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Is the Dow Making a Mistake in Giving Alcoa the Boot?

By Matthew DiLallo - Sep 13, 2013 at 2:00PM

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Alcoa is losing its spot as a Dow 30 stock. That doesn’t mean the company is finished.

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It's a bittersweet week for those of us with ties to the City of Pittsburgh. The iconic Dow Jones Industrial Average announced a sweeping change to the markup of its 30 stock index. Among the three stocks it's cutting loose is one of Pittsburgh's own: Alcoa (AA). For a city that has been through a lot over the decades, it was just one more reminder that the economy of the past isn't what will drive the future. On a more positive note, at least the Pirates are finally thriving, having secured the first winning season since 1992.

For Alcoa, the move by the Dow marked the end of an era. The aluminum giant had been a member of the index since 1959. However, it's a move that isn't surprising given how much the company has suffered since the financial crisis. In one sense, the move is merely confirming what we already know: Alcoa isn't as reflective of the overall economy as it once was. While the economy has steadily recovered, Alcoa simply has never regained its footing.

That being said, this isn't a company whose best days are completely in the rear view mirror. In fact, Alcoa just might be on the cusp of a new phase in aluminum demand growth. Because of the trend toward fuel efficiency brought on by an aggressive change in CAFÉ standards, Alcoa really could be in the driver's seat to benefit from increased future demand.

A recent study shows that an all-aluminum vehicle can reduce its total body weight by 40%, which provides an 18% boost in fuel economy over a comparable steel based structure. The auto industry is really starting to take notice. For example, Tesla's (TSLA 4.67%) red-hot Model S boasts of an all-aluminum body. Not only is the all-electric car producing stunning performance, but it also received one of the highest safety ratings ever from the National Highway Traffic Safety Administration. That's because, pound-for-pound aluminum can absorb twice as much crash energy as steel.

Aluminum is also starting to really catch the eye of Ford (F 2.21%), which is considering using liberal amounts of it to build the next generation models of its F-150 and Mustang. Not only would replacing steel with aluminum boost fuel economy, but it would also increase performance and safety.

Because of this, Alcoa sees its automotive aluminum sheet sales tripling by 2015. Most of that move will be because mass market producers like Ford are seeing the benefit of switching to aluminum for the body of the vehicles it makes. Overall, Alcoa sees the use of aluminum auto sheets for vehicle bodies quadrupling to 420,000 tons by 2015. That's in addition to a 15% increase in aluminum used elsewhere in the vehicle to a total of 2.66 million tons by 2015. While auto currently makes up just a tiny slice of Aloca's sales, this growth is still encouraging. 

Clearly, the automotive industry is key to driving Alcoa's future performance. That being said, whether Alcoa is in the Dow doesn't really matter. Sure, it was a nice little feather in its cap, but its long-term future isn't tied to what index it's in, but instead its business prospects. Right now, the potential future growth thanks to the increased usage of aluminum by the automotive industry is a real catalyst to fuel Alcoa's growth. So, like the Pirates, it appears that the future of this iconic Pittsburgh based enterprise is much brighter than its recent past.

Matt DiLallo has the following options: long January 2014 $10 calls on Ford and short January 2014 $10 puts on Ford. The Motley Fool recommends Ford and Tesla Motors. The Motley Fool owns shares of Ford and Tesla Motors. 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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