Alcoa (AA.US): The subsequent resumption of production in the Middle East is expected to be more gradual, and the new production capacity planned before the war may be difficult to implement

The Zhitong Finance App learned that a research report released by Wall Street financial giant Jefferies (Jefferies) after a recent meeting with Alcoa (AA.US) executives shows that Alcoa's business complexity and execution risk over the past few years have weighed down valuations, while AliGroup acquisitions, pre-delivery cash accumulation, progress in Western Australian mining approval, and improvements in existing asset cash conversion capabilities are expected to drive valuation repair. The bank maintains a positive stance on aluminum prices, while being relatively neutral on alumina. It reaffirms Alcoa's “buy” rating and gives a target price of $60, which is 53.1% higher than the research report showed last Friday's closing price of $39.19.

In addition, the “Australian listed securities AAI” was also “bought”, with a target of 87 Australian dollars; the target of 60 dollars is based on net present value analysis, and the price-earnings ratio is not simply applied. According to the Jefferies analyst team, even if aluminum prices enter the normalization stage, the company may still reduce valuation discounts through asset integration, stable production, and cash accumulation. “Australian listed securities AAI” refers to Alcoa's CHESS depositary rights (CDIs) listed and traded on the Australian Stock Exchange (ASX). The transaction code is AAI. It is quoted in Australian dollars and represents Alcoa's common stock interests. It corresponds to the same Alcoa company as the US stock code AA, and is not another Australian aluminum company.

The aluminum market can be described as absorbing price premiums brought about by previous supply shocks in the Middle East. Jefferies's research report, which focuses on American aluminum and aluminum market transactions, indicates that LME aluminum prices dropped significantly by about 17% from the beginning of June, mainly affected by the resumption of production in the Middle East and increased supply in Indonesia; on November 3, LME three-month aluminum fell another 2% to 3032.50 US dollars/ton. Supply in the Middle East, which previously supported the rise, was disrupted on a large scale under the geopolitical crisis, and the electrification and AI computing power infrastructure construction process is still worth paying attention to for aluminum demand, but the market has begun to re-estimate the balance between supply and demand after the new supply is realized. As a comparison, LME aluminum prices previously hit 3707.50 US dollars/ton on June 1, 2026, the highest level in more than four years.

According to earnings data previously released by Alcoa, the third-quarter revenue of this major global producer focusing on bauxite and aluminum products was US$3.704 billion, up 23.7% year-on-year, slightly below the unanimous expectations of Wall Street analysts of about US$3.77 billion; the adjusted EPS was US$1.82, higher than the US$1.51 forecast and the loss of US$0.02 for the same period last year. However, after excluding special projects, the adjusted EBITDA was US$789 million, down 12.4% from the previous month, which largely indicates that operational improvements have not fully offset the fall in aluminum prices. According to Jefferies, what really enhances financial resilience is free cash flow of 472 million US dollars for the quarter, which has reached a cumulative total of 894 million US dollars in the last two quarters.

The process of resuming production is reducing aluminum prices, and electricity costs and trade flows determine profit distribution

Resuming production in the Middle East can increase supply, but the speed of recovery depends on the actual economy of production. Alcoa management pointed out that the aluminum import cost for some Middle Eastern smelters has exceeded 800 US dollars/ton. The subsequent resumption of production is expected to be more gradual, and the new production capacity planned before the war will also be more difficult to implement; at the same time, the company expects that China's upper limit of 45 million tons/year of raw aluminum production capacity will still be implemented.

The market's differences over supply and demand in 2027 focus on whether these new supplies can be delivered on time: According to a series of recent dynamic forecast reports compiled by the agency, CRU expects a global excess of 1.4 million tons of aluminum next year, Wood Mackens expects 500,000 tons, and Bank of America only expects 239,000 tons. The latter two place more emphasis on restrictions on Indonesian ports, electricity, and supporting construction. Therefore, Jefferies's view of Alcoa is based on the judgment that supply growth is constrained by costs, but this does not mean that global supply is determined to continue to be in short supply.

The positive impact of the AI computing power infrastructure construction process, which is currently in full swing, on Alcoa is mainly transmitted through data center construction, supporting power grids, and competition for power resources. The massive expansion of AI computing power resources has increased demand for aluminum, and has also made it more difficult to obtain low-cost electricity with additional smelting capacity; Jefferies's research report indicates that power equipment accounts for more than one-third of aluminum production costs, so assets with stable, low-cost power sources are more competitive.

The profit ultimately earned by Alcoa also depends on the difference between “LME base price+regional price rise+product premium” and actual costs. Jefferies believes that the company has already benefited from 50% of the Section 232 tariffs to reshape trade flows: if Canada gets the discount alone, the US still needs to import aluminum from other sources, the Midwest may maintain support, and the company's low-cost Canadian assets may obtain additional profits; if the exemption is extended widely to other aluminum-producing countries, the fall in litre water will weaken this advantage. This is why Jefferies believes that AI computing power requirements, tariffs, and electricity prices must be analyzed in the same profit framework. Whether Alcoa can further benefit from increased demand still depends on changes in aluminum prices, regional rise, and production costs.

The logic behind the $60 target: improved cash flow supports valuations, and mergers and acquisitions provide further catalysts

The AliGroup acquisition is the most important company-level catalyst. The initial consideration for the transaction was approximately US$4.1 billion, including US$3.1 billion in cash and approximately 17 million Alcoa shares, with an additional maximum contingent consideration of US$750 million linked to commodity prices. Delivery is expected in the first half of 2027. Its value is to expand the integrated scale of bauxite-aluminium-raw aluminum and improve procurement, operation and supply chain allocation; the company expects the net present value of the synergy benefits to be about 900 million US dollars, and it is expected to increase EPS and free cash flow after delivery.

Jefferies places particular importance on capital accumulation before delivery: the underlying cash formed under the “lock box mechanism” was about 300 million US dollars at the end of the third quarter. The bank is expected to exceed 800 million US dollars by mid-2027. Combined with Alcoa's own cash flow, it will help reduce net leverage after the merger. The accumulated economic value of these cash metals before delivery did not automatically reduce the US$3.1 billion cash consideration; the company's cash resource reserve of US$4.408 billion at the end of the quarter also included US$2.6 billion raised for the acquisition and issuance of bonds.

The stability of mining sources and operations determines whether the improvement in cash flow is sustainable. Alumina production increased 11% month-on-month in the third quarter, and Pinjarra refinery resumed operations, but the alumina division still lost $1 million in EBITDA after adjustment; the aluminum division contributed 862 million US dollars, indicating that current profits are mainly supported by the smelting business. Production and shipments of the two divisions are expected to increase in the fourth quarter, but the aluminum business is facing a month-on-month pressure of about 30 million US dollars for raw materials and maintenance, and about 30 million US dollars for alumina costs.

Despite progress in Western Australia's approval, a precise distinction is still needed: the government announced that it will approve the 2025-2029 mining management plan, the new temporary exemption will actually be valid until the end of 2027, and the long-term EIA for the new mining area has not yet been completed. The ELYSIS technology, renewable electricity, and the 2050 net zero operating target, which the Jefferies research report focuses on, are related to long-term costs and asset competitiveness. The AI computing infrastructure process has also brought other specific monetization opportunities: part of the land at the old Massena East plant is intended for buyers to develop a data center. The potential repayment is up to US$315 million, but payments are linked to licensing, capacity expansion, and operation.

Jefferies is optimistic about the strategic value of AliGroup's acquisition, but the profit and cash flow forecasts in the report are still calculated based on Alcoa's independent operating caliber. Therefore, what is most important in terms of valuation is that the Jefferies model has not been included in AliGroup and does not predict a continuous sharp rise in aluminum prices and EPS in the coming years: the LME average annual aluminum price assumptions from 2026 to 2028 were 3298, 3197, and 3086 US dollars/ton, respectively, and the adjusted EPS was 6.53, 5.30, and 5.48 US dollars, respectively; the free cash flow per share listed in the report rose from $2.43 to $3.71 and $3.96. An important condition for cash improvement is that the outflow of approximately US$899 million of working capital and discretionary pension payments in 2026 will not be repeated in subsequent years.

According to the reference price of $40.18 on the model page, the 2027 price-earnings ratio is about 7.6 times, EV/EBITDA is about 3.9 times, and the return on free cash flow is about 9.2%. Whether these low multiples can be converted into gains depends on cash release and merger execution, not just cyclical stocks looking cheap. 40.18 US dollars is the stock price used by the model to calculate the valuation index, and 60 US dollars is the target price. For example, 40.18 dollars divided by the predicted EPS of $5.30 in 2027 gives a price-earnings ratio of about 7.6 times; this indicates that the stock's valuation at $40.18 is not the valuation corresponding to the target price of $60. The $60 target was derived using a net present value analysis.

The optimistic, benchmark, and pessimistic scenarios for Alcoa in the Jefferies research report are $90, 60, and $30, respectively. Among them, the optimistic and pessimistic scenarios correspond to aluminum and alumina prices being about 15% lower than the benchmark, clearly showing that commodity prices, merger and acquisition catalytic, and cash flow growth trajectories will still determine the valuation space.