Canada’s Alcan Inc. was acquired in 2007 by Rio Tinto for $38.1 billion in what was then the biggest metals and mining transaction in history. Here’s a look back at TSI’s analysis of Alcan.

ALCAN INC. $48 (Toronto symbol AL; SI Rating: Average) is the world’s second-largest producer of primary aluminum, after U.S.-based Alcoa Inc., with about 13% of the world’s aluminum production capacity. Manufacturers turn primary aluminum into a wide variety of products, including automotive parts, construction materials and beverage containers. North America accounts for a third of its sales.

Alcan’s sales rose from $9.15 billion in 2000 to $24.9 billion in 2004, mainly due to its acquisitions of European aluminum companies Algroup in 2000, and Pechiney in 2003 (all amounts except share price in U.S. dollars). However, earnings before unusual items fell from $2.52 a share (total $587.0 million) in 2000 to $0.76 a share ($251.4 million) in 2003, due to falling demand and prices for aluminum. In 2004, strong industrial growth in China increased global aluminum demand by 10%. Consequently, Alcan’s 2004 profit jumped to $1.75 a share ($645.8 million).

Due to regulatory concerns over Alcan’s high market share after the Pechiney acquisition, the company consolidated its rolled aluminum products business into a new company called Novelis Inc. In January 2005, Alcan shareholders received one Novelis common share for every five shares they held. The spin-off let Alcan satisfy regulator demands to sell some of Pechiney’s assets. It also let Alcan keep these assets away from its competitors, and retain Novelis as a significant customer.

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More exposed to price swings

However, the Novelis spin-off increased Alcan’s sensitivity to raw aluminum prices, which adds to the stock’s volatility. But we feel that the long-term outlook for aluminum is still strong. Carmakers are incorporating more aluminum into their products, since its light weight improves fuel economy. Builders are also using more aluminum due to its high resistance to corrosion.

In fact, global aluminum demand now exceeds production. Demand will probably continue to outpace supply for the next year or two.

Alcan did not spin off all of its manufacturing businesses to Novelis. It still makes a variety of aluminum products for the aerospace and automotive industries. These engineered products generate higher profits than Novelis’s products, and now supply 20% of Alcan’s total sales.

Packaging unit has long-term appeal

The company also held on to its packaging operations, which supply flexible aluminum and plastic packaging to the food, pharmaceutical and personal care markets. Packaging accounts for 30% of the company’s sales.

Alcan is now expanding its packaging business to take advantage of growing demand for processed foods, particularly in developing regions where a lack of refrigeration makes it difficult to store fresh foods. For example, it recently paid an undisclosed sum for the 35% of Propack that it did not already own. Propack supplies packaging products to food and pharmaceutical companies in China.

The company is also improving the earnings potential of its packaging division, mainly by replacing older plants with new, more efficient ones. These moves are part of a broader plan by Alcan to cut its annual expenses by $360 million.

Cost cuts offset higher oil prices

These savings should help Alcan’s mining and smelting operations cope with rising electricity and raw material costs. Rising oil costs have also increased the price of plastic resin, which has squeezed profit margins at Alcan’s packaging unit. It’s likely that the company will continue to find new ways to lower its costs.

Alcan operates in 55 countries, which makes its earnings sensitive to world currency movements. The recent rise of the U.S. dollar compared to the Euro and other currencies has hurt Alcan’s earnings growth in 2005. However, the company uses hedges to minimize its currency exposure.

Despite two big acquisitions in the past five years, Alcan’s balance sheet is in good shape. Long-term debt is a reasonable 54% of shareholders’ equity, and it has $236 million ($0.64 a share) in cash. That gives it plenty of flexibility to make more acquisitions, or expand production.

Stock up 31% in past three months

Alcan’s stock fell from around $62 before the Novelis spin-off to $35 in October 2005, partly due to concerns over possible insider trading related to the Pechiney purchase. Accounting problems at Novelis also cast a shadow on the stock, but it has moved up again due to rising aluminum prices.

The stock now trades at 17.4 times the $2.38 U.S. a share that Alcan will probably earn in 2005. It’s also attractive at just 67% of its sales of around $62 U.S. a share, and 10.9 times its 2005 cash flow forecast of $3.80 U.S. a share. The $0.60 U.S. dividend yields 1.4%.

Alcan is a buy.

This article is from January 2006 and updated in 2016.