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Morningstar | Arconic Spurns Its Suitors To Refocus On Turnaround Efforts; Our $24 FVE Is Unchanged

Arconic's board of directors has elected to no longer pursue a sale of the company after conducting a corporate strategy and portfolio review. This news likely came as a surprise to many, as media reports had indicated that the sale of Arconic to Apollo Global Management was imminent. Indeed, many sell-side fair value estimates have been brought down to the rumored offer price of $21-$22 per share in recent weeks.

Our fair value estimate has ranged between $22 and $25 per share since Arconic was spun out from Alcoa in late 2016 but has held steady at $24 per share since late October 2018. Although Arconic shares have traded sharply lower on the news that the company will not be acquired, our assessment of the company's intrinsic value is unchanged. We also maintain our no-moat rating. We view this sell-off as an attractive entry point for investors with a longer investment horizon.

As expressed in our recent notes on the takeover rumors, an offer price in the low $20s per share would not adequately compensate shareholders. This view now appears to be shared by Arconic's board. Instead, the company seems to be embracing the notion that the business can be turned around. The decision not to sell can be viewed as a vote of confidence in the company's long-term prospects.

Arconic's market-implied enterprise value/last 12-months EBITDA multiple is now below 7, low compared with the 8.5 times multiple on midcycle LTM EBITDA we apply in our valuation model. This compares with an average EV/LTM EBITDA multiple of 9.9 since Arconic started trading as a separate company from the legacy Alcoa. Additionally, Arconic's current multiple sits well below those of close competitors. Allegheny Technologies, Carpenter Technology, and Kaiser Aluminum traded at multiples of 9.6, 8.6, and 9.9, respectively, and 9.4 on average, as of the Jan. 18 market close.

To be fair, recent quarterly earnings have provided little encouragement about the company's near-term prospects. We forecast adjusted operating income of $1.39 billion in 2018, a 4.4% decrease from 2017 levels. Although we don't expect Arconic's profitability to improve significantly in the near term, we contend that the company's gradually improving performance will support multiple expansion with time. We expect profitable growth to resume in 2019.

It is important to note that our above-consensus fair value estimate requires only 200 basis points of adjusted operating margin expansion by 2022 from 2017 levels. Additionally, the company's portfolio review will help management usher in cost-cutting measures and operational improvements with time. A more efficient operating model, concurrent with a resumption of profitable growth for the engineered products and solutions segment in 2019, should establish positive momentum for the company.