Arconic Corporation: Risk Factors
Summary
- The recently listed Arconic Corporation has witnessed insider buying and is labeled as an outperformer by many analysts.
- The company faces many headwinds in 2020, and some of these can blow very hard.
- COVID-19, overreliance on one large customer, and a few other risks have the potential to drag its performance this year.
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When does money run out of time? The countdown begins when investable assets pose too much risk for too little return; when lenders desert credit markets for other alternatives such as cash or real assets. - Bill Gross
Recently listed Arconic Corporation (NYSE:ARNC) witnessed a spurt in its price after five insiders picked up its shares. For those not familiar with the stock, ARNC is a provider of aluminum sheets and extrusions to the automotive, aerospace, transportation, and construction industries. It has recently been spun off from its parent, Howmet Aerospace (HWM).
Is it wise to follow the herd and buy ARNC now because many analysts are bullish on it? At a time when the market's getting inflated because of a COVID-19 bubble?
On April 15, 2020, I had reported in The Lead-Lag Report that a COVID-19 bubble was expected, tweeted about it, and even published a piece here.
Image Source: Twitter
Given that ARNC is a recent listing that is thriving in a bubble, investors need to understand if it is good enough for an investment. I urge all investors to consider the following risks the company faces:
Risk Factors
1. COVID-19 Risks
The company has admitted that the nature and extent of COVID-19's impact cannot be measured now. There's a lot of uncertainty about the business, and if the disruption drags on for a long time, it will have a material impact on the company's finances.
As per one SEC filing, several of its customers in the automobile and aerospace industry have temporarily suspended operations, and it is not clear how many have reopened at the time of writing this post.
The COVID-19 disruption should continue till we develop a vaccine, an effective treatment, or herd immunity, whichever comes first. To cope with the uncertainty, the company has decided to save $200 million by reducing operating expenses by $150 million and capital expenditure by $50 million. The Board of Directors and the employees have taken pay cuts. On May 25, 2020, the company laid off 24 employees at its Massena facility. ARNC's Tennessee and NY facilities will be shut till demand returns, while other facilities in Europe, U.K., China, and Russia will operate at reduced capacity.
2. Customer-Specific Risks
ARNC derives 35% of its revenues from ground transportation and 18% from aerospace markets. Ford (F) is its largest customer and it alone contributes 13% to the company's revenues.
Most American automakers had shut down for almost two months in response to the disruption. Ford's employees have been testing positive for the virus since it reopened, and the company has had to temporarily shut down its plants on and off. Worker unions have begun pressurizing the company to test all employees and shut plants for 24 hours after a worker tests positive.
Automobile manufacturing capacities had sharply dropped in Q1 2020, and Q2 2020 may be worse. Auto research firms estimate new vehicle sales to fall by 32% in May 2020 year over year.
If you add up jerky production, low demand, and idle capacities, it becomes easy to guess that the automobile industry's demand for raw material will be adversely impacted. There's no doubt that ARNC's ground transportation orders will take a solid hit.
Image Source: St. Louis Fed
ARNC derives 18% of its revenues from the aerospace industry. Commercial airlines are in bailout mode after COVID-19 hit the industry, and the travel and tourism sector has been battered out of shape. This is another blow that will hit ARNC's sales.
3. Financial Risks
Image Source: ARNC's Q1 2020 SEC Filing
The company generated negative operational cash flows of $295 million in Q1 2020, mainly because of an increase in receivables and inventories. It also had to take on third-party debt of $1,200 million because of the spin-off.
As of March 31, 2020, ARNC has long-term debt of $1,419 million in its books. Its equity capital was net $1,613 million ($3,045 million parent company investment less $1,432 million accumulated loss). That gives us a DE ratio of a little over 1:1.
Inventories too were high at $844 million - of this, $738 million represented work-in-progress. These inventories are extremely high when you consider that the company's revenues in Q1 2020 were $1,611 million. Sure enough, the work-in-progress inventory is because of orders received, but then we still have to check how it moved in Q2 2020.
Summing Up
ARNC faces many headwinds in 2020 - falling demand, dropping sales, top-heavy customer list, a slowdown in auto and aerospace industries, and debt - all these factors will put pressure on the company's operations.
To its credit, ARNC is a quality stock with strong cash reserves and it has taken proactive measures to combat the COVID-19 disruption.
So what will I do as an investor?
I'd wait and watch the Q2 2020 results and keep tracking the stock. I also would cut through the hype and wait for an effective COVID-19 vaccine or treatment to be developed. Once there is clarity that the disruption would blow over, I would still wait for the first uptick in demand in the automotive and travel industry before buying the stock. At this moment, my rating is neutral.
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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (2)
Anyway if you believe Arconic will survive the covid19 trauma to its customers and markets then buying ahead of the recovery is a sure way to make $$$
