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Introduction

Alcoa (AA) is a basic materials company that engages in the production and fabrication of aluminum products. Alcoa has a lot of upside because demand for aluminum is trending higher. The price of aluminum is recovering while economic conditions are improving which keeps me optimistic on the future of Alcoa. Alcoa is one of the best opportunities on the Dow Component.

Qualitative Analysis

Source: Information pertaining to Alcoa came from the shareholder annual report and shareholder quarterly report.

Aluminum represents more than 80% of Alcoa's revenues. Alcoa is a world leader in the production and management of aluminum.

(click to enlarge)

The primary metals division smelts bauxite ore into aluminum. The flat-rolled products division converts aluminum into a plate, sheet, or foil prior to it becoming cooled (basically casting metal into a more usable form). The engineered products and solutions division is further downstream, and focuses on the production/development of aluminum structural systems (for example: the outer-shell of cars, airplanes and buildings). Aluminum is lighter then steel, more cost effective to produce, and is generally a better alloy for vehicles. The alumina division mines bauxite ore from properties it owns or leases. Aluminum is made by extracting alumina from bauxite and then removing oxygen from the alumina. Alcoa engages in all aspects of production, development and extraction of aluminum.

(click to enlarge)

Alcoa anticipates the demand for aluminum to roughly double by 2020. From a micro-economics standpoint, the demand curve is shifting to the right, as a result the market equilibrium will be shifted upwards on the supply/demand curve. This will result in higher prices. As a result of higher prices, Alcoa's profit margins are likely to drastically improve by 2020.

(click to enlarge)

Source: Chart from London Metal Exchange

The futures market is anticipating that the price of aluminum will be at approximately $2,350 by 2016. An up-trending cost-curve is good for aluminum producers. Alcoa is a producer of aluminum therefore Alcoa will enjoy higher prices on its products and services.

Alcoa will be an excellent investment, because of the improving price of aluminum, rising demand for aluminum, and improving global economic outlook.

Alcoa competes directly and indirectly through substitution and competition for natural resources. Alcoa competes with companies like BHP Billiton (BHP), Rio Tinto (RIO), Freeport-McMoRan Copper & Gold (FCX), Vale SA (VALE), Century Aluminum (CENX), Kaiser Aluminum (KALU), and Crown Holdings (CCK), among many others.

Technical Analysis

Alcoa is breaking out of the symmetrical triangle formation, implying that the stock is in for a long-term up-trend.

(click to enlarge)

Source: Chart from freestockcharts.com

The stock is trading below the 200-Day Moving Average while trading above the 20-, 50-Day Moving Average. The stock recently broke above the upper tend-line of the symmetrical triangle formation, implying further upside in the stock. The technical analysis supports the buy-thesis in the stock.

Notable support is $6.20, $8.00 and $8.50 per share. Notable resistance is $9.75, $10.75 and $13.00 per share.

Street Assessment

Analysts on a consensus basis have high expectations for the company going forward.

Growth Est

AA

Industry

Sector

S&P 500

Current Qtr.

30.00%

19.70%

17.40%

9.20%

Next Qtr.

183.30%

48.40%

37.70%

14.50%

This Year

170.80%

-3.60%

16.80%

7.10%

Next Year

47.70%

18.40%

-0.20%

12.80%

Past 5 Years (per annum)

-31.42%

N/A

N/A

N/A

Next 5 Years (per annum)

10.38%

17.52%

9.33%

9.10%

Price/Earnings (avg. for comparison categories)

14

10.57

12.36

12.03

PEG Ratio (avg. for comparison categories)

1.35

1.24

2.55

1.42

Source: Table and data from Yahoo Finance

The company shows reasonable growth as analysts on a consensus basis have a 5-year average growth rate forecast of 10.38% (based on the above table). The short-term expectations are high as analysts anticipate 170% growth in earnings in 2013, with 47.7% growth in earnings for 2014.

Earnings History

12-Mar

12-Jun

12-Sep

12-Dec

EPS Est

-0.04

0.05

0

0.06

EPS Actual

0.1

0.06

0.03

0.06

Difference

0.14

0.01

0.03

0

Surprise %

350.00%

20.00%

N/A

0.00%

Source: Table and data from Yahoo Finance

The average surprise percentage is 92.5% above analyst forecast earnings over the past four quarters (based on the above table).

Forecast and History

Year

Basic EPS

P/E Multiple

2003

$ 1.09

34.86

2004

$ 1.50

20.94

2005

$ 1.41

20.97

2006

$ 2.59

11.59

2007

$ 2.98

12.27

2008

$ (0.09)

-

2009

$ (1.23)

-

2010

$ 0.25

61.56

2011

$ 0.57

15.18

2012

$ 0.24

36.17

Source: Table created by Alex Cho, data from shareholder annual report, and price history is from Yahoo Finance.

The EPS figure shows that earnings grew throughout 2003-2007. Throughout 2007-2009, earnings and revenues dropped as the company was adversely affected by the great recession. Once the United States economy exited the recession in 2010-2011 the company earnings improved.

(click to enlarge)

Source: Chart created by Alex Cho, data from shareholder annual report

By observing the chart we can conclude that the business is cyclical and is affected by macroeconomics. Therefore the largest risk factor to Alcoa is the slowing of international gross domestic product growth. So as long as the world economy continues to grow, the company will generate outstanding returns over a 5-year time span based on the forecast below.

(click to enlarge)

Source: Forecast and table by Alex Cho

By 2018 I anticipate the company to generate $1.99 in earnings per share. This is because of earnings growth, rising commodity prices, international expansion, improving global outlook, and cost management.

The forecast is proprietary, and below is a non-linear chart indicating the price of the stock over the next 5 years.

(click to enlarge)

Source: Forecast and chart by Alex Cho

Below is a price chart incorporating the past 10 years and the next 6 years. Detailing 16 years in pricing based on my forecast and price history on December 31st of each year.

(click to enlarge)

Source: Forecast and chart created by Alex Cho, data from shareholder annual report, and price history is from Yahoo Finance.

Investment Strategy

AA currently trades at $9.08. I have a price forecast of $13.88 for December 31st 2013. The stock is below value, and I anticipate a recovery in value throughout 2013.

Short Term

Over the next twenty-four months, the stock is likely to appreciate from $9.08 to $13.88 per share. This implies 52.9% upside from current levels. The technical analysis indicates the stock is in the beginning stages of a long-term up-trend, further backing the buy-thesis on the stock.

Investors should buy AA at $9.08 and sell at $13.88 to pocket short-term gains of 52.9% in 2013-2014.

Long Term

The company is a great investment for the long-term. I anticipate AA to deliver upon the price and earnings forecast despite the risk factors (competition, commodity prices and economic conditions). Alcoa's primary upside catalyst is international expansion, rising demand in emerging markets, and cost management. I anticipate the company to deliver upon my forecasted price target of $42.47 by 2018. This implies a return of 367% by 2018. This rate of return is exceptional but comes with a high-level of risk (5-year beta of 2.1).

A higher yielding investment opportunity albeit having higher risk is to buy the Jan 17, 2015 calls at the $10.00 strike. The call premiums trade for $1.19. The price forecast for the beginning of 2015 is $20.50. The rate of return if the calls expire at $20.50 is 782%. The break-even point is $11.19.

AA has a market capitalization of $9.7 billion. The lack of liquidity makes this an investment opportunity appropriate for smaller institutions, or growth oriented investors who have a high risk tolerance.

Conclusion

Alcoa is an exceptional investment opportunity, a true gemstone on the Dow Component, perhaps one of the best opportunities out on the market. If the economy continues to improve, Alcoa will experience a resurgence in valuation that will be unprecedented.

The conclusion remains simple: buy Alcoa.

Source: Alcoa: The Best Long-Term Opportunity On The Dow