Why I Feel Bearish About Alcoa?

Alcoa Inc. (AA) stock is trading near its 52-week low of $10.39, and its last closing price $11.06 is down 37.7% from its 52-week high of $17.75 reached in late November.  Shares of the firm have slipped into negative territory in terms of year to date returns, a worrying figure of 33.5%. In this article, let's take a look if this is an apparent investment opportunity.

The Outlook

The company produces and manages primary aluminum, fabricated aluminum, and alumina worldwide, with focus on several end markets, including packaging, automobiles, aircraft, and construction.
This integrated producer company is a low-cost producer of alumina and this should lead to greater profitability. Aluminum prices continue with a downward trend and will remain like this if the dollar continues in a bull market.  Alcoa needs prices to appreciate in order to generate positive returns, which is opposite to the current environment. Further, this commodity depends on Chinese smelters which are more likely to close capacity the coming months due to a slower demand. This fact makes it very difficult to Alcoa to achieve those desired returns.

On the other hand, I believe airline fundamentals are improving with a projected air travel demand rising. Further, the auto industry, which is one in which the company has focused, is showing signs of growth in sales. Aluminum is the second largest-volume component material in automotive vehicles and is expected to be used more in the future.

Strategic Bets

The company formed a joint venture with Ma'aden, the Saudi Arabian Mining Company, with the aim to reach the lowest-cost aluminum production, generating cost savings simply because a third of its production comes from energy.

After it has purchased Firth Rixson, a global leader in aerospace jet engine components, this year the company agreed to purchase RTI International, a global supplier of titanium and specialty metal products and services for the commercial aerospace, defense, energy and medical device markets. It is expected the deal will generate $100 million in annual cost savings by the end of 2019. To relativize this number, the company expects for fiscal 2015 to generate over $500 million of free cash flow.

Revenues and Earnings

On April 8, 2015, Alcoa reported strong first-quarter profits, but the past days it reported second-quarter earnings that missed analysts' estimates. Net income fell to $0.10 per share from $0.12 in the same quarter a year before and $0.14 per share reached in the first quarter. After the strong net income achieved in the first quarter, of $0.28 per share, excluding the impact of special items, the company misses estimates, earnings were $0.19 per share.

Total Company revenues for Q2 rose to $5.9 billion, compared with the $5.81 billion average estimate. This was a result principally strong automotive and aerospace volume.

Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 20.51x, trading at a premium compared to an industry median of 16.30x for the industry. To use another metric, its price-to-sales ratio of 0.53x is below the industry median of 1.25x and is close to 1-year low of 0.55. Further, its price-to-book ratio of 1.12 is below the industry median of 1.29x. The first metric indicates that the stock is relatively overvalued.

Final Comment

Alcoa is the world's largest producers of aluminum and alumina and one day is going to recover from lows, maximizing its value-add portfolio. The company has not done very well in the last quarter, so in my opinion, it is not a good bet at this current price level, not only by the fear that the price fall further, but for the fact that I think it would not provide a great return in the short term.

Prominent investors who share my thoughts, such as Jim Simons, Richard Snow, Stanley Druckenmiller and Steven Cohen have sold out the stock in the first quarter, while Mario Gabelli has reduced his position in the stock by 2% to 2.4 million shares or Israel Englander who reduced the stake by 10% to 3.18 million shares.

Disclosure: I hold no position in any stocks mentioned.
Published on Jul 9, 2015
By Omar Venerio
Capital Markets, Derivatives and Financial Management Professor, Master in Finance and CFA candidate. I am an independent trader of stocks and options and passionate about the stock market.

Copyrighted 2016. Content published with author's permission.

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