Aluminum producer Alcoa (NYSE:AA) is on a roll in 2014, with its shares already up 55%. Back in April, I wrote that Alcoa is poised for a breakout, and the same has happened. But the good thing is that Alcoa hasn't run out of breath yet. The company recently reported strong second-quarter results, and looking ahead, strong momentum in various end markets will continue propelling Alcoa shares higher.
Alcoa is counting on two major themes to power its growth. The first is strong operational performance, and the second is its continuing transformation and changing portfolio.
Alcoa's downstream performance was outstanding in the previous quarter, as the company recorded the highest level of profit as well as margin. Additionally, midstream profit increased 34%, and the upstream also put in an improved performance.
Aerospace prospects look strong
At present, Alcoa looks like a new company that has established its focus on specialized products like alloy components for aircrafts. The company is focused on portfolio transformation through the $3 billion acquisition of Firth Rixson, a U.K.-based maker of jet-engine components, which strengthens its already solid aerospace portfolio and affirms the management's commitment to the aerospace industry.
Recently, Alcoa also announced that it has won a big contract from Pratt & Whitney in the aerospace sector. According to an Alcoa press release:
"Leading aerospace manufacturer Alcoa today announced a 10-year, $1.1 billion agreement with Pratt & Whitney, a division of United Technologies Corp. (NYSE:UTX), for state-of-the-art jet engine components. Under the deal signed at the Farnborough Air Show, Alcoa will supply key parts for Pratt & Whitney's engines, including the forging for the first ever aluminum fan blade for jet engines. The forging was developed for Pratt & Whitney's PurePower engines using an advanced aluminum alloy and a proprietary manufacturing process. Also for the PurePower engines, Alcoa is developing a fan blade forging using its most advanced aluminum-lithium alloy."
So, Alcoa's focus on innovation is allowing it to make solid progress in the aerospace business. This is good news for investors, as the large commercial aircraft segment is expected to grow 12.1%. In addition, Alcoa sees a robust commercial jet order book with nine years of production backlog as of now.
Also, according to IATA, the fundamentals in the aerospace sector are expected to remain strong. IATA expects a 5.9% rise in passenger demand and a 3.1% increase in cargo demand. Also, airline profits are expected to increase and reach approximately $18 billion for the industry this year. The order book for jet engines is also full, with 23,000 engines on firm order.
Alcoa has positioned itself to benefit from the positive prospects in the aerospace business. It recently made a $100 million investment to expand its structural engine component offering in La Porte, Indiana and a $25 million investment to further enhance its jet engine blade performance in Hampton, Virginia.
Automotive on a roll
Apart from aerospace, Alcoa expects the automotive market to further drive its growth. Auto sales have rebounded handsomely over the last couple of years. According to Alcoa, the automotive segment in North America is expected to grow at a rate of 2% to 5%. In Europe, the auto market is expected to grow in the range of 0% to 4% for this year. For China, the segment is on track to grow in the range of 6% to 10% this year.
Moreover, the heavy-duty truck segment in the U.S. has gained strong traction. As a result, Alcoa has increased the expected growth forecast of the segment from the earlier range of 5% to 9% to the range of 10% to 14% for this year. Quoting Alcoa management:
"Now the orders are up 20% year-over-year and on a year to date basis even 28%. The order book is very nice set at 119 trucks, the historic average is 114, this is up 39%. Decent fundamentals 3.7% of the freight ton miles are up 1%, freight price up. Production we believe the forecast is increasing. We do think 140,000 units on a year to date basis, this is as a 15% up on a year on year basis."
Better demand and pricing ahead
Another important thing to note is that along with solid demand, Alcoa is expecting an increase in aluminum pricing going forward. According to Bloomberg:
"Alcoa Inc. forecast global aluminum demand will exceed production this year, predicting an end to an almost decade-long surplus driven by Chinese output that has saddled the industry with lower prices.
Alcoa is among aluminum producers outside of China to have shuttered unprofitable smelters amid a glut of the lightweight metal. The New York-based company yesterday reported better-than-expected first quarter earnings and said it now sees a global supply deficit of 730,000 metric tons. In January it had predicted a 106,000-ton surplus."
Thus, Alcoa is well-positioned to continue growing. The company is seeing strength in demand, and better pricing will help it sustain the momentum in the future. In fact, Alcoa's bottom line is expected to grow at a terrific rate of almost 48% for the next five years, more than double of the 20% industry average, and almost 10 times the bottom line growth rate of 5% reported in the last five years. Considering that Alcoa trades at a forward P/E ratio of just 20, it looks like a solid growth pick at a reasonably cheap valuation, and investors should definitely hold the stock in their portfolio for solid long-term gains.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.