Is Alcoa Stock’s Recovery Too Good To Be True?

After an impressive 140% rise since the March 20 lows of this year, at the current price of $13 per share, we believe that Alcoa’s stock (NYSE: AA) has breached its near-term potential. Alcoa’s stock has rallied from $5.48 to $13.06 off the recent bottom compared to the S&P which increased 44% during the same period. The stock was able to beat the broader market in the last 4 months as aluminum prices rebounded and started to rise since April following the US government announcing a string of measures along with stimulus packages announced in other economies to keep businesses afloat. Also, with the Chinese economy opening up, the market is expecting a rise in aluminum demand. However, the stock is down 76% from levels seen at the end of 2017, a little over 2 and a half years ago.

Despite Alcoa’s stock price being lower than its pre-Covid (February 2020) level of $17, we believe it is slightly above its intrinsic value, as demand and revenue are expected to be lower than last year. Our dashboard What Factors Drove -76% Change In Alcoa Stock Between 2017 And Now? provides the key numbers.

Some of the stock decline between 2017-2019 is justified by the roughly 10.5% decrease in Alcoa’s revenues during this period, while its operations turned loss-making in 2019. While Alcoa’s revenue declined in 2019 and has reached below its 2017 level, the P/S (price-to-sales) multiple has seen a continuous decline over the years and the stock price also declined. We believe that the stock is unlikely to see a further upside after the recent rally and the potential weakness from the recession driven by the Covid outbreak.

Alcoa’s P/S multiple declined from 0.9x in 2017 to 0.4x in 2019, while the company’s P/S currently stands at 0.2x. Additionally, Alcoa has put 1.5 million metric tons of aluminum smelting capacity under review, which will lead to lower shipments and thus subdued revenue in the future. We do not think the company’s P/S multiple has much upside left, and in the near term is likely to remain around the current level as a lower multiple would be a reflection of expectations of lower revenue in the near term.

What’s could drive a drop in price?

As increasing number of steel players are shedding capacity, with demand from automobiles being modest, China has increased its exports of semi products at a lower price, which has, in turn, led to a decline in the price of primary aluminum products worldwide. To add to this, the global spread of coronavirus led to lockdown in various cities across the globe, which affected industrial and economic activity. The aluminum demand from industry players affects global aluminum price levels, in turn impacting the company’s price realization for its products. Lower demand from construction and automobile players, has led to a drop in global aluminum prices from $1,820/ton in January 2020 to $1,570/ton in June 2020. This was reflected to a certain extent in the company’s Q1 2020 results, with the company reporting a 12.4% y-o-y drop in total revenues. Q2 2020 reflected a better picture of the crisis with revenue declining by 21% on y-o-y basis.

However, over the coming weeks, we expect continued improvement in demand and subdued growth in the number of new Covid-19 cases in the U.S. compared to the rate seen in April-May to boost market expectations. Additionally, the gradual lifting of lockdowns is also giving investors confidence that developed markets have put the worst of the pandemic behind them. Following the Fed stimulus — which helped set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view, with investors now mainly focusing their attention on 2021 results.

As the global lock downs are gradually being lifted, aluminum prices saw some recovery in July and currently stand at over $1,660/ton, compared to $1,570/ton in June 2020. This recovery is due to expectations of demand increasing in the next few months and supply constraints being eased. However, despite global price showing signs of recovery, Alcoa is unlikely to be able to take complete advantage of higher prices as it is looking to sell part of its aluminum assets, which would mean the company’s shipments are likely to decline when global prices are on an upside. Thus, revenue growth in 2021 is expected to be marginal despite a very low base in 2020. This could trigger some sell-off in the stock and it could go down from its current levels. Based on Alcoa’s valuation, Trefis has a price estimate of $12 per share for Alcoa’s stock, slightly lower than its current market price.

So, while Alcoa seems to be overvalued as of now, which S&P 500 component stocks have the best chance of outperforming the benchmark index? Our 5 In the S&P 500 That’ll Beat The Index: TWTR, ISRG, NFLX, NOW, V look promising.

For further insight into the mining space, check how rival Rio Tinto’s stock has performed and also see how Vale compares with Cleveland-Cliffs.

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