I was going to buy the stock after a brief check on balance sheet and the usual valuation exercises but I decided that it is high time I stopped buying stocks based on emotions and not a lot of research. It has not helped me before and recently I ended up selling many of my holdings which I was not comfortable with, at a loss (PWER, ENOC, VE).
At the moment, I want to concentrate on the management of Alcoa and what direction it has taken after the crisis in 2008-2009. We will see if the management has been successful in the plans it has put forth and if going forward we can trust the management to make sound decisions for Alcoa.
The CEO of Alcoa is Klaus Kleinfeld (let me call him K for short). K has a PhD in management and he has a 20 year work history at Siemens AG (SIE). From January 2005 to June 2007 he served as a CEO of Siemens and upstaged a dramatic recovery for this German giant. Mr K broke away from the cumbersome corporate culture defended by his predecessor Von Pierer. Von Pierer believed that the synergies among the various divisions at Siemens justifies its complexity. Well performing businesses will offset the weak ones and overall one would get a slow and steady growth. K on the other hand did not share this belief. He wanted Siemens to go to the market as one seamless infrastructure provider. Instead of fighting for small contracts Siemens can contract for the whole infrastructure. Like designing and building a metro rail system from scratch. Few companies have that kind of expertise, depth and reach to build something like this from scratch. Furthermore, this extensive expertise will lead to cost savings and a significant competitive advantage. K started getting out of less profitable business and getting into the ones with higher margins and profitability. This led to company turning a profit of $3.96 billion, up 35% from the year before. The shareholders rewarded the company by sending the share price up by 40%.
K left Siemens and joined Alcoa in 2007. The reasons behind his not renewing the contract at Siemens also shows a bit of his integrity. During his tenure Siemens’ current and former employees were increasingly being pursued by watchdogs and prosecutors in Europe and the US. There were allegations of bribery, corruption and foul play. K was never implicated in anything illegal, the supervisory board felt that a clean sweep at the top is probably the best medicine to free Siemens from its problems. His predecessor Von Pierer resigned from the chairman position of the supervisory board (he was the one under whom the alleged scandals took place). The board decided to look at the direction the investigations were taking before renewing the contract of K. K was not very happy about it and he decided to take himself elsewhere. In his words
"Every day I have to go out there and put my credibility on the line. The team needs to know there is clear leadership. It's not about individuals but whether you have the entire supervisory board united behind you. That was the issue for me."
He joined Alcoa as a COO and in May 2008 was appointed the CEO. The shares of Alcoa then traded at around $40 a piece. During the next few months it crashed to a value of around $10 a share. The significant drop was a result of the global economic turmoil and the fear that the world was collapsing into itself. The current price of $10.24 will not give you much faith in the new CEO (and the management) but let me assure you that during Alcoa has changed for the better during the tenure of K as the CEO. It is now more financially stable, has better margins and more profitable as a company. We will see that under his watchful eye AA has improved its operations as well as its cash flow and is now a much better investment then it was 3 years ago in 2008.
Let us look at the 2007 annual report figures to see what Alcoa was before Kleinfeld became its CEO. When Kleinfeld took over as CEO the capital expenditure at Alcoa was out of sync with the cash it generated from operations. It also had an illiquid balance sheet with only $483 million in cash.
|Item (in $ million)||2007||2011|
|Cash from operations||3,112||2,193|
|Cash and equivalents||483||1,939|
Kleinfeld focused on cash. He set aggressive cash targets and then pulled back capacity and eliminated a lot of cash costs. He targeted to get to a $850 million maintainance cap-ex and $400 million in growth cap-ex. In 2009 he took down the casting facilities by 50%. Davenport, the largest mill North America was made to run at less than 70% and Texarkana was shut down entirely. What it did was to get the company to its fixed costs and with a lower volume (sales) it is going to hurt profitability. But the alternative was to continue producing with no demand. It would have made Alcoa absorb the costs and then it would have been put in inventory. They would have had much better earnings but would have been on the road to disaster.
In the 4Q-2009, there was a $759 million decline in debt and increase in cash by $759 million. I plan to look at the conference call and the shareholder letters before making a decision to buy the stock. I will update the readers when I am done reading them.