Analysts are currently bearish about Alcoa (AA) and Century Aluminum (CENX) given uncertainty in the industrial economy. Based on my review of the fundamentals and multiples, I find significant risk for both companies but attractive upside for Alcoa.
From a multiples perspective, Alcoa and Century are unstable due to earnings volatility. Alcoa trades at a respective 19.4x and 10.7x past and forward earnings while Century trades at a respective 10x and 23.5x past and forward earnings. Both have 110% or more volatility than the broader market and minimal capital allocation policies only make investors more nervous. Given inflationary concerns and political unrest in the Middle East, basic materials investors are more interested in gold producers.
At the third-quarter earnings call, Century's management noted disappointing business trends:
[C]ash LME price on average was down 8% in Q3 versus Q2. As you know, we do much of our business on a one-month lag basis and so the one month lag price was down 4% quarter-to-quarter. In this context our realized unit prices both in the U.S. and in Iceland were down as expected, down 5% in each of the U.S. and in Iceland.
Turning to the shipment volumes you can see this data if you go to the end of the financial information, again, that follows the press release. Firstly, in past quarters we did a small portion of our business in Iceland on direct basis versus total this past quarter, in the third quarter were 2,030 tons, so when you make that adjustment you'll see that, yeah, domestic volumes were down 2% quarter-to-quarter.
Carbon and energy costs are putting pressure on margins while revenue streams are shaky - particularly in regard to power contracts at Mount Holly. Management is accordingly placing a significant amount of focus on trimming its cost base.
Consensus estimates for Century's EPS forecast that it will decline by 75.2% to $0.27 in FY2011, and then grow by 66.7% and 155.6% in the following two years. These projections are highly uncertain and, accordingly, it is challenging to extrapolate off of them.
Alcoa, on the other hand, has greater certainty. It is the largest producer of alumina, which offers attractive margins. This basic material is in scarce supply and challenging to develop. The disconnecting of alumina to aluminum will further help the former's price. The vertical integration of the business also affords it greater control over expenses to navigate macro cyclicality. Aluminum prices are trending better than what some expected, although there has been weakness in Europe. To address industrial concerns in Europe, management announced that it was closing 240K tons of its capacity in Europe. Management guided for a 7% rise in aluminum consumption in 2012. It also divested some of its lower margin and stagnant downstream businesses.
Consensus estimates for Alcoa's EPS forecast that it will decline by 25% to $0.54 in 2012 and then grow by 77.8% and then by 27.1%. Modeling a 3-year CAGR of 19.2% for EPS and then discounting backward by a WACC of 9% yields a fair value figure of $15.33, implying as much as 49% upside.