Can Alcoa Be the Stock It Once Was?

With shares of Alcoa (NYSE:AA) trading around $14, is AA an OUTPERFORM, WAIT AND SEE, or STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

T = Trends for a Stock’s Movement

Alcoa is engaged in the production and management of aluminum, fabricated aluminum, and alumina combined through its participation in technology, mining, refining, smelting, fabricating, and recycling. Alcoa’s products are used worldwide in aircraft, automobiles, commercial transportation, packaging, building and construction, oil and gas, defense, consumer electronics, and industrial applications. The company’s operations consist of four worldwide segments: Alumina, Primary Metals, Flat-Rolled Products, and Engineered Products and Solutions.

Aluminum maker Alcoa, already a leading supplier to aerospace companies, hopes to see sales in that sector soar with its deal to buy UK jet engine components maker Firth Rixson for $2.85 billion. The acquisition also drives Alcoa’s strategy of focusing on key growth markets such as autos and aerospace. “The acquisition of Firth Rixson is a major milestone in Alcoa’s transformation,” Alcoa CEO Klaus Kleinfield said in a statement. Alcoa bought Rixson, which makes rings, forgings and other metal products used in jets, from private equity firm Oak Hill Capital Partners. Alcoa will pay $2.35 billion cash, plus $500 million of stock and an additional $150 million potential earn-out.

The aluminum maker projects a compound annual commercial jet growth rate of 7 percent through 2019 and sees a current nine-year production order backlog at 2013 delivery rates. Aerospace giants Boeing (NYSE:BA) and Airbus are ramping up production as carriers revamp their fleets with more fuel-efficient aircraft. Alcoa said it expects to see cost savings top $100 million per year in five years. The companies project the deal will close by the end of this year. After trading in a narrow range in the back half of 2013, Alcoa’s stock took off in mid-December, and it’s advanced 59 percent since then to the highest point in nearly three years. The stock has been helped by expectations the auto industry will use more aluminum. Ford Motor (NYSE:F) announced earlier this year plans to roll out a lighter, more fuel-efficient aluminum body version of its F-150 pickup. Industry watchers say other automakers may follow suit. Ford said this week the aluminum body F-150 is on track for a rollout by year-end.

T = Technicals on the Stock Chart Are Strong

Alcoa stock has been surging higher over the past several months. The stock is currently trading near highs for the year and looks poised to continue. Analyzing the price trend and its strength can be done using key simple moving averages. What are the key moving averages? The 50-day (pink), 100-day (blue), and 200-day (yellow) simple moving averages. As seen in the daily price chart below, Alcoa is trading above its rising key averages which signal neutral to bullish price action in the near-term.

AA

(Source: Thinkorswim)

Taking a look at the implied volatility (red) and implied volatility skew levels of Alcoa options may help determine if investors are bullish, neutral, or bearish.

Implied Volatility (IV)

30-Day IV Percentile

90-Day IV Percentile

Alcoa options

29.63%

70%

68%

What does this mean? This means that investors or traders are buying a very significant amount of call and put options contracts, as compared to the last 30 and 90 trading days.

Put IV Skew

Call IV Skew

July Options

Flat

Average

August Options

Flat

Average

As of today, there is an average demand from call buyers or sellers and low demand by put buyers or high demand by put sellers, all neutral to bullish over the next two months. To summarize, investors are buying a very significant amount of call and put option contracts and are leaning neutral to bullish over the next two months.

On the next page, let’s take a look at the earnings and revenue growth rates and the conclusion.

E = Earnings Are Mixed Quarter-Over-Quarter

Rising stock prices are often strongly correlated with rising earnings and revenue growth rates. Also, the last four quarterly earnings announcement reactions help gauge investor sentiment on Alcoa’s stock. What do the last four quarterly earnings and revenue growth (Y-O-Y) figures for Alcoa look like and more importantly, how did the markets like these numbers?

2014 Q1

2013 Q4

2013 Q3

2013 Q2

Earnings Growth (Y-O-Y)

-223.08%

-1,087.31%

184.62%

44.44%

Revenue Growth (Y-O-Y)

-6.50%

-5.31%

-0.57%

-1.91%

Earnings Reaction

3.75%

-5.42%

2.01%

-0.12%

Alcoa has seen mixed earnings and decreasing revenue figures over the last four quarters. From these numbers, the markets have been pleased with Alcoa’s recent earnings announcements.

P = Excellent Relative Performance Versus Peers and Sector

How has Alcoa stock done relative to its peers, Aluminium Corp. of China (NYSE:ACH), BHP Billiton (NYSE:BHP), Noranda Aluminum (NYSE:NOR), and sector?

Alcoa

Aluminium Corp. of China

BHP Billiton

Noranda Aluminum

Sector

Year-to-Date Return

40.64%

3.68%

0.79%

5.47%

4.31%

Alcoa has been a relative performance leader, year-to-date.

Conclusion

Alcoa is a an aluminum producing and supplying giant all around the world. The company made a deal to buy UK jet engine components maker Firth Rixson for $2.85 billion. The stock has been surging higher over the past several months and is currently trading near highs for the year. Over the last four quarters, earnings have been mixed while revenues have been declining. However, investors have been pleased with recent earnings announcements. Relative to its weak peers and sector, Alcoa has been a year-to-date performance leader. Look for Alcoa to OUTPERFORM.

Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

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