On April 11Â Alcoa (AA, Financial) reported first-quarter earnings with the company reporting revenue of $4.9 billion, representing a decline of 15% on a year-on-year basis.
Further, the company’s earnings declined by 92% on a year-on-year basis. While the numbers seem to be disappointing, the stock is worth considering for the next five years.
The first reason to be bullish on Alcoa is the company’s fundamentals even in challenging times. For the first quarter, Alcoa reported cash and equivalents of $1.4 billion. This gives strong liquidity support in the coming quarters even if market conditions remain challenging.
While the company’s cash used in operation was $430 million for the first quarter, I don’t see near-term cash burn on working capital buildup as a matter of concern. From a liquidity perspective, Alcoa reported asset sales of $234 million for the first quarter, and I expect continued asset sales in the foreseeable future to provide additional liquidity support.
Growth in the aerospace industry is the next important factor to be bullish on Alcoa for the long term. For the fiscal year, the company is projecting 6% to 8% growth in the aerospace segment, down from an earlier estimate of 8% to 9%. While there are near-term headwinds, the long-term outlook remains bullish for this sector. Just to put things into perspective, Alcoa has won contracts worth $10 billion in the last 12 months from the aerospace segment. Once global economic activity accelerates, the aerospace segment backlog should strengthen further.
The defense segment is another potential growth driver for Alcoa in the long term; on March 3 Alcoa won a contract worth $50 million from the U.S. Army for R&D projects focused on developing innovative, light-weighting solutions for ground combat vehicles. This is a commencement of a long-term association with the U.S. Army and once there is progress in R&D, there will be demand for the company’s lightweight structures.
Another segment that has big potential in the long term is the heavy-duty truck and trailer end market. While the segment growth is negative in the near term and is likely to remain weak in the foreseeable future, the long-term prospects are bright with growth likely to come from China, Latin America and India. Therefore, Alcoa is likely to have multiple growth drivers in place once there is sustained recovery in the global economy.
From a demand-supply scenario, the following comment from the company’s first-quarter results puts things into perspective:
"In 2016, Alcoa projects an approximately 1.1 million metric ton global aluminum deficit as 5% global aluminum demand growth (revised from 6%) outweighs 2% global aluminum supply growth (revised from 3%). In addition, the company projects a global alumina deficit of 1.4 million metric tons."
Therefore, the company’s fundamentals are likely to improve in the coming years with global alumina deficit. I am certainly not expecting Alcoa stock to surge meaningfully higher in the foreseeable future, but current valuations might be hard to get when the industry recovers along with sustained recovery in emerging markets. Therefore, gradual accumulation in this quality name is a good idea.
Alcoa has declined by 26% in the last 12 months, and this is a good buying opportunity. For the year to date, the stock has remained largely sideways, and it appears the stock has bottomed out. Therefore, it makes sense to consider some exposure at these levels with a time horizon of three to five years.
Disclosure: No positions in the stock.
