The world of metals and mining has had a rough go of it for the past half-decade. The Chinese infrastructure boom that didn't maintain double-digit growth for decades and decades, as many thought it would, has led to a massive oversupply of just about every basic commodity. This oversupply has caused a lot of pain for aluminium giant Alcoa (NYSE:AA) and iron ore specialist Vale SA (NYSE:VALE).
However, both companies have some catalysts on the horizon that could make each a compelling investment: Alcoa with the spinoff of its parts manufacturing business, Arconic, and Vale with the completion of its massive S11D mine. With both companies looking to shake things up in the coming years, which one is the better investment today? We asked two of our contributors on either side of the debate to plead their case. Here's what they had to say.
Tyler Crowe: The reason that Alcoa -- and its anticipated spinoff company Arconic -- looks compelling as an investment today is twofold. One aspect is that Alcoa is pulling several different levers in order to increase profitability for both companies, and the other is that the company's stock looks undervalued, especially when you consider what an investor will get when the two companies separate.
There's no doubt that Alcoa, and just about every other mining and metals company, has seen some tough times over the years. When demand was high a few years ago, just about every metals company out there poured billions into new facilities that would catch up. Today, though, that oversupply has made the production at many facilities simply too expensive to justify keeping them open. Some think that over time this oversupply will pass, and they have simply slowed growth to weather the storm.
Alcoa, on the other hand, has acknowledged that this oversupply situation could last a long time, so instead it has shed a decent portion of its base metal mining and processing facilities to become a smaller, lower-cost supplier. From 2010 to 2015, Alcoa's average cost per ton of alumina and aluminium has gone from the 30th and 51st percentiles, respectively, of global supply to the 23rd and 43rd percentiles, respectively. In 2016, the company's efforts to reduce costs could help it move even lower on the cost curve.
Then there are the efforts that it is making with its Arconic value-add product company to make it a major competitor as a parts manufacturer. In the past 18 months, the company has signed more than $11 billion in supply contracts with several aerospace clients, including multibillion-dollar deals with Airbus and Boeing. Arconic's strategy right now is to focus its growth on high-value products for aerospace and automotive while shedding lower-margin products like packaging. This move has helped this part of the business generate a record EBITDA margin of 16.4%, with plans to increase it to 17%-19% in 2016.
If management can execute on all of these things, then Alcoa as is would look like a rather compelling investment. When you also consider the company's stock, though, it looks even better. Today, Alcoa is trading at a price-to-tangible book value of 1.8, well below its 20-year average of 3.2. If you look beyond the general outlook for the mining and metals industry, and home in on the moves Alcoa has planned, it looks like a great buy today.
Matt DiLallo: I'll admit that there is a lot to like about Alcoa's plan to spin off Arconic, as well as the bullish outlook for the aluminium market. However, Vale has been so beaten down not just by the weak iron ore market, but by the troubles within its home country, Brazil, that it is a bit more exciting in my book.
Vale's stock price is down roughly 85% since the commodities boom started to implode five years ago. Some of that was its fault: It joined the rest of the sector to invest heavily in growing output based on assumptions that demand, and therefore pricing, would stay elevated for years to come. On top of that, the company's stock price is under additional pressure from Brazil's economic malaise, with the commodities-driven economy hurt by weak commodity prices and a massive political corruption scandal. The country's rampant inflation is making it harder for Brazilian companies to operate, with Vale being forced to tap its emergency credit lines for funding because it was unable to secure outside financing.
While Brazil's issues are far from over, the country is starting to work through its problems. Furthermore, the commodities markets are beginning to show some signs that the worst is over, which could set the stage for a future recovery. In addition, Vale is getting ever closer to bringing its enormous S11D project online. Once complete, S11D will be one of the lowest-cost and most productive iron ore mines in the entire world. It is a game changer for the company, as it will significantly boost Vale's production while pushing its iron ore costs down substantially. The mine's rock-bottom costs are critical because they will enable Vale to earn robust cash flow even if iron ore prices remain muted.
These compelling catalysts on the horizon could drive Vale's stock to outperform Alcoa's over the long term. While there is clearly more risk that these factors will not play out as planned, it is hard to ignore Vale's upside potential.