Is Alcoa Undervalued At These Prices?

With shares of Alcoa (NYSE:AA) trading around $8, 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 primary 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 reportable segments: Alumina, Primary Metals, Flat-Rolled Products, and Engineered Products and Solutions. As economies worldwide expand, raw material suppliers like Alcoa stand to see rising profits. Growth in developing countries is key to a rising stock price for Alcoa, so watch that as this growth continues.

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T = Technicals on the Stock Chart are Mixed

Alcoa stock has not participated in the recent S&P 500 rally. In fact, the stock is consolidating at multi-year lows. Once it stabilizes, the next move the stock makes is key. 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 around its tangled key averages which signal neutral 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

29.86%

50%

47%

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

Put IV Skew

Call IV Skew

June Options

Steep

Average

July Options

Steep

Average

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

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2013 Q1

2012 Q4

2012 Q3

2012 Q2

Earnings Growth (Y-O-Y)

44.44%

221.89%

-186.67%

-100%

Revenue Growth (Y-O-Y)

-2.88%

-1.52%

-9.13%

-9.45%

Earnings Reaction

0%

-0.21%

-4.6%

-4.1%

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

P = Excellent Relative Performance Versus Peers and Sector

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

Alcoa

Aluminum Corp. of China

BHP Billiton

Noranda Aluminum

Sector

Year-to-Date Return

-1.90%

-15.11%

-14.19%

-34.21%

-5.26%

In a poor performing sector, Alcoa has been a year-to-date relative performance leader.

Conclusion

Alcoa provides aluminum products and services to companies in growing industries around the world. The stock has suffered in recent years and has not really participated in the current S&P 500 rally. Over the last four quarters, earnings have been mixed while revenues have decreased, which has not pleased investors. Relative to its weak peers and sector, Alcoa has been a year-to-date performance leader. WAIT AND SEE what Alcoa and its industry do in coming quarters.

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