Alcoa eyes growth in 2012
The world's leading aluminum producer is focusing on building high-quality engineered products that boost margins.
Consequently, the market has been quite harsh on the company's stock, pushing it down into single digits.
We have taken these factors into account in revising our price estimate for Alcoa from $16 to $14, which is approximately 40% ahead of the current market price.
Alcoa still stands behind its earlier forecast of aluminum consumption doubling by 2020, which translates into a 6.5% annual growth over the next nine years. Global economic uncertainty may not allow aluminum to recover during the next six months, but we believe that Alcoa's restructuring efforts and initiatives to develop high-end engineered products, as well as its focus on the automotive sector will help drive sales and allow for better operating margins going forward.
Alcoa is the world leader in the production and management of primary aluminum, fabricated aluminum and alumina, and competes globally with other mining giants like Rio Tinto (RIO) and BHP Billiton (BHP).
Alcoa is increasing focus on its midstream flat-rolled products and its downstream engineered products, eying the huge demand potential from automotive manufacturers. Globally, there is a shift toward the use of aluminum in automobiles to reduce vehicle weights in order to achieve better fuel efficiency.
The company is investing significantly in research and development to produce better technologies and materials for vehicles. Alcoa's joint venture with China Power Investment Corporation to manufacture high-quality engineered products also points to its shift of focus to higher margin businesses. However, in the near-term, the input costs here are significant.
With rising input costs, we have lowered our forecast for EBITDA margin on alumina sales to around 11% over the Trefis forecast period. Consequently, the decline in market prices will affect the Primary Metal margins as well. We estimate the figure at around 8.5%.
Flat rolled products were in demand in 2011 as well, with the average realized annual price jumping approximately 14%. We estimate them to hold strong going forward as well. As per our revised estimate, engineered products will witness robust growth of approximately 10% and EBITDA margins above 15%.
According to Trefis estimates, the primary aluminum business accounts for 29% of Alcoa's value. Although the engineered products division accounts for a small percentage of the company's revenues, better profitability and increased research and development will increase its contribution to overall profits going forward. We estimate that the business accounts for 28% of the company's stock value, about equal to the company's alumina business.
Alcoa has maintained its outlook for the next 10 years, stating that global aluminum demand will double by 2020, which implies a 6.5% compound annual growth rate. The company posted an operating loss of $193 million in Q4 2011, but we believe that strong fundamentals and robust outlook will help Alcoa's revenues going forward. Aluminum prices are largely driven by global economic conditions, so as the global economy eventually improves the company should post better earnings.
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