Alcoa Stock Jumps as Company Divides
In response to falling aluminum prices, Alcoa Inc. (NYSE:AA) is prioritizing focus over expansiveness. Alcoa stock soared on Monday September 28th as the company announced a split between its upstream and production divisions. However, AA stock holders shouldn’t worry; they’ll be well compensated for the “anti-merger”.
Aluminum prices have been in free fall for the last year, decimating the profitability of producers like AA. However, Alcoa executives aren’t taking the price slump lying down. They’ve decided to split the company into two distinct entities. (Source: Wall Street Journal, September 28th, 2015)
The company that will keep the Alcoa name and AA stock symbol is the upstream division.
Why AA Stock Could be so Valuable
The key to understanding Alcoa’s stock split is to think about what makes a good company. Of course, one could just ask how much Alcoa earns and call it a day, but that isn’t enough to estimate future performance.
Some analysts argue that a good company invests heavily in itself. When you see high investments in R&D or equipment upgrades, it can mean that a company aggressively pursing more market share. Ultimately, those investments could show up on the firm’s bottom line.
Other experts think share buybacks represent responsible corporate governance. If Alcoa had a reservoir of cash, these analysts would call for increased payments to AA stock holders.
The return for Alcoa investors would be fantastic, but this argument is inherently sceptical of management’s ability to properly invest profits.
However, nearly all analysts agree that a focused company is usually successful. Alcoa has taken that principle to heart, choosing to divide their upstream division and their production division.
Managing the Alcoa Split
Sometime in the second half of next year, Alcoa will spin off a “value-add” business to trade under a separate stock symbol. The new company will focus exclusively on engineered products and solutions.
That part of Alcoa currently generates about $14.5 billion in revenue. Most of the revenue comes from the aerospace industry, to which Alcoa jet engine parts and gas turbine airfoils.
Meanwhile, AA stock will continue to represent the upstream business. The company’s bauxite-mining, alumina-refining, and aluminum production activities are central to the Alcoa brand, contributing $13.2 billion in revenue for the last 12 months.
Alcoa executives think each division will perform better as separate entities. Rather than always seeking ways to overlap the business or muddling the chain of command, each section will simply strive for optimal efficiency.
No wonder AA stock holders are ecstatic.
By concentrating their attention on cost-cutting, both AA and its spin-off are gunning for a higher stock price. It’s a proven strategy to generate better cash flows and a higher price-earnings ratio.
Since the spin-off will only be finalized in the second half of 2016, we expect huge returns for AA stock. Investors are likely going to get very bullish as the date approaches, and they could push the stock to $15 or even $20. The sky’s the limit for Alcoa stock.