Demand from the aerospace industry has grown at a steady rate for the last couple of years. Higher fuel prices have forced airline companies to order new energy-efficient aircraft. Global airline traffic has also grown, which further boosted the demand for new aircraft.
However, there are concerns that aerospace demand growth rates might come down in the near term. Notably, the travel industry is specifically at risk from rising acts of terrorism.
Another concern for Arconic has been related to pricing pressures, particularly on new aircraft platforms. Alcoa’s (AA) chair and CEO, Klaus-Christian Kleinfeld, spoke candidly on this topic during the company’s 2Q16 earnings conference call. Kleinfeld stated that “it’s better to be on a platform than not to be on a platform.”
With aerospace companies (BA) (ITA) tightening their purse strings, there’s little that component suppliers (WWD) (CSTM) can do—it becomes a question of choosing growth over margins. However, Alcoa is looking at further productivity improvements in the upcoming quarters. These improvements are expected to offset the negative impact of pricing pressures.
Despite these pressures, Alcoa’s Engineered Products and Solutions (or EPS) segment has managed to increase its margins in the last couple of quarters, as you can see in the graph above.
Previously, Alcoa (AA) was looking at an investment-grade credit rating for Arconic. However, given the current market scenario, Arconic may not be able to attain an investment-grade credit rating. Because Arconic has taken over the current outstanding debt of Alcoa, its leverage ratios would be somewhat higher than some of its comps.
There are several opportunities for Arconic investors in the medium to long term, which we’ll discuss in the final article in this series.