Demand Isn't The Problem For Carpenter Technology; Execution Is

Although demand for specialty alloys has been strong almost across the board, progress remains shaky at best for Carpenter Technology (CRS), as the company’s earnings and cash flow are not reflecting what is actually a pretty healthy demand environment. To the extent it makes anybody feel better, Carpenter isn’t the only alloy company to take a beating in the market, as Carpenter, Universal Stainless (USAP), Haynes (HAYN), and Allegheny (ATI) have all been weak over the past six months as investors have been spooked by the 30% fall in nickel prices and the risk of rising costs, not to mention potentially slower growth in 2019.

It’s tough to continue advocating for this company and stock when the results just aren’t coming through. Ramping up the Athens facility has been a much slower process than expected, and management could have done a much better job of forecasting the maintenance-driven earnings shortfall in the last quarter. While the shares do look undervalued below the $50s, and the company’s investments in additive manufacturing could pay off in a bigger way in five to 10 years, it’s tough to keep extending the benefit of the doubt to the company.

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Demand Isn't The Problem For Carpenter Technology; Execution Is

Carpenter Is Seeing Good Demand Growth, But Operating Leverage Remains A Work In Progress

While it has been frustrating at times, specialty alloy company Carpenter (CRS) has been making progress. The shares are up 11% from when I last wrote about the company, beating the S&P 500 over that time and matching Allegheny (ATI), but lagging Haynes (HAYN) and Universal Stainless (USAP). Along the way, the company has been posting some good revenue growth, though margin leverage has been more of a laggard than I'd hoped.

Carpenter shares do still look undervalued, though the 20% or so gap in valuation I previously saw has now shrunk to around 10%, and I'm a little concerned that my out-year margin assumptions are a bit too aggressive. Still, demand is taking off in the aerospace market, the company is still doing well in the medical and transport market, and oil/gas demand continues to recover. What's more, there seems to be a real sense of urgency on the part of customers to get the company's Athens facility qualified, something that should lead to meaningfully higher utilization and significant margin leverage.

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Carpenter Is Seeing Good Demand Growth, But Operating Leverage Remains A Work In Progress

As Company's Rebuild Their Supply Channels, Universal Stainless & Alloy Products Is Coming Back To Life

I thought Universal Stainless & Alloy Products (USAP) looked undervalued back in the fall, but little did I suspect (or expect) that the shares would shoot up more than 80% in only about nine months. While I did expect service centers to look to replenish their inventories in order to be better-positioned for growing aerospace deliveries and recoveries in markets like oil/gas and heavy industry, the market seems to be much more inclined now to believe in a sharper recovery trajectory.

I have shifted my recovery expectations ahead by more than a full year, lifting my fair value estimates, but I'm hesitant to go too far too fast. Expectations for aerospace deliveries aren't exactly swelling right now, and sell-side analysts have been trimming back their expectations for the steepness of the oil/gas recovery. Universal Stainless still has places where it could outperform (better expense control, better mix of higher-value alloys), but these shares have pretty much trounced peers and comparables like Allegheny (ATI), Carpenter (CRS), and Haynes (HAYN) over the last year and its going to take a significant improvement in financial results just to support this level of valuation.

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As Company's Rebuild Their Supply Channels, Universal Stainless & Alloy Products Is Coming Back To Life

Carpenter Technology Waiting For Orders To Drive Utilization

Like Universal Stainless (NASDAQ:USAP), I thought back in February that Carpenter Technology (NYSE:CRS) was an interesting high-risk way to play improving sentiment about aerospace (or aerospace components) with maybe an "at least it won't get worse" kicker from energy. Like USAP, Carpenter has rewarded that viewpoint, with the shares up almost 50% from the time of my last article.

I'm not as bullish on Carpenter now, though. I do believe that the comments coming from major engine suppliers like General Electric (NYSE:GE) and United Technologies (NYSE:UTX) bode well for deliveries over the next three to five years, but I'm still concerned that overall aircraft deliveries will disappoint (especially in widebodies) and that recoveries in markets like energy will be slower than the bulls hope.

Carpenter does have a lot of self-improvement potential (which could enhance its appeal as a takeout candidate) going into an upturn, but I worry that there is too much capacity in specialty alloys for the company to get back to double-digit ROICs. With that, I suppose there could still be some trading appeal here, but my fundamental view is less bullish.

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Carpenter Technology Waiting For Orders To Drive Utilization

Universal Stainless & Alloy Products May Be Bottoming, But The Future Remains Murky

When I last wrote about Universal Stainless & Alloy Products (NASDAQ:USAP), I thought this struggling specialty alloys company had some speculative appeal but only for aggressive risk-seeking investors. The shares have since risen about 30%, on par with fellow alloys company Carpenter (NYSE:CRS), better than Haynes (NASDAQ:HAYN) (up 15%), and worse than Allegheny Technologies (NYSE:ATI) (up 56%). I believe these gains have been fueled by optimism that the "perfect storm" of weakness in aerospace, power gen, oil/gas, and heavy equipment has largely bottomed and that sales and margins should improve from here.

I think USAP could be 10% to 20% undervalued today, and that's assuming the company doesn't regain prior peak sales until 2023 and prior peak gross margins until 2021 (the difference being a mix shift toward higher-margin products). On the other hand, I don't think the company is exactly out of the woods with respect to its debt position and there is ample capacity in the specialty alloy market. Add in wobbliness in aerospace order books and persistent low energy prices, and this remains a stock that's really only suitable for the risk-seeking investor.

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Universal Stainless & Alloy Products May Be Bottoming, But The Future Remains Murky

Seeking Alpha: Carpenter Technology Ready For Demand And Free Cash Flow Growth

Carpenter Technology (NYSE:CRS) has done alright since my December 13 write-up, climbing more than 22% but trailing Precision Castparts (NYSE:PCP) and Allegheny Technologies (NYSE:ATI) (while outperforming specialty alloy companies Universal Stainless (NASDAQ:USAP) and Haynes International (NASDAQ:HAYN)). There have been some challenges for the company as its major aerospace end market worked down inventories of engine parts and fasteners, but lead times are expanding, nickel prices are rising, and Carpenter is nearly finished with the addition (and customer qualification) of a new premium/super-premium facility in Athens, Alabama.

On the negative side, Carpenter already trades close to its historical average EBITDA multiple (around 8.5x). On a more positive note, the order books of the major commercial aircraft OEMs stretch out for years and should support double-digit growth for several years.

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Carpenter Technology Ready For Demand And Free Cash Flow Growth

Seeking Alpha: Has Universal Stainless & Alloy Products Bottomed?

When last I wrote about Universal Stainless & Alloy Products (USAP), I was bullish on the long-term potential of the company's efforts to upgrade its product mix, but skeptical about the valuation of the stock. Since then, the shares are down about 7%, having spent the last six months chopping between $32 and $38. In that time, that company's progress on volume growth and mix has been frustratingly inconsistent.

I have a nerdish interest in metallurgy and companies like Allegheny Technologies (ATI), Carpenter Technology (CRS), A.M. Castle (CAS), and Haynes International (HAYN), but following companies and science is a completely separate issue from the stocks. I do generally like the potential for advanced alloy growth in aerospace, power machinery, and oil/gas, and I also do believe that vacuum induction melting (or VIM) products will skew USAP's mix higher over time. Here and now, though, it's hard to call the shares undervalued, with an apparent fair value around $33 to $37.

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Has Universal Stainless & Alloy Products Bottomed?

Seeking Alpha: Carpenter Technology Upgrading Capacity And Margins At The Right Time

The success or failure of Carpenter Technology (CRS) is ultimately going to have much to do with the fate of the commercial aerospace cycle, so how you feel about that market certainly plays into whether this is a worthwhile idea to consider. Apart from that, though, Carpenter has been making moves to broaden its end market mix (including a growing opportunity in energy). Carpenter is also adding high-end capacity ahead of an expected upswing in demand and this move should prove a good one for both sales and margins.

With more than 40% of sales tied to the cyclical aerospace market (and another 20% or so tied to other cyclical markets like autos/transportation and energy), cash flow-based methodologies don't work particularly well here. Carpenter Technology has historically carried a full-cycle EBITDA multiple around 7.5x, but multiples are usually in the low double-digits at this point in the cycle (ahead of a significant pick-up in results). Assigning a 10x multiple to the average 2014 EBITDA estimate results in a target in the high $60s, and I think Carpenter is an idea worth considering today.

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Carpenter Technology Upgrading Capacity And Margins At The Right Time

Seeking Alpha: Universal Stainless & Alloy Products Looking For Improving Markets And Mix ASAP

End-markets like aerospace, oil/gas, and power gen may not be back up to full power right now, but investors have already started positioning themselves for a better 2014. With that, the stocks of specialty metal/alloy producers like Allegheny Technologies (ATI) and Carpenter Technology (CRS) have strengthened recently, as have those of more conventional steel producers like Nucor (NUE) and Steel Dynamics (STLD).

The much smaller and less well-covered Universal Stainless & Alloy Products (USAP) has also enjoyed a solid rebound of late, with the shares up about 30% since early August. USAP is well-positioned to benefit from destocking in end-markets like aerospace and oil/gas, but the company also has a potentially powerful earnings driver in a mix that is shifting toward higher-value products. This stock is like many others in that it is not particularly cheap today, but I do like the prospects for better results in the coming years.

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Universal Stainless & Alloy Products Looking For Improving Markets And Mix ASAP