Despite an impressive rise of about 145% since the March lows of this year, at the current price of over $13 per share, we believe Alcoa stock (NYSE: AA) is still below its near-term potential. Alcoa’s stock has rallied from $5.48 to $13.47 off the recent bottom compared to the S&P which increased 55% during the same period. The stock has outperformed the broader market in the last 7 months as aluminum prices rebounded and started to rise since April following the US government announcing a string of measures along with stimulus packages announced in other economies to keep businesses afloat. Also, with the Chinese economy opening up and lockdowns being lifted, the market is expecting a rise in aluminum demand along with easing of supply constraints.
With the stock still more than 20% below its pre-Covid (February 2020) peak, we believe that the stock will rise from here, though it is unlikely to reach its pre-crisis level. This is because the revenue growth is likely to remain subdued as the company plans to offload some of its operating assets. Our dashboard What Factors Drove -75% Change In Alcoa Stock Between 2017 And Now? provides the key numbers behind our thinking.
Some of the stock price decline between 2017-2019 was justified by more than a 10% decrease in Alcoa revenues during this period. With Alcoa’s revenue declining in 2019 and dropping below its 2017 level, the P/S (price-to-sales) multiple has seen a continuous drop over the years as the stock price also declined. The stock also suffered with Alcoa reporting losses in 2019. Alcoa’s P/S multiple dropped from 0.9x in 2017 to 0.4x in 2019. The multiple slumped sharply in 2020 following the outbreak of the pandemic which led to a decline in aluminum prices. The multiple currently stands at 0.24x. We believe that the company’s P/S multiple has the potential to rise marginally to over 0.25x in the near-term as aluminum prices are expected to remain elevated following the gradual lifting of lockdowns. This is likely to lead to an uptick in the stock price as the crisis abates.
What’s the upside trigger?
Aluminum prices were dropping since late 2019 as an increasing number of steel players were shedding capacity due to lower demand from automobiles. Also, primary aluminum prices were affected due to increased exports of semi products from China. To make things worse, the global spread of coronavirus led to lockdown in various cities across the globe, which affected industrial and economic activity. The aluminum demand from industry players affects global aluminum price levels, in turn impacting the company’s price realization for its products. Lower demand from construction and automobile players, has led to a drop in global aluminum prices from $1,820/ton in January 2020 to $1,570/ton in June 2020. This was reflected in the Q2 2020 results where Alcoa’s revenues decreased 21% y-o-y. However, with the gradual lifting of lockdowns, aluminum prices have rebounded since June and have increased to over $1,840/ton in October 2020. Increase in price realization was reflected in the 10% sequential rise in Alcoa’s revenues in Q3 2020 (compared to Q2 2020).
The actual recovery and its timing hinge on the broader containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. Despite recovery in aluminum prices, the stock is unlikely to see major upside in the near term as the company’s revenues are not expected to see a sharp rise. As a part of a restructuring, Alcoa has put part of its aluminum assets under review. This is likely to hit the top line adversely in the near term. However, margins are likely to improve from 2021 as the company shifts its focus to its core assets and operations. Thus, an increase in aluminum prices, the company’s renewed focus on core operations with expectations of better earnings, and with investors’ focus having shifted to 2021 numbers, Alcoa’s stock is likely to go up slightly despite recovering 145% over recent months. As per Trefis, Alcoa’s valuation works out to $14 per share.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.