Aluminum is an increasingly important metal in the world. And when it comes to this lightweight and strong material, no name stands out more than Alcoa (AA +0.00%) -- a company that effectively helped to create the aluminum industry over its 100-year-plus history. But an incredible history doesn't make a company an instant buy. Here's what you need to know to figure out if Alcoa has a place in your portfolio.
Where it sits
Alcoa today isn't the same company it was just a couple of years ago. That's because it broke apart from specialty parts maker Arconic (ARNC +0.88%) in late 2016. This is a very important fact to understand. Arconic took the pieces of the business that made things like high-end airplane parts, value added products for which Arconic can charge higher prices; Alcoa kept the pieces of the business that sell commodities.
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Aluminum is the end product in the value chain here, with bauxite mining and alumina refining representing two key intermediary steps before you get to the metal. Alcoa is the largest bauxite miner in the world, and one of the largest alumina refiners. It has a first quartile cost position in each of these businesses. While Alcoa uses roughly 90% of the bauxite it mines to make alumina, it only uses about 30% of the alumina it refines to make aluminum. Alcoa sells the bauxite and alumina that it doesn't use to third parties.
The aluminum Alcoa makes, meanwhile, is largely commodity aluminum that it sells to third parties. This aluminum is then turned into other things, like airplane parts, by its customers. The key takeaway here, however, is that Alcoa's top- and bottom-lines will generally go up and down along with commodity prices. Yes, Alcoa will benefit along with its customers from increased demand for aluminum in the aerospace and auto markets, among others, but it's a vastly different way to play the space because it doesn't actually make these higher-margin products.
Do you like the prospects?
This was on clear display in late 2017, when aluminum prices rocketed higher on Asian demand. Between December 13th and December 28th, the price of aluminum rose by nearly 14%. Alcoa's stock price, however, advanced nearly 30% over that span. For reference, Arconic's shares rose just under 10%. This makes sense, given that higher aluminum prices are a mixed blessing -- they mean Arconic's costs are going up, even if those higher prices eventually get passed along to customers.
So the key question you have to ask yourself when you are considering Alcoa is: What part of the aluminum industry do I want be in? If you want to own a specialty parts maker, don't buy Alcoa. If you want commodity exposure, Alcoa is a good option to consider.
Since commodity prices can rise and fall quite dramatically, you need to be prepared for some notable ups and downs in Alcoa's stock price. But the backdrop is pretty good overall. For example, Alcoa believes that the bauxite and alumina markets are basically in balance, which means fair pricing should prevail. However, it expects aluminum markets to be in state of deficit in 2018, with global demand growth of around 5%. That suggests strong commodity prices for aluminum, and solid earnings for Alcoa.
Because of the late 2016 break up of Alcoa and Arconic, 2017 was really a transitional year for each company. Alcoa, for its part, was able to increase revenues by nearly 25% in 2017, roughly double adjusted EBITDA, and materially increase its cash position. All in, it was a successful first year as a stand-alone entity, driven partly by a recovering commodity market. It's also a new base from which to consider future performance -- but one built during a highly beneficial commodity rally. Although Alcoa's projections for the aluminum market suggest a positive outlook for 2018, commodity prices sometimes don't behave as you'd like. In fact, aluminum prices are way down this year, and so is Alcoa's share price.
Two ways to go
There are really two ways to think about Alcoa. The first is using the company's shares as a way to time the aluminum market's short term fluctuations, to which it is highly leveraged. Management's generally positive outlook for 2018 suggests you might be interested if that sounds like you. Just be prepared for the inevitable ups and downs.
This, however, isn't how I think about investments, so I wouldn't suggest Alcoa, or any other company, for this type of short-term investment approach. But you can also think about Alcoa as a long-term way to invest in aluminum's growth as it displaces other materials in key markets -- like steel in cars and planes. If that's what you're after, the outlook for any one year is just a small part of the picture. You'll want to focus on how well Alcoa positions itself in the industry (where it sits on the cost curve, for example) and how it handles its finances (is its balance sheet getting stronger or weaker?). On that front, Alcoa appears to be doing a good job of positioning itself as an industry leader and a desirable investment. And with the stock off nearly 20% from its recent highs, you might find now is a good time to consider an investment.
