Morningstar | Cost Headwinds Will Stymie Allegheny's Profit Growth in 2019 but Favorable Long-Term Outlook Intact
Given material cost headwinds facing Allegheny Technologies in the first half of 2019, the company's strong profit growth momentum has been disrupted. However, we still view the company's long-term prospects as highly favorable. Gradually improving build rates for next-generation commercial aircraft will continue to drive an improving product mix and the benefits of operating leverage for Allegheny. Operational challenges in the first half of 2019 will lead to only a pause for the company's profit growth rather than a structural derailment. Although we've tempered our near-term profit forecasts, our $31 per share fair value estimate and narrow-moat rating are unchanged.For 2019, we now forecast $515 million of adjusted EBITDA, down from our prior estimate of $558 million. This assumes that high performance materials and components segment operating margins rise only slightly year on year to 15%. However, we remain confident that the segment will meet (and modestly exceed) management's targeted 20% operating margin by 2021. We maintain a cautious outlook for the flat-rolled products segment, as commodity-grade product exposure ensures that market conditions will continue to prove challenging. Indeed, the FRP segment flipped to an $11 million operating loss in the first quarter, in part because of weaker demand for commodity stainless products. We believe future FRP operating margins will be capped at 3%, which is below the 4.5% margins achieved in 2018.
Having traded lower in light of soft first-quarter earnings results, share prices remain below our fair value estimate. Although management expects the operational headwinds facing the company to only partially subside in the second quarter, we contend that today's weakness represents an attractive entry point to a promising long-term growth story. Even though Allegheny's profit growth will pause this year, we believe that free cash flow will reach $250 million, in line with management's guidance.
Allegheny Technologies is a manufacturer of specialty materials and components. The company operates in two business segments: High Performance Materials and Components, which produces a range of specialty materials, parts and components for several main end markets, including aerospace and defense, medical, and energy; and Flat Rolled Products, which produces nickel-based alloys, specialty alloys, titanium and titanium-based alloys, and stainless steel in a variety of forms including plate, sheet, engineered strip, and Precision Rolled Strip? products.
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