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Morningstar | Allegheny Technologies Still Ascending Toward Cruising Altitude for Margins

Allegheny Technologies is one of the world's largest manufacturers of diversified specialty materials, a market leader in the production of airframes and components for commercial and military jet engines. The company offers a product portfolio of highly specialized titanium and nickel-based alloys in addition to other specialized metal products. The aerospace industry is likely to drive substantial growth for Allegheny in the years to come as next-generation jet engines and airframes will require significantly larger volumes of titanium and nickel-based alloys in order to minimize weight and maximize fuel efficiency. Allegheny is also leveraged to the production of highly specialized components used in unconventional oil and gas drilling plays and corrosion-resistant alloys used in power plants.Allegheny reports via a high-performance materials and components segment as well as a flat-rolled products segment. Although the high-performance metal business accounts for roughly two thirds companywide sales, it generates effectively all of Allegheny's operating income. The vast majority of the high-performance metal segment's sales are derived from aerospace and defense customers, and we expect this to increase as next-generation commercial aircraft production ramps up through the end of the decade.The flat-rolled business competes across more commodified product lines that exhibit little to no customer switching costs. Although this business still manufactures nickel- and titanium-based alloys, commodity stainless steel has historically been the flat-rolled business’ largest product line. In 2016, management actively reduced the segment's commodity-grade product exposure, which restored profitability in 2017 after four consecutive years of operating losses. The company uses raw material surcharges and index mechanisms to offset the impact of changing raw material costs.The commercial aerospace end market will serve as the key driver of profitable growth for Allegheny Technologies into the future. We expect the combination of operating leverage stemming from volume growth and an improving product mix to drive material margin expansion.