Is This Aluminum Manufacturer A Good Stock to Buy?

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Alcoa (NYSE: AA) is down 1% so far in 2012, continuing a bear run in the stock that has been going on for several years (the stock price peaked above $45 in July 2007 and now trades just above $9 per share). The stock was hit hard by the financial crisis and recession in the U.S., as might be expected given that the basic materials stock as a beta of 2; aluminum is used to build airplanes and cars, and so demand depends on broader economic activity. Because of this factor and because of the effects of supply, aluminum prices are up from their lows in early 2009 but below prices from the end of 2010, which had about reached their pre-crisis levels.

Alcoa earned 3 cents per share in the third quarter of 2012 ignoring significant one-time charges, which brought the company into the red. Even the 3 cent figure was a decline from the 15 cents per share the company had posted in the third quarter of 2011. Revenue was down as well, falling 9%, as both shipment volume and prices declined.

As a result of its performance- and the expectations of the stock market that Alcoa’s recent troubles will pass, with the result being that prices have only slightly declined this year- the stock trades at a very high multiple of trailing earnings. However, Wall Street analysts are even more confident in the company’s future prospects than investors; their consensus estimates imply a forward P/E of only 13. We think that an earnings multiple in that range is reasonable for a high-beta stock with a modest dividend yield (1.3% at current prices). Ron Gutfleish’s Elm Ridge Capital, a hedge fund with over $2 billion under management, slightly increased its position in Alcoa during the second quarter of 2012, bringing its total to 5.7 million shares. Find more stock picks from Elm Ridge Capital. Samlyn Capital, managed by Robert Pohly, initiated a position of 1.9 million over the same time frame (see more stocks Samlyn likes).

Other aluminum companies include Aluminum Corp. of China (NYSE: ACH), Century Aluminum (NASDAQ: CENX), and Kaiser Aluminum (NASDAQ: KALU). Aluminum Corp. of China is expected to be unprofitable both this year and next year, and we’d imagine that it is highly exposed to the Chinese economy in particular. With growth slowing there, and the company not generating positive earnings, we would avoid it. Century also has had negative earnings, but has been beating Street estimates and is expected to break into the black next year. However, it will still carry a high earnings multiple if it meets these targets- 43x- and with even more sensitivity to a bear market at a beta of 2.8, we’d prefer Alcoa to this company as well. $1.1 billion market cap Kaiser is in a more stable situation. Its revenue and earnings increased in its most recent quarter over the same period in 2011. It trades at trailing and forward P/Es of 19 and 14, respectively, with continued analyst projections giving it a five-year PEG ratio of 1. Investors should take a closer look at Kaiser; it appears to be the best value in the aluminum space.

For an alternative way to invest in a company tied to global commodity demand, investors could look at Freeport-McMoRan Copper & Gold (NYSE: FCX). Copper is a particularly sensitive indicator of the strength of the global economy, and Freeport-McMoRan’s beta is a bit higher than Alcoa’s at 2.3. The company suffered severe declines in revenue and earnings last quarter compared to a year ago, and trades at 12 times trailing earnings with a dividend yield of 3.1%. Read our discussion of Freeport-McMoRan from last month.

We’re a bit cautious on Alcoa as so much of its valuation is derived from an expected improvement in its business. While there do seem to be aluminum companies that are worse values, Kaiser looks a bit better and investors who want a basic materials stock could consider companies tied to other commodities as well.

This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article.The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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