Even after stubbornly low aluminum prices, Alcoa (AA, Financial) had a good run in 2013. The stock had gained more than 37% since the start of October; however, it tumbled over 5% after it released its quarterly report. Alcoa shared a terrible report as it shared a net loss of over $2.39 billion, 33% less than what the analysts' were expecting. This signifies a massive year-over-year dip as last year, the company reported net income of $242 million. On the revenue front, Alcoa reported a year-over-year plunge of 5%.
In the previous quarter, Alcoa had managed to offset the reducing prices of aluminum by increasing productivity. However, you can't go on increasing production forever, and the quarterly result is a proof that the reduction in prices has finally taken a toll on Alcoa.
In addition, a joint venture of which Alcoa owns 60% admitted bribing officials in the Middle East kingdom of Bahrain through a London-based middleman. The affiliate, Alcoa World Alumina LLC, will pay $384 million in fines and criminal penalties for violating a federal law against bribing foreign officials.
Wide-scale aluminum users have long complained about the rising costs incurred as a result of delayed metal deliveries. As a result, the London Metal Exchange imposed a new set of rules through which the warehouses with the longest delivery time will see that time cut down to half, enabling them to deliver more aluminum than they can consume. This ultimately put more pressure on aluminum prices, which are already near a four-year low.
Furthermore, aluminum prices are projected to remain well below the long-term price assumption of $2,250 a ton in each of 2013 and 2014, primarily because of the market's high inventory levels and production overcapacity.
So, things don't look too good for Alcoa, do they? Well, I'm still optimistic about the company's prospects and a one-time miss doesn't mean the company is down and out. So, let's take a look at the factors that will propel the company's growth in the future.
Bribery Issue Not as Bad as It Sounds
Alcoa will pay $384 million to resolve U.S.A. criminal and civil probes, after a unit admitted to paying bribes to members of Bahrain's royal family and officials at a state-owned company to win business. As per the Justice Department, this penalty includes a criminal fine of $209 million, a forfeiture of $14 million, and a disgorgement of $161 million to the Securities and Exchange Commission. According to SEC, this settlement is the fourth-largest in an FCPA case. But it isn't as bad as it looks. The company's CFO, William Oplinger, claimed that this penalty is manageable as they will be spread over five payments.
Automobile and Aerospace Sector
While other miners like Vale and Rio Tinto have decided to shun their aluminum business, Alcoa has taken a completely different route. Alcoa stated that it gained $1.1 billion in productivity improvements in 2013. However, lower prices mostly wiped away those gains. To tackle the low prices, Alcoa has decided to shift its focus to value-add business, which now accounts for 57% of the company's revenue. This can prove to be a very good strategy for Alcoa as it can benefit from the automobile and aerospace sector.
Alcoa witnessed a worldwide growth of 9% to 10% in the aerospace sector. Commercial planes were the primary driver of this growth. Looking ahead, the company predicts a decent 7% to 8% growth rate in this segment in 2014.
Moreover, there is a hefty backlog order with Boeing and Airbus of nearly 10,000 planes. Both the aerospace giants received orders from Emirates worth $76 billion for their 777X and A380 models respectively. In addition, Boeing has a backlog of more than $500 billion for its 787's and 777's and it could take up to 8 years to clear this accumulation. Thus, demand from the aerospace sector will remain strong in the upcoming years and it will largely benefit Alcoa.
Moving on, the company also expects the automotive industry to become more aluminum-centric, which would lead to a more than threefold growth in revenue from this segment. The company is very optimistic about the auto industry shift to lightweight vehicles, which will increase the percentage of aluminum parts used in them and can prove to be a tailwind for the company. Ford (F) has already announced that it will be unveiling the new Ford F-150 at the Detroit Show on 18 January, 2014. Due to the use of aluminum, the F-series pickup trucks will lose as much as 700 pounds. Aluminum will represent about 20% of the pickup's weight, up from about 5%-6% percent today.
This is a win-win situation for both the companies. Not to forget, F-150 has been the top-selling vehicle in the U.S.A. for 31 consecutive years and a lighter version-which will boost its efficiency-should keep that record intact. This will largely benefit Alcoa and will also lead the way for other automakers in producing aluminum made cars.
Getting a Boost
Moreover, Goldman Sachs recently upgraded Alcoa's rating from neutral to buy. In addition, analyst Sal Tharani revised his price target upwards to $11. Tharani noted, "We estimate Alcoa will add more than $2bn of revenue and more than $525mn of additional EBITDA to its mid- and down-stream businesses over the next three years from end-market growth and share gains. Alcoa's downstream businesses, particularly Engineered Products, are less aluminum price sensitive and we see upside in Alcoa despite our lackluster outlook for aluminum supply-demand fundamentals. In addition, we see further upside beyond our current estimates from the automotive market through growth in "body-in-white" body sheet, as well as from aluminum-lithium in aero. Also, we expect continued productivity improvements and estimate positive free cash flow starting next year."
Conclusion
Alcoa may be down, but it's definitely not out. As the one of the largest producers of aluminum, Alcoa is well-positioned to benefit from the increasing usage of aluminum in different applications in aerospace and automotives. And if aluminum prices increase in the coming years, Alcoa will yield sensational returns. So, I think investors should buy Alcoa on the dip.
