Why Bank Of America Went Bullish On Alcoa

• Alcoa Inc AA is down 38.5 percent year-to-date.
• Timna Tanners, analyst with Bank of America Merrill Lynch, upgraded Alcoa to Buy with a $12 price target.
• Tanners based the firm's stance on the opinion that aluminum prices have lost "relevance" to Alcoa's share price.

Bank of America Merrill Lynch is not yet ready to call a bottom in aluminum prices, but the firm is starting to see a turn that could lead shares of Alcoa higher. According to Tanners, who uses Michael Widmer's aluminum price forecast as a baseline, Alcoa has an "established track record" for addressing low aluminum prices "quickly." Tanners said that the firm typically cuts costs, curtails production, or permanently shuts capacity when prices fall. That response means that "over time aluminum prices should become less relevant" for Alcoa.

Tanners said that investors have subsequently penalized Alcoa unfairly for aluminum's weakness, particularly in the wake of its purchase of RTI and Firth Rixson, two acquisitions that benefit from "structurally strong aerospace demand." With these acquisitions, the company reduced "its earnings sensitivity to aluminum the commodity." As a result, Tanners argued that it deserved a higher multiple.

Alcoa shares gained 2.2 percent on Tuesday to $9.70. The stock is more than 20 percent undervalued based on BofA Merrill's target price. That price target uses an 8x multiple on 2016 and 2017 estimated EV/EBITDA, below the 10-year average.