Alcoa: Not Much Upside Without Increase In Aluminum Prices

Mar.26.12 | About: Alcoa, Inc. (AA)

The aluminum business has been in quite a rut as aluminum prices have fallen significantly from their 2011 highs. The recent announcement by China of prioritizing low inflation over growth hasn't helped either. The fact that the LME Aluminum Warehouse Stocks Level are at 5 year highs compounds the problem. This has caused aluminum producers to cut production. Alcoa (NYSE:AA) expects that these factors "will result in a global aluminum industry deficit of 600,000 metric tons in 2012." Note, this will just eat into the inventory at a rate of just over 10% suggesting that the inventory has a long way to go to return to previous levels.

With all of that in mind, the stock is fairly valued. However, if one expects aluminum prices to recover then the stock is a great buy. The trailing valuation metrics suggest that the stock is undervalued with significant upside on an aluminum recovery. Below is an in depth look at the valuation metrics and the stock chart.

Valuation: Alcoa's trailing 5 year valuation metrics suggest that the stock is undervalued as all of the metrics are below their respective 5 year averages. Alcoa's current P/B ratio is 0.8 and it has averaged 1.1 over the past 5 years with a high of 2.2 and low of 0.5. Alcoa's current P/S ratio is 0.4 and it has averaged 0.7 over the past 5 years with a high of 1.2 and low of 0.3.

Price Target: The consensus price target for the analysts who follow Alcoa is $12. That is upside of 15% from today's stock price of $10.11 and suggests that the stock is fairly valued at these levels. This also suggests that the stock has limited upside and should be avoided at its current stock price.

Forward Valuation: Alcoa is currently trading at about $10 a share with analysts expecting EPS of $0.96 next year, an earnings increase of 96% y/y, for a forward P/E ratio of 10.5. Taking a look at the company's publically traded comparisons will give us a better idea of the stock's relative valuation. Kaiser Aluminum (NASDAQ:KALU) is currently trading at about $49 a share with analysts expecting EPS of $3.76 next year, an earnings increase of 21% y/y, for a forward P/E ratio of 12.9.

Century Aluminum (NASDAQ:CENX) is currently trading at about $9 a share with analysts expecting EPS of $0.84 next year, an earnings increase of 342% y/y, for a forward P/E ratio of 11. Noranda Aluminum (NOR) is currently trading at about $11 a share with analysts expecting EPS of $1.43 next year, an earnings increase of 70% y/y, for a forward P/E ratio of 7.3. The mean forward P/E of Alcoa's competitors is 10.4 which suggests that Alcoa is fairly valued relative to its publically traded competitors.

Earnings Estimates: Alcoa has beat EPS estimates 1 times in the past 4 quarters. The company's EPS figures have come in between -7 cents and 1 cents from consensus estimates or about -31.8% to 3.7% from analyst estimates. The company has reported earnings that have differed from analyst estimates by a wide margin which suggests that the stock may experience upside from earnings surprises.

Price Action: Alcoa is down 40.9% over the past year, underperforming the S&P 500, which is up 8.9%. Looking at the technicals, the stock is currently below its 50 day moving average, which sits at $10.23 and below its 200 day moving average, which sits at $11.30.

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