Friday, October 08, 2010

Alcoa (NYSE:AA): Appetite for hard assets and healthy demand should keep aluminum prices elevated; Upgrade to OW - J.P. Morgan

J.P. Morgan is upgrading Alcoa (NYSE:AA) to Overweight from Neutral with a $20 price target (prev. $16). The move comes after the co reporter its quarterly results last night.

According to the firm, the upgrade comes to reflect the impact on their 2011 estimates from the new aluminum price forecasts of JPM metal strategist, Michael Jansen. Mr. Jansen raised his 2011E aluminum price forecast to $1.06/lb from $0.98/lb and 4Q10E to $1.07/lb from $0.95/lb, vs. today’s price of $1.04/lb, which is the primary driver for their raising their 2011E EPS for AA to $1.38 from $1.02 and 4Q10E EPS to $0.14 from $0.10. The increases are to reflect an expanding appetite from investors to hold hard assets given their unease about the prospects for further easing along with stronger than anticipated demand for metals from real consumers. While the aluminum balance is still expected to be in surplus over the next several years, Mr. Jansen believes that zero interest rates, unfettered storage capacity, and investor involvement in the space should allow the industry to carry surplus inventories and allow for prices to trade higher than otherwise expected.

- Alumina should benefit from de-linking and low-cost production. While higher aluminum prices are the main reason for JPM's increased earnings expectations for 2011, they also think the company has the potential to expand its profitability over the next several years in its Alumina business. As spot alumina prices have generally traded above LME-linked alumina prices, they think AA’s Alumina segment should benefit as the company moves away from LME-linked price contracts over the next several years, while increased lowcost production should aid margins as well.

- Solid 3Q beat. AA reported 3Q10 EPS of $0.09 (excluding one-time net charges of $0.03) vs. JPM estimate of $0.01. The beat vs. their numbers was primarily due to better than expected profitability in AA’s Primary Aluminum segment.

- Raising PT to $20. JPM is raising their Dec 2011 price target to $20 from $16 to reflect their higher earnings estimates. Firm's new target is based on a 2011E EV/EBITDA multiple of 6.9x vs. AA’s average forward multiple of 7.8x since 2002. They think a discount is warranted until the company can demonstrate a higher degree of earnings leverage to rising aluminum prices than it has over the past several years. AA currently trades at 5.2x their 2011E EBITDA.

Notablecalls: This is the Street high target among tier-1 firms. Not a bad call. JPM is very respected.

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