Detroit Has Good News for Alcoa

Recent reports on U.S. auto sales have shown that cars and light trucks are selling stronger than they have since 2007; that is great news for Alcoa because it will benefit from the increased demand for aluminum. Increased demand from the U.S. automotive sector is accounted for the company's most recent earnings release, but to see these numbers come to fruition, as well as show more strength than expected, is encouraging. Also important is the fact that numbers from both General Motors and Ford show that demand is widespread and solid for both brands.

By the numbers
When Alcoa released numbers earlier in July, the company said that it believed automotive demand would rise by 1%-4%, but in the U.S. that demand would be more likely in the 2%-5% range. Almost a month later, with the auto industry putting up very strong numbers, those estimates may prove conservative. Autodata recently revised its estimate for light-vehicle sales in July to 15.8 million, while Ward's Automotive Group pegged sales of cars and light trucks at 15.6 million, down a bit from the posted 15.9 million sales in June. The latter represents the strongest back-to-back readings since late 2007.

Looking more granularly, GM posted a sales increase of 42% for small cars in July and 44% for full-sized pickups. Ford's small car sales rose 32%, growing faster than the 23% for the F-Series pickups. The broad growth for both companies is important because it suggests a reemergence of wide demand for American autos. Where the Big Three had largely been pigeonholed as good at making trucks and little else, Consumer Reports magazine recently gave high marks to the Chevy Impala, calling it the best sedan in the U.S.

F Chart
F Chart

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Japanese automakers have continued to sell strongly as well, which is positive for Alcoa's global demand. Auto sales have climbed at least 10% in each of the last three years, suggesting that the trend will continue. Still, it is important to remember the importance of China to the Alcoa story. Chinese demand in the automotive sector is expected to grow at an impressive 7%-10%, meaning that the health of the Chinese economy is still a critical factor for Alcoa.

Is it time to buy Alcoa?
While the news for the aluminum maker is positive, it is hard to get fully behind the stock relative to more diversified plays like BHP Billiton. Alcoa is still trading at 67 times earnings, while BHP has a P/E of 17.6. BHP has an operating margin of 30%, relative to Alcoa's 3%, and at a time that commodities have seen considerable pressure, BHP carries a dividend yield of 3.6% relative to Alcoa's 1.5%.

AA Chart
AA Chart

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The news from Detroit is bullish for Alcoa, but it needs to be kept in context. I believe the stock is still expensive, making it acceptable as a long-term speculative play. In the immediate term, BHP looks like a better bet, as do both Ford and GM on the continuing strength of their respective recoveries.

For Alcoa and the broader auto market, the role of China is key. China is already the world's largest auto market -- and it's set to grow even bigger in coming years. A recent Motley Fool report, "2 Automakers to Buy for a Surging Chinese Market", names two global giants poised to reap big gains that could drive big rewards for investors. You can read this report right now for free -- just click here for instant access.

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Fool contributor Doug Ehrman has no position in any stocks mentioned. The Motley Fool recommends Ford and General Motors. 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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