Is Alcoa Really a Bargain Right Now?
John is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
With the price of Alcoa's (NYSE: AA) stock at a 20 year low, I just need to ask this question: Is this company a bargain right now? Should investors buy it or at least take a look?
Where is Alcoa?
Revenues and profits declined for Alcoa on a year over-year basis. Lower realized prices ate up earnings, even as certain segments of its business were in demand. Demand was higher in four key areas: aerospace, distribution, industrial gas turbines and packaging. But, three other areas were down: Industrial, building and construction demand for aluminum failed to reach the same levels they did last year.
It is good to be cautious right now about the whole aluminum industry, which is still over-supplied. The problem manifests itself in prices as Chinese mills continue to supply aluminum at below-cost levels, as opposed to the initial expectations of capacity cuts. On top of this, the European debt situation has squeezed prices to a two year low. As long as the Chinese continue to produce like they do instead of cutting production, I do not see how there can be any change in either the market or Alcoa’s immediate future.
On the bright side, the global rolled products are what is holding together Alcoa right now. If demand can pick up even further in these sectors, (aerospace, automotive and transportation sectors), it would mean better operating margins for the company in the future. The company’s recent strategy realignment and capacity cuts for smelters and alumina refining should continue to drive productivity improvement. Let's take a look at aerospace as an example of how well it has performed in that sector.
Aerospace
Alcoa, whose aluminum was used on the world’s first-ever flight by the Wright brothers at Kitty Hawk, N.C., has a vast aerospace portfolio generating $3.4 billion in revenues. The aluminum giant has signed new multiyear agreements worth around $1.4 billion with Airbus to supply products for all the passenger jet maker’s commercial programs, including the new A350.
Aerospace is a bit more technical than just straight aluminum; often it uses titanium and nickel and creates aluminum-lithium alloys, which results in lighter and lower cost airplanes. This is one reason the aerospace division is winning! How can one go wrong when weight is lighter and maintenance requirements are significantly lower. Alcoa’s products can deliver 22%-27% greater fuel efficiency, reduce weight by 5%-10%, double the length of time needed between structural and corrosion inspections, and increase passenger comfort. The company has a backlog of around 8,300 large commercial aircraft at end of the second quarter, equivalent to over eight years of production. This will also bring on more contracts with Boeing (NYSE: BA).
Is Alcoa a Bargain?
Alcoa presently trades at 8.14 and is near a 20 year low. So is it a good buy right now? One thing we can see about the company is that it still has a lot of potential as seen in the recent Airbus contract. The company has done a great job downsizing with the global contraction. The company has the ability to explode once the price and demand for the metal increases. Many investors do not know this, but the company is big on R&D—it spends 1% a year on the development of new technologies dealing with aluminum.
But if I was looking for reasons not to invest, I might consider its debt ratio of .69. With a total debt load of $9.5 billion and cash on hand of $1.7 billion, it does not look very inviting. Obviously metal prices have contributed to this, but a strong management group and the cut-backs that have been made are helping. It recently reported a positive free cash flow of $246 million, compared to last quarter’s negative $506 million, an improvement of $752 million.
It may be possible that industries are looking for ways to provide greater fuel efficiency and that this will lead the demand for lighter metals like aluminum. Will the demand for the metal grow at the 7% clip that Alcoa predicts this year? I am not sure about that. It has predicted 13% to 14% growth in aerospace this year, 4% to 8% growth in automotive, and 2% to 3% global growth in beverage cans. But will it happen? Like many stocks today, Alcoa’s future is in doubt until some kind of certainty regarding global growth emerges. But one cannot deny that a company trading at a price nearing twenty year lows looks very inviting!
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