Alcoa Inc. (NYSE:AA) has been pushed down over 70% the last five years as a weak aluminum industry continues to plague the company. This aluminum miner is a situational turnaround story that may finally get a breakout in the near future thanks to bolstering industry fundamentals. Ray Dalio, founder of Bridgewater Associates, is one of Alcoa’s big name investors (check out Ray Dalio’s top picks).
The aluminum company has been looking to establish itself in new markets that includes packaging and transportation. Alcoa recently signed a deal with Airbus to provide aluminum sheet and plate for aircraft manufacturing – a deal valued at $1.4 billion. Other key initiatives include a joint venture with a Saudi Arabian mining company to build the largest low-cost aluminum facility in the Middle East. Going along with its cost cutting efforts, Alcoa curtailed its smelting capacity by almost 400,000 metric tons earlier this year in an effort to trim excess fat, so to speak.
Alcoa is expecting aluminum demand to be up in the current fiscal year thanks to continued demand increases in North America, Brazil and India. The real fundamental demand driver will be an expected 10%+ increase in China. Compared to the other major mining companies Alcoa has seen some of the more robust weakness, with 5-year average operating margin in the mid-single digits, where all the other mining stocks have an average of 25% or higher. In an effort to combat a declining margin problem, Alcoa hopes to improve its midstream and downstream operations.
Alcoa sales are expected to be down 6% in 2012, but rebound strongly, up 9% in 2013 on the back of rising aluminum prices. Part of the driving force for aluminum demand is the economic outlook. GDP for the U.S. is expected to grow 1.8% in 2013 and global GDP of 2.3%. Although there are a number of other more diversified mining companies with some exposure to the aluminum markets, such as BHP Billiton Limited (NYSE:BHP), Vale SA (NYSE:VALE), Cliffs Natural Resources Inc (NYSE:CLF) and Rio Tinto PLC (NYSE:RIO), we believe that the positive price and volume increases will drive Alcoa the highest. But what about the competitors?
BHP is a diversified mining company that trades in the mid-range of the industry at 13x trailing earnings. Compared to its forward P/E of 16x BHP might be a bit overvalued. The miner pays a respectable dividend that yields 2.9% but is only expected to grow earnings by 6% over the long term. BHP had billionaire Steve Cohen, founder of SAC Capital, make a big bet on the on the mining company in 3Q with a new stake (check out Steve Cohen’s top picks).
Vale is the Brazilian based metal mining company that also happens to pay one of the more impressive dividend yields at 5.5%. This and its low P/E of 9x makes the miner look attractive at first glance. Digging deeper, we see that Vale is cheap for a reason, with a long-term expected earnings growth rate that is a negative 20% annually. Vale had billionaire Louis Bacon take a new position in the stock last quarter (see all of Louis Bacon’s bullish bets).
Cliffs is an iron ore producer that pays the highest dividend yield of the five stocks at 7.4% after the company has been pushed down by 40% year to date. We remain cautious on this volatile stock – with a beta of 2.4 – and a growth rate that is expected to be near zero for the next five years. Billionaire Jim Simons took a new position in the mining company in 3Q (check out Jim Simons’ top picks).
Rio Tinto trades at 26x trailing earnings, but its forward P/E is only 7x. We believe this miner is one of the best plays in the industry given its 17% 5-year expected earnings compounded annual growth rate. This mining stock pays a 2.9% dividend yield and has managed to perform relatively well in 2012, up 20% year to date. Billionaire Ken Fisher – founder of Fisher Asset Management – was one of the top investors in Rio Tinto last quarter (see Ken Fisher’s new picks).
Alcoa does pay a modest dividend yield of 1.3%, and the special turnaround situation it provides includes both income and downside protection. We believe the miner is poised for a breakout given its lower-cost facilities – that will drive greater profitability – and a secular upswing in aluminum markets should drive its top line. In addition to Ray Dalio, fellow billionaire Ken Griffin was another one of Alcoa’s key investors (see all of Ken Griffin’s newest picks).
