Arconic (NYSE:HWM) has been somewhat of an enigma since it was first assembled inside Alcoa. An aerospace-component manufacturer operating during one of the best commercial aerospace up cycles in history, it never seemed to be firing on all cylinders.
That theme continued in the now independent company's latest earnings report, with Arconic reporting results that beat expectations and guidance for 2018 that underwhelmed. Shares fell by more than 10% in the days following the results, a clear sign of growing investor frustration. Fortunately, for the first time since Arconic's spinoff, there is reason for hope improvement is on the horizon.
Arconic reported fourth-quarter earnings of $0.31 per share on sales of $3.27 billion, beating consensus estimates of $0.24 per share in earnings on sales of $3.07 billion. But the company, a maker of metal fasteners and components for aerospace, automotive, and other customers, also expected 2018 adjusted earnings to come in at between $1.45 and $1.55 per share, below the consensus estimate of $1.61, and forecast full-year free cash flow of $500 million compared to analysts expectations of $730 million.
The results continue a disturbing trend for Arconic, a business that was cobbled together last decade by Alcoa and then spun off as an independent entity in late 2016. It was the Arconic portion of the business that plagued Alcoa's results in the quarters leading up to the split, and it has failed to live up to expectations as a stand-alone company.
Klaus Kleinfeld, the architect of the rollup that became Arconic, who served as Alcoa CEO and then took over at Arconic after the split, was ousted last April as part of a dispute with activist fund Elliott Management. His replacement, Chip Blankenship, only signed on as CEO on Jan. 15. During his first call with investors, on Feb. 5, he said Arconic would initiate a strategic review he described as "a thoughtful approach regarding our strengths and weaknesses ... to determine the best way to unlock our potential."
With every quarter the perception grows that Arconic's previous management struggled to properly integrate the assets that were assembled, a process Arconic will now revisit with its strategic review. The business acquired when Alcoa bought Firth Rixson for $2.85 billion in 2014 was noted as a particular disappointment this quarter in terms of free cash flow and earnings performance.
"While the company has many strengths, there are clearly areas that need improvement," Blankenship told investors. "In the end, it comes down to execution and I am working with our team to improve here."
Arconic rolled out a long list of headwinds that it expects to impact 2018 results, including weakness in its power and turbine business, pricing pressure in aerospace, higher raw material costs, and inventory burn-down on stagnant aircraft platforms. Arconic also announced some cost-saving steps, including a plan to move its headquarters from New York to a yet-to-be-named lower-cost location, freezing pensions for nonunion employees, as well as some overhead reductions.
To be fair, some of Arconic's issues stem from delays outside of its control, notably United Technologies unit Pratt & Whitney's struggles to deliver its new fuel-efficient engine. United Technologies' chief financial officer, Akhil Johri, admitted last fall that Airbus narrow-body jets are stuck on the ground awaiting delivery of P&W geared turbofan engines, though the company has said more recently that it believes the worst of its problems are finally behind it.
Momentum is (slowly) building
Some progress has been made. As part of the split, Arconic -- which was seen as the higher-growth of the two businesses -- was required to relieve most of Alcoa's debt burden, taking on more than $8 billion in obligations. In 2017, the company reduced its net-debt-to-EBITDA ratio by about 30%, to 2.5 now, taking interest expense down by about 25% in less than two years' time.
But to date Alcoa has been the better stock since the split, appreciating by 134% since October 2016 compared to Arconic's rise of less than 10%. Even before the recent sell-off, the shares were up only 30% from where they started when the spinoff was completed.
Things won't change overnight, but it feels like a good time for value investors to consider buying into Arconic. If nothing else, expect Blankenship's review to conclude with some divestitures once the company gets a better grip on how its different business units collaborate and where it has a competitive advantage. Segments including its global rolled-products business, responsible for about $5 billion of its $13 billion in total sales in 2017, or its transportation and construction solutions business, which brings in $2 billion in sales, could potentially end up on the block in a streamlining campaign.
There's even a chance there will be a sale of the entire company. Rumors of potential interest from Honeywell refuse to go away. When asked, the new CEO said "we will look at everything" before adding the primary goal of the review was not to initiate a sales process.
There's value in Arconic's portfolio. Hopefully Blankenship is the leader who can bring that value out.