Time waits for no one. Themarket has rung in the New Year, and
slow-to-move investors may miss out on further gains ahead. So I'm
moving quickly to name the second pick in my $100,000
As is the case with
, my initial holding, it's also a well-known company. Its roots go
back to 1887, when chemist (and company founder) Charles Martin
Hall figured out how to make aluminum through the use of an
If you missed the
, then allow me to explain. StreetAuthority is giving me $100,000
to invest in my absolute best investment ideas. I'll be sharing my
trades with you for free -- but only for a limited time. This
morning, I bought 1,090shares of Ford at a price of $11.44, after a
self-imposed two-daywaiting period . The stock has moved up more
than 5% since I mentioned it on Friday, Dec. 30, so readers who
jumped on my recommendation already are showing a nice gain.
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The advances are coming from stellar sales figures for last month.
Sales rose 10% from a year earlier in December, which was at the
top end of the forecast consensus range. On a full-year basis,
sales rose a healthy 17%. That strong finish to 2011 is why I think
the current consensus earnings-per-share (EPS ) forecast of $0.26
for the fourth quarter is too conservative and likely to be
Now, on to today's business...
Buy #2: A beneficiary of a shrinking industry
The prolonged economic weakness in the United States and Europe has
surely been hard on industrial firms, as demand for many goods
remains well below levels seen in the middle of the last decade.
Adding insult, Chinese manufacturers have ramped up quickly,
flooding the world with lower-priced products.
Perhaps no companies have felt the twin pressures of falling demand
and rising supply as acutely as the world's makers of aluminum. Not
only has economic activity slowed in recent years in the world's
largest economies, but China has in recent years built dozens of
new aluminum smelters that created a glut of the lightweight shiny
industrial material, which goes into everything from soda cans to
Making aluminum consumes lots of electricity. But one company's
management made a brilliant move, building new aluminum smelters
where energy is really, really cheap, in places like Iceland and
Trinidad & Tobago. The fact that this company is the
lowest-cost producer of aluminum in the world has made life even
more difficult for rivals in China and elsewhere. That's why, when
I looked at
back in October
, I mentioned that the Chinese government has begun to deprioritize
I am reproducing this chart from that story, as a picture tells a
With China now anet importer of aluminum, Alcoa has one
less migraine to worry about.
Somemarket forecasters even say China's 2013 aluminum output will
drop back to 2009 levels.
Of course, demand is the other part of the equation, and this stock
is near a52-week low on concerns that European demand for aluminum
How dim is the view for Alcoa? At a recent $9, the stock is nearly
80% below levels seen back in 2007.
Using the parlance of the investment business, the Alcoa story
"has warts on it." The decision to build a network of low-cost
energy-efficient smelters came at a painful price: The company
spent a combined $10.3 billion in 2006 through 2008. Management was
unaware that demand for aluminum would soon plunge.
The good news: the spending program is winding down. Alcoa doled
out just $1 billion in capital spending in 2010, enabling the
company to generate $1.1 billion infree cash flow . The company's
capital spending plans are unlikely to top $1.0 billion to $1.5
billion in current and future years. In effect, Alcoa is now
positioned to post respectablefree cash flow in tough times, and
poised to post stunningly high levels ofcash flow when the
globaleconomy perks up.
The past 12 months tell the tale. Sales in 2011 came in around $21
billion -- roughly $7 billion below 2007 levels. Yetfree cash flow
likely exceeded $1 billion once again.
Actual financial results in the near-term will rest on aluminum
pricing. Thespot price has fallen from around $1.17 per pound in
August (before the European financial crisis gained steam) to a
recent $0.88 per pound. As the European crisis is resolved, look
for a quick move back to $1 a pound. And when the globaleconomy is
truly healthy, I see thespot price heading north of $1.25 a pound.
As a point of reference, Alcoa would likely earn around $0.65 a
share with aluminum prices at $1.05 at pound (EPS would build
by about $0.20 a share for each $0.05 rise in aluminum prices).
We're not there yet, but that's theprofit framework you need to
keep in mind asshares scrape along the bottom. (If you want a
really long-term view of where profits can go in the peak of the
cycle, Alcoa earned more than $3 a share in 2007, andshares trade
for less than three times thatearnings peak.)
The downside protection -->
Alcoa's stock is worth slightly more than the $9.65 billion in
tangible book value on itsbalance sheet . Yet thatbook value figure
is quite understated because the value of a number of manufacturing
facilities has been written down due to depletion. In terms of
replacement value, if one were to build Alcoa's factories from
scratch, then you're likely looking at amarket value closer to 40%
lower than the real value of the company's assets.
Equally important, Alcoa should remainfree cash flow positive, even
if the globaleconomy slumps further in 2012. A weakeconomy would
actually benefit Alcoa as higher-cost rivals get flushed out. As it
stands, many aluminum producers are operating at a loss with
aluminum trading for roughly $1 a pound. That's a price point at
which Alcoa can still turn aprofit .
The upside triggers -->
The Alcoa trade requires a leap of faith. The company will kick
offearnings season on Monday, Jan. 9. I suspect the company will
actually deliver a small loss instead of the consensus
$0.08-a-share forecastedprofit . (The losses are coming from the
timing of costs and pricing, and Alcoa likely remains profitable on
a core production-per-pound basis.)
Why get into this stock ahead of such an event? Because themarket
anticipates a sorry outcome, and there's a solid chance investors
will start to focus on management's expected long-termbullish
outlook for supply, demand and pricing.
This stock chart tells you one thing. Alcoa has few fans
right now. That's my favorite kind of set-up.
I expect any rebound to be slow and steady. It may take several
quarters, but a move back to the mid-teens, with fairly solid
downside support, looks like a favorable risk/reward to me.
Action to Take -->
In light of the risk associated with the coming quarterly results,
I am opening a fairly modest position by buying 300shares
at the opening oftrading on Friday, Jan. 6
. That equates to about $2,500. I will re-assess that stance once
the numbers are out, and may look to boost the stake.
Here's the Latest Snapshot of my $100,000 Real-Money
-- David Sterman
P.S. -- The response to my first trade in my $100,000 real money
portfolio was overwhelming. Many of you were able to get in on Ford
ahead of me, and I hope we can both profit handsomely from it going
forward. If you missed my first trade and want to be notified any
time I update a holding or take a new position, I urge you to go
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miss a thing.
David Sterman does not hold positions in any securities
mentioned in this article. StreetAuthority owns shares of F in one
or more if its "real money" portfolios.