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After several months (even years) of what has seemed like a 'slow death' stock (see chart below), Alcoa (AA) has regained life in a big way. After uncomfortably oscillating in a channel between $7.50 and $8.50, exploded over the last two weeks. On 10/22, AA was up over 8% on four times the normal volume, as it shared earnings news that was interpreted as a sign of good times ahead for the stock. Given that AA has traded as high as $40 in times past, should you buy with hopes of secular tailwinds, or ignore this head fake for a clearer signal in the future? Below are a few arguments for the latter view.

(click to enlarge)(c

Riding a Temporary Tailwind.

Politically Incorrect. Alcoa and other Aluminum producers have enjoyed (up to) a 150% pricing premium because of market inefficiencies in the Aluminum Exchange (aka LME or London Aluminum Exchange). These market inefficiencies have to do with the speed at which physical aluminum has to trickle out of LME's warehouses, and a myriad of other factors.

Not unreasonably, aluminum customers are incensed at the impotence of the LME, and its inability to keep Aluminum producers from demanding hefty premiums over the futures price for actual delivery of the metal. Alcoa is incensed that the LME is trying to fix itself, and calls its attempts at efficiency unreasonable and careless. AA has reasons for fear, since the last thing the Aluminum industry needs is for a metal glut to be compounded by a pricing collapse from distribution efficiency. Senate scrutiny of this and other commodity price fixing might have died down, but I wouldn't (as the market seems to do) count on these dying out.

Analyst Skepticism. Analysts seem to share my skepticism on the likelihood of Aluminum prices firming up in any secular way, or for AA's productivity and currency driven earnings blip to not reverse course next quarter. On October 22 (after AA's blip) Deutsche Bank stuck to its earlier sell rating, and a $5.5 target price. Others like BMO Harris have a more generous $7 target on the stock, but still far below today's trading price. There are counter-arguments from Jim Cramer, who makes the case that AA is transforming from a raw metal production company to a service (i.e. specialty finished product) company. If you buy that thesis, you can make a long-term stock purchase with the expectation of a fundamental repricing of the stock. While that side of the business has been growing and growing well, it is not clear that finished products growth is adequate to compensate for any LME driven price deflation of raw Aluminum price.

Not Exactly Cheap. Staying with AA as it stands (a company heavily dependent on Aluminum pricing), the chart below indicates that its EV/EBITDA numbers don't standout as a particularly unique value in the Aluminum industry. (click to enlarge)(click to enlarge)(click to enlarge)

Furthermore, if you want to invest in metals, you might be better off with BHP Billiton (BHP) or Freeport McMoran (FCX), that offer similar value on a valuation basis, but are more diversified. FCX spreads your bets between Copper, Gold and Aluminum. And BHP allows you to play metals as well as the longer-term Potash shortage with its Janssen project.

(click to enlarge)

In short, if you want to play AA, play it for the right reasons - namely that you believe in a secular growth new market such as Aerospace. There isn't a lot of market evidence to chase it just based on momentum.

Source: Alcoa: Don't Get Caught Up In The Recent Earnings Beat