Alcoa Inc (NYSE:N:AA) is a company that has suffered due to weak commodity prices. The continued weakness in the economy has also hurt its operations in the past as it had to slash its production to deal with aluminum prices. However, as a leader, the company has shown to the rest as to how to beat the industry trend and engaged in product mix to beat the heat. The stock seems to have taken more of severe beating than it deserved. The current situation appears to be one such that as valuation demanded the stock to trade higher. Also, recently a hedge fund manager termed the stock a dramatically undervalued one. The company’s stock could be worth buying at current levels and let’s looks at the reasons for it.
Best To Buy Before Break-Up
Alcoa Inc (NYSE:AA) indicated in September last year that it was going to split into two. As a result, it would separate its energy, mining, aluminum-producing assets from divisions that roll out a number of metal components for different industries. The split is expected to be completed in the first half of the current year. Whenever a company announces a split, it would always be better to buy the stock before the split happens. The reason was very simple. The investor would get the shares in both the companies. Any weakness in one of the stocks could very well get compensated by the other. Also, the strength in any one of the company would get a big boost in the absence of recording any weakness from other divisions. While upstream would satisfy the income investors, the value added unit would be liked by investors focused on growth.
Alcoa Inc (NYSE:AA)’s plan to split into two has the potential to be a game change for both the companies also. After more than a century, the two divisions would be ready to lead a life as a stand-alone. There was no doubt that it was heading for a big, as well as, complicated process of splitting. However, the focus would be on sorting out the connections between the planned two firms. For instance, upstream would make the materials, i.e. aluminum, and value addition in one umbrella whereas the other would be an integrated firm. The company’s successful split would make the current year a memorable one. On the other hand, any failure could be a big disaster for it. Therefore, execution assumes importance.
Hedge Fund Boosts Its Stake
Elliott Management Corp. has preferred to lift its stake to 7.4% in Alcoa Inc (NYSE:AA). That is a clear indication that the hedge fund is fully behind the aluminum maker ahead of the split. The latest move was in continuation of its earlier effort to accumulate it to 6.4% stake. The hedge fund took the decision to invest in it after the spin-off of its more assorted parts-making business from the operations of its main raw-aluminum. In a filing, Elliott said that the shares of the aluminum manufacturer were undervalued dramatically. The hedge fund was confident that the split would create substantial value than the current levels. That is an indication to shop the shares at the present level.
Paul Singer, Elliott representative, has been in touch with Alcoa Inc (NYSE:AA)’s senior executives. That included its CEO, Klaus Kleinfeld. The hedge fund said that the biggest aluminum maker’s stock was not fully valued among the mining and metal firms in the America. In fact, that prompted it to invest in it. Since 2011, raw aluminum prices have slipped significantly. The hedge fund is also believed to be pushing to divest power generation business. There is also another reason to remain bullish on the stock.
Demand Is There
Even in the sluggish economic environment, Alcoa Inc (NYSE:AA) tries to find demand for its products. One of the reasons for it was the mix of product. The recent success was more due to its product mix. That landed itself in satisfying the needs of the aero-plane manufacturers like Boeing Co (NYSE:N:BA). Currently, aerospace firms needed lightweight metals and the increasing demand would boost the aluminum maker’s share price. Boeing, as well as, the Britain-based Airbus Group (L:0KVV) was the customers of the company. As a result, the company expects lightweight metal sales to increase in the current year.
Alcoa Inc (NYSE:AA) estimates about a 8 – 9% sales increase from these aerospace sector. The confidence was due to the continuous strong demand for big commercial aircraft, as well as, jet engines. Aside from the two aerospace firms, the company also struck an alliance with GE Aviation, which could have the potential to value over $1.5 billion. The agreement will enable the company to supply advanced nickel-based superalloy, aluminum, and titanium components for an extensive range of engine programs. The company has about $9 billion in supply contracts in aerospace in the last year, which included the transaction.
Automotive Sector
Aside from the aerospace, the automobile space would also help Alcoa Inc (NYSE:AA) to gain in the sector. Last year, aluminum automotive sheet witnessed 18% growth. That apart, the aluminum maker expands its factory plans to provide aluminum sheet to General Motors Company (NYSE:N:GM), Ford Motor Company (NYSE:N:F) and Fiat Chrysler Automobiles NV (NYSE:N:FCAU). In the next few years, the company is expecting aluminum sheet content per vehicle to grow. As a result, aluminum auto sheet demand would hit one million metric tons before the year 2025.
On valuation, Alcoa Inc (NYSE:AA) shares are valued less than the broader index. For instance, its price-earnings were 17.4 times whereas S&P500 enjoyed price earnings ratio of 19.0 times. Similarly, its price to book ratio was 0.7% compared to the broader index’s 2.7%. In the same way, price to cash flow was 3.9% compared to S&P500’s 11.5%. These ratios also suggest that there is enough space to grow.
Conclusion
Alcoa Inc (NYSE:AA) stands to gain from product mix and the widening acceptance of aluminum in different industries. For instance, aerospace and automobiles were the two industries that gains from using aluminum. Also, the split should help the company in more than one way. Though the commodity price continued to play havoc, the current levels provide an opportunity to gain.
Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.