Alcoa: a Strong Buy After Earnings

Shares of the aluminum giant, Alcoa (AA) have risen approximately 39%, after bottoming to its lowest level of $6.74 a share in the second-half of January 2016, due to a rise in aluminum prices. The aluminum prices jumped nearly 11% over a seven-week stretch through early March to a little over $0.73/ lb from $0.66 lb in the first week of January 2016. However, the prices have then deteriorated and settled at little more than $0.67 lb at present, yet reflecting a 2% growth since year-to-date.

Well positioned to tap demand in the end market

The aluminum giant, with the aim of increasing market value for its shares, has recently decided to spin off its higher margin businesses such as aerospace, automotive, commercial transportation and building & construction into a separate entity, namely Arconic.
This is indeed a good move due to the fact that increasing usage of aluminum into these businesses will allow Alcoa to unlock value for Arconic more effectively, which remain more attractive going forward, compared with its historical business segments like industrial gas & turbine, mining and packaging, as shown in the chart below.

Alcoa, with its value-add business or Arconic, had produced revenue of $13.5 billion, after-tax operating income of $1.0 billion and adjusted EBITDA of $2.0 billion, up 5% over 2014. Moreover, the company during 2015 secured approximately $9 billion in aerospace contracts in 2015, which is more than double the amount in 2014, due to accelerated investment in the aerospace segment. In fact, the aluminum giant during the fourth-quarter 2015, announced at long-term agreements with Boeing valued at over $2.5 billion and over a $1.5 billion contract with GE Aviation.

In addition, Alcoa has inaugurated its state-of-the-art jet engine parts facility in La Porte, Indiana in the last reported quarter. This facility will enable Alcoa to manufacture nickel-based structural parts, which are about 60% larger for the industry’s best-selling jet engines for large commercial aircraft. Apart from these advancements, the aluminum giant completed its jet engine expansion in Hampton, Virginia. The most interesting thing is that this facility includes technology that cuts the weight of Alcoa’s highest-volume jet engine blades by 20 % and significantly improves aerodynamic performance.

These increased investments in the infrastructure and growth in contracts will enable the company to tap the aerospace business aggressively, which is expected to grow to the tune of 8% to 9% in 2016. In fact, it expects the large commercial aircraft to register approximately a 15% growth this year. Thus, it plans to ramp up products for these large-volume platforms such as the 320, the A350 and the 787.

And to top it all, the company with its business improvement programs such as costs reductions across its portfolios is expecting productivity and margin improvement of $650 million for its value-add business and approximately $600 million for its upstream in 2016. For example, Alcoa has recently implemented an overhead reduction program across the operation, which is expected to generate $100 million in cash costs savings in 2016 and around $225 million over a couple of years.

Conclusion

Alcoa, therefore, remains a very attractive investment avenue in the long-run. It should be able to get better with this spin-off, costs reduction moves and growing end-market demand for aluminum. Also, the recent rise in the aluminum prices should enable the company to improve its margins going forward and improve its bottom line performance this year.
Published on Apr 12, 2016
By Subhen Mittra

Copyrighted 2016. Content published with author's permission.

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