- Alcoa's stock is worth slightly more than the tangible book value on its balance sheet.
- Alcoa should remain free cash flow positive, even if the aluminum prices remain weak for all of 2014.
- Management's decision to do away with legacy businesses have begun to pay off.
Given strong evidence of improved business conditions, we've become extremely bullish on Alcoa's (NYSE:AA) prospects. While the market for aluminum has yet to return to robust levels, Alcoa management continues to make the best out of what has been a brutal situation. But that's all about to change. And following a strong first-quarter earnings report, I've got the sense that Alcoa is no longer interested in moral victories.
On Tuesday, Alcoa lead-off earnings season by reporting revenue of $5.45 billion, which was a 2.5% miss. According to some estimates, analysts were looking for revenue of $5.59 billion. Revenue was impacted by (among other things) lower aluminum prices and reduced production from Alcoa's European mills. But this is not a surprise.
What was a surprise, however, was Alcoa's 9 cents earnings per share, when excluding restructuring and one-time charges. This was a strong beat of 80%. The Street expected earnings of 5 cents.
For Alcoa, there was a bit of vindication. Although analysts had warmed up to the idea of better pricing environments, there's still a "wait-and-see" attitude. Management deserves credit for making productivity improvements. Deutsche Bank analyst Jorge Beristain needed convincing. He has a sell recommendation on the stock with a price target to $5.50.
Beristain clearly underestimated how quickly management would move Alcoa's business away from low-margin commodity areas to stronger growth drivers that create value for investors. And given that management demolished earnings estimates amid 2% decline in revenue is a perfect example.
Beristain saw the stock as "dead money." Alcoa had other ideas, including management's well-timed decision to do away with Primary Metals business, which had become more trouble than it was worth. That, and the company's ongoing cost-cutting efforts have demonstrated how Alcoa's performance is, in fact, better than its industry.
Accordingly, my price model for aluminum, which have been trimmed by 10% and 12%, respectively, for fiscal year 2014 and 2015, remains conservative. This, however, should not be considered an indictment on Alcoa or its management team. But unlike most, I don't expect Alcoa to manufacture growth out of thin air. Global demand for aluminum is isn't there yet.
The good news, though, is that Alcoa's management, which has always remained upbeat about the company's prospects, has maintained 7% demand growth in aluminum for this fiscal year, which was 1% better than what the company guided for last year. And I believe another 7% demand growth target for all of 2015 will also be encouraging.
For that matter, China is seen as accounting for the lion's share of that growth. It's also worth noting here that despite recent weakness in Europe, management offered some encouraging words, suggesting that Europe was beginning to show improvement.
What's more, given that companies such as Ford (NYSE:F) and Boeing (NYSE:BA) have become large consumers of aluminum in their vehicles and jets, there remains untapped growth areas for Alcoa. Plus, when you factor that appliance makers such as General Electric (NYSE:GE) might also contribute to the demand for aluminum, Alcoa's future is brighter than it has ever been.
As it stands, even though Alcoa stock is up 65% since their October low, these shares may not be done climbing. Alcoa's stock is worth slightly more than the tangible book value on its balance sheet. This is an understated metric, which points to fair value of $15.
Equally important, Alcoa should remain free cash flow positive, even if the aluminum prices remain weak for all of 2014. Note, management believes aluminum prices will improve. But all signed suggest that the economy is getting better, which support better operating structures for Alcoa.