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Morningstar | No Major Surprises in Arconic's 3Q Results as Acquisition Rumors Swirl

Arconic issued encouraging third-quarter results as organic revenue grew year on year across all three reporting segments and companywide adjusted operating increased modestly. Overall, even though the results showed slow and steady progress toward ongoing profitable growth, they served as a reminder that the company's turnaround efforts will likely bear fruit over a longer time horizon. Having updated our valuation model, our fair value estimate rises to $24 per share from $23 due to time value of money effects. Our no-moat rating is unchanged.

Our near- and long-term profit forecasts are essentially unchanged for Arconic. For 2018, we forecast adjusted EBITDA of $1.97 billion and adjusted earnings of $1.32 per share on sales of $14.09 billion. For comparison, management is guiding to adjusted earnings of $1.28-1.34 per share and revenue between $13.7 billion-14.0 billion. Although revenue guidance was unchanged, the updated earnings guidance was increased from the previous range of $1.17-1.27 per share.

Although Arconic has struggled to deliver profitable growth in recent quarters, we still believe the company's performance will improve in the coming years. Our base case points to only 2.5% annual revenue growth over our five-year explicit forecast period. However, margin expansion across all three segments should help drive 5.4% adjusted operating income growth over the same time period. Ultimately, we expect adjusted operating margins will expand to just above 13% in a midcycle environment versus just 9.9% in the third quarter. Although this might seem aggressive given the company's inconsistent execution, we remind investors that margins exceeded 12% as recently as early 2017. Additionally, we still believe rising demand from next generation commercial aircraft will "lift all boats" for companies like Alcoa with sufficient exposure to the associated supply chain.

Media reports have indicated that Arconic is currently considering at least one acquisition offer but management provided no incremental detail during the earnings call. Reports have also speculated that the potential for liabilities from the Grenfell Tower fire in London are a sticking point in any ongoing negotiations. Currently, Arconic does not believe that it will face any significant liabilities. We share this view and we do not include any such liabilities in our base-case scenario. Our bear-case scenario, however, does assume that a sizable liability emerges.