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What Does the Future Hold for Alcoa?

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With a market capitalization of $9 billion, Alcoa (NYSE: AA) remains at the forefront of the aluminum industry. Alcoa is the world's largest aluminum provider, as well as, a leading refiner of alumina and miner of bauxite.

Yet, over the past five years, the firm has lost about 70% of its value. Alcoa's five-year stock chart shows a sharp downward momentum. The stock reached the peak of $39 in May 2008, and since then it has drastically plummeted to around $8.50. Nevertheless, investor sentiment is optimistic about Alcoa's future prospects. Morningstar indicates a five-year growth forecast of 22%. EPS for 2013 is expected to follow a clear upward trend indicating a positive outlook for the company.

Financial performance

For the third quarter of 2012, oversupply within the market and declined realized metal and realized aluminum prices led to a weak performance. Alcoa ended the quarter with a 9% decline in revenues compared to last year. The company reported loss from continuing operations of $143 million, or $0.13 per share. Continuing operations were negatively impacted by a settlement agreement with Aluminium Bahrain B.S.C. (Alba) resolving a civil lawsuit. To cover part of the settlement costs, Alcoa made a $40 million charge against third quarter's earnings. However, excluding one-time special items, the company gained $32 million or 3 cents per share.

Overall, despite the challenging market conditions, the company managed to boost its midstream and downstream businesses. Adjusted EBITDA for Global Rolled Products reached record levels and stood at 72% above the 10-year average. The Engineered Products and Solutions segment generated adjusted EBITDA margin of 20% reflecting a significant improvement over the previous two quarters. In addition, Alcoa demonstrated consistent improvement in days working capital for twelve consecutive quarters. Thus, liquidity remained strong. The firm had enough cash on hand and was able to cover its current liabilities and maintain a dividend yield of 1.40%.

Stock performance and valuation

Technically, the stock is beaten down. Alcoa shares have been trapped in a steep downtrend for quite some time. Since the beginning of the year, the stock has underperformed the market, touching bottom-low levels. The latest closing price was around 4% below the SMA200, and about 1% below the SMA50. Nevertheless, analysts suggest that the stock has limited downside. The average target price implies a 20% appreciation potential. Out of twenty analysts tracked by Wall Street Journal, ten indicate a “hold” rating. Seven of them suggest it is worth buying and only three analysts recommend a “sell” rating.

At current valuation metrics, Alcoa could be an intriguing investment. It is trading at 40% discount to sales and 30% discount to book value, pointing to a possible value opportunity. Also, with a forward P/E ratio substantially lower than the five-year average levels, the stock is considered to be relatively cheap.

Alcoa vs the rest

Among the firm's major competitors are companies like Aluminum Corporation of China (NYSE: ACH) and Century Aluminum (NASDAQ: CENX). In terms of market penetration, Alcoa is ahead of its peers. It operates a wide network of over 200 facilities across 31 countries, which boosts the company's capacity and enhances its global reach. Also, the company benefits from a series of competitive advantages. Its vertical integration and its size provide significant privileges like lower input costs and greater efficiency.

Aluminum Corporation of China primary serves the domestic market. China's lack of raw materials and energy sources accelerates production costs for aluminum producers. So far this year, the company failed to generate positive earnings primarily because of its concentration on the Chinese market. The slowing growth in China has weakened demand trends leaving domestic aluminum producers with overloaded inventories.

Century owns primary aluminum capacity in the U.S. and Iceland. The company has also suffered from continuing losses. Over the past five years, EPS followed a downward pace of over 50%. For the third quarter of 2012, its net losses almost doubled compared to the same period in 2011. Moreover, the stock is trading with unfavorable valuations and a beta that implies increased systematic risk. 

Looking ahead

Alcoa's profitability is directly linked to cyclical demand and volatile commodity prices. Considering the tough market conditions, Alcoa could be a risky investment at the moment. Recently, the firm revised downwards its 2012 global aluminum demand forecast to 6%.

Nonetheless, it expects accelerated demand trends over the next seven years. Amidst the current challenging economic environment, Alcoa is aiming to achieve a turnaround by focusing on strategic initiatives. In an effort to expand its global market reach, Alcoa joined forces with The Saudi Arabian Mining Company (Ma'aden). Recently, the two companies successfully commissioned the first of 720 smelting furnaces signaling the launch of the aluminum industry in Saudi Arabia.

Overall, with about 15% share in global aluminum production, Alcoa is well-positioned to benefit from a future market recovery. For value investors, the current depressed levels provide a unique opportunity for substantial gains.

FaniKel has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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