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Following Relief Rally, Allegheny Technologies' Valuation Premium To Comparable Transactions Is Undeserved

Allegheny Technologies Incorporated's market capitalization implies a >12x EBITDA multiple on the High Performance segment's FY15 adjusted EBITDA; and that's undeserved.

Management's recent moves to lay off one-third of Flat-Rolled Products segment employees is long overdue and applying "a band-aid to a gusher".

Nickel pricing has not recovered, yet the stock now discounts far higher profit margins, a significant discrepancy considering that nickel prices drive the company's profit margin profile.

Right off the bat, I'll admit that I have been dead wrong on Allegheny Technologies Incorporated (NYSE: ATI) so far. I thought the stock was a buy in the low-$20s, then it fell to <$10. I changed views following 4Q15 earnings and thought the stock would fall further due to deteriorating margins in the High Performance segment. Instead, a relief rally in commodity-related stocks and long overdue management actions have driven the stock higher. As a result, the stock is up almost 60% YTD.

Source: Google Finance

But the recent rally, in my view, is unwarranted. There are four reasons that I think the stock is overvalued at this point:

1) Nickel prices have not recovered sufficiently to boost profit margins.

Allegheny Technologies Incorporated's profit margins are tied to nickel pricing. ATI delivers many of its nickel-based alloys and specialty metals to customers under long-term agreements, particularly aerospace engine OEMs. Within these long-term agreements, there are surcharges and raw materials index charges that ATI charges customers based on the price of nickel. If nickel prices move higher, these surcharges are higher, and ATI's profit margins increase. When nickel prices decline, surcharge/index revenue declines, and so do profit margin percentages. A deflationary nickel pricing environment leads to compressed profit margins, as nickel raw material purchased at higher historical prices fails to be offset by surcharge revenues based on current prices.

As seen below, nickel pricing, while possibly bottoming, has not recovered sufficiently to expect any meaningful...


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