Alcoa Overvalued Despite Sell-Off
Concerns about the growth prospects of the aluminum company's aerospace exposure over a longer time horizon lead us to lower our fair value estimate.
Alcoa (AA) shares traded sharply lower after the company reported third-quarter earnings on Oct. 11. The key factor weighing on share prices was undoubtedly management's downward adjustment to its guidance for all three value-add segments. As discussed in our second-quarter earnings note, we had been highly skeptical that management would be able to achieve its prior guidance. With this outlook already reflected in our valuation model, our companywide 2016 EBITDA forecast is largely unchanged. However, management's commentary during the earnings call inspires concern about the growth prospects of the company's aerospace exposure over a longer time horizon. We are particularly discouraged with regard to the integration of Firth Rixson, which Alcoa acquired back in November 2014. Therefore, we've tempered our long-term profit forecasts for the Engineered Products and Solutions segment. As a result, we've reduced our fair value estimate to $23 per share from $25. Our no-moat rating is unchanged.
We continue to view shares as overvalued. Although today's sell-off indicates that investors now anticipate weaker growth for the company's aerospace-facing product lines, we also maintain a negative outlook for aluminum prices. We expect the aluminum cost curve to shift lower amid large-scale capacity additions in China, and we anticipate that Chinese aluminum demand growth will continue to decelerate. We forecast only 2% annual demand growth in China through 2020, well below consensus expectations for 5% annual growth. Our long-term aluminum price forecast is $1,440 (in real terms), roughly 17% below current spot prices.
Alcoa remains on track to split into two companies on Nov. 1. The legacy upstream operations will retain the Alcoa name, while the value-add operations will be housed by a new company named Arconic. As of Oct. 11, we view the split as value-neutral, as both dis-synergies and efficiency gains will likely prove modest.
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Andrew Lane does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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