ATI - ATI: A Good Buy At Lower Valuation

2023-07-16 05:54:52 ET

Summary

• ATI Inc. is expected to benefit from robust momentum in the Aerospace and Defense End market.
• The new sales commitments along with increased titanium melt capacity is expected to drive the company’s revenue in the coming years.
• Discounted valuation makes ATI a good buy.

Investment Thesis

ATI, Inc. (ATI) is strategically positioned to capitalize on the continued strong momentum in the Aerospace and Defense industry, which is generating significant demand for the company's materials. Moreover, the secured $1.2 billion sales commitment is set to impact ATI’s performance from 2024 to 2029, with an average annual revenue increase of $200 million, coupled with the rise in titanium melt production and unprecedented titanium demand, is projected to drive the company's revenue in the foreseeable future.

The company's current stock price is trading at a significant discount compared to its historical levels. And, I believe, discounted valuation along with promising growth prospects make ATI a good investment option at the current levels, hence, I have a buy rating on this stock.

Business Overview

ATI Inc. specializes in the production of specialty materials and operates through two main segments, High-Performance Material & Component (HPMC) and Advanced Alloys & Solutions (AA&S). The HPMC segment generates approximately 80% of its revenue from the Aerospace and Defense (A&D) sector, with a strong emphasis on maximizing growth in materials and components for Aero Engines. This segment offers a diverse portfolio of high-performance materials and advanced metallic alloys that are specifically designed to meet the unique specifications and demands of the aerospace engine industry. ATI Inc.'s HPMC segment is dedicated to providing tailored solutions that enhance the performance and efficiency of Aeroengine materials and components.

On the other hand, the AA&S segment specializes in the production of nickel-based alloys, titanium and titanium-based alloys, and specialty alloys, which caters to various end markets, including Energy, Aerospace and Defense (A&D), Automotive, and Electronics. The AA&S segment manufactures products such as plate sheets and PRS (Precision Rolled Strip) that are essential for these industries. By operating in these two segments, ATI Inc. aims to provide innovative solutions and advanced materials that meet the demanding needs of its customers in different sectors, contributing to solving global challenges across various industries.

Last Quarter Performance

The company's revenue grew 25% to $1.04 billion, as compared to the prior years quarter, with strong double-digit growth across both the HPMC and AA&S segment. This growth across the segments was primarily driven by the strength across the businesses related to the A&D end market, particularly in the Airframe and Jet engine business. These businesses experienced an Y/Y growth of 81% and 58% respectively, which more than offset the negative impact from Medical and Electronics end market which saw an Y/Y decline.

While the company's margins on the other hand declined, as the adjusted EBITDA margin contracted 220 bps Y/Y to 12.8% in the first quarter of 2023. The margin decline was mainly due to $29 million of COVID related employee retention incentives in the prior year quarter, which enhanced Q1 2022 margin by 350 bps to 15%, that created tougher comparison for the company's margin in the first quarter of 2023.

Momentum to Continue in the Aerospace and Defense (A&D) End Market

The company experienced strong momentum, primarily in the A&D end market, despite some supply chain and delivery delays during the quarters. This was primarily due to bullishness among OEMs about aircraft deliveries reaffirming future build rates, which drove historic demand for ATI’s materials.

The Jet engines business, which accounts for the largest portion of the company's A&D end market business, grew 58% as compared to the prior year quarter. The other two, Airframe and Defense businesses also continued their strong momentum during the quarter, which makes revenue share of A&D, 56% in ATI’s total revenue from 44% in the previous year. The strong demand growth in ATI’s materials and forging is expected to continue further in this end market, primarily because of the production ramp-up of engines and increased airframe shipment, driven by narrow-body and wide-body production rate improvement.

On the defense side as well, the robust demand should continue, followed by the accelerated ground vehicle armor order and continued growth in Carrier and Submarine fleet which should further drive the sales in this core end market, benefitting the company’s revenue in 2023 and beyond.

About The Rest Of The End Markets

In addition to the positive outlook of the A&D end market, other end market including Energy, Medical, and Electronic & Automotive, which also contributes to a significant portion of the company’s revenue, are also poised to grow in the coming quarters. The energy sector, which includes Oil & Gas (O&G) and specialty energy business, has benefited from steady growth in electrical power generation in the past quarters, which is expected to continue further. This along with the continued need for energy supply and security, which are driving elevated levels of upstream capital expenditures, should continue to drive growth in ATI’s materials used in the O&G industry.

The Medical end market experienced a sequential as well as Y/Y decline due to a temporary headwind related to the production outage during the last quarter, however, the overall demand remains favorable, primarily due to the expected benefits from reshoring trends in key materials. The Electronics and Automotive end market on the other hand is currently experiencing softness in China impacting the end market negatively, however, the strong hafnium demand for semiconductors and other applications should partially offset the negative impact from Asian precision rolled strip business, which should benefit the company’s revenue in the coming quarters.

Long Term Opportunities

Titanium, an important chemical element with exceptional strength and durability, is currently experiencing unprecedented demand. ATI’s customers are asking for all of the Titanium and specialty alloys it can produce as per current capacity. The historic demand is primarily driven by the increasing investment in the A&D sector, which is expected to take the titanium market to $52.5 billion market in the next 10 years. To meet this growing demand, the company is working to increase its titanium melt capacity, which includes restarting previously idled capacity in Oregon.

In the month of June, ATI Inc has obtained approximately $1.2 billion in new sales commitments from various Aerospace and Defense companies, specifically pertaining to these titanium nickel and materials that are essential for high-quality manufacturers to increase their production capacities and meet the growing demand. The company is expected to begin reaping the benefits of these sales starting in 2024 and continue until 2029, with an average estimated annual revenue of $200 million. This development is expected to significantly enhance ATI Inc's overall revenue in the upcoming years.

These steps to meet this demand should also benefit the company to capture demand earlier than its competitors and market share gain. ATI is also working towards maximizing uptime in this industry, where lead times of 50 to 70 weeks are becoming normal, which should further support the company in its market share gain, benefiting the company’s revenue in the coming years.

Risk

My thesis relies on the sustained support from the Aerospace and Defense (A&D) end market. However, there are concerns regarding the weakening performance of ATI's smaller industrial markets, particularly the Electronic and Automotive sectors, which are experiencing challenges due to softening economic conditions in China. This is particularly relevant to the Asia precision rolled strip business, which serves this market segment. Although this specific business accounts for only 5% of the company's total sales, if the economic conditions in China further deteriorate, it could have a negative impact on this part of ATI's business, creating headwinds for the company's overall revenue.

Valuation and Conclusion

ATI is currently trading at 20.50x FY2023 consensus EPS estimates of $2.27 and 16.19x FY2024 consensus EPS estimates of $2.87, which represents a significant discount towards its 5-year average P/E of 41.29x. The continued strong momentum, particularly in the Aerospace and Defense end market, should continue to fuel the company’s top line in the coming quarters. And this robust demand environment along with the sales commitment of $1.2 billion for next 6 years and increasing titanium capacity should further drive the company’s revenue in the longer term. Considering the promising growth prospects and a lower valuation of the stock as compared to the historical levels, I recommend a buy rating on this stock.

For further details see: