Years of slack demand amid tepid global economic growth had AA stock on the skids. Things got so bad that AA stock was even exiled from the Dow Jones Industrial Average last year.
In response to all this global weakness, Alcoa has been slashing capacity to bring production more in line with demand. The company also has been focusing more on higher-margin value-added products. True, it has been a long and painful process closing smelters and idling workers, but the market sure likes the results.
Indeed, since getting the boot from the Dow in late September, AA stock is up more than 57%. For the year-to-date, AA stock is closing in on a 25% gain following the Alcoa earnings release.
Reports like the one Alcoa dropped late Tuesday get a lot of the credit for the run. Alcoa suffered yet another net loss on charges for closing smelters and rolling mills, but after excluding those costs (as analysts do), earnings came to 9 cents per share. That exceeded Wall Street’s average estimate by 4 cents — a big earnings beat.
More remarkably, Alcoa was able to pull that off even as first-quarter revenue fell nearly 7% to $5.45 billion from $5.83 billion a year ago, hurt by another 8% drop in aluminum prices.
But the market isn’t just applauding a leaner cost structure at Alcoa. It’s bullish on AA stock because of higher demand in a number of huge and higher-margin segments.
After all, Alcoa didn’t move the needle on its forecast for worldwide aluminum demand. Total demand this year is expected to grow 7%. That’s in line with Alcoa’s prior outlook, and matches what happened last year. Demand for aluminum is by no means accelerating, which doesn’t bode well for a pick up in prices.
AA stock: Autos and Airplanes to the Rescue
But stagnant prices are no matter, because demand in other areas is taking up some of the slack, thanks to Alcoa focusing on finished products for the automotive and aerospace markets.
Automakers are incorporating more aluminum into their designs to lose weight and add fuel efficiency. That helped Alcoa’s engineered-products division enjoy a record first quarter, driven by demand for things like new lightweight wheels for heavy-duty trucks.
At the same time, aluminum demand from the aerospace industry is projected to grow 8% to 9% this year, faster than the overall market. Importantly, finished and engineered products have higher margins.
Take a look at AA stock’s forward price-to-earnings multiple and you can see how bullish the market is. Fetching 23 times forward earnings, AA stock looks ridiculously overpriced at first. Heck, AA stock’s five-year average P/E is just 19.
But the market isn’t looking in the rearview mirror. All it cares about is Alcoa’s long-term growth forecast of 32%. That kind of growth more than justifies a multiple of 23 on AA stock.
That said, AA stock is by no means a slam-dunk buy at this point. Despite the hot-growth prospects, the average analyst rating is “Hold,” mostly because shares look fairly valued at these lofty levels.
AA stock definitely deserves a place on any watch list, though. AA stock has had a number of significant pullbacks throughout its extended rally. Pouncing on the next one could throw the price/value equation into your favor.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.