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Alcoa (NYSE:AA) is a major player in the aluminum production and alumina supply business with sales approaching $25 billion. S&P estimates that AA had a market share of 14.8% in the global market for primary production of aluminum.

The stock is down 71% during the last five years compared with the 2.5% decline in the broader markets. The company has a market capitalization of $10.2 billion and offers a dividend yield of 1.26%. In this article, I will perform valuation analysis to determine the fair value and 12-month price target.

I started my analysis by reviewing the historical growth rates for AA. These are shown in the table that follows:

Growth Rates

10 Year

5 Year

1 Year

Revenue

2%

-4%

19%

Income

4%

-23%

141%

EPS

1%

-27%

129%

Book Value

0%

-7%

-10%

It is not hard to see why the stock is down 70% during the previous five years. The company's revenue, income, EPS and book value all declined during this time period. Although the company had an impressive last year, the decline in book value is very disappointing to me.

Going forward, I project an EPS growth rate of 20% aided by global economic recovery, and an increase in the price of aluminum. The industry itself is estimated to grow at a 15% clip over the long term.

Coming to profitability, the company has largely maintained its gross margins and improved its operating margins over the last 10 years. The net margin of 2% has also been consistent. The returns on equity, invested capital and assets are abysmal in my opinion. The table that follows presents the profitability and operational metrics.

Profitability & Operations

10 Year

5 Year

1 Year

TTM

Gross Margin

19%

17%

18%

18%

Operating Margin

5%

3%

6%

6%

Net Margin

3%

1%

2%

2%

Return on Invested Capital

4%

2%

3%

3%

Return on Equity

6%

3%

4%

4%

Return on Assets

2%

1%

2%

2%

Valuation

Valuation analysis was performed using relative valuation. The multiple used in the analysis was developed using historical analysis of the company's and the peer group's multiples. The peer group selected for this analysis consisted of Kaiser Aluminum (NASDAQ:KALU), Alumina Ltd (AWC), Aluminum Corp of China (NYSE:ACH), Norsk Hydro ASA (OTCQX:NHYDY), and Century Aluminum (NASDAQ:CENX). A comparison between AA and its peer group is shown below.

Symbol

TTM P/E

Margin (NYSE:TTM)

Growth

Gross

Operating

Prev 5 Yr

Future 5 Yr

KALU

33.63

11%

4.4%

-16%

15%

AWC

23.99

-34%

-69%

-23%

34%

ACH

65.2

-

-

-33%

46%

NHYDY

8.58

-

-

-28%

1%

CENX

128.62

12%

4.4%

-52%

16%

AA

17.93

18%

6%

-35%

20%

The table below shows the valuation analysis results.

Valuation

AA

Next Yr Proj EPS

$0.96

EPS Growth Rate

20%

Future EPS (5 Yr)

$1.65

Expected P/E

16.4

Price 5 Yrs Out

$27.02

Levered Beta

1.80

Risk Free Rate

2%

Risk Premium

8.00%

Size Premium

0.62%

Cost of Equity

17.0%

Fair Value

$12.82

Current Price

$9.57

% Overvalued

-34%

As shown in the table above, AA currently trades at a significant discount to fair value. It is expected to offer a return of 187% over the next five years and is a play on the global economic recovery in general, and growth in demand for transportation and construction in particular.


Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AA over the next 72 hours.

Disclaimer: Kindly use this article for information purposes only. Please consult your investment advisor before making any investment decision

Source: Alcoa - A Ridiculously Cheap Stock With 187% Return Potential