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Morningstar | ARNC Updated Star Rating from 26 Jul 2018

Arconic shares were once again boosted by an article in The Wall Street Journal reporting that private equity groups have issued buyout offers to the company. This is the second such article to be published in the past 10 days, with the most recent July 25 article providing some incremental details. It indicates that potential buyers have proposed a deal price in the "mid-$20s" and that Arconic's board will discuss the offers in a July 26 meeting. The WSJ article also states "no deal is imminent."

Although this news has driven share prices higher toward our $23 per share fair value estimate, our outlook is unchanged. In considering our fair value estimate, any higher deal price would represent poor value for the buyer. As we expressed in our July 16 note, our fair value estimate implies an enterprise value of 10 times trailing 12-month adjusted EBITDA of $1.972 billion after adjusting for no-moat Arconic's pension and environmental remediation liabilities. In looking at PitchBook data for merger and acquisition transactions across comparable companies in recent years, this multiple appears to be a reasonable baseline. It would fall roughly in line with the current 10.4 times multiple associated with aluminum-centric peer Kaiser Aluminum.

In considering consensus price targets, our $23 per share fair value estimate represents the median. Over our five-year explicit forecast period, our valuation assumes that revenue grows at a 2.5% annual rate and that adjusted operating margins expand from 11.2% in 2017 to 13%. However, given the company's recent struggles, we expect all three reporting segments to suffer at least 100 basis points of margin compression in 2018 from the prior year. Our 2018 adjusted operating margin forecast is just shy of 10%. Although the company appears to have steeply overpaid to acquire high-value aerospace-facing product lines, this exposure should still help usher in higher profits in a slow but steady manner over the next few years.