Last week I recommended buying aluminum giant Alcoa (AA) ahead of earnings for what I felt was a valuation that was significantly below where the company deserved to be. As with other companies, the stock has been beaten up of late due to slowness in business spending. For Alcoa, the result was a 44% drop in its stock for all of 2011.
While many saw a falling knife, I saw tremendous value in the Dow component – this is even though several prominent analysts had lowered their 2012 earnings estimates by at least 25%. For me, the optimism rested on the company’s own confidence – to the extent where it believed in its ability to execute, assured that its long term fundamentals were intact.
On Monday, Alcoa proved true on that promise – to some extent. Though the company posted a fourth quarter loss that was largely attributable to the huge declines in aluminum prices, it provided investors with a favorable outlook for the global demand of the metal – particularly in aerospace and automobile markets. The news of the loss was widely expected and didn’t shock anyone since (as noted) several analysts had already dropped expectations by 25%.
Its net loss was $191 million – the first loss that it has posted in over a year. For the quarter ending in December the loss registered at 18 cents a share. On a year-over-year basis it looks pretty bad when compared to the 24 cents per share it previously earned. The quarter included one-time charges of $185 million. But with its recent restructuring plans which included closing a good portion of its smelting operations, these expenses were to be expected. So if you take that out, the loss was actually considerably less.
The good thing about its report was that the bad news is now out. What investors care more about is what to expect for the coming year - and they got just that. The company’s CEO, Klaus Kleinfeld, predicted that cutbacks in aluminum production will create a global deficit in aluminum supplies of about 600,000 metric tons this year. He also forecast that global aluminum demand will increase 7% in 2012.
Long Case for the Long Term
It’s hard to argue with the CEO of any business about its growth potential much less for one with a track record of performance such as Alcoa. CEOs don’t often boast about these projections to get investors excited if they don’t really believe it themselves. So I’m going to classify Mr. Kleinfeld’s optimism as one to watch for the coming year and one that I feel will also be proven to be right.
Ahead of the company’s earnings announcement, Fellow Seeking Alpha contributor David Sterman made an excellent case for why the company deserves a long look. In a recent article he said the following:
- Alcoa's stock is worth slightly more than the $9.65 billion in tangible book value on its balance sheet. Yet that book value figure is quite understated because the value of a number of manufacturing facilities has been written down due to depletion. In terms of replacement value, if one were to build Alcoa's factories from scratch, then you're likely looking at a market value closer to 40% lower than the real value of the company's assets.
- Equally important, Alcoa should remain free cash flow positive, even if the global economy slumps further in 2012. A weak economy would actually benefit Alcoa as higher-cost rivals get flushed out. As it stands, many aluminum producers are operating at a loss with aluminum trading for roughly $1 a pound. That's a price point at which Alcoa can still turn a profit.
I have to agree with David on this and feel that the stock has the capability to appreciate this year by at least 50%. It helps that the company said its growth projection continues to be ahead of the 6.5% rate required to meet its forecast of doubling in global aluminum demand over the next decade. Not to mention it has also been working hard to reduce costs and move down the cost curve, on the refining and smelting side of the business. It is looking to move refining costs from the thirtieth percentile in 2010, to the twenty third percentile by 2015. This is on top of its goal to increase EBITDA margins. With these clear strategies in place and sound management, it is hard to bet against a stock that is already undervalued.
The fact of the matter is aluminum and many of its characteristics are needed in several large business productions mainly for its high strength to weight ratio as well as its ability to resist corrosion. Because of this, companies such as Ford (F) as well as Boeing (BA) should become large consumers of aluminum as they evolve into utilizing it more into their vehicles and jets. And if you add the fact that it makes sense for appliance makers such as General Electric (GE) might also contribute to the demand for aluminum it becomes easy to see why the company’s CEO is so optimistic about its long term growth prospects.