Alcoa has been around for 120 years. Its main business is in the production and sale of aluminum. They have over 100,000 employees in 44 countries. They are the world leader in production and management of aluminum. They are very diversified. This is important so that if one area of the world or one industry has problems then AA would be in trouble. But if they sell products to many industries in many countries, then the risk is mitigated – if one country or industry has problems, it is only a mall portion of AA’s business. Here are some of the locations they sell to and some of the people who buy their products:
–They sell to: N America (55%), Europe (25%), Pacific (14%), S Amercia (6%)
–They sell to many established companies: Airbus, Toyota, ExxonMobil, Lockheed Martin, Nissan
–They sell to many industries: Aerospace, Automotive, Building and Construction, Commercial Transportation, Industrial Markets.
They were also named one of Most Sustainable Corporations in the World at the World Economics Forum in Davos, Switzerland (2007). Why is that important? Because, many companies come up with something that gets them a lot of sales and a lot of profit for a few years. One example is Crocs – you know those weird sandals that come in many different colors and cost $30. I would say that their sustainability is very low. A stock only goes up if they can raise their profits. And I don’t think Crocs can raise their profits for too many years after their initial product push. You already see spin off versions of their shoes for half the Crocs’ price. And they are not going to be able to branch out their business very easily. They can’t very well go into the food industry or the clothing industry. There is just nowhere for them (and many other companies) to grow their profits. Most companies are not very sustainable. But AA is.
Another thing that would be important to know is the future demand for aluminum. If the world isn’t going to be needing much aluminum in the future, then that would be bad for AA. For the last 30 yrs there has been a 3.3% per yr increase in demand. And for the next 20 yrs, it is predicted that demand will grow by 3.7% per yr. Most of this growth will come from Eastern Europe, India and China. China’s growth is expected to go from 7 kg per capita per yr to 25 kg per capita per yr – a growth of 400%. The chart here is the development (blue) and expected development (red) from 1980 to 2030 of aluminum consumption in kg per capita.
If you’ve never read an annual report it is something you ought to do. The 2007 Alcoa Annual Report can be found here. There is a lot of useful stuff in there. It tells about all the products/countries that use their aluminum. Pretty interesting stuff: from futuristic fighter planes to Chinese buses to American sports cars to Australian wine caps. And if you don’t want to read the accounting mumbo jumbo, then just look at the first 20 pgs or so.
High points from AA Income Statement
1 ) Net Income rose by 15% in 2007. And it did this while sales were flat from 2006 – more efficient operations. This means that they were much more efficient. Not many companies can grow profits 15% while their sales are flat.
2 ) Employees decreased by 13%. They realize that they need to do more with less and hold their waste down. This is probably where a large chunk of their profit growth came from (reducing costs).
3 ) Dividends paid increased by 13%. They paid out $0.60 per share in 2006 and $0.68 per share in 2007. That is good growth. Their yield is 2.1%. Their payout percentage is 28% (they pay out 28% of their profits as dividends).
4 ) Book Value increased by 15%. Book value is a company’s assets minus liabilities (which equals its shareholder equity). So if a company sold all of its assets and then paid all of its liabilities, then took that amount and divided equally among all shares, that would be the book value of each share. Warren Buffett posts his increase in book value on the 2nd page of his annual report every single year to show his shareholders what he has done for them. As book value goes up, share price will inevitably go up.
5 ) Total Shareholder Return was 24% (stock appreciation + dividends) in 2007. This far outpaced the market last yr.
6 ) Return on Capital = 13%. ROC is equal to (Net Income – Dividends) / Total Capital, so it is a measure of how efficiently a company uses its capital to produce profit. This is a very important metric to grade a company on. The magic number on return on capital (ROC) and return on equity (ROE) is 12%. You want to be above 12% for both.
7 ) Return on Equity = 16%. This is just as important as ROC. ROE = Net Income / Shareholder’s Equity. It reveals how much profit a company earns in comparison to the total amount of shareholder equity. If you, as an investor, bought a company for $100,000 and that company made $10,000 of profit in the first yr, you’d have an ROE of 10%.
8 ) Net Profit Margin = 8%. This is important as it shows how much sustainability a company has. If they are making a 1% profit, it is likely because there is a lot of competition in their industry/market. For comparison, Walmart’s profit margin is 3%. Its fairly easy to sell things in a retail space. Contrarily, it is fairly difficult to produce and manufacture aluminum.
9 ) Sales have grown by 9%/yr for last 5 yrs (50% in total). That is very good growth that will likely continue (based on increased demand).
10 ) Net Income has grown by 20%/yr for last 5 yrs (150% in total). This is huge. As profits grow (and net income is a Wall street’s phrase for profits; they are the same thing), stock price grows. And over the last 5 yrs, the stock is only up 20%. With profits up 150% and stock price up 50%, I think the stock is undervalued.
Couple others things worth mentioning:
1 ) AA has revenues of $30B per yr while the company is valued @ $25B. Other mining companies have much higher price/sales ratios. Price/Sales ratio (P/S) is simply the company’s price divided by the company’s sales (or revenues). CLF is a mining company and its P/S is 3.5. RIO, the largest mining company in the world has a P/S of 3.75. Given these examples, it makes no sense that AA P/S is 0.83.
2 ) The PEG of AA is 0.62. PEG is one of the measures Peter Lynch, arguably the greatest mutual fund manager of all time, used to pick his stocks. If you invested $1 in Mr Lynch’s fund, 12 yrs later he’d have given you back $27 (your $1 would have grown to $27). The PEG measure is P/E divided by the projected growth of the company. P/E is price of the stock deivded by earnings per share of the stock. In essence it is how much a dollar of profit costs. If the P/E is 10, then you have to pay $10 for the right to $1 dollar of profit. If the P/E is $40, then you have to pay $40 for $1 of profit. Mr Lynch liked PEGs of less than 1. And AA is significantly less than 1. The lower the number the cheaper the company is (the lower the better value).
Personal Disclaimer: I don’t own any shares of AA at the moment. If I had spare dollars laying around, I would buy some. I am fully invested most of the time.
Option play: I urge you to not get involved in stock options unless you are very knowledgeable, very speculative and very risk inclined. But for those of you brave souls looking to play in options consider the Jan 10 $25 Calls. If the stock price goes up 20% before Jan 10, you’ll make 33% in 18 months. The option would cost you $9/share and if the stock price (now @ $31) went to $37, you’d turn your $9 into $12 (buy @ $25, sell @ $37).
If you have questions, comments, thoughts on this, please post. Interested in your feedback.
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