2 Positives Missing From Alcoa's Stock Valuation

Morgan Stanley’s Evan Kurtz believes Alcoa Corporation (NYSE: 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 (NYSE: 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.