Jefferies: Alcoa's Valuation Will Benefit From Balance Sheet Improvement, Capital Returns

Alcoa Corp AA, which has become lean-and-mean following the November 2016 divestiture of its downstream business, picked up sell-side bull on Wednesday.

The Analyst

Jefferies analyst Christopher LaFemina initiated coverage of Alcoa with a Buy rating and $65 price target.

The Thesis

Alcoa shares are undervalued and offer investors a "free embedded call option on alumina and aluminum prices," as well as low-cost organic growth, LaFemina said in a Wednesday note.

Alcoa has sustainable competitive advantages, including a fully-integrated model, low-cost mines and refineries and high-quality smelters, the analyst said. The company's assets are located in low-risk regions, and it possesses spare smelting capacity that can be brought online without incremental capex, he said.

Alcoa is well-positioned to generate cash flow, plow the cash back into the business and return cash to shareholders, LaFemina said, attributing the positive cash picture to high-quality assets and a strong balance sheet.

The commodities Alcoa deals in, namely aluminum, alumina and bauxite, are low-risk, with aluminum being less cyclical and volatile than other metals, according to Jefferies.

The sell-side firm views Alcoa's priority as being a gradual shift from funding pension and debt paydown to capital returns, with dividend initiation likely this year.

By 2023, Jefferies sees Alcoa's cumulative capital return potential to be equivalent to almost 30 percent of its market cap.

"We recommend that investors buy AA shares now," LaFemina said.