Alcoa released the 3Q results. They are in line with Gudovac's expectations first
outlined in early July. Management pro-actively cost cuts early in the economic crisis. Management recognized the impact and instituted brutal and forceful measures.
The cost cutting measures are nearly fully implemented. Alcoa has reduced headcount by nearly 22,000. Procurement targets have been met. Overhead has been reduced lower than target goals. Working Capital efficiency targets have been met. Capital Expenditure is on track at one-quarter of peak rates.
3Q Results - On Track
These efforts produced results. The Cash Flow hemorrhaging of last year is effectively under control. The slide from Alcoa's 3Q presentation presents the subject with some clarity. Free Cash Flow remains negative. However, it should turn positive in early 2010 as the full impact of cost cutting flows through the Enterprise.
Risks to generating positive cash flow in 2010 are illuminated by this slide. Prices are shown by the yellow line. World Inventory is shown by the fields. Prices have skyrocketed from their lows - which is good. The question Owners need to ask is whether price increases are sustainable in the face of tidal wave of inventory languishing in warehouses.
Alcoa's managers can read this chart as well as anyone, they are certain to manage their output to accommodate the glut of inventory. However, Owners should be careful to understand that pricing risks are more-or-less uncontrollable by Alcoa management at this stage of the cycle.
Debt remains a significant issue for Alcoa. Alcoa's 3Q interest coverage rate remained at a bare 1.0x. Management is doing a decent job of improving the balance sheet. However, owners should recognize that even a minor downturn in prices or volume could reverse this suddenly.
What Price to Buy Alcoa ?
Gudovac is ambivalent about determining a buy price for Alcoa at this time given the unknowns - but will make an honest college try
Alcoa's dividend has been cut to 12 cents per common. - which makes it nearly a immaterial consideration at this time. Prospective owners can venture that Alcoa will increase its dividends at some point in the future. At what time in the future is anyone's guess - an increased dividend is not taken into account in this pricing.
Alcoa's revenues appear to be leveling out in the $16-$20 Billion range with an EBITDA of some $1.5 - $2 Billion. Management estimates CAPEX to be $850 Million in 2010. We can assume that the $850 is close to maintenance CAPEX levels. Using EBITDA as a proxy for Cash Flow and subtracting out minimum CAPEX of $850 Million - one arrives at cash available to debt or equity of between $650 and $1,150 Million. This annual run rate appears to be possible for the foreseeable future.
What is a Equity worth for an Alcoa that generates those numbers ? Guodvac has plugged the numbers into the Gordon Growth model. The results are shown below.
Gudovac has been generous with the both weighted average cost of capital ( WACC ) and long term growth rate which significantly improves the Equity Value. Looking at the table it becomes quickly apparent that Alcoa has a heavy overhang of Debt & Long Term Liabilities relative to its ability to generate cash.
If commodity prices drop, Equity will have virtually no value at a total of $450 million. This translates into an approximate share price of 46 cents.
If commodity prices remain where they are and volume grows slightly from 3Q levels, then Alcoa's equity is worth nearly $13 Billion. This translates into an approximate share price of $13.30 - not too far off Mr. Market's current price of $14 and change.
Clearly Owners will need to make their own judgement regarding the prospect of a drop in commodity prices. The higher the probability of a drop in commodity prices, the closer to the 46 cents price an owner will price Alcoa common.
Commodities is not Gudovac's business. Therefore, he leaves speculation regarding the direction of commodity prices to those more knowledgeable than he.
Note - splitting the difference between 46 cents and $13.30 results in a median price of $6.88, not too far off Gudovac's price in early July.
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