Alcoa Corporation (AA, Financial) has seen its stock price soar over the past few months after delivering a string of solid financial results. The company has witnessed increased shipment volume for aluminum given the rising demand and also benefitted from a strong price rise.
More recently, the management also entered into an agreement to repower the Portland Aluminum smelter in Australia. Alcoa was also in the news for completing its sale of Warrick Rolling Mill to Kaiser Aluminum, raising valuable cash and retaining an interest in the nearby smelter facility.
Could these positive developments make the stock an attractive opportunity, or is this cyclical company nearing the top of its profitability cycle?
Recent financial performance
Alcoa's most recent result surprised the markets and led to a strong runup. The company reported a top-line of $2.87 billion for its first quarter of fiscal 2021, which was a staggering 20.54% growth as compared to the $2.38 billion in revenue reported in the corresponding quarter of the previous year. The company cruised past the analyst consensus estimate of $2.63 billion.
Alcoa's revenues translated into a gross margin of 20.14% and an operating margin of 11.74%, which were higher than in the same quarter of last year.
The company reported net income of $175 million and adjusted earnings per share (EPS) of 79 cents, which was significantly above the average Wall Street expectation of 44 cents. It is worth highlighting that Alcoa generated close to $520 million in the form of free cash flows in the quarter.
Aluminum price rise and cash position
The steady upward trend in prices of aluminum has resulted in record revenue and income for Alcoa in the first quarter of 2021. The average realized price was up 36% since the low in the second quarter of 2020, which was largely driven by economic revenue, restarting of manufacturing and tightness in the physical availability of aluminum.
Moreover, the various government monetary and fiscal stimulus programs have supported stronger demand in aluminum's end-use markets, which is expected to continue as vaccination efforts progress, lockdowns are eased and additional stimulus measures are implemented. This bodes well for Alcoa's top-line in the coming quarters.
Apart from this, the company has made strong efforts in improving its balance sheet. In March 2021, the company closed on the Warrick Rolling Mill sale to Kaiser Aluminum, generating cash proceeds of approximately $670 million and reducing the net debt on the company's balance sheet. All these actions were in line with Alcoa's capital allocation framework target of retaining $1 billion cash on the balance sheet and eliminating all material debt maturities until 2026.
The China upside
China has been increasing its global production of aluminum for over a decade now since its manufacturing sector is growing at a solid pace with subsidized primary aluminum capacity. The country has set carbon dioxide reduction goals and targets to achieve a peak in emissions by 2030 and carbon neutrality by 2060. Additionally, China has also announced its latest five-year plan to reduce its carbon intensity per unit of GDP by 18% until 2025.
Given the pressures and constraints in China, I think it is likely that the supply growth in the country will slow as the primary aluminum industry there approaches its 45-million-ton capacity cap, which is likely to drive significant positive change in the industry's fundamentals.
Alcoa is well-positioned to meet the demands arising from this evolution in the global aluminum industry. The company's line of low-carbon products, called Sustana, is among the most comprehensive set of offerings in the aluminum industry and includes EcoSource, the world's first and only low-carbon smelter grade alumina product. All these factors could be important contributors to Alcoa continuing its growth story in the coming quarters.
Valuation
As we can see in the chart above, Alcoa's stock price has multiplied nearly five times in the past 12 months, largely driven by optimism over the growth in aluminum consumption and an upward price trend. However, the company is trading at an enterprise-value-to-revenue multiple of 0.85, which appears to be among the lowest in the metals and mining sector, indicating that there is possible scope for multiples expansion assuming the positive macro surrounding aluminum continues to prevail.
The management expects shipments to remain at high levels and has increased the estimated full-year 2021 alumina shipments range by 100,000 tons. Also, Alcoa's deal to sell its aluminum rolling mill business to Kaiser Aluminum for $670 million has significantly reduced the capital gearing on its balance sheet. Overall, I believe that despite the recent runup, Alcoa deserves a "Hold" rating.
Disclosure: No positions.
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