American aluminum giant Alcoa (NYSE:AA) deserves credit for the internal operating improvements it has made in recent times. Unfortunately, the company is still in the business of selling aluminum and aluminum products, and that has long been one of the least attractive industrial metals for investors. While Alcoa does continue to look undervalued on the basis of historical valuation norms, this stock will probably be a value trap until and unless aluminum prices start picking up.

Top Investment Trends For 2013: We go over a few investment trends for you to think about for 2013.

A Decent End to the Year
Whether Alcoa really deserves to be seen as an economic bellwether is a topic for another day, but the reality is that it's the first major earnings release of every cycle. To that end, investors are likely to be reasonably pleased, albeit not thrilled, with what Alcoa reported.

Revenue fell 8% this quarter as production and shipment levels were fairly flattish in comparison to the third quarter. Unfortunately for Alcoa, aluminum prices have remained stubbornly unimpressive, with 2012 cash prices on the London Metal Exchange ending close to where they started.

Profits were quite a bit better, though. Gross margin improved almost four points, while operating income jumped 200%. EBITDA was up about one-third (and EBITDA margin improved more than three points) while segment ATOI more than doubled.

By segment, alumina ATOI was down two-thirds (on 3% shipment growth), but quite a bit better than expected. Alcoa's primary metals business was also stronger than expected, with the company reversing a year-ago loss despite lower realizations. Midstream and downstream operations posted record results, but came in weaker than analysts projected on a bigger seasonal slowdown.

Is China Still Calling the Tune for Aluminum
On management's call, Alcoa's CEO highlighted an outlook for a 7% aluminum demand growth in 2013, up from 6% in 2012. Importantly, demand from/in China is expected to contribute about half of that growth, so the state of the Chinese economy is important to aluminum companies beyond Chalco (NYSE:ACH).

Looking at major aluminum markets, management sees strong ongoing growth in aerospace as Boeing (NYSE:BA) and Airbus look to keep pace with their commercial backlogs. While the truck market is expected to recover, Alcoa is looking for a slowdown in autos relative to 2012.

It's Down to Prices Now
Alcoa has done a very good job over the past few years of taking costs out of the upstream businesses and shifting the midstream/downstream mix and processes towards better margins. While management is still targeting further benefits in the coming year, I think Alcoa has already pocketed the bulk of what it can do with these restructurings.

As a result, I think Alcoa's outlook is highly dependent upon aluminum prices. Prices are still below the $1.10 or so per pound that I think represents a "sweet spot" where Alcoa can post meaningfully better results. While most analysts and industry participants expect better prices in 2013 and 2014, time will tell.

In the meantime, it's worth asking if aluminum is a good place for investors to make their bets. As the Commercial Metals (NYSE:CMC) earnings release suggested, maybe the steel market is finally ready to recover. Likewise, iron prices have shot up again and Vale (NYSE:VALE) and Cliffs Natural Resources (NYSE:CLF) will prosper if those prices hold. Last and not least, an improvement in the global economy should also lift copper prices, and investors may want to consider names like Freeport McMoRan (NYSE:FCX) and Southern Copper (NYSE:SCCO).

The Bottom Line
Analysts have cut down their 2013 EBITDA forecasts on Alcoa by about 5% since the last quarter. Even at this lower level, though, the shares look pretty cheap on the basis of historical multiples. Using Alcoa's historical average EBITDA multiple (about eight) would point to a $17 fair value, while even a steeply discounted multiple (say on the order of 6.5 times) would suggest that Alcoa is underpriced.

It wouldn't surprise me if Alcoa enjoys a very good run if those aluminum prices pick up. What's more, I'm not sure how much downside is left in a stock trading at three-quarters of book value and only 20% above tangible book. So, although there's a very strong sense of deja vu here (and the risk of a value trap), I would still be interested in Alcoa at these prices.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  2. Savings

    Do Natural Gas Prices Always Follow Oil Trends?

    Prices for oil and natural gas are highly correlated. But investors should be aware of different factors affecting the prices of these commodities.
  3. Markets

    Why Gluten Free Is Now Big Business

    Is it essential to preserving your health, or just another diet fad? Either way, gluten-free foods have become big business.
  4. Professionals

    Chinese Slowdown Affects Iron Ore Market

    The Chinese economy's ongoing slowdown is having a major impact on iron ore demand.
  5. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  6. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  7. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  8. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  9. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  10. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. Benchmark Crude Oil

    Benchmark crude oil is crude oil that serves as a pricing reference, ...
  5. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  6. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
RELATED FAQS
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!