Aluminum: A Boost For Auto Efficiency by Capital Ideas Online

Shares in aluminum have rebounded strongly of late. The Dow Jones U.S. Aluminum Index has risen over 93% in the last year. Once viewed as a precious metal whose value was greater than gold, aluminum is now one of the most abundant metals on the planet. Demand for the product surged when the canning industry transitioned away from steel in favor of the lightweight aluminum.

Aluminum may be lighter than steel but it is significantly more expensive. Therein often lies the dilemma for the durable, resilient product. The aluminum marketplace is transitioning again. With Ford and other auto manufacturers emphasizing more energy efficient vehicles, demand for aluminum could spike again.

A Changing Marketplace

Russia’s continued presence in the Ukraine has disrupted the steel market but has helped to boost the price of aluminum. But, a more pressing issue is Indonesia’s ban on the export of bauxite ore. Bauxite ore is first refined into alumina before it is refined to aluminum. To produce one ton of aluminum requires between four and seven tones of bauxite ore.

Between 2007 and 2013, Indonesia generated about 60 percent of the bauxite exports globally. The largest producer of aluminum is the world is China whose massive stockpile of bauxite ore will run out this year. China has already committed to huge bauxite import increases from Australia but will need to do more to continue producing at current levels. The bottom line is that the cost of aluminum will rise until solutions are at hand.

Aluminum  and the Auto Industry

Aluminum auto bodies are already used by high end manufacturers for the Audi A8 and Jaguar XJR and now other manufacturers have put the industry on notice that new designs are in the works. Aluminum is currently a popular choice for many parts including hub caps and engines but a commitment to aluminum bodies would be lucrative for aluminum sheet metal producers. Presently, Alcoa and Novelis are the top US sheet aluminum metal producers.

While transitioning auto bodies to lightweight aluminum makes sense from the energy point of view, it would be a massive undertaking for the industry. Aluminum manufacturers would be expected to invest heavily in new equipment and the auto manufacturers would need to make even larger investments in their assembly line magnetic pulling equipment.

The auto industry projects that aluminum bodies would reduce the vehicle’s weight by 10 percent which would result in a 7 percent improvement in fuel efficiency. In January 2014, the Wall Street Journal reported that Novelis was spending $550 million to upgrade plants in Germany, China and the US in anticipation of more manufacturers making the change. At that time, Novelis was producing mile long strips of 6 foot aluminum sheets to be used on Ford Motor Company (NYSE:F)’s F-150, the most popular pickup truck in the US. 900 pounds of aluminum would replace 1,500 pounds of steel in a full bodied F-150.

The bottom line is that if the auto industry moves to aluminum car and truck bodies, not just parts, aluminum manufacturers will enjoy a resurgence in demand.

How To Play Aluminum

If you believe the auto industry is committed to energy efficiency, aluminum bodies will soon dominate the industry and the aluminum industry will benefit. The largest sheet producers are Alcoa and Novelis, a division of India’s Hindalco Industries.

If you are like me, your faith in Alcoa Inc (NYSE:AA) has wavered over time. I have begun to focus on shares of Century Aluminum but some analysts are keen on Alcoa as a broader reflection of the marketplace.

Century Aluminum Co (CENX)

Century Aluminum Co (NASDAQ:CENX) ratified a five-year collective bargaining agreement with the United Steelworkers for the 400 hourly workers at the Sebree plant in late July this year. The agreement improves the company’s competitive position. Not coincidentally, Century Aluminum shares reached a 52-week high of $21.06 on August 5, 2014 achieving a 175 percent gain from its 52-week low of $7.65.

As Capital Cube notes, CENX is focused on revenue growth. The company has not efficiently managed its increased revenue. The key to future gains will be driven by management’s ability to carry the increased revenue to the bottom line.

Since 2010, CENX has lagged behind peers in Price to Sales. Currently, CENX Price to Sales is on par with peers. As revenues have climbed, Price to Book has passed peers. The challenge for management is to improve the failing gross margin. I believe that with revenues in hand, management will achieve significant improvement in the months ahead.

Alcoa Inc. (AA)

A giant in the production of sheet aluminum, Alcoa stands to post significant gains when the auto industry transitions to aluminum bodies. On July 27, 2014, CNBC’s Dennis Gartman touted AA as the “best buy out there.” The commentator is convinced that Alcoa Inc (NYSE:AA)’s $500,000 investment in new sheet manufacturing equipment is ahead of the trend. It is also worht noting that  Alcoa CEO Klaus Kleinfeld sold $12.9 million worth of shares at $16.08 in late July. In mid-JulyAlcoa announced a $1.1 billion supply contract with jet engine manufacturer Pratt Whitney. The agreement is for various parts used by the engine manufacturer including a new aluminum fan blade.

Despite being one of the key performers in the sector, AA-US has not paid a consistent dividend over the last five years when 2 of the five dividends paid were substandard. Capital Cube indicates that Alcoa has a strong cash cushion. Unlike CENX, Alcoa’s management has aggressively built strong reserves.

Aluminum Stock Alcoa Reserves

Yet, Alcoa Inc (NYSE:AA)’s growth is substandard compared to peers. Gross margins need repair and have since 2009. Price to Sales is favorably below peers. Historically, Alcoa’s Price to Earnings has been substandard.  If you are like me, you need to be convinced about AA. The company may just be too big to capitalize on its growth potential.

The views and opinions expressed above are those of the author and do not necessarily reflect the views of  CapitalCube.com, AnalytixInsight, Inc., its affiliates, or its employees.