Decoding the Bullish Argument for Alcoa Heading into 2017



Bullish argument

As we discussed in the previous part, Alcoa’s earnings are sensitive to commodity prices (XLB). In this part, we’ll analyze the bullish argument for Alcoa (AA) as we head into 2017.

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Higher metal prices

Donald Trump’s win in the presidential election helped fuel a rally in aluminum prices, like most other commodities. Although aluminum pared some of its recent gains, it’s still trading above the $1,700 per metric ton price level. Among other factors, higher input costs are supporting aluminum prices. Alumina prices have shown strength over the last few months. Two key factors drove alumina’s price action. First, alumina seems headed for a supply deficit this year following Chinese curtailments. Second, higher coal prices are supporting alumina prices. The global aluminum cost curve shifted upward due to higher coal and alumina prices. Higher raw material prices could continue to support aluminum prices.

Bauxite sales

Bauxite could be another growth driver for Alcoa. Until now, most of the bauxite that Alcoa used to mine was consumed in its captive alumina operations. In fiscal 2015, Alcoa generated revenue of only $71 million from third-party bauxite sales. However, it has been aggressively pursuing bauxite sales over the last few quarters. It signed contracts valued at ~$600 million for 2016 and 2017.

US investors have few options to play the aluminum industry (NHYDY) (RIO). Solely based on being a pure-play integrated aluminum producer and the lack of quality assets in this space, Alcoa could command a scarcity premium. Alcoa’s leverage ratios look comfortable compared to some of the other companies in the space (CENX).

Meanwhile, bears could also like their chances next year. We’ll discuss this more in the next part.


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