Alcoa, Century Aluminum Too Risky Given Macro Uncertainty

| About: Alcoa, Inc. (AA)

Since approximately one year ago, Alcoa (NYSE:AA) has lost more than one-third of its value and is now rated a "buy" on the Street. I find that the company faces significant headwinds going into 2012 on the operational, financial, and economic fronts. Century Aluminum (NASDAQ:CENX), which is rated a "hold" on the Street, similarly faces these challenges after a volatile 2011. In light of macro uncertainty, I strongly recommend staying on the sidelines.

While both of the stocks are highly risky, Century has more than 60% volatility with its beta of 3.4. It trades at a respective 9.8x and 23x past and forward earnings while offering no dividend yield. Alcoa offers a dividend yield of 1.2% while trading at a respective 19.3x and 10.7x past and forward earnings.

At the fourth quarter earnings call, Alcoa's CEO, Klaus Kleinfeld, noted several positive developments despite the erosion of shareholder value:

"And in addition to that, we have the bolt-on acquisitions on the fasteners side from Perry Republic [ph], TransDigm. We expanded our footprint, 4% EBITDA margin improvement for percentage points, and 4% to 7% market share gains depending on where you go. Trico, the acquisition and the windows side increased our North American commercial window share by 18%.

So that's that on the operational side. If you look here at the financial targets, and I don't want to go through all of them, we basically achieved all of them, achieved or overachieved all of them together with on the right-hand side, the strategic targets. And that will continue. We're going strong into 2012, and we're well trained and capable to act fast and face up the challenging market conditions".

Even still, macro uncertainty will keep aluminum priced at low levels. Volumes are meanwhile being reduced and the first quarter of 2012 is likely to be to sequentially worse due to $75M impact from operational difficulties and down-time. Deutsche Bank warns that 2012 free cash flow could be negative hill leverage trends upwards given low output costs. Management is scaling back more than one-tenth of its 4.5M smelting capacity. Fortunately, much of the reduction will take place in the always-stagnant Europe.

Consensus estimates for Alcoa's EPS forecast that it will decline by 19.4% to $0.58 in 2012 and then grow by 65.5% and 27.1% in the following two years. Assuming a multiple of 14x and a conservative 2013 EPS of $0.93, the rough intrinsic value of the stock is $13.02, implying 27% upside. If the multiple were to decline to 9.5x and 2013 EPS turns out to be $0.91, the stock would fall by 15.6%.

Century, if anything, faces even more downside. Carbon and energy costs are cutting into margins at the same time that investors remain concerned about operations at Hawnesville and power contracts at Mount Holly. With that said, the company is attempting to cut back on its cost base and has showcased a successful story in Iceland where operational costs are 20% less than that of domestic. During the economic downturn, the company restructured its balance sheet to avoid credit issues. Alcoa's strategy was to cut jobs and mitigate costs. In any event, both companies lost roughly one-third of value since the start of 2011.

Consensus estimates for Century's EPS forecast that it will decline by 74.3% to $0.28 in 2011 and then grow by 64.3% and 152.2% in the following two years. Given the high beta of 3.4 and volatility with earnings, Century is substantially risky for a basic materials firm. As runaway spending continues, inflation will inevitably follow and investors are advised to seek an interest in gold. Kinross (NYSE:KGC), for example, has nearly 90% less volatility and trades at only 13.2x and 9.9x past and forward earnings.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.