Activist Eyes Alcoa

12/17/2015 7:00 am EST


Marshall Hargrave

Contributing Editor, Wyatt Investment Research

Elliott Associates, the hedge fund run by billionaire Paul Singer, recently revealed a more than 6% stake in this metals company, observes Marshall Hargrave in Daily Profit.

Alcoa (AA) is down 40% over the last year. As the world's third-largest producer of aluminum, Alcoa is heavily tied to the price of aluminum, which has been on the decline for more than five years now.

But Alcoa is still the top billionaire commodity play around. The key for investors that are skeptical of commodities is that Alcoa has already agreed to break itself into two parts.

Alcoa's split will include creating a company that focuses on custom-made and engineered products for the aerospace and auto industries, dubbed the "value-add" company.

The remaining upstream company will produce aluminum and other metals. So basically, Alcoa is separating the commodity business from the engineered products.

Elliott Associates is supportive of Alcoa management's plans to split. The fund has said that it believes the spin-off will create value substantially above the current share price.

Aluminum is a cyclical industry and we could be close to the bottom in pricing. Alcoa also has some of the lowest costs of production in the industry. But the hedge fund really sees value in the split-up of the company, which is expected to close in the second half of 2016.

Of note, Elliott Associates said that the market is undervaluing Alcoa's manufacturing business given the fall in aluminum prices. A split could help the market properly value the company.

Elliott Associates has already been in talks with management to boost value post-split. This includes selling off the power generation assets following the breakup.

It's worth noting that the upstream business has historically generated the bulk of Alcoa's operating income. But over the years it's been making large investments into the production (value-add) parts of the company.

Those should start paying off going forward and further reduce its reliance and sensitivity to aluminum prices.

Alcoa has a joint venture with Saudi Arabian mining company Ma'aden, which has been producing for less than a year. This is said to be the lowest-cost aluminum production operation in the world.

The company also has the opportunity to boost margins in its value-add company following the spin-off, as that business has margins well below direct competitors.

It's also worth noting that Alcoa offers a 1.3% dividend yield. At just over six times forward enterprise value-to-EBITDA, it's the cheapest we've seen Alcoa in close to five years.

Commodities have been a tough group of stocks to own over the last few years. Alcoa has been no different. But the company's recent plans to split—and activist investor Elliott Associates' involvement—makes it one of the only commodity stocks worth owning today.

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