Allegheny Technologies Inc ATI (XNYS)

Transcription

1 Morningstar Equity Analyst Report Report as of 07 Mar 2016 Page 1 of 12 Morningstar Pillars Analyst Quantitative Economic Moat Narrow Narrow Valuation QQQQ Undervalued Uncertainty Very High Very High Financial Health Moderate Source: Morningstar Equity Research Quantitative Valuation ATI Current 5-Yr Avg Sector Country Price/Quant Fair Value Price/Earnings Forward P/E Price/Cash Flow Price/Free Cash Flow Dividend Yield % Source: Morningstar Bulls Say ONext-generation commercial airliners will use a significantly higher proportion of titanium as a percentage of total weight relative to older models. OThe company will benefit from an increase in unconventional techniques used to extract oil and natural gas due to its production of specialized alloys that stand up to harsh drilling environments. OThe company s aftermarket aerospace sales should increase as global air traffic continues its steady growth. Bears Say USAp Undervalued Fairly Valued Overvalued OThe company is leveraged to cyclical end markets, and its financial results have been volatile over the past several years. ODespite surcharge pricing for many of its products, raw material price increases can still dent the company s near-term results. ORising stainless steel export volumes from China have pressured margins for U.S. producers. ATI's Outlook Remains Positive Amid New Labor Agreement Ratification and Stainless Trade Case Andrew Lane, Sr. Eq. Analyst, 26 January 2016 Investment Thesis Allegheny Technologies is one of the largest manufacturers of diversified specialty materials in the world. Allegheny is a market leader in the production of airframes and components for commercial and military jet engines and offers a product portfolio of highly specialized titanium and nickel-based alloys in addition to other specialized metal products. The aerospace industry is likely to drive substantial growth for Allegheny in the years to come as next-generation jet engines and airframes will require significantly larger volumes of titanium and nickel-based alloys in order to minimize weight and maximize fuel efficiency. Allegheny is also leveraged to the production of highly specialized components used in unconventional oil and gas drilling plays and corrosion-resistant alloys used in power plants. Allegheny reports via a High Performance Metals and Components segment as well as a Flat-Rolled Products segment. Although the high-performance metal business accounts for only half of companywide sales, it generates the vast majority of ATI's operating income and, over the past decade, commanded margins an average of 3 times higher than those associated with flat-rolled products. About 70% of the high-performance metal segment's sales are derived from aerospace customers, but we expect this to increase as next-generation aircraft production ramps up. The flat-rolled business competes across more commodified product lines that are subject to more intense competition. Although this business still manufactures nickel- and titanium-based alloys, commodity stainless steel is the flat-rolled business largest product offering. The company uses raw material surcharges and index mechanisms to offset the impact of changing raw material costs. Over the course of 2015, Allegheny integrated a new state-of-the-art $1.2 billion hot-rolling and processing facility as well as a new titanium sponge facility that should allow it to win additional long-term contracts and drive margin expansion in the years to come. Andrew Lane, Sr. Eq. Analyst, 07 March 2016 Analyst Note Allegheny Technologies benefited from two encouraging developments on March 4. The company announced that its union-represented flat-rolled employees would return to work and that the Department of Commerce initiated an investigation on the import of stainless steel sheet and strip. Given that these developments were both widely expected, our $27 per share fair value estimate and narrow-moat rating are unchanged. Shares have rallied more than 80% since the end of January and are now trading in 4-star territory. United Steelworkers members will return to work beginning the week of March 13, having ratified a new four-year agreement with the company. Allegheny's management team took a hard line during the negotiation process, as union employees had been locked out from the company's facilities since Aug. 15, Management has long held that a new, more competitive labor agreement would help the company improve its cost position for the manufacture of flat-rolled products. Although the flat-rolled products segment will likely report losses in the first quarter, we continue to believe that management will achieve its guidance to restoring profitability in the second half of the year. On a separate note, the Department of Commerce announced on March 4 that it has initiated antidumping and countervailing duty investigations on the import of stainless sheet and strip from China. Allegheny Technologies filed the petition on Feb. 12 along with three other U.S. stainless producers. The U.S. International Trade Commission is scheduled to issue a preliminary determination on March 28, and the Department of Commerce is expected to deliver its final determination on Nov. 18. In recent years, industrial metals trade cases targeting China have been highly successful, while the cases targeting other countries have yielded mixed results. Economic Moat Andrew Lane, Sr. Eq. Analyst, 26 January 2016 We believe Allegheny Technologies operates with a narrow economic moat. In our view, the most appropriate lens with which to analyze the company s competitive advantages is our moat framework for commodity processors. Moaty businesses that operate in this space tend to benefit from intangible assets and switching costs, and we believe that Allegheny exhibits both of these moat

2 Morningstar Equity Analyst Report Page 2 of 12 Close Competitors Currency (Mil) Market Cap TTM Sales Operating Margin TTM/PE Carpenter Technology Corp CRS USD 1,485 2, AK Steel Holding Corp AKS USD 667 6, sources. Allegheny has a wealth of technical expertise that allows it to operate in the production of high-value, specialized steel products. The company applies advanced metallurgy to manufacture alloys that are resistant to corrosion as well as to extreme heat and pressure. It is one of only a handful of companies that make such products, as there exist significant barriers to entry. Allegheny s high-performance nickel-based and titanium-based alloys form the foundation of its moat. These products must be developed to exacting customer specifications using advanced production methods that are difficult to replicate. First, the process of mixing and melting specialty metals and alloys requires highly specialized furnaces and machinery that are very capital-intensive and require a great deal of time to construct, achieve qualification, and ramp up. Allegheny s alloys are required to undergo commissioning and qualification cycles that generally take one to three years because, in many cases, the materials must be approved by not only the company s customers, but also by the end users. Therefore, although the qualification process is lengthy and capital-intensive, a product qualification effectively establishes an intangible asset that allows for long-lasting business relationships as customers are compelled to enter into long-term supply contracts with qualified suppliers. Boeing, for example, recently expanded and extended its titanium supply agreement with Allegheny to run through the end of the decade. Additionally, in some cases, Allegheny will work with customers to develop new alloys. Collaborations of this nature usually lead to long-term sourcing agreements. Although Allegheny is on the cutting edge in developing specialty alloys, patents are less of a barrier to entry than one might expect. Mainly, this stems from the fact that Allegheny s customers prefer to enter into supply relationships with a number of different companies and, therefore, prefer that the production of mission-critical materials not be patent-protected. Switching costs ultimately stem from the fact that, whether considering an oil well or commercial aircraft, Allegheny s specialty alloys constitute a small portion of the construction cost but have a very high cost of failure. For this reason, the company s business relationships are very sticky, and customers are reluctant to switch to unproven suppliers solely on a cost basis. Therefore, we expect that the industry will be largely limited to the existing players, allowing each market participant to generate attractive returns on invested capital. Wide moats are hard to come by for commodity processors, however, as cost advantages tend to be fleeting and other moat sources generally aren t influential enough to stave off product replication for much longer than a 10-year period. Additionally, more than half of Allegheny s flat-rolled product shipments are derived from the sale of more commodified products such as stainless steel that are sold into markets that are much more competitive. These product lines weigh on Allegheny's return on invested capital and partially dilute the moatiness of the company as a whole. Therefore, it is unlikely that Allegheny will be able to establish a wide moat in the years to come. From a quantitative perspective, Allegheny generated an average return on invested capital of 14% over the past decade. This period spans a full business cycle, as returns exceeded 30% before the onset of the global financial crisis but remained below 10% in each of the past seven years. In a midcycle environment, we expect the company generate returns on invested capital only slightly above its 9.2% weighted average cost of capital. Valuation Andrew Lane, Sr. Eq. Analyst, 20 October 2015 Our fair value estimate is $27 per share. We expect Allegheny s earnings to grow materially over our explicit forecast period as demand from its key end markets improves, shipment volume increases, and margins expand. Per our forecasts, the operating leverage associated with our expectations for improving shipment volume and the ramp-up of the highly efficient hot-rolling and processing facility will help Allegheny expand operating margins to a midcycle level of 14%. Although this would require significant margin expansion from current levels, our forecast sits well below the peak margins that the company established before the onset of

3 Morningstar Equity Analyst Report Page 3 of 12 the global financial crisis, which came in just above 20%. Our expectation that total net sales will grow at roughly a 3% compound annual rate over our explicit forecast period is predicated upon our view that commercial jet deliveries will grow in the mid- to high-single-digits through We expect material volume growth to the aerospace end market in 2016 and 2017 as Allegheny supplies large volumes of specialized materials and aircraft components to its key customers in the aerospace industry. Robust shipment volume growth to the aerospace end market will be partially offset by weaker commodity-grade shipment volume growth, as the company has shuttered high-cost capacity for commodity-grade products. We expect a modest decline in the company s inventory position over our explicit forecast period, which leads to a material decrease in days sales of inventory. Due to the ongoing qualification process of the new titanium sponge facility, Allegheny has had to keep developmental product inventory that will ultimately be worked through as qualification is achieved and production ramps up. Additionally, the hot-rolled processing facility is likely to improve lead times, which would allow for a more rapid inventory drawdown as shipment volumes grow. To arrive at our fair value estimate, we apply an 11% cost of equity assumption because of our belief that Allegheny is subject to above-average systematic risk. Combining our cost of equity assumption with an 8% cost of debt assumption, our model assumes a 9.2% WACC. Additionally, we apply an exit multiple of 8.0 times enterprise value/ebitda, which sits below the company s trailing 10-year average. Risk Andrew Lane, Sr. Eq. Analyst, 26 January 2016 Relative to our broad coverage universe, the company is subject to high revenue cyclicality, as evidenced by the fact that revenue has fluctuated by 10% or more in either direction over eight of the past 10 years. In our view, Allegheny exhibits medium operating leverage and medium financial leverage. According to our forecasts, Allegheny is capable of generating a 14% operating margin in a midcycle environment. This level of profitability materially exceeds the company s trailing 10-year average of 7.6%, as we believe Allegheny should deliver much improved profitability as it benefits from the aerospace industry s cyclical upturn. Given that the company offers commodity-grade product exposure and is undergoing a major restructuring, we assign a very high uncertainty rating. Management Andrew Lane, Sr. Eq. Analyst, 19 January 2016 We assign a standard stewardship rating to Allegheny s management team, as we believe that the company s executives have been adept stewards of shareholder capital without distinguishing themselves as exemplary. CEO Richard Harshman, who became president in August 2010 and CEO in May 2011, has been with the company in various capacities since This length of tenure is typical for Allegheny s management team,as most of its executives have been with the company for quite some time. We applaud Harshman s capital allocation strategy, which has been largely focused on expanding the production of high-margin performance metals. This directive is reflected by the acquisition of Ladish, additions to the company s titanium production capacity and specialty rolled product capacity, and the sale of the less-attractive tungsten business. Given the value of Allegheny s metallurgical expertise, we think it is important that the company continue to invest in optimizing its production processes and capabilities. The only factor that concerns us is that management has occasionally raised capital via equity issuance even though the company s balance sheet could have supported materially higher debt commitments before leverage ratios became stretched. Additionally, although free cash flow has been disappointing in recent years, Allegheny has sustained profitability fairly consistently, and we anticipate that the company s management team will drive material earnings growth through our explicit forecast period.

4 Morningstar Equity Analyst Report Page 4 of 12 Analyst Notes Archive ATI's Outlook Remains Positive Amid New Labor Agreement Ratification and Stainless Trade Case Andrew Lane, Sr. Eq. Analyst, 07 March 2016 Allegheny Technologies benefited from two encouraging developments on March 4. The company announced that its union-represented flat-rolled employees would return to work and that the Department of Commerce initiated an investigation on the import of stainless steel sheet and strip. Given that these developments were both widely expected, our $27 per share fair value estimate and narrow-moat rating are unchanged. Shares have rallied more than 80% since the end of January and are now trading in 4-star territory. United Steelworkers members will return to work beginning the week of March 13, having ratified a new four-year agreement with the company. Allegheny's management team took a hard line during the negotiation process, as union employees had been locked out from the company's facilities since Aug. 15, Management has long held that a new, more competitive labor agreement would help the company improve its cost position for the manufacture of flat-rolled products. Although the flat-rolled products segment will likely report losses in the first quarter, we continue to believe that management will achieve its guidance to restoring profitability in the second half of the year. On a separate note, the Department of Commerce announced on March 4 that it has initiated antidumping and countervailing duty investigations on the import of stainless sheet and strip from China. Allegheny Technologies filed the petition on Feb. 12 along with three other U.S. stainless producers. The U.S. International Trade Commission is scheduled to issue a preliminary determination on March 28, and the Department of Commerce is expected to deliver its final determination on Nov. 18. In recent years, industrial metals trade cases targeting China have been highly successful, while the cases targeting other countries have yielded mixed results. Allegheny Technologies Reaches Tentative Agreement With USW on New Contract; Fair Value Unchanged Andrew Lane, Sr. Eq. Analyst, 23 February 2016 On Feb. 22, Allegheny Technologies reached a tentative agreement with the United Steelworkers that covers over 2,000 employees. If ratified by USW members, a process estimated to take two to three weeks, the contract will signal the end of a lockout that was initiated in August We have closely monitored the lockout and, given our view that Allegheny and the USW would ultimately reach an agreement, our $27 fair value estimate is unchanged. Although the final terms of the contract probably aren't as favorable for Allegheny as the terms management initially proposed, we still expect the new contract to provide some measure of cost relief. The combination of high-cost facility closures and the new employee contract should help management achieve its guidance that the flat-rolled products segment will restore profitability by the second half of However, Allegheny's flat-rolled operations are likely to continue to operate on the upper half of the industry cost curve. Although Allegheny's shares have rallied year to date, we continue to view the stock as significantly undervalued. Stemming losses across the company's flat-rolled operations will put the attractive profitable growth potential of Allegheny's high-performance materials and components segment on full display. Rising volumes of high-margin products to the aerospace end market will drive margin expansion via an improved product mix and the benefits of operating leverage. We expect this trend to strengthen in the second half of 2016 as volumes for castings and forgings rise relative to mill products. Additionally, a stabilization in oil prices will help protect against further volume declines to oil and gas customers. Over a longer time horizon, we expect rising volumes to exploration and production customers will provide a modest tailwind for profits. U.S. Stainless Producers File Trade Case Against Chinese Imports; No Change for AK Steel or ATI Andrew Lane, Sr. Eq. Analyst, 16 February 2016 A group of four U.S. stainless steel manufacturers, including both AK Steel and Allegheny Technologies, filed a trade case on Feb. 12 against the import of Chinese stainless steel and strip. The case asserts that Chinese stainless exporters have benefited from subsidization and have engaged in illegal dumping, meaning that they have sold material in the U.S. below the price charged in its home market. The petition alleges antidumping margins of 53.69% to 83.24%, a penalty that, if enacted, would

5 Morningstar Equity Analyst Report Page 5 of 12 materially reduce Chinese stainless import volumes. This is the first stainless trade case ever filed against China in the U.S. Per data provided by the U.S. Commerce department, Chinese stainless import volumes reached 147 thousand short tons in 2015, accounting for 32% of total import volumes. Perhaps more importantly, volumes from China accounted for 81% of incremental imports to the U.S. over the last three years. The petitioners are hoping that a favorable trade case outcome will allow them to recapture some of the foregone market share. The investigation process for this trade case should take roughly one year, with final determinations expected in the first quarter of We reiterate our view that the ultimate impact of most steel-related trade cases tends to disappoint relative to the enthusiasm surrounding their filing, as expressed by petitioners and investors alike. Often when import volumes from a particular country are diminished due to trade sanctions, import volumes from other key exporting countries rise, and domestic producers capture only a modest degree of market share. A stainless trade case has reportedly been in the works for some time, and we believe that any potential upside for volumes and prices for Allegheny Technologies and AK Steel is already reflected in our forecast for each company. Therefore, our fair value estimates of $27 and $1.80 per share, respectively, are unchanged. Although 4Q Results Were Weak, We've Boosted Our Long-Term Expectations for Allegheny Technologies Andrew Lane, Sr. Eq. Analyst, 26 January 2016 Allegheny Technologies' fourth-quarter results fell short of our expectations, as the flat-rolled products segment again reported heavy losses. However, based on management's commentary during the earnings call, we now have even more conviction in our view that the company's high-performance materials and components segment will deliver strong profitable growth through Allegheny's current share price reflects skepticism that management will be able to stem losses from flat-rolled products. Indeed, there is much work to be done, as the segment reported operating losses of $120 million on only $282 million of sales in the fourth quarter. However, management reiterated its guidance that the segment will restore profitability by the second half of 2016, in part because of the closure of commodity-grade capacity. We assume that the company will achieve this goal. A stabilization of the segment will put the profitable growth of the high-performance materials and components segment on full display. We expect that segment's volumes to increase materially as a result of rising delivery rates for next-generation commercial aircraft in 2016 and beyond. This trend will boost margins due to the benefits of operating leverage and a much-improved product mix. We've raised our long-term revenue forecast for the segment to reflect management's long-term guidance of $3 billion in sales in Because of the benefits of a more favorable mix shift than we had anticipated, we've increased our companywide midcycle operating margin forecast to 14% from 12%. After updating our valuation model to reflect weaker 2016 results but stronger long-term profits, our narrow moat rating and fair value estimate of $27 per share are unchanged. We've adjusted Allegheny's uncertainty rating to very high, which better aligns with the company's high degree of financial leverage and reflects the wide range of outcomes reflected by our bull- and bear-case scenarios. Allegheny Technologies Fourth Quarter $267 Million Pre-Tax Charges; Fair Value Estimate Intact Andrew Lane, Sr. Eq. Analyst, 19 January 2016 In a Jan. 19 press release, Allegheny Technologies provided more detail as to the pre-tax charges the company would book in its fourth-quarter earnings release on Jan. 26. This update follows Allegheny's Dec. 10 announcement that highlighted operational rightsizing efforts aimed to reduce the company's commodity stainless and grain-oriented electrical steel (GOES) exposure. The Jan. 19 press release announced the company's intent to book $267 million of pre-tax charges in the fourth quarter that include $181 million of non-cash, long-lived asset impairment charges for its Flat-Rolled Products segment, $76 million of non-cash inventory charges, $6 million of severance charges, and $4 million of idling costs. The asset impairment charges address a $127 million write-off of the remaining goodwill associated with the Flat-Rolled Products business.

6 Morningstar Equity Analyst Report Page 6 of 12 Fourth-quarter charges will also include a $54 million impairment charge to reduce the carrying value of long-lived assets at the Midland, Pennsylvania, commodity stainless facility and Bagdad, Pennsylvania, GOES facility. It is highly unlikely that these facilities will be brought back online anytime in the near future, as we don't expect an imminent improvement in market conditions for these products. The inventory-related charges include $51 million in non-cash net realizable inventory reserves that offset LIFO reserve benefits due to falling raw material prices and a $25 million non-cash charge to revalue non-premium quality grades of titanium sponge inventory to current market prices. We've updated our valuation model to reflect the pre-tax charge guidance as well as lower standard-grade shipment volumes from the Flat-Rolled Products segment. However, because the effected capacity was only marginally profitable over our forecast period, our $27 per share fair value estimate is unchanged. Our narrow-moat rating for Allegheny Technologies also remains intact. Near-Term Headwinds Hide Attractive Aerospace Growth Prospects for Undervalued Allegheny, Carpenter Andrew Lane, Sr. Eq. Analyst, 08 January 2016 In this note, we revisit our investment theses for Allegheny Technologies and Carpenter Technologies ahead of their upcoming earnings releases on Jan. 20 and Jan. 28, respectively. We contend that the near-term headwinds facing each company obscure the attractive long-term growth prospects associated with their exposure to the aerospace end market. Allegheny and Carpenter are currently in 5-star territory, trading at a steep discount to our fair value estimates on an uncertainty-adjusted basis. We assign a $27 per share fair value estimate to Allegheny and a $55 per share fair value estimate to Carpenter, as we expect that the challenges currently facing each company will gradually dissipate, clearing the way for profitable long-term growth. Allegheny Technologies Announces Facility Idlings, Predicts Profitability for FRP Segment Andrew Lane, Sr. Eq. Analyst, 11 December 2015 On Dec. 10, Allegheny Technologies issued a press release that outlined rightsizing actions the company will undertake to improve the competitiveness of its flat-rolled products, or FRP, segment. Allegheny plans to reduce its exposure to commodity-grade stainless steel and grain-oriented electrical steel, or GOES, as these product lines have weighed heavily on profitability. The company is also cutting its quarterly dividend to $0.08 per share from $0.18 to support liquidity. Management is taking two specific actions. First, Allegheny will idle its standard stainless melt shop and sheet-finishing operations in Midland, Pennsylvania, in January. Second, by April, Allegheny will idle its GOES operations. Given Allegheny's high-cost position and our view that stainless and GOES prices will remain lower for longer, we view the permanent closure of each facility as a likely outcome. This is especially true given that demand for Allegheny's GOES product lines has been supplanted, in part, by demand for high-permeability GOES products, which Allegheny is not currently equipped to manufacture. We applaud management for "cutting bait" in the GOES space, rather than chasing market share via further investment. Having committed to these idlings, management is now forecasting that the FRP segment will be "modestly profitable by the second half of 2016." Our valuation model currently points to $28 million of adjusted operating income for the FRP segment in 2015, and we maintain our estimate in light of the updated forecast. It's been a challenging year, as the FRP segment suffered $122 million of losses through the third quarter. However, we contend that Allegheny will be able to achieve management's forecast, owing to these cost-cutting efforts, the benefits of a fully operational hot-rolling and processing facility, and the eventual consummation of a more favorable contract with union employees. Our $27 per share fair value estimate and narrow moat rating remain intact. Allegheny Technologies Issues Weak Third Quarter Results; Fair Value Estimate Lowered to $27 Andrew Lane, Sr. Eq. Analyst, 20 October 2015 We expected very weak third-quarter results for Allegheny

7 Morningstar Equity Analyst Report Page 7 of 12 Technologies amid an employee lockout, elevated stainless import levels, and the fact that the new hot-rolling and processing facility (HRPF) was not fully operational. The company's performance, however, was worse than we had anticipated. Segment operating losses totaled $73 million in the quarter, a massive decline from operating profits of $21 million in the previous quarter and operating profits of $60 million in the same period last year. The Flat-Rolled Products (FRP) segment was the fly in the ointment, reporting operating losses of $92 million. We were also discouraged that operating profits for the High Performance Materials and Components (HPMC) segment reported operating profits of only $19 million, a 58% sequential decline. Based on these results, our prior 2015 and 2016 operating margin forecasts for both segments now appear unattainable. We now expect the HPMC segment to deliver operating margins of 8% and 10% in 2015 and Our 2015 and 2016 operating margin forecasts for the FRP segment are negative 10% and 1.5%, respectively. We've tempered our expectations for the boost that the company's new HRPF will provide in Management initially guided that the facility would drive a $150 million run-rate operating profit improvement by the fourth quarter of 2015 relative to 2014 levels, but progress was delayed by a defective component that has since been repaired. In light of less favorable market conditions, we now expect the HRPF to deliver only a $75 million boost to 2016 operating profits relative to 2014 levels. Although near-term cash flows will likely remain depressed, our long-term forecasts are effectively unchanged. We've lowered our fair value estimate to $27 per share from $29, as we continue to think shares will generate attractive returns for long-term oriented investors as high-value shipments to the aerospace end market drive earnings growth. real terms, through 2020, we now expect the company's Flat-Rolled Products segment to generate a 5% midcycle operating margin, down from 6% previously. Even so, this marks a significant expansion from the flat-rolled division's second-quarter operating margin of negative 0.7%. In our view, progress will be made on the cost side, as the integration of the company's new hot-rolling and processing facility should deliver roughly $100 million of incremental operating income in Although the flat-rolled business continues to struggle, we remain excited about the growth prospects of Allegheny's High Performance Materials and Components segment. Although third-quarter guidance indicated that sales to the aerospace market are likely to decrease sequentially due to seasonality, we expect significant sales growth in 2016 and beyond. We contend that headwinds stemming from elevated stainless import volumes and the ongoing employee lockout have left the stock trading at a very attractive entry point for long-term investors. Per our estimates, accounting for Allegheny's debt position and pension liabilities, the current market price would be justified if we assigned zero equity value to the Flat-Rolled Products segment and a 9.5 times EV-to-EBITDA multiple to our 2016 EBITDA forecast for the High Performance Materials and Components segment. We believe these to be conservative estimates. For the flat-rolled operations, the ramp up of the hot-rolling and processing facility should restore profits in 2016 and beyond. For the high performance segment, a 9.5 times multiple sits below the multiples paid by other companies for the recent acquisitions of Precision Castparts and RTI International Metals. ATI's Third Quarter Guidance Highlights Formidable Market Conditions; Fair Value Estimate Decreased Andrew Lane, Sr. Eq. Analyst, 07 October 2015 We've cut our fair value estimate for Allegheny Technologies to $29 per share from $37, as we expect weak stainless steel prices to lead to lower midcycle operating margins than we previously expected. Given our outlook that stainless prices will rise only modestly, in

8 Quantitative Equity Report Release: 07 Mar 2016, 11:52, GMT-06:00 Reporting Currency: USD Trading Currency: USD Allegheny Technologies Inc ATI Page 1 of 1 Page 8 of 12 Last Close 04 Mar 2016 Quantitative Fair Value Est 04 Mar 2016 Market Cap 04 Mar 2016 Sector Industry Country of Domicile ,696.9 Mil p Industrials Metal Fabrication USA United States Allegheny Technologies Inc is a specialty metal producer. It offers various specialty metals which includes titanium and titanium alloys, nickel-based and superalloys. Quantitative Scores Scores All Rel Sector Rel Country Quantitative Moat Narrow Valuation Undervalued Quantitative Uncertainty Very High Financial Health Moderate ATI USAp Undervalued Fairly Valued Overvalued Source: Morningstar Equity Research Valuation Current 5-Yr Avg Sector Median Country Median Price/Quant Fair Value Price/Earnings Forward P/E Price/Cash Flow Price/Free Cash Flow Dividend Yield % Price/Book Price/Sales Profitability Current 5-Yr Avg Sector Median Country Median Return on Equity % Return on Assets % Revenue/Employee (K) Quantitative Moat Financial Health Current 5-Yr Avg Sector Median Score Country Median Distance to Default Solvency Score Assets/Equity Long-Term Debt/Equity Price Versus Quantitative Fair Value Quantitative Fair Value Estimate Total Return Sales/Share Forecast Range Forcasted Price Dividend Split Momentum: Negative Standard Deviation: Liquidity: High Wk Yr Total Return % / Market (Morningstar US Index) Dividend Yield % Price/Earnings Price/Revenue Morningstar Rating Q QQQQQ QQQQ QQQ QQ Q TTM Financials (Fiscal Year in Mil) 5,183 5,032 4,044 4,223 3,720 3,720 Revenue % Change Operating Income % Change Net Income Operating Cash Flow Capital Spending Free Cash Flow % Sales EPS % Change Free Cash Flow/Share Dividends/Share Book Value/Share 107, , , , , ,913 Shares Outstanding (K) Profitability Return on Equity % Return on Assets % Net Margin % Asset Turnover Financial Leverage Gross Margin % Operating Margin % 1,482 1,463 1,527 1,509 1,492 1,492 Long-Term Debt 2,475 2,480 2,894 2,598 2,083 2,083 Total Equity Fixed Asset Turns Growth Per Share 1-Year 3-Year 5-Year 10-Year Revenue % Operating Income % Earnings % Dividends % Book Value % Stock Total Return % Quarterly Revenue & EPS Revenue (Mil) Mar Jun Sep Dec Total , , , , , , , , , , , , , , ,031.5 Earnings Per Share () Revenue Growth Year On Year % Morningstar All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore is not an offer to buy or sell a security; are not warranted to be correct, complete or accurate; and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced, in any manner without the prior written consent of Morningstar. Please see important disclosures at the end of this report. ß

9 Morningstar Equity Analyst Report Page 9 of 12 Morningstar Equity Research Methodology Fundamental Analysis At Morningstar, we believe buying shares of superior businesses at a discount and allowing them to compound over time is the surest way to create wealth in the stock market. The long-term fundamentals of businesses, such as cash flow, competition, economic cycles, and stewardship, are our primary focus. Occasionally, this approach causes our recommendations to appear out of step with the market, but willingness to be contrarian is an important source of outperformance and a benefit of Morningstar s independence. Our analysts conduct primary research to inform our views on each firm s moat, fair value and uncertainty. Fundamental Analysis Economic Moat Rating Economic Moat Fair Value Estimate Uncertainty Assessment QQQQQ QQQQ QQQ QQ Q Star Rating The economic moat concept is a cornerstone of Morningstar s investment philosophy and is used to distinguish high-quality companies with sustainable competitive advantages. An economic moat is a structural feature that allows a firm to sustain excess returns over a long period of time. Without a moat, a company s profits are more susceptible to competition. Companies with narrow moats are likely to achieve normalized excess returns beyond 10 years while wide-moat companies are likely to sustain excess returns beyond 20 years. The longer a firm generates economic profits, the higher its intrinsic value. We believe lower-quality no-moat companies will see their returns gravitate toward the firm s cost of capital more quickly than companies with moats will. We have identified five sources of economic moats: intangible assets, switching costs, network effect, cost advantage, and efficient scale. Fair Value Estimate Our analyst-driven fair value estimate is based primarily on Morningstar s proprietary three-stage discounted cash flow model. We also use a variety of supplementary fundamental methods to triangulate a company s worth, such as sum-of-the-parts, multiples, and yields, among others. We re looking well beyond next quarter to determine the cash-generating ability of a company s assets because we believe the market price of a security will migrate toward the firm s intrinsic value over time. Economic moats are not only an important sorting mechanism for quality in our framework, but the designation also directly contributes to our estimate of a company s intrinsic value through sustained excess returns on invested capital. Uncertainty Rating The Morningstar Uncertainty Rating demonstrates our assessment of a firm s cash flow predictability, or valuation risk. From this rating, we determine appropriate margins of safety: The higher the uncertainty, the wider the margin of safety around our fair value estimate before our recommendations are triggered. Our uncertainty ratings are low, medium, high, very high, and extreme. With each uncertainty rating is a corresponding set of price/fair value ratios that drive our recommendations: Lower price/fair value ratios (<1.0) lead to positive recommendations, while higher price/fair value Economic Moat COM PETITIVE FORCES WIDE NARROW NONE COMPANY PROFITABILITY Moat Sources: Intangible Assets Switching Costs Network Effect Cost Advantage Efficient Scale

10 Morningstar Equity Analyst Report Page 10 of 12 Morningstar Equity Research Methodology ratios (>1.0) lead to negative recommendations. In very rare cases, the fair value estimate for a firm is so unpredictable that a margin of safety cannot be properly estimated. For these firms, we use a rating of extreme. Very high and extreme uncertainty companies tend to have higher risk and volatility. Quantitatively Driven Valuations To complement our analysts work, we produce Quantitative Ratings for a much larger universe of companies. These ratings are generated by statistical models that are meant to divine the relationships between Morningstar s analyst-driven ratings and key financial data points. Consequently, our quantitative ratings are directly analogous to our analyst-driven ratings. Quantitative Fair Value Estimate (QFVE): The QFVE is analogous to Morningstar s fair value estimate for stocks. It represents the per-share value of the equity of a company. The QFVE is displayed in the same currency as the company s last close price. Valuation: The valuation is based on the ratio of a company s quantitative fair value estimate to its last close price. Quantitative Uncertainty: This rating describes our level of uncertainty about the accuracy of our quantitative fair value estimate. In this way it is analogous to Morningstar s fair value uncertainty ratings. Understanding Differences Between Analyst and Quantitative Valuations If our analyst-driven ratings did not sometimes differ from our quantitative ratings, there would be little value in producing both. Differences occur because our quantitative ratings are essentially a highly sophisticated analysis of the analyst-driven ratings of comparable companies. If a company is unique and has few comparable companies, the quantitative model will have more trouble assigning correct ratings, while an analyst will have an easier time recognizing the true characteristics of the company. On the other hand, the quantitative models incorporate new data efficiently and consistently. Empirically, we find quantitative ratings and analyst-driven ratings to be equally powerful predictors of future performance. When the analystdriven rating and the quantitative rating agree, we find the ratings to be much more predictive than when they differ. In this way, they provide an excellent second opinion for each other. When the ratings differ, it may be wise to follow the analyst s rating for a truly unique company with its own special situation, and follow the quantitative rating when a company has several reasonable comparable companies and relevant information is flowing at a rapid pace. Quantitative Economic Moat: The quantitative moat rating is analogous to Morningstar s analyst-driven economic moat rating in that both are meant to describe the strength of a firm s competitive position. Uncertainty Rating Price/Fair Value % 95% 135% 105% 110% 80% 90% 70% 155% 85% 115% 60% 175% 80% Low Medium High Very High Uncertainty Rating 125% 50% Q QQ QQQ QQQQ QQQQQ

11 Morningstar Equity Analyst Report Page 11 of 12 Unless stated otherwise, this Research Report was prepared by the person(s) noted in their capacity as Equity Analysts employed by Morningstar, Inc., or one of its affiliates. This Report has not been made available to the issuer of the relevant financial products prior to publication. The Morningstar Rating for stocks identifies stocks trading at a discount or premium to their intrinsic value. Five-star stocks sell for the biggest risk-adjusted discount whereas one-star stocks trade at premiums to their intrinsic value. Based on a fundamentally focused methodology and a robust, standardized set of procedures and core valuation tools used by Morningstar's Equity Analysts, four key components drive the Morningstar Rating: 1. Assessment of the firm's economic moat, 2. Estimate of the stock's fair value, 3. Uncertainty around that fair value estimate, and 4. Current market price. Further information on Morningstar's methodology is available from This Report is current as of the date on the Report until it is replaced, updated or withdrawn. This Report may be withdrawn or changed at any time as other information becomes available to us. This Report will be updated if events affecting the Report materially change. Conflicts of Interest: -No material interests are held by Morningstar or the Equity Analyst in the financial products that are the subject of the Reports. -Equity Analysts are required to comply with the CFA Institute's Code of Ethics and Standards of Professional Conduct. -Equity Analysts compensation is derived from Morningstar's overall earnings and consists of salary, bonus and in some cases restricted stock. -Equity Analysts do not have authority over Morningstar's investment management group's business arrangements nor allow employees from the investment management group to participate or influence the analysis or opinion prepared by them. Morningstar will not receive any direct benefit from the publication of this Report. - Morningstar does not receive commissions for providing research and does not charge companies to be rated. -Equity Analysts use publicly available information. -Morningstar may provide the product issuer or its related entities with services or products for a fee and on an arms length basis including software products and licenses, research and consulting services, data services, licenses to republish our ratings and research in their promotional material, event sponsorship and website advertising. -Further information on Morningstar's conflict of interest policies is available from If you wish to obtain further information regarding previous Reports and recommendations and our services, please contact your local Morningstar office. Unless otherwise provided in a separate agreement, you may use this Report only in the country in which the Morningstar distributor is based. Unless stated otherwise, the original distributor of this document is Morningstar Inc. Redistribution, in any capacity, is prohibited without permission. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate, nor may they be construed as a representation regarding the legality of investing in the security/ies concerned, under the applicable investment or similar laws or regulations of any person or entity accessing this report. The opinions expressed are as of the date written and are subject to change without notice. Except as otherwise required by law, Morningstar, its affiliates, and their officers, directors and employees shall not be responsible or liable for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. You should seek the advice of your financial, legal, tax, business and/or other consultant, and read all relevant issue documents pertaining to the security/ies concerned, including without limitation, the detailed risks involved in the investment, before making an investment decision. Please note that investments in securities are subject to market and other risks and there is no assurance or guarantee that the intended investment objectives will be achieved. Past performance of a security may or may not be sustained in future and is no indication of future performance. As the price / value / interest rate of a security fluctuates, the value of your investments in the said security, and in the income, if any, derived therefrom may go up or down. For Recipients in Australia: This report has been authorized by the Head of Equity and Credit Research, Asia Pacific, Morningstar Australasia Pty Limited and is circulated pursuant to RG 79.26(f) as a full written permission. To order reprints, call To license the research, call

12 Morningstar Equity Analyst Report Page 12 of 12 restatement of an original report (by the named Morningstar analyst) which has already been broadly distributed. To the extent the report contains general advice it has been prepared without reference to your objectives, financial situation or needs. You should consider the advice in light of these matters and, if applicable, the relevant Product Disclosure Statement before making any decision to invest. Refer to our Financial Services Guide (FSG) for more information at For Recipients in Hong Kong: The research is distributed by Morningstar Investment Management Asia Limited, which is regulated by the Hong Kong Securities and Futures Commission to provide services to professional investors only. Neither Morningstar Investment Management Asia Limited, nor its representatives, are acting or will be deemed to be acting as an investment advisor to any recipients of this information unless expressly agreed to by Morningstar Investment Management Asia Limited. For enquiries regarding this research, please contact a Morningstar Investment Management Asia Limited Licensed Representative at For Recipients in India: This research on securities [as defined in clause (h) of Section 2 of the Securities Contracts (Regulation) Act, 1956], such research being referred to for the purpose of this document as Investment Research, is issued by Morningstar Investment Adviser India Private Limited. Morningstar Investment Adviser India Private Limited is registered with the Securities and Exchange Board of India under the SEBI (Investment Advisers) Regulations, 2013, vide Registration number INA , dated March 27, 2014, and in compliance of the aforesaid regulations and the SEBI (Research Analysts) Regulations, 2014, it carries on the business activities of investment advice and research. Morningstar Investment Adviser India Private Limited has not been the subject of any disciplinary action by SEBI or any other legal/regulatory body. Morningstar Investment Adviser India Private Limited is a wholly owned subsidiary of Morningstar Associates LLC, which is a part of the Morningstar Investment Management group of Morningstar, Inc., and Morningstar, Inc. is a leading provider of independent investment research that offers an extensive line of products and services for individual investors, financial advisors, asset managers, and retirement plan providers and sponsors. In India, Morningstar Investment Adviser India Private Limited has only one associate, viz., Morningstar India Private Limited, and this company predominantly carries on the business activities of providing data input, data transmission and other data related services, financial data analysis, software development etc. The author/creator of this Investment Research ( Research Analyst ) or his/her associates or his/her relatives does/do not have (i) any financial interest in the subject company; (ii) any actual/beneficial ownership of one per cent or more securities of the subject company, at the end of the month immediately preceding the date of publication of this Investment Research; and (iii) any other material conflict of interest at the time of publication of this Investment Research. The Research Analyst or his/her associates or his/her relatives has/have not received any (i) compensation from the subject company in the past twelve months; (ii) compensation for products or services from the subject company in the past twelve months; and (iii) compensation or other material benefits from the subject company or third party in connection with this Investment Research. Also, the Research Analyst has not served as an officer, director or employee of the subject company. The terms and conditions on which Morningstar Investment Adviser India Private Limited offers Investment Research to clients, varies from client to client, and are spelt out in detail in the respective client agreement. written permission. To order reprints, call To license the research, call