In the previous article, we saw that Alcoa’s (AA) valuation multiples are lower than some of the other mining companies, including Norsk Hydro (NHYDY) and Rio Tinto (RIO). However, a lower valuation multiple doesn’t necessarily mean that a stock is undervalued. Several factors, including growth prospects and leverage metrics, tend to impact a company’s valuation.
Comfortable leverage ratios
Alcoa (AA) has debt liability of ~$1.5 billion, which is composed mostly of notes that were issued in September 2016. Along with its total debt levels, we should also look at its net debt, which equals total debt minus the cash and cash equivalents.
Thanks to Alcoa’s strong cash flow generation in November and December 2016, its net debt has fallen below $600 million. Based on Alcoa’s trailing 12-month EBITDA,[1. earnings before interest, taxes, depreciation, and amortization] the company has a net-debt-to-EBITDA multiple of ~0.6x. This ratio looks comfortable when compared with some other mining companies (CENX) (XME).
Looking at current commodity prices, Alcoa could generate positive free cash flows this year. During the 4Q16 earnings call, Alcoa’s management listed several priorities in deploying its cash. The company could consider funding its pension and OPEB (other post-employment benefits) obligations that are currently underfunded by $3.1 billion.
Alcoa could also look at deleveraging its balance sheet. The company could look at growth projects, especially in its Bauxite segment, to enhance shareholder value. Alcoa upwardly revised its 2017 capital expenditure guidance. The company noted that it plans to spend $150 million toward “return-seeking projects.”
In our view, Alcoa’s valuation multiples could be somewhat conservative, looking at the company’s prospects and relatively higher multiples of some of the other mining companies. Alcoa’s earnings estimates could also be on the conservative side, which we’ll explore in the next article.