Alcoa Is on the Operating Table
Kyle is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
sym·bi·o·sis noun\ˌsim-bē-ˈō-səs, -ˌbī-\
1 : the living together in more or less intimate association or close union of two dissimilar organisms (as in parasitism or commensalism); especially : mutualism
2: a cooperative relationship (as between two persons or groups) <the symbiosis…between the resident population and the immigrants —>
~Merriam-Webster English Dictionary, 2012
"The best thing that happens to us is when a great company gets into temporary trouble...We want to buy them when they're on the operating table." - Warren Buffett
Alcoa (NYSE: AA) has its tentacles (I use the word lovingly) stuffed into every aspect of the aluminum trade: technology, mining, refining, smelting, fabricating, and recycling. To discuss Alcoa is to give a State of the Union Address on the World of Aluminum. The company is currently the third largest aluminum concern in the world, and is the only mining/recycling “supermajor” that is actively seeking to expand its market share in the declining metal.
This unique, symbiotic relationship makes this analysis of Alcoa's Strengths, Weaknesses, Opportunities and Threats an altogether different animal from SWOT treatments you may have read of other companies. There are no new marketing initiatives, for example. No new technology or new wonder drug. To be bullish on Alcoa is to be bullish on a global economic recovery occurring within whatever time horizon that you as an investor find to be acceptable. However, as we'll see, the implied profits for investors willing to ride out the economic downturn are immense indeed.
Productivity Gains: Alcoa is reigning in costs on upstream segments, growing top line on downstream segments.
Low Historical P/E: Historically, Alcoa stock has been trading at an average of between 16 and 23 and its current price to earnings ratio is at the lower end of this range at around 18.
Rivals Decimated: The Great Recession and its aftermath is proving to be land grab for Alcoa. Miningmx reported that Alcoa would seek to buy mines used in the manufacture of aluminum from BHP Billiton (NYSE: BHP) and Rio Tinto (NYSE: RIO). BHP and Rio have shelved aluminum mining operations, owing to the poor outlook for aluminum. Rio Tinto has put up for sale 13 aluminum assets including its Gove operations in Australia since October last year to improve the group’s financial performance. Aluminum prices have fallen 3.3% this year after an 18% decline in 2011. The metal is currently the second least-profitable business in Rio's portfolio, earning just $442 million on sales of $12.2 billion.
BHP Billiton sold its 33.3% stake in an alumina project in Guinea earlier this month and abandoned plans for a smelter in the Democratic Republic of Congo and stopped exploration at Guinea's Boffa Santou Houda sites.
Global Infrastructure: Alcoa has large scale operations in the U.S.A. (Point Comfort), Canada, Brazil (Pocos De Caldas), Australia (Kwinana, Wagerup, Pinjarra), Spain (San Ciprian), Italy, Suriname (Paranam), Iceland, and Norway. With the purchase of Evermore Recycling, Alcoa is now the world's #1 recycler of aluminum.
Aerospace: Global aerospace remains solid at a 13% to 14% growth rate. Aluminum is heavily used in aircraft.
Automotive (U.S.) market: 10-15% growth.
Aging U.S. Heavy Trucks/Trailer Fleet (US): The U.S.'s truck fleet is aging (average age: 6.6 years) and will have to be replaced within the next decade. The 20-year average age of heavy trucks is 5.8.
Weak Demand: Aluminum prices have fallen 3.3 percent this year after an 18 percent decline in 2011. Aluminum for three-month delivery traded at $1,952.50 a metric ton on the London Metal Exchange as of 6:07 p.m. in Melbourne.
Cost Restructuring: Alcoa is currently trimming back its aluminum production in order to bring supply in line with global demand.
Falling Heavy Trucks and Trailer Orders: Until global shipping and construction companies overhaul their heavy trucks, demand will continue to collapse. North American orders were down -23% in Q2, and an additional -13% in Q3. European Q3 truck registrations are down -18% from Q2. Chinese truck registrations are down -17% from Q1 to Q2 and -31% from Q2-Q3.
Alcoa: Look out below! (Source: Yahoo Finance)
European automotive market: Europe continues on its downward spiral, partially offsetting U.S. gains (-4% to -9% contraction in Q3)
Macro factors: Remember when I said that this SWOT analysis was going to take a strange turn? Well, we've arrived.
Alcoa's Opportunities going forward rely almost exclusively on Macro trends, and will likely continue to do so until aluminum supply is brought back into line with demand. Positive developments for aluminum/Alcoa include: ECB bond buying, a Grand Bargain on the fiscal cliff, additional Fed stimulus/increased asset purchases, Chinese stimulus and lower oil prices.
Macro factors: No Grand Bargain, rising bond rates in Southern Europe, no further stimulus, Chinese downturn, and higher oil prices.
Aluminum's ultra-low density, corrosion resistance, and – for the trucking and aerospace industries – vital alloys, as well as the fixed life expectancy of existing aluminum structures (aluminum has no fatigue limit, which means that aluminum-based structures will ultimately collapse from stress) will win out over politics and economic concerns. Aluminum demand is growing in every region other than Europe/Japan, while global output is contracting annually for the first time in three years. Lower oil prices, reduced supply, and excellent execution of company cost-cutting initiatives will accelerate Alcoa's return to growth.
For long term investors, Alcoa is a steal at $8.28 a share – a little over half Alcoa's P/B of .5258 (104.67% undervalued) – as even a modest increase in global GDP implies a much higher valuation. Nevertheless, while I'm happy to empty out the piggy bank for Alcoa at $8ish, I suspect the inevitable political brinkmanship over the fiscal cliff to take the stock as low as $6.50 before rebounding.
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