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Why You Shouldn’t Give Up on Alcoa despite Its Recent Weakness

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What’s the downside?

As noted in the previous articles, Alcoa (AA) has seen negative price action in 2018 amid the weakness in base metals. The broader sell-off in the equity markets and Alcoa’s 4Q17 earnings miss haven’t helped the stock either.

Meanwhile, despite the stock’s recent weakness, its downside could be limited. Let’s discuss this in perspective.

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Valuation

Alcoa is valued at an EV (enterprise value) of 4.2x its 2018 consensus EBITDA (earnings before interest, tax, depreciation, and amortization) and 4.5x its consensus 2019 EBITDA. The stock’s valuation multiples are among the lowest among aluminum producers as well as other metals and mining companies. Century Aluminum (CENX) and South32 (S32) have one-year forward EV-to-EBITDA multiples of 8.8x and 5.2x, respectively.

Alcoa’s valuation multiples are based on its 2018 expected EBITDA of $2.5 billion. However, we should remember that Alcoa’s earnings, like those of other commodity producers (RIO) (XLB), are sensitive to underlying commodity prices. Currently, both alumina and aluminum prices are lower than what Alcoa baked in when giving its 2018 EBITDA guidance of $2.6 billion–$2.8 billion.

Macro environment

Meanwhile, despite the recent bearishness in aluminum prices, the lightweight metal’s downside could be limited unless we see a sharp global sell-off.

While Chinese aluminum exports have been on an uptrend, aluminum’s demand outlook seems decent enough to absorb them. Some company-specific factors could also help Alcoa, as we’ll explore in the next article.

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