Time to Look at Mining Stocks After the Rally in Alcoa Shares?

Chris Lau, Kapitall: Alcoa shares rallied after reporting weak earnings. Does this signal it's time to look closely at mining stocks?

The sharp rebound in shares of Alcoa (AA) seems confusing: after reporting weak fourth quarter earnings on January 10, the stock closed at close to a 52-week high. Trading volume was above average, too. With such bullish convictions, should investors believe the worst is over for mining stocks?  

Weak quarter for Alcoa

To assess the health of the sector, investors could look first at Alcoa. The company earned 5% less than last year's Q4, and lost $2.34 billion. Revenue declined 5.3% to $5.59 billion, thanks to a drop in aluminum shipments.

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Despite the poor results, Alcoa expects global demand for aluminum to improve this year. But investors should still be cautious. Stronger demand from the aerospace and automotive sectors, along with higher home and office building needs, will likely be necessary to support the aluminum market.

Comparable investments

Right now Alcoa trades at a premium. Its forward P/E is 31, similar to some other large cap metal companies.  Nucor (NUE) stands at 35.7, compared to 12 for Freeport-McMoRan (FCX) – although part of Freeport's valuation is probably due in part to the extremely low prices for gold. Freeport also has a much larger market cap.

Click on the interactive charts below to view data over time. 

Costs a worry?

Investors in this sector should also be mindful of electricity costs. This is the most expensive cost factor in the production of aluminum. If firms were to lower their costs using more natural gas, which is cheaper, big companies like Alcoa could stand to benefit. 

Outperformance could be followed by adjustment….

The share price rise for Alcoa contrasts greatly to Freeport, whose shares are nearly flat in the last month:

Investors looking to book profits might want to consider Freeport shares. The high 3.45% dividend yield in Freeport is appealing too, compared to 1.06% for Alcoa.

However Freeport's leverage in gold could also be a mixed blessing. The stock is certainly priced as a bargain right now, but only if gold prices start to rebound. Cautious investors may want to wait until after tapering proceeds some before taking a position in this sector. 

 

(Written by Chris Lau, a Kapitall Writer.)

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