Alcoa: From bust to boom?

This cyclical stock now trades 33% below book value and could be poised to double.

By TheStockAdvisors Jun 29, 2012 10:38AM
By Nathan Slaughter, Scarcity & Wealth

Alcoa (AA) doesn't need much of an introduction. The company has been at the vanguard of every major aluminum industry innovation for well over a century.

With aluminum below the industry's cost of production, plant closures are putting a crimp on supplies. As a result, the world could be headed toward an aluminum deficit in the next 12 month -- perhaps marking the turning point from bust to boom. Last year's worst performing Dow Industrial stock, Alcoa could put in one of the best showings over the next year. 

From mining bauxite to refining it into alumina, Alcoa is a global leader every step of the way. This vertical integration cuts out the middleman and generates additional income that slips through the fingers of many rivals.

Alcoa is also the world's biggest supplier of primary aluminum, accounting for 4.5 million tons annually -- or one out of every 10 pounds used on the planet. Finally, it's the No. 1 maker of fabricated finished products for use in the auto and aerospace sectors and other markets.

Combined, Alcoa sold $25 billion worth of aluminum products last year to customers in 30 countries.   

Aluminum is a prime example of what happens when investors overreact. In 2011, prices  tumbled to $2,000 per ton from $2,800, a precipitous drop of nearly 30%. Traders were undoubtedly expecting economic slowdowns in Europe and elsewhere to blunt manufacturing and bite into aluminum demand.

But physical demand didn't fall by 30%, or 20%, or even 1%. In fact, aluminum usage rose by 10%. Clearly, with demand rising by 10% and prices crashing by 30%, speculators were reacting more to external noise than real fundamentals.

And Alcoa actually outperformed the industry with an impressive 19% revenue growth. But the market never bothered to correct its mistake. Alcoa stock, one of the Dow's best performers in early 2011, finished the year with a dismal 43% loss.

In the first quarter of 2012, Alcoa shocked the market by posting a solid profit when just about every analyst was expecting a whopping loss.

Remarkably, profit margins in the key flat-rolled products segment nearly doubled from a year ago to reach $430 per ton. That's not just 87% above the historical 10-year average of $230 per ton -- it's the highest in Alcoa's history.

But the market still thinks Alcoa is bleeding to death. The stock is trading for less than $9. Before the crash, investors were paying more than $50 per share.

Once some of the fear subsides, the market will adjust the price to more adequately reflect what this company is really worth. Forget about the cash that will be generated in the years ahead. AA is trading at a 33% discount to its current book value.

Even in the worst-case scenario where the company is forced to liquidate its assets and pay off debt, there would still be $13.21 per share. That implies an upside of at least 40% -- but investors with the faith to buy now could pocket even bigger gains once aluminum recovers.

It's not often that mature Dow stocks offer such strong potential, but I believe Alcoa is worth more than double its current $8.55 price tag.

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