Market participants who are bullish on Alcoa (AA) point to Berkshire Hathaway’s (BRK-B) acquisition of Precision Castparts. Berkshire acquired Precision Castparts (PCP) at a trailing-12-month EV/EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) of 13x. In light of the PCP acquisition, some analysts believe that Arconic could be worth more than the combined entity.
To be sure, Alcoa currently trades at a steep discount to what Warren Buffett paid for Precision Castparts. However, Arconic isn’t totally comparable to PCP, as we’ll explore in this part of the series.
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.
Arconic 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 (DIA) are likely to look at the margins and total EBITDA.
Arconic’s leverage ratios will likely be higher than PCP’s, as Alcoa plans to retain most of the current consolidated debt with Arconic. Generally, companies with higher leverage tend to trade at a discount compared to peers with less financial leverage.