Why Alcoa Will Breakout to $15 In 2013

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

If you suffered a blackout and are just now waking up while holding shares in aluminum giant Alcoa (NYSE: AA) at this time last year, the good news is - you haven’t missed anything. Unfortunately, the bad news is, well… you haven’t missed anything.

The stock ended 2011 trading at $8.54 per share and as of this writing it is trading at $8.59. However, there are reasons for optimism that 2013 will send the stock to new highs. The question though, is whether or not aluminum prices will cooperate. Early indicators suggest that it will.

Q3 Wasn’t Great But Far From Terrible

In the most recent quarter, Alcoa reported a loss of $143 million, or 13 cents per share. However, this wasn’t so bad when you consider that a significant portion of it stemmed from continuing operations. Also, it included a payout from an environmental lawsuit totaling $175 million.

Otherwise, the company would have earned $32 million, or 3 cents per share. Essentially, the company beat on its bottom line. Revenue arrived at $5.8 billion – exceeding analysts’ estimates of $5.54 billion. The dip in revenue was due to the prolonged weakness in aluminum prices which have declined by 5% from the previous quarter and by 17% year-over-year.

Nonetheless, Alcoa’s upstream business logged impressive improvements, delivering almost $100 million of aggregate growth across its various segments, which include Alumina and Primary Metals. Management figured out ways to offset sustained cost concerns with improvements in price and mix as well as productivity gains.

Making All of the Right Moves

Despite what has been significant market turmoil, the company continues to make the best out of a bad situation. The good news is that things are only looking up from here. Aside from the prospects of a rebounding industry, Alcoa’s management continues to speak favorably about the automotive and aerospace industries.

It certainly bodes well for the stock if companies such as Ford (NYSE: F) and Boeing (NYSE: BA) have started to migrate towards using aluminum in their vehicles and jets. It sounds good, but its more than just an environmental decision. Ford is looking for a competitive edge and the company understands that the lighter metal will help meet tougher federal fuel-economy targets.

However, it will not be easy to convince truck enthusiasts that aluminum is as tough as steel. But on the other hand, cutting 700 pounds off the truck will add extra horsepower. So there’s a give and take. For Boeing however, the issue is a bit more sensitive as one can imagine. Weight in the sky is different from weight on the ground. It goes without saying.

However, there’s also a cost and maintenance factor to consider. According to Tony Morales, Alcoa’s marketing directors for aerospace aluminum, an “aluminum-intensive” narrow-body jet made of new alloys would be up to 10 percent lighter than a “composite-intensive” plane and would cost 30 percent less to build and repair. In other words, Boeing's future will depend on aluminum.

These potential growth areas are in addition to management’s forecasts of 6% growth for aluminum over the next several quarters. Likewise, the company expects other areas of its business to see significant improvements. These include gas turbine markets, food packaging as well as commercial transportation.

It also should help that the company has recently signed a $1.4 billion multiyear deal with Airbus to supply aluminum and aluminum-lithium wing parts and fuselage panels for Airbus's A320 and A380 jetliners as well as the A350 wide-body jet that is still in development.

Likewise, the company signed a joint venture with a Saudi Arabian mining company, Ma’aden, a deal that is pegged to be the lowest-cost producer among other smelting systems of Alcoa around the world. It will help Saudi Arabia become the regional leader in the global aluminum industry. Clearly, Alcoa’s management is making all of the right moves and appears intent on returning value to shareholders.

Bottom Line

With all of these factors considered, the (potential) aggregate effect suggests that Alcoa is undervalued by at least 40%. $12 to $15 per share seems more reasonable. This also assumes an 8 times forward multiple on 2013 EBITDA, which is .5 lower than the company’s historical average.

It’s also worth noting that this is all based on the assumption that aluminum prices will rebound. While Alcoa can’t control this aspect of its business, the company’s management nonetheless makes this a great bet. And a modest yield of 1.3% doesn’t hurt either.

rsaintvilus has no positions in the stocks mentioned above. The Motley Fool owns shares of Ford. Motley Fool newsletter services recommend Ford. 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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