Alcoa: Revised $16 Price Estimate, Long-Term Outlook Still Solid

November 29th, 2011 by Trefis Team
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Alcoa

Global economic conditions have taken a toll on Alcoa (NYSE:AA), with the company posting a significant decline in earnings and revenues in the third quarter. The cumulative effect of the decline in metal prices due to seasonal factors and weakness in Europe has hurt the company’s margins. Consequently, the market has been quite harsh on the company’s stock, pushing it down into single digits. We have taken these factors into account in revising our price estimate for Alcoa’s stock from $20 to $16, which is still approximately 60% ahead of the current market price. We expect that the company’s initiatives to develop high-end engineered products and its focus on the automotive sector will help drive sales going forward, hence our still-bullish price estimate. Alcoa is the world leader in the production and management of primary aluminum, fabricated aluminum and alumina, and competes globally with other mining giants like Rusal, Rio Tinto (NYSE:RIO), BHP Billiton (NYSE:BHP) and Chalco (NYSE:ACH).

See our complete analysis for Alcoa’s stock here.

Year-over-year growth but sequential decline

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Overall, when compared to the third quarter of 2010 the company has shown substantial growth with revenues up 21 percent and earnings up 182 percent. However, industrial demand for alumina, aluminum and other related products has declined in Q3 2011 when compared to the second quarter, eventually leading to a decline in prices. Outside of Europe, the company witnessed a growth in shipments in most of its markets, albeit at a slower rate than in the first half of 2011. Aerospace and Transportation were the only two sectors that saw revenue growth in the third quarter. The decline in demand not only hurts shipments, but also the selling price of the aluminum, thereby reducing revenues and margins.

Revisions in our forecasts

We have adjusted our forecast to account for the decline in margins and shipments across all the divisions as prices of the metal decline with the decline in demand. The Chinese Yuan continues to make things worse for the company as it faces the brunt of cheaper Chinese imports. The company may not be able to meet our initial forecasts of primary aluminum and alumina shipments, but its midstream products (flat-rolled aluminum sheets) and engineered products should help sustain volumes and margins.

Long-term outlook is still strong

Alcoa has maintained its outlook for the next ten years, stating that global aluminum demand will double by 2020, which implies a 6.5 percent compound annual growth rate. For the year 2011, the company estimates that aluminum demand will grow by 12 percent, primarily driven by Chinese demand growth and partially offset by a decline in European sales.

Focus on midstream and high-end products will drive growth

Demand for lighter weight materials in automotive manufacturing continues to rise as manufacturers look to reduce the weight of their vehicles to increase fuel efficiency. Aluminum alloys carry a better strength-to-weight ratio than steel and are increasingly being viewed as an attractive substitute for steel. We detailed this trend and the upside it holds for Alcoa’s business in a separate note earlier. Alcoa’s midstream business consists of the flat-rolled products it produces for use in aerospace, automotive, consumer electronics, appliances and other industries.

Alcoa is also focusing on developing units for the production of engineered products to serve the automotive and aviation industry primarily. The company entered into a joint venture with China Power Investment Corporation (CPI) to set up such a unit in China. You can see the details on the venture and the upside that sales in developing regions provide for the company in our previous note on the development.

Although the stock has taken a beating in the past few months, we believe that Alcoa’s fundamentals are strong, primarily due to the new initiatives that the company is taking to drive its sales in the midstream and engineered products markets.

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