Aerospace, Not Auto Will Drive Alcoa's Earnings Higher

Alcoa's recent acquisition solidifies its aerospace presence.

Jul 1, 2014 at 10:20AM

There's been a lot of buzz regarding the penetration of aluminum producers into the automotive market. This buzz has been a major driver of Alcoa's (NYSE:AA) rally this year. Alcoa predicts that auto sheet demand in North America will grow at a pace of 50% annually. Yet, the automotive segment brought just 6% of Alcoa's value-add revenue last year. The biggest contributor for Alcoa's value-add revenue was the aerospace segment with $4 billion of revenue. Recently, the company announced an acquisition of Firth Rixson, which will further grow its aerospace portfolio. This move will likely lead to more upside for Alcoa's shares.

Spending money where it matters most
The rationale for this deal is very sound – spend money on the segment that brings most profits. What's more, Alcoa's own estimates tell that aerospace sales will grow 8%-9% this year, while automotive sales will grow 1%-4%. While the aluminum auto sheet growth estimates are impressive, this growth comes from a low base.

What's more, steel suppliers like U.S. Steel (NYSE:X) and AK Steel (NYSE:AKS) have not hung out the white flag to the aluminum invasion. Alcoa believes that the share of aluminum mass in SUV will rise from 9% today to as much as 37% in the future. However, these estimates seem to assume little resistance from steel producers. Meanwhile, both U.S. Steel and AK Steel stated they were taking the threat from aluminum seriously, and were ready to work on future products that will compete with aluminum, especially on the cost side.

Whether one believes that aluminum will grow as big as optimists predict or not, one thing is for sure – this is mostly a story about the future. At the same time, aerospace is what brings earnings now.

Top line and bottom line growth ahead
Last year, Firth Rixson scored $1 billion in revenue. This number is projected to grow to $1.6 billion in 2016, and the big part of this estimate is based on existing long-term arrangements. This is what Alcoa needs now, as its first quarter revenue fell 6.5% from last year's number. One could argue that the bottom-line growth is more important than the top-line growth, but there was no bottom-line growth either.

The acquisition will cost Alcoa $2.85 billion, consisting of $2.35 billion cash, $500 million of Alcoa's stock and a $150 million potential earn-out. As Alcoa had just $665 million of cash at the end of the first quarter, the purchase is financed with debt. This will likely bring Alcoa's total debt to $10 billion. This is a rather big number, but the company can afford some additional leverage.

The growth of aerospace segment is surely worth the spending. While Alcoa estimates that the transaction will be neutral to earnings in the first year, it is likely to be accretive thereafter. This is exactly what the company needs, as possible growth in the auto sheet segment will demand more investment, and, thus, will not be a major contributor to the bottom line in the near future.

Do you know this energy tax "loophole"?
You already know record oil and natural gas production is changing the lives of millions of Americans. But what you probably haven't heard is that the IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America's greatest energy companies. Take advantage of this profitable opportunity by grabbing your brand-new special report, "The IRS Is Daring You to Make This Investment Now!," and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Vladimir Zernov has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information