By Jeff Reeves
We recently launched a feature highlighting the 10 best stocks to buy for all of 2012. The idea was to find a pick that investors could buy and hold ALL YEAR, and ride to profits.
My pick for this feature was the Dow Jones component Alcoa (NYSE:AA). And here's why:
When Alcoa reported earnings in October, CEO Klaus Kleinfeld told investors, “Alcoa is a confident company in a nervous world. We are well prepared for whatever lies ahead, with more cash on hand, lower debt and continued focus on profitable growth.”
It would be natural to write off those comments as mere platitudes for Wall Street’s grumpy traders. But taking a closer look at Alcoa across the past several weeks has made me agree with Klaus — and consider AA stock as a bargain buy to hang on to across 2012.
Shares of Alcoa were trading as high as $18 this spring before sovereign debt fears, stagnant job numbers and other issues sent the stock back into a tailspin. AA stock is under $9 to end the year.
Yes, big problems persist in the global economy, and aluminum demand and prices remain weak as a result. However, Alcoa hasn’t seen the $9 level since spring 2009. Are the macroeconomic fears really worse now than in 2009?
Oh, and by the way — massive restructuring plans have not just returned Alcoa soundly to profitability, but resulted in steady growth for several quarters running. Is AA stock really a worse investment now that it is streamlined, in the black and paying down debt?
Obviously no stock is risk-free. But in my opinion, Alcoa has limited downside and lots of upside in 2012. Here’s why:
Improving earnings: Alcoa has seen year-over-year profit increases in each of the last eight quarters. It has also seen revenue go up year-over-year for seven straight quarters. The result is that fiscal 2011 revenue is going to be up about 35% over last years’ numbers if estimates for Q4 hold. Profits will be up even more dramatically, to 81 cents a share for the full year 2011 compared to just 25 cents in 2010 — more than triple last year’s numbers. Forecasts for 2012 include even more improvement in both sales and profit numbers. We'll find out on Jan. 9 when Alcoa kicks off earnings season if it can keep up this earnings momentum.
Bargain stock: Alcoa has a forward P/E of about 9.4 right now, based on a stock price of $9 per share and 2012 earnings estimated at 96 cents. If AA stays right on schedule and simply moves up to a P/E valuation of around 12, we get to $12.50 per share — a whopping 38% upside! Imagine what will happen if Alcoa keeps beating earnings estimates in 2012.
Dividend potential: Alcoa has a fairly meager yield of about 1.3%, based on a quarterly payout of three cents. That payment has been stagnant since March 2009, too, after it was cut from 17 cents quarterly. However, there’s good reason to expect a dividend increase in 2012. Alcoa has returned to profitability and surely will be feeling pressure to hand back some of that cash to shareholders. Not only will a dividend increase give you a great yield on cost if you buy at $9, it will attract buying pressure to AA stock as other investors continue to seek out safe-haven dividend stocks amid the market turmoil.
Aluminum prices can’t move much lower: The CEO of one of Alcoa’s competitors, Norway’s Norsk Hydro (OTCQX:NHYDY), recently said aluminum prices are about as low as the industry will allow them to go because many producers risk operating at a loss if aluminum gets any lower than $2,000 per metric ton, or roughly 91 cents per pound. Chief Executive Svein Richard Brandtzaeg said, “If there is a lengthy (low price) situation, the chances for shutdowns are increasing.”
Reports indicate that Chinese aluminum producers already have cut back annual production by about 1.5 million metric tons — showing that even if demand remains weak, producers are going to get aggressive with supplies to boost prices that way. I won’t say prices have nowhere to go but up, since weak demand could persist. But it is clear that aluminum producers are going to act together to ensure they don’t go significantly lower.
Right-sized for hard times, ready for recovery: So why aren’t investors flocking to Alcoa stock if it has all these things going for it? Well, because the primary factor affecting demand for aluminum is economic growth — specifically, production of durable goods like cars and construction projects. But there are reasons to expect baseline aluminum demand won’t drift much lower because car sales and construction already have taken big hits. There’s also Brandtzaeg’s point that the aluminum industry will continue to curtail supplies to ensure prices don’t drift lower, either.
As for Alcoa’s operations, big cost cuts over the past few years, including some 13,500 layoffs handed down in 2009 (a staggering 13% of its work force), have streamlined the company for hard times. Alcoa is is lean and on the defensive — which means if things stay challenging, AA stock should hang tough.
I know what you’re saying. This all nice — in theory. The reality, of course, is that things can certainly get worse — much worse — for Alcoa and for many stocks on Wall Street.
Auto sales should be up almost 10% in 2011 from 2010 numbers and easily could retreat to those earlier levels in the coming year. Housing starts and other construction statistics indicate marked improvement over 2010 as well, and it’s not unrealistic to think that housing could backslide too. Demand could plummet, aluminum prices could crash and AA stock could take a beating.
That’s a risk I’m willing to take. I think Alcoa has limited downside after its tumble across the past few years and recent return to profitability, and will at worst move sideways in 2012.
As for upside, I think $12 is reasonable. According to Thomson/First Call, 16 Wall Street analysts have an average target of $12.73 and a mean target of $12.25. Most recently, Barclays put a $13 target on a AA stock in November with an equal weight rating.
That’s a 33% upside from here. Maybe not enough to win our Best Stocks for 2012 contest, but certainly returns any investor would be happy with.
Disclosure: I am long AA.