ALCOA, INC' Ticker AA Corporate Finance Analysis

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ALCOA, INC.Ticker (AA)Corporate Finance Analysis
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Introduction

• Overview
• Investment Analysis
• Risk Analysis
• Performance Results
• Conclusion

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Overview

• Purpose
• Select a company in which to invest 100,000
• Goal is to outperform the NASDAQ composite in the
  period between March 11, 2006 and May 1, 2006

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Overview

• Business Description
• Alcoa is the worlds leading producer of primary
  aluminum, fabricated aluminum and alumina
• Global company operating in 42 countries
• 13 increase in sales between FY04 and FY05

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Investment Analysis
6
Investment Analysis

• Investment Thesis
• Consensus earnings estimates will move upward
  during our holding period
• Alcoa shares are significantly undervalued when
  valued on either a P/E or DCF basis, which imply
  fair value in the range of 36-37.50
• Closed at 29.23 on March 10
• Alcoa shares will appreciate considerably

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Investment Analysis

• Overview of Aluminum Supply/Demand Dynamics
• Over the past 3 years, spot aluminum prices have
  risen over 70
• Aluminum Demand and China
• Supply Side Aluminum Production Capacity
• We expect the aluminum price to remain high in
  the near to intermediate term

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Investment Analysis

• Alcoas poor performance was because during the
  2003 share price run-up investors had materially
  overestimated Alcoas earnings leverage to the
  rising aluminum price

History of Alcoas Share Price Performance Since
January 2003
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Investment Analysis

• We believe that the relationship between the
  aluminum price and key input prices occurring
  over the last several months will increase
  Alcoas earnings leverage to the rising aluminum
  price and potentially result in a positive
  earnings surprise

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Investment Analysis

• The other factor that we believe caused Alcoa to
  under perform earnings expectations during 2004
  and 2005 relates to movements in currency
  exchange rates

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Investment Analysis

• Assuming Alcoa can reach its historical average
  relative valuation of 96 of the SP500 multiple,
  we calculate a target price of 37.51, implying
  potential upside of 28 from Alcoas close on
  March 10, 2006
• We calculate the value of Alcoa shares on a
  discounted cash flow basis is approximately 36,
  implying 24 upside from Alcoas close on March
  10, 2006

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Risk Analysis
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Risk Analysis

• Potential startup of idled Chinese Capacity
• Potential labor unrest
• Excess Capital expenditures

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Risk Analysis

• Idled Chinese Capacity
• Greatest risk to aluminum fundamentals
• China Capacity
• 2 million tons of idled capacity
• Represents 6 of total global capacity
• Potential startup
• Negative shift in supply/demand balance
• Lower prices ? Lower revenues
• Mitigating factors
• Alumina shortage
• Energy shortage

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Risk Analysis

• Potential labor unrest
• Master contract being renegotiated
• 15 locations with 9000 employees
• Expires May 31st
• Key meeting May 18th
• Potential strike June 1st
• Headline Risks ? may sour investors
• Negative pressure on shares
• Exit two weeks before key meeting

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Risk Analysis

• Excess Capital Expenditures
• Alcoa long-term strategy
• Shift away high cost production
• Cheaper energy and labor deals
• Alcoa capital expenditures
• 1.1B in 2004 ? 2.1B in 2005
• Estimated 2.5B to 3.0B in 2006
• Correct long-term strategy
• Investors reaction?
• Unexpected announcements?

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Performance Results
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Performance Results

• Alcoa shares dramatically outperformed the NASDAQ
  index during our holding period.
• Alcoa 16.6
• NASDAQ 1.9 (Benchmark)
• SP500 1.8

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Performance Results

• On April 10 reported first quarter 2006 earnings
  ahead of expectations
• Alcoas reported EPS came in at .70, a full 37
  ahead of first call consensus of .51
• On the day following Alcoas earnings report, AA
  shares traded up 3.8 in a down market (SP 500
  down 0.8)
• Alcoas results were driven by strong aluminum
  prices up 24 from first quarter 2005

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Performance Results

• March 10th consensus estimates for EPS
• 2.08 (2006)
• 2.12 (2007)
• May 1st consensus estimates for EPS
• 2.78 (2006), an increase of 34
• 2.72 (2007), an increase of 28

Trend
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Performance Results

• Our call on Alcoa shares was dependent upon
  aluminum fundamentals remaining strong
• Aluminum prices were up about 6
• Natural gas prices were down about 10
• Relevant currencies were roughly unchanged

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Performance Results

• Key Point
• Investors had failed to recognize the
  re-coupling of Alcoas earnings to the underlying
  aluminum price
• Investors were focused on poor earnings
  performance between 2004 and early 2005

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Performance Results

• On April 28, Alcoa traded down nearly 4.5 in an
  otherwise up market (SP500 up 0.3)
• Chinas central bank raised interest rates
  unexpectedly
• Reflects a tightening monetary policy
• China is a key driver of metals ? AA down

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Conclusion
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Conclusion

• Despite the unexpected China setback, our Alcoa
  holding did broadly play out as we had expected
• Alcoa shares did not quite reach our price target
  of 36-37.50
• Outperformed for the precise reasons we had
  outlined before our purchase

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Questions
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Comparison
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