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Three Key Differences Between Alcoa and Precision Castparts

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Alcoa and Precision Castparts

As discussed previously, Alcoa (AA) has historically traded at a discount to Precision Castparts (BRK-B). As we’ll explore in this part of the series, there are several differences between Alcoa’s and Precision Castparts’ value-add businesses.

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Revenue mix

Alcoa’s Engineered Products and Solutions (or EPS) segment, which supplies aerospace components, accounted for a little less than 45% of Alcoa’s downstream revenues in the most recent quarter. On the other hand, according to Precision Castparts, 70% of its sales come from the aerospace market. Companies in the aerospace component space generally trade at higher valuation multiples.

Earnings margin

Alcoa’s upstream segment had an adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) margin of 14.8% in fiscal 2015. The segment’s EBITDA margins are weighed down by the Transportation and Construction Solutions (or TCS) and Global Rolled Products (or GRP) segments. The GRP segment has an adjusted EBITDA margin in the ballpark of 10%. Although Alcoa says that the per-ton EBITDA is a better indicator for the GRP segment, for valuation purposes, markets are likely to look at the margins and total EBITDA.

Leverage ratios

While Alcoa had a net debt-to-EBITDA ratio of 2.8 in its most recent filing, Precision Castparts had a ratio at 1.6. It’s important to note that higher leverage ratios increase a company’s risk profile. Companies with high leverage tend to trade at lower valuation multiples. Constellium (CSTM), a Europe-based fabricator, has been weighed down by its higher leverage ratios.

Meanwhile, Alcoa expects the profitability of its EPS segment to improve considerably this year. In the next part, we’ll discuss what this would mean for the company.

To get a diversified exposure to the materials sector, you could consider the Materials Select Sector SPDR ETF (XLB). Metal producers currently form ~12% of XLB’s portfolio. Together, Alcoa and Ball Corporation (BLL) form ~4.7% of XLB’s portfolio.

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