Alcoa Inc (NYSE:AA) was downgraded to a sell rating with a price target of $5.50 per share by Deutsche Bank analyst Jorge Beristain, who believed that the primary metals business of the aluminum giant is dragging its equity value by equity value.
Alcoa stock price decline
The stock price of Alcoa Inc (NYSE:AA) declined following the release of the negative conviction from the analysts. The shares of the company are currently trading around $7.86 a share, down by 2 percent around 2:33 P.M. in New York.
In a note to investors, Beristain explained that the downgrade was due to the “deteriorating outlook” of the primary aluminum business of Alcoa Inc (NYSE:AA). According to him, the new price target of $5.50 a share represents a 32 percent downside from its current trading levels. The research firm’s previous price target for the company was $9 a share.
“Our downgrade is primarily driven by DB’s lower medium-term aluminum price outlook (12-13% lower in 2014-15 to $0.82 and $0.88/lb, respectively), which cuts 2014E and 2015E EPS by over half. In this report we postulate that Alcoa should consider spinning off Primary to reduce its negative drag and maximize equity value,” wrote Beristain.
Alcoa to face negative cash flow
In addition, Beristain stressed that the primary metals business of Alcoa Inc (NYSE:AA), which accounts for 27 percent of its revenue in the second quarter, would end up suffering a negative cash flow if the prices of aluminum continues to decline and the premium for rapid delivery (premia) goes back to its normal level. He estimated that the business unit is a $1.2 billion drag to the equity value of the aluminum giant.
Beristain said, “If aluminum stays flat but premia reverts back to normal levels, that’s where we see Alcoa getting squeezed,. We’re seeing lower realized prices going forward to the point that they’ll get back to break-even levels in that business.”
Alcoa spending on maintenance
In addition, Beristain suggested that the profitability of Alcoa Inc (NYSE:AA) on a cash cost basis is probably declining to as low as $0.04 per pound, and he sees the company spending on maintenance. He further stated, “What we’re arguing, cash flow to cash flow wise, the system is in trouble” and he pointed out that costs on maintenance or charges for closing capacity are unavoidable.
On the other hand, the management of Alcoa Inc (NYSE:AA) believed that the company has the “right structure.”