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 (AA). After all, CEOs don't often boast about these projections to get investors excited if they don't really believe it themselves. So investors should classify Mr. Kleinfeld's optimism as one to watch for the coming year and certainly one that I feel will also be proven to be right. Because he knows that the growth of the world's population all but guarantees the growth of Alcoa's business. Yet the stock remains incredibly cheap - why?
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 market leader - 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. This was made evident several weeks ago when it reported fourth quarter earnings.
Pedal to the metal
On January 9, 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.
In 2011, the world consumed 44 million tons of aluminum, a figure that was up from 39 million tons in 2010. Yet, 2012 there is a projection that demand for aluminum will grow at a rate greater than the historical trend lines for the balance of the current decade. For this reason, I continue to wonder, how can the stock remain at such depressed levels relative to its own growth potential? I continue to feel that the stock has the capability to climb to $15 at some point during the year. The reason is simply that Alcoa has had a history of trading one-year forward EBITDA multiple in the range of 6 and 8. So using this metric, as well as analysts' EBITDA 2012 estimates with a 7 multiple, suggest that $15 might even be somewhat conservative.
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 in their vehicles and jets. And if you add the fact that 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. Investors looking for a conservative long term play in the sector may also consider two of Alcoa's main competitors in Kaiser Aluminum (KALU) as well as Century Aluminum (CENX).
Disclosure: I am long AA.