Alcoa Inc. (NYSE:AA) kicked off the new earnings season late on Tuesday, reporting better-than-expected revenue and a good 2013 outlook.
After the company’s fourth quarter earnings report, two research reports were released on Wednesday which took a look at the year ahead for Alcoa: one from Nomura Equity Research and the second by Jefferies. Here at ValueWalk, we took a look at both and shared some of their highlights.
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Nomura: Neutral Rating with a $9.00 target price
In Nomura’s report, “Define Running to Stand Still…$1.3bn of Gross Productivity Gains but Only $0.09 of EPS,” analysts reviewed the following three topics:
Running to a Stand Still Remains the Theme for Alcoa
Alcoa Inc. (NYSE:AA) is performing well from an operational perspective with its $1.3 billion 2012 productivity gains ($786 million actual costs); this is above the initial $850 million target. But there’s been a consistent theme over the past several years, as other cost increases such as labor cost inflation, rising energy costs, and higher pension expense have offset productivity . These costs increased by $650 million and suggests that 2012’s net productivity benefit on its income statement was $136 million or ~$0.09 EPS.
After realizing $1.3 billion for productivity gains, there are hopes for a higher earnings per share leverage, but some of the productivity appears in the improved cash flow metrics. Alcoa Inc. (NYSE:AA)’s OCF fell by $700 million as compared to an LME-related headwind of ~$1.3 billion.
Surge in Premiums Doesn’t Appear to be Benefiting Realizations
Alcoa also hasn’t fully capitalized on the recent rise in physical merchant premiums, which depending on the region, have increased between 40% and 100% year-over-year in the fourth quarter. Physical premiums jumped $104/tonne in Europe, $66/tonne in the U.S., and $119/tonne in Japan as expected, as AA realized improved ASPs.
Based on the fourth quarter 2011 LME prices, a $100/tonne rise in premia would equal a 5% benefit to realized prices. Analysts will speak with Alcoa IR/management soon to determine if realizations matched the LME price in terms of percentage movement in the fourth quarter (down 2%), as seen in the context of limited impact from net currency and mix changes.
Structural Challenges Facing Industry and Alcoa Inc. (NYSE:AA) Remain Significant
Another component of the ‘industry running in a stand still’ theme includes three factors:
- Chinese aluminum self sufficiency despite high cost status
- The correlation of aluminum prices to resource currencies to which Alcoa’s costs are exposed
- Worsening structural oversupply conditions leading to unprecedented levels of inventory; this will ultimately need to be absorbed.
Assuming 2013 in aluminum prices stay at $1.00/lb (vs. 2012’s $0.92 average), analysts only see Alcoa Inc. (NYSE:AA) generating $0.40 earnings per share. AA would then trade at 26x 2013’s earnings per share at $1.00/lb aluminum.
In the short run, aluminum has a downside risk, after the higher technical move that may create significant correlation risk.
Jefferies: Hold Rating with $10 target price
In Jefferie’s report, “Alcoa Inc. (NYSE:AA) Reports $0.06 – Equals Our Estimate” analysts highlighted the following key takeaways:
- Alcoa reported an in-line quarter and continues to gradually improve its balance sheet, but the secular challenges facing the aluminum industry remain. While the company’s shares are less expensive and FCF likely to improve, analysts see better values within Metals and Mining.
- There’s a disagreement with the mainstream media’s assertion that Alcoa is some type of earnings, economic, or stock market bellwether. Its shares have sharply fallen over the past decade, when most Metals and Mining stocks performed well. Alcoa has faced very unique challenges and therefore analysts see little “read through” for the companies in either their our universe or for the economy.
- Alcoa’s upstream business is challenged thanks to weak LME aluminum prices. In 2012, the average LME aluminum price was $0.92/lb or about 16% lower than 2011’s $1.09 lb. average price. By responding to weak aluminum prices, Alcoa cut 240ktpa of smelting capacity in Spain and Italy, and closed 291ktpa of U.S. smelting capacity last year. In the fourth quarter, the Primary Metals segment benefited from a $161m, after-tax, gain from the $600 million sale of Tapoco Hydroelectric Project assets.
- Alcoa’s midstream and downstream segments continue to perform well. Midstream ATOI of $69 million in the fourth quarter more than doubled as compared to the fourth quarter 2011. Alcoa expects a 14% midstream revenue increase in 2013 to $8.4 billion, up from 2012’s $7.4 billion. This comes from an average LME aluminum price of about $0.97/lb. Downstream ATOI for the fourth quarter rose 12% year over year to $137 million, while Alcoa sees a downstream revenue at $6.2 billion in 2013–a 13% year-over-year rise.
- In December, the first hot metal was poured at Ma’aden in Saudi Arabia; Alcoa has a 25.1% stake in it and it is estimated to cut Alcoa’s position on the refining and smelting cost curves by two percentage points. Alcoa’s capex contribution to Ma’aden is expected to be $350 million in 2013. Along with Ma’aden, Alcoa will spend $1 billion on sustaining capex and $550 million on growth capex this year.
- Valuation/Risks: The $10 price target assumes a net firm value 5.5 times analysts’ 2014 EBITDA estimate in a year. They see a modest upside and Alcoa shares are fully valued with a small dividend yield. There is little downside for both Alcoa shares and the price of aluminum, but there are better risk/reward opportunities within global Metals and Mining. The primary risk facing Alcoa Inc. (NYSE:AA) shares is a collapse in the aluminum price or the global economy.