All's Not Well With Alcoa


Question: When is a 27% increase in sales, and a doubling of profits, bad news?

(A) When Wall Street wanted to see profits rise even higher.
(B) When the profits are bunk.
(C) When it's Alcoa doing the reporting.
(D) All of the above.

If you circled (D), go to the head of the class. It's too early to say how investors will react to Alcoa's (AA) news today, or whether they'll take the news as an indication of how other metals makers such as U.S. Steel (X) and Nucor (NUE) will perform when they report later this month. (Alcoa shares did decline modestly in afterhours trading last night.) If you ask me, the news was not good.

Alcoa's headline issues
As we pick apart Alcoa's earnings, the first sign of trouble is in big, bold headline type: Alcoa misses earnings estimates. Wall Street analysts were looking for Alcoa to deliver $0.34 per share in second-quarter profits. The best Alcoa could dig up was $0.28 and a few pieces of pocket lint.

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Sure, Alcoa beat on revenues. $6.6 billion in quarterly sales outpaced even the most optimistic analyst estimate, which had said the company might do $6.55 billion in business. Alcoa beat that number by a cool $50 million, and CEO Klaus Kleinfeld told investors to expect 12% demand growth this year, and 100% growth through 2020.

But that's good news, right? In Alcoa's case, not really.

The uptick in sales would be good news, if Alcoa showed any indication of being able to profit from the trend. It doesn't, and that's the problem.

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Alcoa's profit problem
Sales may be going gangbusters -- up 24% in the first half. But so far this year, Alcoa has improved its cash from operations by less than 13%, while capital spending rose nearly 10%. The net result is that through the first half of this year, Alcoa managed to generate only $86 million worth of free cash flow. That's better than the $65 million Alcoa squeezed out in H1 2010 -- but a far cry from the $743 million in profits the company crowed about last night.

I wish I could tell you this was an aberration. I wish I could say "all's well at Alcoa." But the truth is that over the past five years, this company has burned through $2.3 billion in negative free cash flow ... all the while reporting $3.8 billion in net profit. Perhaps the saddest thing of all about yesterday's news is that it's not really news at all. It's just par for the course at Alcoa.

Motley Fool contributor Rich Smith does not own shares of, nor is he short, Alcoa. You can click here to see his holdings and a short bio.