Alcoa (AA) recently announced plans to spin off its aerospace and automotive divisions into a new company, Arconic.
In this clip from the Industry Focus: Energy podcast, Tyler Crowe and Taylor Muckerman explain why the spinoff, which is set to take place sometime in the next eight months, has so many investors excited. They also talk about how the new company could either take off like a rocket or find its growth burdened by its parent's substantial debt load.
A full transcript follows the video.
This podcast was recorded on April 14, 2016.
Tyler Crowe: I have been very interested in a spinoff for a couple of reasons. Like you said, it's looking much more robust in terms of a company. There is certainly some opportunity with the expansion of aerospace and defense, and we're starting to see automotive with Ford F-150 going to a lot more aluminum in construction, for the lighter...
Taylor Muckerman: Yeah, aluminum frame. Tesla, all-aluminum frame.
Crowe: It really intrigues me. One of the reasons it also intrigues me is, looking at the financials, specifically of Arconic -- I'm going to hate that.
Muckerman: (laughs) It's tough to say.
Crowe: We'll get used to the name eventually. But, if you look, margins were actually pretty good. I mean, they have an operating margin of about 16%, which is pretty decent. And, another reason that that one actually interests me is, another move that happened a few months ago was Berkshire Hathaway buying Precision Castparts. If you look at the two businesses, when you take the spinoff and Precision Castparts head-to-head, they look relatively similar.
So from an investor's standpoint, Arconic does kind of interest me a little bit, especially from a valuation, because if you look at how much Berkshire paid for Precision Castparts, compared to what you could pay for Alcoa today and get both with the split and shed your Alcoa shares, it does look very attractive from a valuation standpoint. The thing that worries me more than anything else is how the company decides to divide up the debt. When you have a company like this, how is that going to break out? And how is that going to affect the company's profitability long term? Because if they tie up all of the debt into the new company, Arconic...
Muckerman: Yeah, the interest is going to crunch margins.
Crowe: ...to pay it off, yeah. That's going to be my one issue. So, I am watching this one with quite a bit of interest, more than I normally would with Alcoa. So, I'd really like to see that happen.
Muckerman: Absolutely, yeah. You look at the automotive parts sector in particular, right now, it's trading at a very cheap multiple on price-to-book compared to other sectors. Gavekal Research put out a great image this morning -- or, at least, I saw it this morning, and it listed probably 20 to 30 industries, not just the main sectors, but industries. And right down there with banking at the very bottom with a 0.9 price-to-book value, automotive parts and suppliers were right down there just above 1. So, it's a very cheap sector right now. Not to say that that's all this is tied to, because there's aerospace involved in there as well. But maybe it's something to look at when they spin it off in the second half of this year.