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What Comfortable Leverage Would Mean for Alcoa Investors

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Comfortable leverage ratios

A company’s net debt equals its total debt minus cash and cash equivalents. Due to Alcoa’s (AA) strong cash flow generation in November and December 2016, its net debt fell below $600 million on December 31, 2016. Based on Alcoa’s trailing-12-month EBITDA (earnings before interest, tax, depreciation, and amortization), the company has a net debt-to-EBITDA multiple of ~0.6x. This ratio looks comfortable when compared with other mining companies (CENX) (NHYDY).

Alcoa’s debt levels also look comfortable on other parameters. Alcoa’s current market capitalization is almost ten times its current net debt. Credit rating agencies may recognize improved commodity markets and Alcoa’s lower leverage ratios, and so we could see a credit rating upgrade soon.

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Optionality

During the 4Q16 earnings call, Alcoa’s management listed several priorities in deploying its cash. The company could consider funding its pension and OPEB (other post-employment benefits) obligations that are currently underfunded by $3.1 billion.

Alcoa could also look at deleveraging its balance sheet. The company could look at growth projects, especially in the bauxite business (RIO), to enhance shareholder value. Alcoa upwardly revised its 2017 capital expenditure guidance. The company noted that it plans to spend $150 million toward “return-seeking projects.”

Alcoa’s comfortable leverage ratios, coupled with the expected uptick in its earnings, provide the company with optionality in utilizing its excess cash.

Continue to the next part for a look at how analysts are rating Arconic (ARNC).

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