Alcoa (AA) announced after the close of trading yesterday that it will cut some 15,000 jobs or about 15% of its workforce. In addition, the company is halving its capital expenditure budget and hopes to divest its unprofitable foil, electric-systems, automotive-wheel and European transportation-products businesses. Alcoa will expand on October’s smelting capacity cuts as well, bringing the total reduction to 750,000 tons or 18%. This major restructuring comes from the world’s largest aluminum producer and a company that remains profitable (average estimates of $1.46 for 2008) in the midst of the worst recession since the “Great Depression.” However, you would not know this from looking at AA’s stock price, which, although well off its lows, is still a quarter of the price the stock topped out at a little more than a year ago.
The aluminum business has been dramatically affected by the bursting of the commodity bubble and the global economic slowdown. Alcoa was not growing profits as fast as competitors Rio Tinto Aluminum and UC Rusal during the boom in aluminum prices and, until recently, Alcoa’s stock had been fairly range-bound for the last five to ten years. This is in stark contrast to shares of Rio Tinto (RTP), whose price surged during the rise in commodities prices only to collapse when the commodity bubble popped. (Comparative stock price data on privately-owned UC Rusal is not available). Since Alcoa shares did not participate in this run-up in commodity stock prices how do we account for the the 66% drop in just the last six months?
Much of the blame for the loss in market value is attributed to the global recession that commenced in late 2007. It comes as no surprise that aluminum demand has fallen, along with demand for most other industrial goods and commodities. There are reports of surplus aluminum stockpiled in China and Europe as consumption has fallen off a cliff. However, this is precisely why Alcoa management is making drastic cuts in its production and cost structure right now. According to the WSJ, these cost-cutting measures will produce savings of $450 million per year. Apparently, with the stock trading down close to nine percent today, the market has taken news of these cut-backs as evidence of continued weakness in the company and sector.
So long as the global economy shrinks, this stock will likely continue to under-perform; but it is just as likely that beaten-down stocks like AA will richly reward investors when the market begins to price-in an economic recovery. Aluminum has many uses and the question is not if aluminum prices will return to higher levels rather it is a question of when. We are confident that when the tables turn and aluminum demand outpaces supply, industry titans such as Alcoa will be the beneficiary. Unfortunately, this cyclical process is completely out of Alcoa’s control, so management is doing its best to cope in the meantime.
Ockham’s primary valuation metrics for Alcoa seem totally out-of-whack with what is normal for the company. The company’s price-to-book value ratio is approaching .5x, and with goodwill and other intangible assets or price-to-tangible book value it is still slightly below 1. AA receives a Greatly Undervalued rating by our methodology, but visitors to our website will note that it also receives a “yellow sticky note of death“, which is intended to be a warning to all who read that there is something going on with the stock that requires that you look at valuation metrics with a grain of salt because of extenuating circumstances. So, our recommendation for the moment is to keep a cautious eye on Alcoa because despite being “greatly undervalued”, this stock will not rebound much until there is solid evidence of economic recovery. That being said, if the stock falls back into the mid-single digits it would be a patient and disciplined value-investor’s dream stock.