Alcoa Inc (AA), Century Aluminum Co (CENX), Noranda Aluminum Holding Corporation (NOR): One Aluminum Stock to Buy, Two to Hold

The aluminum industry has long been plagued by an overcapacity issue, with major players in the industry failing to attract enough demand to meet the supply they create. As a result, aluminum prices have not moved in a favorable (upwards) direction for the industry.

Alcoa Inc (NYSE:AA)A surprise call

The overcapacity of the industry is why the market was surprised when Alcoa Inc (NYSE:AA), the first company in the industry to report its earnings in the earnings season, gave an optimistic report during its call. The company said that it perceives the global end markets to be solid, estimating a growth of 7% in global aluminum demand for 2013.

There is no doubt that the growth in demand for aluminum remains high. The silver lining in aluminum remains a bright outlook in demand, both near term (strong China auto/truck demand and demand in commercial building and construction, offsetting weak European demand), and long term (accelerating global aerospace build rates and global automotive volume and market-share gains). Alcoa Inc (NYSE:AA)’s downstream businesses remain well positioned to benefit in both the near term and long term.

The problem, however, remains on the supply side. With primary aluminum supplies still growing faster than demand and with Alcoa Inc (NYSE:AA)’s upstream businesses still highly sensitive to underlying aluminum prices, the supply-related challenges in Alcoa Inc (NYSE:AA)’s upstream businesses will continue to outweigh the demand-related opportunities in Alcoa Inc (NYSE:AA)’s downstream businesses.

Even with solid first quarter results, Alcoa Inc (NYSE:AA)’s near-term profit outlook remains constrained by the underlying aluminum price, which is moving in the wrong direction. This means that second quarter Consensus estimates still need to come down and the potential for a meaningful cash burn still exists.

These are headwinds that are unlikely to disappear in the near term, and which remain largely underappreciated by the equity market.

Best shot in the aluminum industry

After releasing its first quarter results, Century Aluminum Co (NASDAQ:CENX) is the best-placed among the US aluminum producers in terms of company-specific growth, cost savings program and cheap valuations.

The company is expected to achieve growth given its plan to restart Ravenswood project. Also its expanding Grundartangi project and gradual development in the Helguvik project will be of great help.

The cost savings program includes renegotiating power contracts at Ravenswood and Hawesville. As far as valuations are concerned, Century Aluminum Co (NASDAQ:CENX)’s shares currently trade at 6.4 times the company’s estimated 2014 earnings before interest, taxes, depreciation and amortization while the other two US aluminum producers trade at 6.8 times their 2014 EBITDA.

Along these same lines and subsequent to first quarter earnings, Century Aluminum Co (NASDAQ:CENX) announced the acquisition of the Sebree aluminum smelter and a tentative power agreement at its Hawesville smelter, both of which are located in Kentucky. The combined impact of these announcements on Century Aluminum Co (NASDAQ:CENX)’s EBITDA is estimated to be at least $70 million to $90 million, implying that the company’s 2014 EBITDA potential may approach $200 million (based on an aluminum price assumption of $0.93/lb) and a share price approaching $12 based on 5.5 times this potential 2014 EBITDA. A target price of $12 means that the company could see an upside of 40% from current levels!

The third player

Noranda Aluminum Holding Corporation (NYSE:NOR) reported solid first quarter results, driven by continued impressive unit cost performance as it continues its track record of meeting or beating its operating targets. Unfortunately, this solid operating performance is overshadowed by a weakness in underlying aluminum prices that have deteriorated further since the relevant first quarter earnings period.

For Noranda Aluminum Holding Corporation (NYSE:NOR), the negative impact of declining aluminum prices is exacerbated by its net-long alumina position (40% of Noranda Aluminum Holding Corporation (NYSE:NOR)’s external alumina shipments are linked to the aluminum prices of the London Metal Exchange). Also, rising natural gas prices have added to the woes as Noranda Aluminum Holding Corporation (NYSE:NOR) consumes 18 MMBtu of natural gas/year.

My foolish take

Overall, the aluminum industry remains an uninteresting space unless incremental demand increases hit the industry and defeat the current oversupply issues. On a company-to-company basis, however, we do find some interesting stories. Century Aluminum Co (NASDAQ:CENX) is seen as the best stock given its cheaper valuations and cost-reduction strategy, while a neutral stance on Alcoa and Noranda Aluminum Holding Corporation (NYSE:NOR) is predicated on declining aluminum prices balanced by improving end markets.

The article One Aluminum Stock to Buy, Two to Hold originally appeared on and is written by Zain Abbas.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.