Alcoa Still Undervalued (AA)

By Justin Kuepper | April 27, 2007 AAA

Alcoa Inc. (NYSE: AA) shares moved up strongly this week after the company announced that it would be exploring strategic alternatives for several of its operating units.

The company also announced its earnings were boosted by record aerospace-demand coupled with higher metal prices; this helped lift its first-quarter profits by nearly 9%.

These announcements are great news for Alcoa shareholders who now stand to benefit not only from a strongly performing and undervalued company, but also a potential buyout target.

Future Earnings Outlook
One of the company's largest customers, the Aerospace industry, continues to drive the company's revenues. Aerospace's demand is expected to remain strong as Boeing (NYSE: BA) expects continued strength in commercial-airplane orders and additional defense orders, after selling more commercial airplanes than it has in five years.

Meanwhile, broad increases in metals purchasing promises to keep prices relatively high in the foreseeable future. Combined, these factors suggest that Alcoa will continue to benefit from strong demand and higher metal prices in its core businesses.

Future Strategic Possibilities
Alcoa said that it would be exploring its strategic options for six of its key businesses:

  1. Flexible Packaging
  2. Closure Systems international
  3. Consumer Products
  4. Reynolds Food Packaging
  5. Electrical and Electronic Solutions
  6. Automotive Castings

This plan to explore strategic alternatives for several of its operating divisions also caught the attention of many investors. Any sale or spin-off of these divisions would unlock significant value for shareholders. Mark Liinamaa, an analyst at Morgan Stanley, said that he believed the sum-of-the-parts value of Alcoa was around $43 per share.

Many others peg the number closer to $45 or $46 per share. Obviously, the sale of these assets would enable shareholders to receive the market value for these assets and help unlock some of this $43 per share in value. (To learn more, read The Merger - What To Do When Companies Converge.)

The Times also reported back in February that BHP Billiton and Rio Tinto had both considered a buyout of Alcoa. Many analysts dismissed these rumors, however, saying the company has too many downstream businesses, including consumer products, which aren't as attractive to companies that might otherwise be interested in a takeover. Consequently, a takeover would have required a breakup of the company, which is something that most suitors would not consider. But now that Alcoa could potentially rid itself of these downstream businesses, the doors for a potential buyout could be reopened.

The Conclusion

In the end, the sale of several of its divisions would enable the company to focus more on its core competencies and unlock value, while making the company much cheaper and more of a pure play for potential suitors. Alcoa has become a cheap stock with a great catalyst -- two key ingredients that investors look for in great opportunities!

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