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Buy Sell Hold: Alcoa Inc. (NYSE: AA) is a Turnaround Play Worthy of Long-Term Investment

By Jack Barnes, Contributing Writer, Money Morning 

While U.S. unemployment is still high and showing no real signs of receding, there are a few indications that the economy is slowly edging back toward a pattern of sustained growth.

That’s important because smart investors are always looking for a turnaround play – that is, a situation that has changed the underlying market dynamics surrounding it.

In today’s case, we look at a company – Alcoa Inc. (NYSE: AA) – that just last week reported its best quarterly results since the third quarter of 2008.

Alcoa in the last 10 quarters laid-off 20,000 employees as management attacked its cost structure by closing facilities around the world. And today it is a much leaner company and better prepared for the future than it was in the fall of 2008.

As a result, the company reported fourth-quarter net income of $258 million, or 24 cents per share, excluding special items. That compares to a net loss of $277 million, or 28 cents per share, during the same period a year earlier.

“The increase in aluminum prices has more than offset high material and industry costs as well as the impact of a weaker U.S. dollar,” Alcoa Chief Financial Officer Charles D. McLane Jr. said on the company’s earnings conference call. “Each of our businesses was able to significantly improve their performance.”

Alcoa operates in 31 countries, giving it diverse exposure to global economic demands. This global reach allows the company to accurately adjust its supply. In the case of the United States, demand has increased enough that Alcoa has announced plans to remove three plants from mothball status. That will let the company resume 137,000 tons worth of production and restore the lost jobs – a positive for local communities.

Alcoa has a market cap of $16.5 billion with an enterprise value of more than $25 billion. The company generated more than $20 billion in revenue in the trailing 12-month period. Its stock pays a small dividend of 0.75%, which is about what you would expect to get in a money market account.

However, Alcoa historically has paid a significantly higher rate. In fact, the company over the last five years has averaged a 2.5% dividend yield. So I expect that the payout will be increased as soon as Alcoa can show that its balance sheet is fully repaired from the restructuring process.

I love to find turn around stories in the Standard & Poor’s 500 Index. These stocks are liquid and typically have enough analyst coverage to provide a peek into what Wall Street expects.

There also is an interesting aspect of the market that you rarely see explained. When a turnaround stock starts to show true signs of having made the turn, Wall Street analysts will typically come out of nowhere to downgrade the stock. The masters of the street, who failed to anticipate the company’s fall from grace, will be there to dog pile onto its stock as it becomes a lower risk investment.

But that’s actually a good thing. It is a sign that someone actually wants to buy the shares again. It is street talk for “Please ignore this stock until our buyers are finished loading up on it.”

All you have to do to get a sense of how the game is played is look at the activity in the ratings. Try taking the number of analyst upgrades in the past year and divide it by the number of downgrades during the same time period – then invert for reality. No joke. Try it.

So let’s review why Alcoa is a “Buy”:

  • Its earnings have bounced back.
  • There’s a good chance its dividend will be increased.
  • It’s once again increasing capacity in the United States.
  • The company has a bullish “inverted analyst” rating.

The bottom line: Alcoa has made the hard decisions that were necessary to become profitable in new economy. It deserves a spot in our long-term portfolio.