As the economy improves, I expect improving media coverage of smaller producers like Anglo Aluminum (GM:ANGLF) and Orbite Aluminae (OTCQX:EORBF). Meanwhile, Alcoa (AA) will help drive higher-risk adjusted returns for the entire sector. In my view, it will be one of the top gainers this year.
In this article, I will run you through my DCF analysis on Alcoa and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to National Aluminum Company (NLC) and Century Aluminum (CENX).
First, let's begin with an assumption about revenues. Alcoa finished FY2011 with $21B in revenue, which represented a 14% gain off of the preceding year. Analysts model a 19.7% per annum growth rate over the next five years.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I expect cost of goods sold to eat 86% of revenue versus 4.5% for SG&A and 0.9% for R&D. I anticipate capex to trend below 4.8% as taxes hold steady around 24%.
We then need to subtract out net increases in working capital. I model accounts receivable as 10% of revenue, inventories as 14.5% for COGS, prepaid expenses as 90% of SG&A, accounts payable as 10.5% of OPEX, and and accrued expenses as 87% of SG&A.
Taking a perpetual growth rate of 2% and discounting backwards by a WACC of 7% yields a fair value figure of $14.35, implying 36.1% upside.
All of this falls under the context of operational challenges:
"[L]et's turn to the fourth quarter. Our loss from continuing operations in the quarter was $193 million or $0.18 per share. Restructuring and other special items totaled a negative $159 million, which brings us to a loss of $0.03 per share…
A 13% drop in the LME, combined with continued European weakness, contributed to the decrease in revenues on a sequential basis. On a year-over-year basis, sales increased 6% despite an 11% drop in LME as the aerospace, automotive, and commercial transportation markets all showed greater than 20% increases in revenue".
Again, however, I believe the firm is overly discounted. From a multiples perspective, Alcoa is cheap. It trades at 19.9x past earnings but only 11x forward earnings. This compares to 56.2x forward earnings for Century and 16.7x past earnings for National Alum. Assuming a multiple of 16x and a conservative 2013 EPS of $0.93, the rough intrinsic value of the stock is $14.88.
Consensus estimates for Century's EPS forecast that it will skyrocket to $0.84 in 2012 and then grow by more than half the following year. The degree of risk in the stock will thus help generate unusually high returns should markets improve better than expected.
Nalco, National Aluminium Company, is safer due to its diversification in a variety of different emerging countries and markets. In addition to bauxite, alumina hydrate, and aluminum production, the India-based company is also invested in electricity generation. For a diverse play on emerging markets which is safer than Century, Nalco is an attractive pick.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.