2 Positives Missing From Alcoa's Stock Valuation

Morgan Stanley’s Evan Kurtz believes Alcoa Corporation AA shares are pricing in a commodity outlook that is meaningfully below the spot aluminum and alumina prices.

Kurtz initiated coverage of the company with an Overweight rating and price target of $27.

The analyst believes that if the spot prices were used, the stock would be worth $35. Even using commodity prices 8 percent below spot, upside potential of 7 percent is implied.

“Our valuation is based on our view that we are at a low point of the aluminum cycle, and our multiples are higher than the mid-cycle average, but in line with peers,” the analyst explained.

Alcoa officially split into two entities on November 1, with the low-margin raw aluminum operations being separated from the high growth aerospace and automotive businesses. The former has continued with the Alcoa name, while the latter is called Arconic Inc ARNC.

“In recent weeks, we have seen some favorable trends that are supportive of continued strength in aluminum and alumina prices, and we think enhance the risk-reward for AA shares,” Kurtz mentioned.

Prior to the split, the imminent separation had been seen as a key catalyst for the stock.

Two Positives

According to the Morgan Stanley report, the current stock valuation doesn't incorporate two key positives.

“[N]ew disclosure reveals that a significant portion of earnings stem from power sales, which deserve a higher multiple, in our view,” the report noted.

Secondly, Kurtz pointed out that opportunity for third party bauxite sales were not fully reflected in the valuation.

“These third-party tons sell for higher margin; we believe they add ~$100 mn in incremental EBITDA annually,” the analyst added.