Why This Stock Is a “Steal” Ahead of Earnings

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

In 2012, Alcoa (NYSE: AA) proved that regardless of how exceptional its management team might be, they were not magicians. Nor was the company immune to depressing macro challenges. However, over the past several weeks, shares of the aluminum giant have risen 14% off the mid-November lows.

This means that despite prolonged struggles in the aluminum industry, investors have begun to appreciate what a “steal” the stock has become. And on Tuesday, with the company scheduled to announce fourth-quarter earnings results, management will either affirm or deny that such optimism is deserved.

Expectations for the Quarter

Analysts are expecting Alcoa to post $0.06 per share in earnings on revenue of $5.64 billion. Although revenue has remained steady, EPS has declined by a penny over the past 90 days, which means that the Street is not expecting any miracles. However, after a rough go of it last year, things can't get any worse in 2013. And Alcoa’s Q3 report showed that a rebound has already begun.

For instance, In Q3 Alcoa reported a loss of $143 million. However, this wasn’t so bad when you consider that a significant portion of that loss stemmed from continuing operations. Also, it included a payout from an environmental lawsuit totaling $175 million. Otherwise, the company would have earned $32 million – enough to beat on its bottom line.

Likewise, revenue arrived at $5.8 billion – exceeding analysts’ estimates of $5.54 billion. There was a slight dip in sales, but difficulties which include a 17% decline in aluminum prices were well documented. There was no surprise there. In fact, the surprise was the company’s ability to show any growth at all.

Alcoa’s upstream business logged impressive improvements. It delivered almost $100 million of aggregate growth across its various segments, which include Alumina and Primary Metals. Remarkably, management figured out ways to offset sustained cost concerns with improvements in price and mix as well as productivity gains. But 2013 is a new year. Investors want to know what's next?

The conference call should provide these answers - including what management plans to do in areas such as automotive and aerospace industries. For some time, the company has pointed to these areas as growth opportunities. Can Alcoa finally enter these spaces?

For instance, a company such as Ford (NYSE: F), which has been looking for a competitive edge can certainly benefit by switching to aluminum. What’s more, the lighter metal will help Ford meet tougher federal fuel-economy targets. Convincing F-150 enthusiasts that aluminum is as tough as steel won’t be an easy task. But on the other hand, cutting 700 pounds off the truck will enhance performance. So there’s a give and take.

These potential growth areas are in addition to management’s forecasts of 6% growth for aluminum in 2013. It will be interesting to see if management maintains that outlook, which has fluctuated between 6 and 7% for portions of 2012.

The stock will move in either direction depending on how guidance hints at projected demand. This will be the surest sign of how management feels about the recovery in aluminum pricing. Likewise, the company expects other areas of its business such as gas turbine markets and food packaging to see significant improvements.

Bottom Line

Management has been making all of the right moves and investors should feel excited that the worst is over. The stock remains undervalued by at least 40%. $12 to $15 per share seems the more reasonable target based on the aggregate effect of these improvements. This also assumes an 8 times forward multiple on 2013 EBITDA, which is .5 lower than the company’s historical average.

rsaintvilus has no position in any stocks mentioned. The Motley Fool recommends Ford. The Motley Fool owns shares of 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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