3 Reasons Alcoa Inc's Stock Could Fall

Despite huge share-price gains and signs of life in the aluminum market, Alcoa is still vulnerable.

Aug 27, 2014 at 9:41AM

Aa Overview
Source: Alcoa.

For years, aluminum giant Alcoa (NYSE:AA) failed to benefit from the broader economy's recovery, performing so poorly that the Dow Jones Industrials (DJINDICES:^DJI) expelled the company from its ranks in 2013. Since then, though, Alcoa shares have rocketed higher on signs of budding strength and hopes for better times ahead. Nevertheless, the company faces a number of challenges, and there are several reasons to believe Alcoa stock could give back some of its hard-fought gains from over the past year. Let's look at three of them.

1. Gains in natural gas prices could put pressure on margins

Aa Refining

Refining raw materials takes huge amounts of energy. Image source: Alcoa.

One challenge of aluminum production is that it's extremely energy-intensive. Although recycling aluminum scrap saves energy, many key customers require primary aluminum production to address quality and consistency concerns. In particular, converting bauxite to alumina requires substantial use of natural gas, while further conversion involves smelting, which employs significant amounts of electricity.

Low natural gas prices in recent years have helped Alcoa keep its productions costs low and minimized the impact of low aluminum prices on its profit margin. Yet natural gas has already rebounded sharply from its lowest level two years ago, and further natural gas price increases could jeopardize Alcoa's future growth. In particular, the potential export of U.S. natural gas in the form of liquefied natural gas could lead to less dramatic price disparities around the world, taking away some of Alcoa's competitive advantage against its international rivals. Alcoa itself has lobbied against LNG exports, arguing that the resulting rise in U.S. natural gas prices would hurt its business and the businesses of other high-energy manufacturing companies. Yet as demand for gas rises, Alcoa will almost certain have to deal with higher costs in the future.

2. Reliance on aerospace and automotive industries leaves Alcoa vulnerable

Alcoa's transformation toward emphasizing its value-add products came at a perfect time for the company, as its primary customers have enjoyed strong fundamental conditions in their own industries. The resurgence in airlines' profitability has pushed demand for new aircraft to unprecedented levels, and airplane manufacturers enjoy huge order backlogs that have prompted them to seek ways to boost production levels. With Boeing (NYSE:BA) expecting $5.2 trillion in industrywide aircraft sales over the next 20 years, Alcoa's strategic move to offer aluminum-based products and other lightweight materials such as titanium appears extremely well-timed. Similarly, automakers' sales have returned to levels not seen since before the financial crisis, and that has put companies in position to innovate; for example, Ford (NYSE:F) is preparing to begin sales of its aluminum-intensive 2015 F-150 pickup truck.

Aa Rolled

Rolled aluminum is used for many purposes. Image source: Alcoa.

Right now, the auto and aerospace industries appear to have sustainable growth prospects. Yet both industries are notoriously cyclical, going through booms and busts as consumers and industrial customers navigate changing economic conditions. Alcoa currently has most macroeconomic trends supporting its growth, but any change in those trends could lead investors to think twice about their expectations for the company.

3. Favorable competitive trends will reverse as aluminum industry recovers

Alcoa took a risk in putting itself in its current position, and so far, that effort has paid off. Major competitors like BHP Billiton (NYSE:BHP) and Rio Tinto (NYSE:RIO) have taken steps to reduce their exposure to aluminum, and their willingness to sell off assets at less than premium prices in part contributed to Alcoa's big share-price decline going into last year. Yet investors are counting on Alcoa's aluminum focus to boost its growth as the industry strengthens.

Aa Recycling

Recycled aluminum saves in energy usage and cost. Image source: Alcoa.

Still, Alcoa can't count on reaping all the success in aluminum for itself. If its turnaround continues to build momentum, BHP, Rio Tinto, and other players could well reverse course and challenge for a portion of what will then be a growing market. Alcoa would still claim its share of gains, and its competitive position would be stronger because of its more consistent long-term strategy. But in the long run, Alcoa's growth rate could be much slower than investors hope, and when shareholders realize that, the stock could give up some of its gains.

Alcoa deserves a lot of credit for its transformation, and even after its impressive share-price gains, the stock trades well below its levels from a decade ago. Yet Alcoa still faces the tough job of continuing its restructuring efforts while also fending off what's likely to become even more intense competition as industry conditions improve. Those pressures could easily force Alcoa shareholders to go through painful corrections in the stock even if the company is eventually successful in executing its long-term business strategy.

Do you know this energy tax "loophole"?

Natural gas isn't just helping Alcoa. It's changing the lives of millions of Americans. But you probably don't realize 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.

Dan Caplinger owns shares of Ford. The Motley Fool recommends Ford. The Motley Fool owns shares of Ford. 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.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers