After more than a 300% rise since its March lows of this year, at the current price of close to $23 per share, Alcoa stock (NYSE: AA) looks overvalued. Alcoa’s stock has rallied from $5.48 to $22.71 off the recent bottom compared to the S&P which increased over 60% during the same period. The stock has outperformed the broader market in the last 8 months as aluminum prices rebounded and started to rise since April following the US government announcing a string of measures along with stimulus packages announced in other economies to keep businesses afloat. The stock is currently slightly above its December 2019 level. Also, with aluminum output set to drop in the next few years due to the restructuring program, the company’s revenue and earnings growth will likely be slower than anticipated earlier. With aluminum prices also not expected to see any major upside in the near term, Alcoa’s stock price is likely to drop almost 20% from its current level. Our dashboard What Factors Drove -58% Change In Alcoa Stock Between 2017 And Now? provides the key numbers behind our thinking.
Some of the stock price decline between 2017-2019 was justified by more than a 10% decrease in Alcoa revenues during this period. With Alcoa’s revenue declining in 2019 and dropping below its 2017 level, the P/S (price-to-sales) multiple has seen a continuous drop over the years as the stock price also declined. The stock also suffered with Alcoa reporting losses in 2019. Alcoa’s P/S multiple dropped from 0.9x in 2017 to below 0.4x in 2019. The multiple crashed sharply in 2020 following the outbreak of the pandemic which led to a decline in aluminum prices. However, with the recovery in aluminum prices as lockdowns are being lifted and sentiment is improving, the multiple has recovered over recent months and currently stands at 0.4x. We believe that the company’s P/S multiple is likely to drop to below 0.35x in the near-term and this is expected to lead to a downside in the stock price.
Where is the stock headed?
Aluminum prices were dropping since late 2019 as an increasing number of steel players were shedding capacity due to lower demand from automobiles. Also, primary aluminum prices were affected due to increased exports of semi products from China. To make things worse, the global spread of coronavirus led to lockdown in various cities across the globe, which affected industrial and economic activity. The aluminum demand from industry players affects global aluminum price levels, in turn impacting the company’s price realization for its products. Lower demand from construction and automobile players, has led to a drop in global aluminum prices from $1,820/ton in January 2020 to $1,570/ton in June 2020. This was reflected in the Q2 2020 results where Alcoa’s revenues decreased 21% y-o-y. However, with the gradual lifting of lockdowns, aluminum prices have rebounded strongly since June and have increased to over $2,000/ton in December 2020. Increase in price realization was reflected in the 10% sequential rise in Alcoa’s revenues in Q3 2020 (compared to Q2 2020).
We believe that the aluminum prices have peaked for now and will not see any major upside in the near term. The recent spike in Covid-positive cases could, in fact, lead to some drop in global aluminum prices on fears on more lockdowns. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. Also, as a part of a restructuring, Alcoa has put part of its aluminum assets under review. This is likely to hit the top line adversely in the near term. Though, margins are likely to improve from 2021 as the company shifts its focus to its core assets and operations, subdued revenue growth will take a toll on earnings. Thus, lower earnings growth, lower production, and no major upside in aluminum prices is expected to lead to Alcoa’s stock dropping to below $20, reflecting almost 20% downside from its current level.
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