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Alcoa: A Sharp Play on Rising Metal Prices In a few weeks when third quarter earnings reports start pouring in, Alcoa's may not be only one of the first, but one of the strongest.

By MarketBeat Staff

entrepreneur daily

This story originally appeared on MarketBeat

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The stock market version of an NFL opening kickoff, Alcoa (NYSE: AA) often gets the party started when it comes to quarterly earnings season.

Lately, the global leader in aluminum products has kicked earnings seasons off with a bang thanks to a surge in metal prices. In fact, Alcoa has topped earnings expectations in each of the last six quarters—and in many instances by a wide margin.

So, in a few weeks when third-quarter earnings reports start pouring in, Alcoa's may not be only one of the first but one of the strongest considering aluminum futures have trended higher since July 1st. This makes Alcoa's stock not only good earnings play but a sturdy long-term bet on the growing global appetite for aluminum.

Why are Aluminum Prices Going Up?

Like many commodities, the price of aluminum has risen sharply during the global economic recovery. Aluminum futures that had slipped below $1,500 per ton in April of last year are currently trading around $2,800. They are rapidly closing in on the record high of $3,070 set back in February 2008.

There are both demand and supply-related reasons behind the stunning rebound in aluminum. Global demand for the metal has been soaring since the economic recovery got underway. Buyers have been scooping up all the aluminum they can for use in construction, cars, airplanes, food & beverage cans, and more.

On the supply side of the equation, China, the world's top aluminum producer, has pulled back on its production levels in favor of green energy ambitions. Meanwhile, pandemic-related container shortages and shipping delays have made it even harder to get a hold of aluminum supplies. Adding fuel to the supply limitations are surging electricity costs which are making it hard to reopen energy-intensive aluminum smelting plants.

How Does Alcoa Benefit from Higher Aluminum Prices?

Since Alcoa's aluminum and alumina businesses together account for the vast majority of overall profits, the company's fortunes are closely tied to the prices it can charge for its aluminum products. Its third segment, Bauxite, is a minor part of the business and has struggled of late due to increased production costs and less favorable pricing.

Although Alcoa has become synonymous with an aluminum industry it pioneered more than a century ago, it does more than simply smelt aluminum. It sells an extensive lineup of value-added aluminum products that includes billets, foundries, rods, and slabs as well as patented cast alloys. In a world that is quickly moving towards clean energy practices, Alcoa also offers low-carbon aluminum products through its Sustana brand. More than three-fourths of its smelted aluminum products are made using renewable energy sources.

So, because Alcoa sells a mix of value-added aluminum products it can command strong pricing that goes beyond the price of basic aluminum. Its customers receive Alcoa products in a state that allows them to be immediately implemented into their own manufacturing processes.

The impact on Alcoa's financial results has been clear. It has recorded $5.7 billion in revenue for the first six months of the year. And with its cost structure relatively steady, profits have been outstanding. Earnings per share (EPS) were $2.28 for the first two quarters combined. Analysts are predicting an even better bottom-line performance in the back half of 2021 as the prevailing supply-demand dynamics keep aluminum prices elevated.

Is Alcoa Stock Undervalued?

Economists are forecasting that aluminum prices will continue to trend higher into early next year. Depending on how supply conditions unfold, the rally could extend even further with new all-time highs in 2022 not out of the question. This means that Alcoa has a significant period to relish in high aluminum prices supported by a well-diversified demand environment.

It also means that the market may still be underappreciating Alcoa's near-term growth prospects despite the recent earnings beats. The stock is trading at less than 9x next year's earnings. This compares quite nicely to the 20x forward P/E ratio for the S&P 500 based on 2022 consensus earnings estimates.

In recent days, there has been downward pressure on aluminum and Alcoa's share price due to the developments in China's real estate sector. The potential impact on aluminum demand in the key construction market of China will be something to monitor. This, however, could amount to a near-term risk that gets outweighed by the longer-term aluminum supply-demand dynamics. It could also make Alcoa's stock even more attractive if the recent downtrend persists.

Look for Alcoa shares to trend lower in the days leading up to its October 13th earnings report. If they do, it will create a great opportunity to buy the stock cheaper ahead of what could be another shiny earnings report—and more importantly, a chance to ride the metals wave into 2022.

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