Alcoa Surges After Worse Than Expected Results (NYSE:AA)

Sign of Alcoa and Arconic on the building in Pittsburgh, Pennsylvania, USA. Alcoa Corporation is an American industrial corporation.

JHVEPhoto

A lot has happened since my last Seeking Alpha article on Alcoa (NYSE:AA) was published. At the time I commented on the company’s sound results it reported on 19 January 2022, and I was really bullish. The stock was trading for around $63 per share. But soon after my article was published, the stock reached almost $100 and then started plunging. I would like to comment on the recently reported results and also explain what has happened to Alcoa and where its stock is headed so far.

Aluminum demand and recent news

You might be thinking I was wrong at the time when I was bullish on Alcoa. After all, everyone is talking about the economic crisis, higher interest rates and a global economic slowdown. Here is an excerpt from the article I wrote earlier on.

Overall, Alcoa says there is support for aluminum prices from supply constraints, lower inventories, and high transportation costs.

The main problem here seems to be many central banks’ increasingly hawkish stance towards monetary policies. This is especially true of the Fed. Many analysts now predict several interest rate hikes this year alone. This might have a negative effect on commodities markets, including aluminum.” I also predicted a recession could be provoked by the hawkish Fed.

Funny enough, the factors of lower supply and the hawkish Fed got even truer this spring. The situation around Ukraine and the sanctions that followed made many investors panic about low aluminum supplies. But the panic faded after the market seemed to understand the collective West would not probably sanction Russian aluminum.

The Fed got much more hawkish since then, and everyone is screaming a recession could be near.

At the same time, there are still supply shortages as far as aluminum is concerned. Right now it is somewhat unlikely the West would sanction Russian aluminum, but there is still such a possibility. So, the supply from Russia, the second-largest aluminum exporter, is still under threat.

If we forget the recession expectations, we should also bear in mind the demand for aluminum should rise in the long run due to the green initiatives. Alternative energy sources, including solar and wind, require special infrastructures where aluminum is needed.

As I have mentioned before, aluminum production requires heavy energy consumption. Partly because of the emissions legislation, partly because of the energy supply deficits, the supply of aluminum should go down.

The excerpt from the company’s presentation illustrates the energy and the aluminum supply crises very well.

Alcoa's earnings

Alcoa’s Earnings Presentation (Slide 15)

As concerns the energy crisis, Europe is one of the most heavily affected regions.

Alcoa's earnings

Alcoa’s Earnings Presentation (Slide 16)

In the last several quarters, Alcoa’s stockholders really enjoyed the cash they were returned by their company. Alcoa also declared a dividend and promised to buy back its own shares during the conference call.

Alcoa's earnings

Alcoa’s Earnings Presentation (Slide 10)

The company spent $555 million in cash returns to its stockholders. It declared its fifth $0.10 quarterly dividend. It is payable on 18 November. As concerns the stock buyback program, Alcoa has already purchased 3 million shares in 3Q22 alone.

Alcoa's cash returns

Alcoa’s Earnings Presentation (Slide 10)

In fact, the net debt rose somewhat in the last quarter but quite insignificantly.

As concerns the company’s recent news, Alcoa cut its production in Norway and Spain in order to cut the energy costs. This, in my opinion, suggests management is taking preventive measures to keep the costs under control.

Alcoa’s earnings results

As I have mentioned before, Alcoa’s earnings results for the last quarter were substantially worse than they had been before. This is mainly due to lower commodity prices and the so-called one-off charges, also known as the special items.

Alcoa's earnings

Alcoa’s Earnings Presentation (Slide 7)

Alcoa's earnings

Alcoa’s Earnings Presentation (Slide 23)

We see that a lion’s share of Alcoa’s special items, $652 million, was due to restructuring charges, namely the company’s US pension annuitization. In my view, the adjusted earnings indicator is not a very relevant indicator since Alcoa has always had issues with its pension liabilities. So, we should not pay any close attention to the adjusted net income presented by Alcoa, I think. Instead, we should focus on the diluted earnings per share and the actual net income that were substantially worse than they had been in the last quarter.

Most of the net profit decrease was due to the commodity price disadvantage and therefore a fall in the sales revenues.

Aluminum prices

Trading Economics

As can be seen from the diagram above, the aluminum prices reached their peak in March 2022 and started falling since then.

The input costs also increased due to the higher energy prices, which also had a negative effect on the company’s earnings.

Risks

Alcoa’s earnings are likely under pressure due to lower aluminum prices. The price of the base commodity is, obviously, one of the most important factors for the company’s well-being.

The commodity price disadvantage is, as I have mentioned before, due to seemingly everyone’s view of a potential recession panic. As you know, aluminum is an industrial metal and the demand for it depends on the health of the global economy. If we suffer from a serious long-term recession, aluminum prices and therefore Alcoa’s stock will stay cheap for a while.

The company is in a sound debt position. So, even the rising interest rates will probably not substantially affect the financial health of Alcoa. The only risk I see for Alcoa is that of a recession.

Valuations

Alcoa reported a loss for the last quarter. So, I decided not to use the price-to-earnings (P/E) ratio to value this company.

Instead, I decided to focus on the enterprise value/earnings before interest and taxes (EV/EBITDA) and the price-to-book (P/B) ratios. Y-Charts generated the following two graphs for me.

The company’s EV/EBITDA is currently near its multi-year lows due to the falling aluminum prices. At the same time, an indicator of around 5.5, substantially below 10, generally suggests undervaluation.

Chart
Data by YCharts

The P/B indicator suggests the same undervaluation.

Chart
Data by YCharts

Alcoa is fairly valued as far as its P/B is concerned. Obviously, the company’s P/B is above the levels seen in the beginning of 2020. But it is still reasonable. A P/B between 1 and 3 is considered to be reasonable.

So, given its results, AA stock is objectively valued, in my opinion.

Conclusion

Alcoa is a sound company, not currently suffering from a high debt load. However, I do not like the fact it has high pension-related expenses, occurring every quarter.

The aluminum prices might stay under pressure due to a likely recession. However, the long-term demand will likely stay high because of the green energy agenda. The current high energy prices are not very good for Alcoa due to the cost pressures. At the same time, they limit the production capacities for other aluminum companies, thus decreasing aluminum supply. This is bullish for aluminum.

I am positive on Alcoa as a company, but I give the stock a Neutral rating due to the likely recession ahead.

Be the first to comment

Leave a Reply

Your email address will not be published.


*