Alcoa Inc (AA): Going Long on the Dow (.DJI)’s Most Shorted Stock

The Aluminum Company of America, or Alcoa Inc (NYSE:AA), has not been receiving much love from investors lately. This is understandable, as the shares have fallen over 16% in the last 12 months. Alcoa shares are trading at the same levels now as in April 2009. Recent underperformance has made betting against the firm popular on Wall Street–more than 8% of outstanding float is being shorted, by far the highest percentage of any stock in the Dow Jones Industrial Average. But in many instances, placing your capital in companies that the masses dare not touch can prove a shrewd decision. Can we be reasonably certain Alcoa Inc (NYSE:AA) is a bargain for $9.3 billion? The company’s reports with the SEC will tell us everything we need to know.

What Alcoa does

The Aluminum Company of America is a dominant player in the aluminum industry, involved in practically every aspect of the business. Its operations consist of four segments: Alumina (also known as aluminum oxide or bauxite), Primary Metals, Global Rolled Products, and Engineered Products and Solutions. Alcoa Inc (NYSE:AA) controls massive bauxite reserves, with mining rights at many sites extending several decades beyond today. Wonderful, but Alcoa realizes that its potential isn’t being maximized when it acts only as a miner and smelter of aluminum. There are profits to be earned in these areas. But management at Alcoa foresees fortunes being made from new applications for the metal. The company’s engineered products and solutions serve a wide variety of industries, including aerospace, automotive, and construction. Active efforts are being made by the company to shift away from classic mining and smelting and into higher margin engineered products. A Wall Street Journal article last month quoted CEO Klaus Kleinfeld as saying  “This is a different Alcoa Inc (NYSE:AA), with more profits generated from value-added downstream operations and less reliance on basic mining and smelting.” Leadership at Alcoa is aware that the way the world uses aluminum will change, as more efficient applications will be discovered in response to changing demands. As such, management is committing substantial resources to stay on top of the aluminum industry.

The debt situation

As a potential owner of Alcoa Inc (NYSE:AA), knowledge of the company’s debt situation is essential. Investors have a fairly wide variety of techniques to analyze debt. To get a good idea of a company’s current financial position, working capital is a very useful metric. Comparing the proportion of working capital to market capitalization and the growth rate of working capital between companies in the same industry can be very informative.

Alcoa conducts most of its alumina refining activities through an entity known as Alcoa World Alumina and Chemicals. This group of companies is 60% owned by Alcoa and the other 40% by Alumina Limited (ADR) (NYSE:AWC), an Australian company. All of Alumina’s business activities involve its partnership with Alcoa.

Along with Alumina Limited (ADR) (NYSE:AWC) I selected Century Aluminum Co (NASDAQ:CENX) as another company to compare with Alcoa. Century  is headquartered in Monterey, California and has production facilities in the southern United States and Iceland. Here is how these three companies stack up in terms of working capital.

*Average is for 2001-2002

In terms of working capital, Century Aluminum Co (NASDAQ:CENX) has done especially well.  Of the three companies its working capital is largest relative to market cap and has experienced the most growth in the last 10 years. Century has done very well managing its working capital during the last decade, but do not let the numbers mislead you. Century’s minuscule size undoubtedly played a key role in the growth rates it has experienced.