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Why Alcoa Stock Popped Today

What happened

Alcoa (NYSE: AA) shares shot through the roof on Tuesday, jumping as high as 10.7% as of 2:40 p.m. EDT. With yet another analyst joining the bandwagon who believes Alcoa shares have significant upside ahead, more and more investors are betting on the stock.

So what

Morgan Stanley turned bullish about the metals and mining sector in June and singled out Alcoa as a top pick. This morning, Morgan Stanley reiterated its buy rating on the stock and thinks it could be worth $51 per share. That's a whopping 62% upside from Alcoa's Tuesday opening price of around $31.55 a share. Morgan Stanley believes the company could earn $0.94 per share in its third quarter versus a loss in the year-ago period.

Morgan Stanley isn't the only one that sees Alcoa performing so well. Just yesterday, Goldman Sachs added Alcoa to its conviction buy list and upped its price target on the stock to $51 a share. Goldman Sachs is betting on rising aluminum prices; sees Alcoa's earnings before interest, tax, depreciation, and amortization (EBITDA) rising by 20% for every 10% increase in aluminum prices; and believes the company's efforts to deleverage should boost capital returns.

On July 16, Citi upgraded its rating on Alcoa stock to buy with a price target of $52 a share, again driven by the company's efforts to strengthen its balance sheet, among other things.

Image source: Getty Images.

So what's behind this flurry of analyst upgrades, you may ask? It's Alcoa's stellar second-quarter numbers released on July 15.

Alcoa reported its highest-ever quarterly net income since it became an upstream aluminum company after splitting into two in 2016. Alcoa's average realized aluminum price shot up more than 60% year over year and it paid down debt worth $750 million in the second quarter. With $1.65 billion cash on hand, Alcoa's net debt (total debt minus cash and equivalents) was only $642 million as of the end of quarter.

Now what

With aluminum prices showing no signs of slowing down and demand for the metal from China remaining strong, Alcoa is upbeat about the rest of the year. It foresees a strong third quarter driven by higher shipments across all its segments -- bauxite, alumina, and aluminum.

Importantly, Alcoa expects double-digit growth in sales of value-add products, which include slab, foundry, rods, and billet this year. Value-add is a part of its aluminum segment, and although Alcoa doesn't provide a breakdown of its contribution to its top line, a slump in demand for value-add products from sectors like automotive was a big reason why the company's earnings fell last year.

In short, analysts' expectations that Alcoa's operational performance will continue to impress isn't unwarranted; and despite aluminum prices hitting record highs in recent weeks, the stock is still trading at less than half the P/E ratio it commanded in 2017. That should leave investors with a lot to think about, while also keeping in mind the cyclicality of commodity markets.

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Neha Chamaria has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.


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