher demand from automakers as a result of increased aluminum usage in vehicles represents a solid forward catalyst.

As a result, while it's easy to be scared off by Alcoa's dramatic rise in share price over the past year, it's not as if the rally is unjustified. Alcoa's fundamentals are improving with each passing quarter, and based on everything coming from management, the future looks bright.

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Bob Ciura has no position in any stocks mentioned. 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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