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1 Major Trend that Could Drive the Stock of Alcoa Inc Higher

By Matthew DiLallo – Mar 13, 2014 at 10:45AM

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Alcoa is perfectly positioned to take advantage of a historic shift in the auto industry.

Alcoa (AA) hasn't treated its long-term investors all that well. Its stock has vastly underperformed the market over the past five and ten year periods. More recently, however, the stock has been doing much better as it has outperformed the market over the past year. That trend could continue as investors are just beginning to realize that the company is perfectly positioned to take advantage of a historic shift within the auto industry.

Setting the stage
American consumers and the government don't agree on much. One area where we do agree is in better fuel economy for our vehicles as 85% of consumers support higher fuel economy regulations. In fact, as the following slide shows, 88% of us see fuel economy as being an important factor in our decision to buy our next vehicle.

Source: Alcoa investor presentation (link opens a PDF)

Because a vast majority of consumers support better fuel economy, as well as to improve our stewardship of the environment and to our strengthen our nation defense, the U.S. government has instituted aggressive CAFÉ standards that will see average fuel economy double by 2025. These new standards pose a challenge to the auto industry, however, that challenge is a real opportunity for Alcoa.

The historic opportunity
Auto manufacturers like Ford (F -2.05%) and General Motors (GM -2.99%) need to pull out all the stops in order to meet these aggressive CAFÉ standards. One of the areas these companies are addressing is the weight of vehicles as a 10% weight reduction can produce 5%-7% in fuel savings. Aluminum is proving to be the best option for auto makers as it's up to 50% lighter than steel, while at the same time providing as much if not more structural support as the heavier components it's replacing. This is in addition to adding superior performance as a lighter vehicle accelerates faster, brakes in a shorter distance and handles better.

Because of these advantages Alcoa sees increasing aluminum intensity in vehicles in the future. As the earlier slide noted, Alcoa sees aluminum body sheet demand per vehicle growing four-fold from 2012 levels by next year and growing ten-fold by 2025. That's a remarkable growth opportunity for the company.

To meet this growth the company recently completed phase one of capacity expansion at a facility in Iowa. Given that more auto manufacturers are using aluminum, we can expect the company to continue growing its capacity in the future to meet this new demand.

Recent examples
We're already seeing this trend toward aluminum unfold at Ford, which recently revealed that the 2015 version of its best-selling F-150 truck would have an aluminum body. That move has the truck shedding 700 pounds off its massive frame. While many see this as a big gamble for Ford, the move could save American consumers $500 million in fuel costs.

Photo credit: Ford 

GM, meanwhile, is a bit farther behind as it's not planning on an aluminum-bodied truck until 2018. That actually marks a bit of a strategy change for GM as the company had focused on building smaller pickup trucks to boost fuel economy. What this shift demonstrates is the long-term and likely sustainable nature of the overall trend toward using more aluminum with Alcoa being the big beneficiary. It actually recently signed a long-term supply contract with GM to supply it with aluminum for its next-generation pickup truck.

Investor takeaway
Alcoa is really positioning itself well to lead this major shift within the automotive industry. The company already has long-term supply deals with both Ford and GM and it's increasing its capacity in order to continue to lead this shift. It's an opportunity that could be what drives shares of Alcoa's stock a lot higher in the future.

Does this make Alcoa our top stock for 2014?

Matt DiLallo has the following options: long January 2016 $10 calls on Ford. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. 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.

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