Alcoa Inc (AA), Rio Tinto plc (ADR) (RIO): A Great Way to Play Industrial Recovery

A company to avoid

Under normal circumstances, operational diversity spreads out risks and stabilizes cash flow. But diversified mining plays like Rio Tinto plc (ADR) (NYSE:RIO) and BHP Billiton Limited (ADR) (NYSE:BHP) are struggling with their towering debt.

Back in 2008, Rio Tinto plc (ADR) (NYSE:RIO)’s management team vowed to cut the company’s net debt by $10 billion. Since 2009, its net debt has declined from $38.9 billion to $21.1 billion. But for the loss-making company, a debt-to-equity ratio of 57% seems pretty high. To reduce its debt, Rio Tinto plc (ADR) (NYSE:RIO) would be selling its diamond assets for around $2.5 billion. Its management has assured that there won’t be any significant decline in its earnings, but Standard & Poor’s begs to differ.

S&P analysts have downgraded Rio Tinto plc (ADR) (NYSE:RIO) from stable to negative, stating that its net debt could worsen in FY13. The company has an extremely expensive operating structure, with $17 billion worth of annual capital expenditures.

Rio Tinto plc (ADR) (NYSE:RIO) already has an adjusted net debt of $33 billion, while its funds from operations-to-debt have declined from 85% in 2011 to 30% in 2012. Analysts at S&P believe that its FFO/debt ratio should be at least 40% for the company’s stable operations. With that in mind, investors should certainly avoid Rio Tinto plc (ADR) (NYSE:RIO) until its shows improvement in its financial health.

Wrap Up

Century Aluminum Co (NASDAQ:CENX) is another pure aluminum play, with an overall primary rated capacity of 674,000 tonnes. Additionally, the company owns a 49.7% interest in a plant at Mt. Holly, S.C., with a rated capacity of 224,000 tonnes. But its management believes that it won’t be able to meet rising aluminum demand.

That bodes well for the company, since its growth will be supply driven and not limited by market demand. Currently, shares of Century Aluminum Co (NASDAQ:CENX) trade at a forward P/E of 12x, and analysts estimate its annual EPS to grow by 7% over the next five years.

But if I had to pick one company to invest in, it would be Alcoa. The company has a low utilization rate, and can ramp up its production without product expansions, saving future capital expenditures. Its management is working toward lowering its debt levels, while its impressive financials present a bullish case.

The article A Great Way to Play Industrial Recovery originally appeared on Fool.com and is written by Piyush Arora.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.