Is Alcoa Out of The Woods?

To say it's been a brutal past few years for global aluminum producers would be putting it mildly. While the broader market, as measured by the S&P 500 Index, continues to shrug off macroeconomic concerns to set new highs, aluminum stocks such as Alcoa woefully under-perform.

With a fresh quarterly earnings report in the rearview mirror, investor eyes are now squarely focused on the road ahead and what the future may hold for the world's leading aluminum producer. Management is very optimistic about the company's trajectory, but investors are likely not as certain. With all this in mind, is Alcoa's future as bright as its leadership would have you believe?

A glance back, a look ahead
At the 2013 Bank of America/Merrill Lynch Global Metals, Mining, and Steel Conference earlier this year, Alcoa laid out its plan to reengineer growth and get its business back on track. A great deal of the company's strategy revolved around cost controls as a means of enhancing profitability.

Indeed, Alcoa has made great strides in getting expenses under control that are helping to boost profitability. Using a very disciplined cost focus, Alcoa has achieved productivity improvements in the amount of $1.3 billion between 2009 and 2012. Furthermore, the company is operating at a very high level of efficiency. Alcoa's EBITDA margin in the first quarter of 2013 stood at 21%, a historic high and all told, is 2.3 times the company's margin ten years ago. And, Alcoa revealed a joint venture in Saudi Arabia that is the lowest cost smelter and refinery in the world.

These cost control measures were the primary driver behind Alcoa's return to profitability in the third quarter. In all, Alcoa booked $0.02 per share in net profits, reversing a net loss on both a quarter-over-quarter and year-over-year perspective.

Smaller industry competitors, while under many of the same pressures as Alcoa, have nonetheless held up better in recent months. Kaiser Aluminum has actually grown diluted earnings per share by 1% through the first nine months of the year. Going forward, Kaiser management expects to see some improvement in efficiency in the fourth quarter, meaning profitability could be even stronger.

Cost controls aren't good enough
While investors should applaud Alcoa for producing profits in its most recent quarter, engineering profits through cost cuts alone aren't a viable long-term strategy. Sooner or later, the company needs to get revenue going in the right direction, which will be difficult given the tough pricing environment for aluminum. To be exact, aluminum prices on the London Metal Exchange declined 3% sequentially and 7% year-over-year.

Tough pricing was the main factor behind smaller aluminum producer Century Aluminum posting a net loss in both the second quarter and through the first half of 2013. Even though the company's revenue actually increased very slightly, the company's net loss expanded through the first half of 2013, year over year.

To be fair, Alcoa management reaffirmed its projections for global aluminum demand, which call for 7% growth for 2013. Growth is expected to be strong across several of the company's end markets, including aerospace and commercial building and construction, where global growth is projected to be at least 9% and 4%, respectively.

Capturing growth across its end markets, combined with further cost controls, are why management is confident that Alcoa is on track to meet its overarching goal this year, which is to be cash-flow positive. While this would represent a great accomplishment for a company that was on the brink of collapse during the heart of the financial crisis, the company advises investors to expect future pricing pressure to persist.

As a result, due to continuing uncertainties, investors may be wise to take a wait-and-see approach to global aluminum producers, including Alcoa. It's worth noting Alcoa's significant progress in many of its key initiatives, including productivity gains and growth in demand across its markets, but the company has not yet demonstrated an ability to produce steady profits with consistency.

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The article Is Alcoa Out of The Woods? originally appeared on Fool.com.

Bob Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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