Aluminum giant Alcoa (NYSE:AA) is in the midst of an impressive turnaround. The stock is up 55% on the year to date, closing Friday at $16.44. It seems such a long time ago that Alcoa was booted out of the Dow Jones Industrial Average for what many perceive as a dead stock. Since then there hasn't been a hotter stock in Dow.
Remarkably, these shares have caught fire even as the market for aluminum has yet to return to robust levels. The good news is that Alcoa is no longer solely dependent on the aluminum industry, which has been marred by weak prices, declining demand and compressed margins.
And on the heels of the company's strong second quarter earnings report, and its $3 billion deal for Firth Rixson, a U.K.-based maker of jet-engine components, Alcoa has its eyes set on the sky while affirming management's commitment to entering the aerospace industry. And that's not to say Alcoa has given up on aluminum. It means that the company's product portfolio is becoming more diversified. And it's only the beginning.
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 at the company. Plus, when you factor that appliance makers such as General Electric (NYSE:GE) can also contribute to the demand for aluminum, Alcoa's future is brighter than it has ever been.
These markets, combined with Firth's projected EBITDA contribution of $350 million in the next two years, makes Alcoa one of the best long-term investments on the market. With an improved aluminum environment, combined with the company's accelerated aerospace transition, Alcoa stock should reach $20 in the next 18 to 24 months, making Alcoa one of the best bargains on the market.
This transition hasn't been easy, however. Although analysts have warmed up to the idea of a better pricing environment, there's still a wait-and-see attitude. Deutsche Bank analyst Jorge Beristain, for example, needed convincing. He has a hold recommendation on the stock with a price target to $15, or 9% below current value. Alcoa management is not swayed by the doubt.
Instead, Alcoa management enacted a well-timed decision to do away with its Primary Metals business, which had become more trouble than it was worth. That, and the company's ongoing cost-cutting efforts have demonstrated how the company's performance is, in fact, better than its industry.
It has been these productivity improvements that has turned the business more favorable. Beristain and other bears 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.
Equally important, Alcoa should remain free cash flow positive, even if the aluminum prices were to take a step back this year or next year. But all signs suggest that the economy is getting better, which supports better operating structures for Alcoa.
From my vantage point, even though Alcoa stock is up close to 80% since the 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 $20. Alcoa's management is no longer interested in moral victories.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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