Alcoa Inc. isn’t waiting around for the aluminum market to emerge from its interminable slump, because that’s not likely to happen any time soon.
Instead, the New York-based company is on a mission to reduce its exposure to the commodity that it was built on. Alcoa’s reanimated stock price suggests that investors are beginning to see the company as more than a bet on aluminum prices – and some analysts believe there may be more gains to come.
“We believe that the market is not fully appreciating Alcoa’s solid position in growing value-added and high-margin aluminum products for the aerospace and automotive industries,” Sal Tharani, an analyst at Goldman Sachs, said in a recent note.
The stock has advanced about 8 per cent this year and is trading around $9.36 (U.S.). Mr. Tharani says it can hit $11 over the next six months, and predicts earnings per share will rise by 130 per cent over the next two years even in the absence of a recovery in aluminum prices. “We expect Alcoa’s earnings to decouple from aluminum price movements and be driven more by end-market demand,” he said.
Prior to the financial crisis, the aluminum business was an uncomplicated profit engine. The so-called commodities super cycle vaulted the mining and metals sector into an era of abundance. But the recession and its aftermath restrained demand for resources in China and other emerging market economies.
Benchmark aluminum prices have fallen by 44 per cent from the pre-crisis peak of $3,114 per metric tonne. Over the same period, Alcoa’s share price has tumbled by 74 per cent. In response, the company has been forced to slim down, shutting down 16 per cent of its smelting capacity with more under review.
While most of its competitors have also embraced austerity, Chinese output has soared, creating a demand-supply imbalance that keeps the price of aluminum perpetually depressed. Last year, global supply exceeded demand by 500,000 tonnes. In the first three quarters of this year, overproduction amounted to 1.2 million tonnes.
“There is very little light at the end of the tunnel,” Thomas Bradtke, partner and managing director of Boston Consulting Group Dubai, said in September at the Metal Bulletin aluminum conference in Geneva.
Alcoa’s upstream businesses – mining, refining and smelting, including its three Quebec smelters – are those most vulnerable to market prices. But its downstream segments, like engineered products, are less price sensitive.
Automotive and aerospace manufacturers in particular, which are increasingly relying on lightweight aluminum products to improve fuel efficiency, are an emerging source of demand for Alcoa. It’s those lines of business that now generate most of the company’s earnings.
“Although the upstream units have historically generated the lion’s share of operating income, the downstream segments have become a much more meaningful contributor in recent years,” Morningstar analyst Andrew Lane said in a report, in which he estimated Alcoa’s fair value at $14 a share.
Accordingly, Alcoa’s stock is showing signs of life. Since early October, when the company beat analysts’ expectations on third-quarter earnings, the share price has risen by 18 per cent – an impressive rebound considering aluminum prices fell by 6 per cent over that stretch.
That gives investors something to hang onto while awaiting a more favourable market for the underlying commodity. “We see upside in Alcoa despite our lacklustre outlook for aluminum supply-demand fundamentals,” Mr. Tharani said.
Of course, Alcoa remains an aluminum company and will require the market for that commodity to return to balance before it can reclaim its former glory. “Like with all cyclicals, the cycle will return,” said Lorne Steinberg, president and portfolio manager at Lorne Steinberg Wealth Management in Montreal. “When that happens, this will once again be a $20 to $30 stock.”
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