Is This Aluminum Producer Cheap Enough Yet?

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

After the oil bubble peaked in 2008, virtually all commodities took a nosedive.  For example, crude oil prices retreated from over $144 per barrel to the $35 range in less than a year.  Aluminum was no exception, falling from a peak of $3,070 per metric ton in August 2008 to a low of $1,340 in February 2009.  Since then, it has rebounded to just above $2,000 per metric ton, or about 35% below its peak. 

However, the share price of my favorite aluminum producer, Alcoa (NYSE: AA) has not rebounded accordingly.  On the contrary, it keeps getting cheaper, currently trading for under $8.50 per share, a long way down from its pre-crash peak of $48.77.  In other words, the stock is still almost 83% off from peak levels.

For comparison sake, crude oil currently trades at around $91 per barrel, off about 37% from its peak, similar to aluminum.  However, when looking at the world’s largest oil company, ExxonMobil, the share price is within 8% of the peak, and in fact the company’s earnings in 2012 have surpassed any results in ExxonMobil’s history.  I realize that the comparison of aluminum and oil is not ideal, but generally commodity-dependent companies have historically performed similarly.  Is Alcoa finally cheap enough to buy or will earnings continue to be poor?

About Alcoa and the Aluminum Business

Alcoa is one of the world’s largest aluminum producers, with 2012 production of 3.74 million metric tons.  The main flaw in my earlier comparison of oil and aluminum is the difference in demand.  While oil demand remains relatively constant, the demand for aluminum is highly dependent on economic growth and certain types of growth in particular.  In fact, the three largest end markets for aluminum (transportation, containers, and construction) account for 62% of all usage.

If you are bullish about global economic growth, particularly in terms of the transportation and construction industries, Alcoa (or a similar aluminum producer) is the way to play it. I believe that with the combination of the continuing American economic recovery, as well as my belief that Europe’s economic troubles will stabilize over the next few years, we will see a healthy rise in global aluminum demand for years to come.

Valuation/Growth

Over the past several years, Alcoa has taken measures to cut costs that analysts generally think will begin to show results in 2013.  Alcoa is projected to earn 61 cents per share for 2013, meaning the stock is trading for 13.8 times forward earnings, which are expected to grow to 87 cents and 94 cents in 2014 and 2015, respectively, for an average forward growth rate of 25.3%.  While these are ambitious and somewhat uncertain predictions, if these were to prove accurate, earnings growth like this should do wonders for the share price. 

Alternatives

The alternatives for those who are considering Alcoa are its Chinese alternatives such as Aluminum Corp of China (NYSE: ACH); and other metal plays such as copper, like Freeport-McMoRan Copper & Gold (NYSE: FCX).

I think Aluminum Corp of China is a very speculative way to play aluminum.  The company is forecast to lose money for the next three fiscal years.  While this stock could produce great profits long-term, it is simply not worth the risk.  In general I don’t recommend playing China through individual stocks for this very reason.

Freeport-McMoran mines for Copper and Gold, giving investors exposure to the ultimate hedge, gold, while providing the same kind of play on infrastructure growth that would lead to increased copper usage.  I love Freeport as a company; however, I believe it is a bit overvalued at the current share price of around $32.  With two big pending acquisitions and uncertain copper demand, I don’t believe the risk is adequately priced in to create a good entry point. 

Conclusion

As far as a pure aluminum play goes, Alcoa is a great way to play the growing infrastructure and transportation needs around the world.  Historically, Alcoa trades at around 16-17 times earnings, so if the consensus is correct, Alcoa could easily be a $15 stock in a couple of years.


KWMatt82 has no position in any stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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