Back-to-back posts on Alcoa (AA) to follow up on a powerful investment theme with the potential for outsized returns over several years. There is a time and a place for each individual stock investment, and the proper synchronicity is all the more important for out-of-favor / out-of-consensus investment themes like Alcoa. The classic elements for contrarian investors are aligning with AA, and big returns will ensue for investors who stick around until a healthier pricing environments for overall metals end-markets. In the meantime, CJF continues to focus on AA’s ability to evolve the business model to execute well during tough times which is driving the stock price higher despite a poor operating/pricing environment today. AA is growing EBITDA in today’s environment of 8% aluminum price declines; visualize the P&L in future years when volume continues to grow and aluminum prices rise!
On the quarter, AA earned adjusted EPS of $0.09, beating estimates of $0.05 handily. Some highlights:
- Sales fell; aluminum prices declined (8% y/y) and capacity/network reduction (in order to achieve productivity gains) led to exits from select markets.
- Productivity improvements of $250m are ahead of schedule. Better productivity and efficiency drives production costs lower and enables stable/higher gross margins in a period of soft end-market pricing. AA’s cost of goods sold declined by 190 bps sequentially during 1Q14, an impressive result.
- Aerospace markets are very strong. AA hiked its estimate of aerospace end-market growth to +8-9% (up 100 bps from 3 months ago). Boeing and Airbus combined have a 10,675 aircraft unit backlog amounting to more than 8-years. In short, the world needs more planes! Growth in passenger miles and fleet expansion in Asia and the Middle East provide visibility. Aircraft prices are also rising while volumes surge. Aerospace is perhaps the healthiest, large, industrial end-market exposure that exists today.
- Automotive remains strong, particularly so in North America. Aluminum content per vehicle is on the rise with advances in aluminum/titanium combination alloys. Ford’s new F150 is constructed with military grade aluminum, as safe as steel, 700 pounds lighter, with better acceleration, and less corrosive. Aluminum content also dominates within a Tesla Model S.
- Despite the soft pricing (down 8%), aluminum demand on a global basis is growing 7% a year based on continued increase in content per item across numerous end-markets.
- AA continues to invest, and is opening a new low cost smelting/refining plant in Saudi Arabia. Considerable start-up costs for this facility are in the current P&L with the benefits to accrue in the future.
- Debt was reduced to below $8b, the lowest level since 2007. Last year, AA’s credit rating was downgraded based purely on soft end-markets. AA continued to deleverage while achieving sweeping productivity gains. Expect a credit upgrade in 2014.
Alcoa rallied 3.8% on Wed to $13 on heavy volume. Shares retraced much of the earnings related gains on lighter volume based on Thursday’s market melt. This provides an opportunity for investors. CJF continues to see a favorable risk/reward and looks for a move into the mid $20s over a 2-year time period.