Alcoa Showing Strong Value Now

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

Alcoa (NYSE: AA) stock has been trading near its 52-week low recently. While there are plenty of reasons to be concerned about this major aluminum producer, I believe that the stock is undervalued and investors should consider buying it. A major catalyst for the company's growth is its Saudi Arabia joint venture with Ma'aden (a Saudi Arabian mining company owned 50% by the Saudi Arabian government) which is a $10.8 billion fully integrated aluminum facility scheduled to start operations in 2013. In addition, aluminum is a major component used in planes and autos which are currently in demand in emerging as well as developed economies.

Economic concerns around the world, and primarily in Europe, have caused the stock price of Alcoa to drop near a 52-week low. This is despite the recent drop in energy prices of over 10%. Energy is one of the largest cost components in Alcoa's production process and I think investors have overlooked this positive development for Alcoa. Currently, its stock trades at a price to earnings ratio, based on the last 12 months of earnings, of about 15.7. On a forward looking basis, the company trades at a price to earnings ratio of 11, below the S&P 500 ratio of 12. I believe that Alcoa should trade above the average market price to earnings ratio due to the wide spread use of aluminum.


In addition, the stock is currently trading 0.6 times its book value and at par with its tangible book value. For comparison, the industry's price to book value ratio is 1.5 and the price to tangible book value is 1.9, both significantly above Alcoa's book value valuation. In fact, a price to book value of one and under can be an indication of a company that has significant unrealized value. Finally, the stock pays a $0.03 dividend per quarter for an annualized yield of about 1.4%. In my opinion, Alcoa offers the rare opportunity of significant capital appreciation. At the same time, it is paying a higher dividend than many short-term and mid-term debt instruments in a low interest environment (expected to continue until late 2014).


A major catalyst for Alcoa's stock price is the company's joint venture in Saudi Arabia. Saudi Arabia has significant reserves of bauxite, which is used to produce aluminum. Alcoa's plant will be one of the lowest cost fully integrated aluminum plants in the world. In addition to bauxite, Saudi Arabia offers abundant oil and gas, good infrastructure, and a central location for exporting the products to the Middle East as well as Africa and Asia. Next year, the aluminum plant will start operating the smelter and the rolling mill with Alcoa supplying the aluminum. In 2014, the mine and the refinery will start production.


The aluminum refinery is expected to produce initially 1.8 million metric tons per year, the smelter 740,000 metric tons per year and the rolling mill 380,000 metric tons. For comparison, in a single quarter, Alcoa ships about 1.3 million metric tons of aluminum products. It appears that the capacity of the new plant will be quite significant. Also, it will be the first mill in the Middle East to produce can sheets.


In addition to this significant development in the Middle East, I estimate demand for Alcoa's product to increase from demand for new aircrafts. The company is expanding the business catering to airplane manufacturing as airlines around the world are ordering more new aircrafts from Boeing (NYSE: BA) and Airbus. For example, Boeing has registered 263, 625, 921, and 418 orders for its commercial aircraft in 2009, 2010, 2011, and 2012 (through May 15). It takes several months of lead time to build an airplane. In addition, Boeing has 4,000 airplanes that are ordered but not produced, so my estimate is that the production of the 2011 orders has not even started. This significant backorder will use up significant amount of aluminum in the coming quarters and years and Alcoa is well positioned to benefit.


Auto demand in the U.S. as well as in other parts of the world is on the rise. Alcoa supplies aluminum to two of the largest U.S. car manufacturers, General Motors (NYSE: GM) and Ford (NYSE: F). GM reported April U.S. sales that exceeded its own expectation. The company sold 213 thousand vehicles in April of 2012 and also raised its own forecast for 2012 of sales between 14 to 14.5 million vehicles from the earlier estimate of 13.5 to 14 million vehicles. Similarly, Ford announced on May 8, 2012 that the company is increasing its 2012 production by 400,000 vehicles and that it will shut down its plants in the summer for one week instead of the usual two weeks. Clearly, auto sales in the U.S. are rebounding. I expect Europe to follow suit in 2013 as it emerges from its current economic slump. Also, I expect demand in developing countries to be robust as more people move to the urban centers.


There are other catalysts for Alcoa's stock. The company recently announced that it is reducing its smelting capacity by 10% which should start to bear fruit to the bottom line in the coming months. Also, aluminum is used in ships and Alcoa delivers the components for many ships. Recently, it collaborated with the Australian defense contractor Austal to produce the leading edges of the outriggers for a ship that Austal is building for the U.S. navy in Mobile, Alabama.


In conclusion, it is my opinion that Alcoa stock is significantly undervalued and as the company's major expansion in Saudi Arabia starts production in 2013, the stock will rise. Alcoa prides itself not only on meeting the demand for aluminum and aluminum products but being a responsible company. Alcoa was recently voted as one of the top ten places to work in Mexico and is also developing innovative products such as a “smog-eating” technology to help sustainability and the environment. A robust demand in key industries such as aircraft and auto construction will help improve demand for aluminum, the price of aluminum will rise, and Alcoa's margins will improve. Given all this, I believe that Alcoa is a great value play and has significant value to be realized in the next one to two year period.

QueenBC has no positions in the stocks mentioned above. The Motley Fool owns shares of Ford. Motley Fool newsletter services recommend Ford and General Motors Company. 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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