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Better Buy: Alcoa Inc. vs. Freeport-McMoRan

By Dan Caplinger - Apr 15, 2016 at 2:34PM

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Which materials stock is a better deal right now? Find out here.

Image: Alcoa.

The materials that go into the products that we use every day come from far and wide, and most people don't realize the network of suppliers that provide essential raw materials. Alcoa (AA) not only produces raw aluminum materials but also has a vertically integrated production process that makes value-added items for specialized purposes. Freeport-McMoRan (FCX -1.12%) has traditionally focused on the copper and gold mining industry, but its foray into the oil and gas exploration and production arena a couple years ago broadened its scope to encompass a larger portion of the natural resources space. Tough times have hit the entire materials sector, but value investors want to know whether one of these stocks is a better investment. Let's compare Alcoa and Freeport-McMoRan on several key metrics to see which looks more attractive currently.

Stock performance and valuation
Alcoa and Freeport-McMoRan have both seen their stocks take big losses over the past year. Alcoa is down 24% since April 2015, but Freeport has fallen nearly twice that amount, posting a 47% loss in the same time period.

Using simple valuation metrics that focus on trailing earnings, it's a bit challenging to assess the relative valuations of Alcoa and Freeport. The primary reason is that both companies have posted net losses on a GAAP basis over the past year. Freeport's earnings have taken a hit from impairment charges related to the plunging price of crude oil, against which the company has to measure the value of its reserves and take appropriate charges as necessary when their value declines. Similarly, Alcoa has posted a net loss due in large part to special items related primarily to closures or curtailments of capacity in its upstream business.

Investors expect both companies to be profitable in the future, however, and forward earnings projections provide at least some insight on relative valuation. Alcoa currently trades at a forward earnings multiple of 18. That's significantly higher than the 14 forward P/E ratio that Freeport has. Looking solely at valuation, therefore, Freeport arguably has an edge over its metal-making competitor.

On the dividend front, comparing Alcoa and Freeport-McMoRan is easy because only one of them currently pays a dividend. Alcoa's current dividend yield is 1.2%, which is below the overall average for the stock market. However, Freeport-McMoRan recently suspended its dividend, which had previously been substantially higher than Alcoa's figure.

Neither company has the ideal track record when it comes to dividends. Alcoa had to slash its dividend by more than 80% in 2009, in the aftermath of the financial crisis and its hit to much of the aluminum maker's core customer base. The company hasn't increased its dividend since then, and recent performance suggests dividend hikes might not come anytime soon.

Freeport made the difficult decision to suspend its dividend entirely back in December. The company had originally hoped that a past cut of almost 85% would be adequate to allow for a dividend while also productively using its cash flow. However, in the end, Freeport chose to preserve as much capital as possible as it considers strategic moves.

It's hard to get excited about a $0.03 per share payout quarterly. But something is better than nothing, and so Alcoa scores better as a dividend stock.

In the end, most of the debate about Alcoa and Freeport centers on their future growth prospects. Alcoa essentially has two different businesses, and although a formal split won't happen until later this year, their respective fates already have different implications for the company. Alcoa's upstream operations are sensitive to the commodity markets, and weakness in construction and infrastructure activity has limited the opportunity for growth in those areas. For the value-add segment, however, a soaring appetite for aircraft and automobiles has heightened demand from the aerospace and automaker sectors. That's why many investors are excited about the impending spinoff of what Alcoa will call Arconic.

For Freeport, exposure to the volatility of the oil, copper, and gold markets presents a constant challenge. Conditions in the copper market remain difficult because imbalances in supply and demand pose fundamental structural obstacles for the company. Meanwhile, low energy prices have caused dramatic losses for Freeport's oil and gas unit, and finding ways to get and retain capital has become more difficult as the energy sector of the stock market has collapsed. All in all, both companies need a turn in commodities in order to maximize their profits, but neither necessarily has a huge advantage.

Both Alcoa and Freeport-McMoRan have the potential to bounce back from their recent difficulties. For now, Alcoa has the brighter future because of its impending spinoff. If the markets cooperate, though, then Freeport could rise in a hurry under the right circumstances.

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Stocks Mentioned

Alcoa Inc. Stock Quote
Alcoa Inc.
Freeport-McMoRan Inc. Stock Quote
Freeport-McMoRan Inc.
$36.31 (-1.12%) $0.41

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