Friday, April 09, 2010

Alcoa (NYSE:AA): Downgrading to Neutral & Removing from JPM Focus List

J.P. Morgan downgrades Alcoa (NYSE:AA) to Neutral from Overweight and is removing the stock from their Focus List. Firm's new target is $16.50 (prev. $21.50).

Firm notes their downgrade reflects their new 2011E EPS of $0.48 (which is based on their metal strategist's aluminum price forecast of $0.92/lb) and lower December 2010 price target of $16.50. Although Alcoa has taken significant costs out of its business by closing high cost operations and through additional procurement and productivity savings, they think it will still struggle to generate attractive returns at JPM's strategist’s
2011 aluminum price forecast of $0.92/lb. While LME aluminum currently sits at $1.04/lb today and the average price for the forward curve in 2011 is roughly $1.11/lb, the firm believes likely weak 1Q results and relatively poor fundamentals for the aluminum market as compared to other metals will encourage investors to gravitate towards companies that have more earnings leverage to their respective metal prices.

Lowering 2010E EPS as headwinds offset rising aluminum prices. JPM is lowering their 1Q10E EPS to $0.04 from $0.18 and 2010E EPS to $0.74 from $1.10. 1Q results should benefit from rising aluminum prices (about $0.12 assuming a 15- day lag), Fx (about $0.02), and additional annual procurement & overhead savings (about $0.05 in the quarter though the number should grow to a run rate of $0.09/qtr as savings are achieved). These gains, however, should be largely offset by the reversal of the $0.06 LIFO benefit from 4Q09 (and perhaps a modest charge) and lower can sheet volumes due to a pricing dispute with a key customer. They are also lowering their estimates for the balance of the year, as can sheet volumes and margins will likely not spring back to pre-dispute levels by Q2 and to account for some further cost inflation.

Lowering target price to $16.50 from $21.50. JPM is lowering their Dec 2010 price target to $16.50 from $21.50 to reflect their lower 2010E EPS and lower EV/EBITDA multiple of 7.5x. Their previous price target was based on AA’s average forward multiple of 7.8x since 2002, but they believe a discount is now appropriate given our 2011 aluminum price forecast. However, if JPM were to hold the current aluminum price of $1.04/lb constant for 2011, their 2011E EPS, holding all other factors constant, would move to $1.36 and 2011E EBITDA to $4.8bn, which would equate to a 2011E EV/EBITDA multiple of 5.2x on the current stock price. Additionally,
applying AA's average forward EV/EBITDA multiple of 7.8x to the $4.8bn of EBITDA would equate to a stock price of $27. AA currently trades at 2010E and 2011E EV/EBITDA multiples of 7.1x and 8.2x respectively.

Notablecalls: With J.P. Morgan's Metals team lowering Alcoa estimates just ahead of their earnings release, I think the call warrants attention. Also, their FY11 EPS estimate of $0.48 is now the Street low.

I thought Deutsche's FY011 EPS ests (lowered last week) were as low as they would go here but looks like JPM had other plans.

JPM upgraded Alcoa back in March 2009, so their clients are sitting on sizable gains.

I think AA will get hit on this downgrade. It's a slow mover & the general tape is strong, so you should be able to get decent fills starting from early on.

$14.50? and if that breaks, another 10-20c lower?


db said...

good call, esp with this dg coming ahead of the Q. nice catch.

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