Alcoa Looks Undervalued, But With Some Significant Asterisks

There are some investors who simply refuse to consider highly cyclical stocks like Steel Dynamics (STLD) or Alcoa (AA), and a quick look at the recent chart outlines some of the reasons why. With Alcoa’s high sensitivity to alumina and alumina prices (a roughly 5% change in aluminum prices can move EBITDA by close to 10%), and the ongoing volatility of the commodity markets, it’s a tough company to model accurately beyond a few quarters. Making matters worse, the valuation norms for the shares seem to have broken down over the least year or so, making it even more challenging to come up with a good sense of where the shares should trade.

When all else fails, I come back to free cash flow, and I do believe Alcoa is undervalued here. Current aluminum prices don’t appear to be sustainable, and Alcoa should see more capacity leave the market in response … though the timing there is of course uncertain. I believe the shares are undervalued below the mid-$30’s, but I’d never consider this as more than a trade.

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Alcoa Looks Undervalued, But With Some Significant Asterisks

Supply Issues Creating A Windfall For Alcoa

While I liked Alcoa (AA) three months ago, and thought that the company could benefit from some supply curtailments, I didn’t expect the significant market disruptions that have pushed spot aluminum prices on the LME to over $2,528/mt (versus less than $2,100 in December). Now, though, the market is dealing with section 232 limitations, problems with the Alunorte facility, and U.S. sanctions against Russian producers, pushing the markets into more substantial supply deficits.

Although Alcoa has had a good run over these last three months, and I don’t view it as a long-term holding, there may still be some worthwhile upside left at these levels.

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Supply Issues Creating A Windfall For Alcoa

Investopedia: Alcoa Still A Victim Of Circumstance

Alcoa (NYSE:AA) deserves a lot of credit for managing a difficult aluminum market and continuing to make productivity improvements. Unfortunately, the market doesn't reward feel-good stories. Accordingly, while Alcoa shares continue to look cheap and the long-term aluminum market fundamentals look better, it seems probable that these shares won't really work until aluminum prices get going again.

A Pretty Strong First Quarter, Relatively Speaking
Alcoa's first quarter wasn't great in absolute terms, but the company did do a fair bit better than expected and Wall Street is all about relative performance.

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http://stocks.investopedia.com/stock-analysis/2012/Alcoa-Still-A-Victim-Of-Circumstance-AA-RIO-ACH-BHP0412.aspx

Investopedia: The Vale Between Two Peaks

Whether it's the anticipated end of QE2, ongoing growth in emerging markets, the economic recovery in North America and parts of Europe, or the fact that hundreds of companies are furiously digging new holes around the world, there are a lot of crosscurrents in the commodity space. 


Although commodities have pulled back in early May, it seems early to call an absolute end to the secular rally. With that in mind, maybe Brazil's Vale (Nasdaq:VALE) is still worth a look for value-oriented investors who want some commodity exposure. (For more, see Investing In The Metals Markets.)


A Disappointing Start to the Year
The first quarter is virtually always the weakest for this huge iron ore and nickel producer, but this quarter was even weaker than analysts had in mind. All of that said, "weak" is a relative notion. Revenue was still almost double the year-ago level, while adjusted EBITDA climbed over 3.5 times from last year's first quarter. So although that EBITDA figure was about 10% below the consensus, clearly it is not as though Vale is scraping bottom. 



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