ATI Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

ATI Inc. is a global manufacturer of specialty materials and complex components, serving the aerospace & defense, medical, and energy markets.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

ATI’s business is primarily composed of two segments: High Performance Materials & Components (HPMC), and Advanced Alloys & Solutions (AAMS).

HPMC, which constitutes the majority of their revenue, focuses on high-performance specialty materials including titanium and nickel-based alloys, superalloys, and powder metals used in aerospace and defense components like jet engines.
AAMS on the other hand, is a more specialized business serving other manufacturing companies with its alloys and solutions.

A key feature of ATI is its expertise in a broad spectrum of advanced materials and processing capabilities to produce complex components with high quality and performance characteristics. They use various technologies to enhance properties of the alloy to use in demanding, high performing sectors.

The revenue distribution is as follows:

Aerospace & Defense contributes almost 50% of its revenue.
Energy approximately 25% which is split between Oil & Gas, Specialty Energy and Electrical Energy.
Other which includes a variety of industries like medical, industrial, and commercial, makes up for around 25%.

In general, the industry has been volatile and cyclical. Supply chains have been greatly affected, which led to both price fluctuations and high inflation.

From a financial point of view, ATI’s margins depend on the nature of their business, which is mostly commodities. As such, their margins are greatly affected by both input costs and demand. Even in good years, they have trouble producing great margins. Let’s look at the financial side of the company.

ATI’s financials have been rather unstable.

From 2019-2021, revenue was decreased greatly because of the COVID pandemic. However, the company has shown recovery by 2022, with revenue reaching its 2019 levels again.
In fiscal year 2022, sales were $3.4 billion and in the first quarter of 2023, the company reported $1.01 billion in sales.
Net income was $-35.2 Million in 2022 and $150 Million in the latest quarter (Q1 2023).
Gross margins in the range of 10-20% but increased to 22% in the most recent quarter. In prior quarters, gross margins were highly fluctuating, showing the volatile nature of the company.
Even though the company has recovered, it still hasn’t had consistent profitability, with major volatility in net income.

The company is heavily impacted by the state of the economy. The recent war has also affected the company a great deal. The company’s management had this to say in their last quarterly earnings call:

“The war and its economic effects are certainly a wildcard. We’ve been taking steps to reduce our exposure to Russian customers, which have impacted margins as they are typically high profitability, but that is a part of our responsibility for compliance”.

The company is in a state of transition, attempting to consolidate operations and reduce debt. Let’s get into details about some numbers.

Current assets were valued at $1.7 billion while current liabilities were valued at $986 million giving a current ratio of ~ 1.7. A healthy current ratio suggests that the company can comfortably meet its short-term obligations.
In the long-term, the company is highly leveraged with liabilities worth $3 billion vs equity at $1.4 billion and has a lot of debt to pay for.
They are, however, trying to control their debt and have reduced long-term debt in the latest quarter. The company is trying to get the debt to EBITDA ratio at 3x, down from 4.2x, this is still a bit too high and needs to be paid down.
Cash and cash equivalents have improved significantly, from ~300 million in previous quarters to around 600 million in the latest, which is a great sign of a business trying to be more robust.

Moat Analysis:

Intangible Assets : The company has a great brand in Aerospace and Defense industries, and they have numerous certifications in their name. Also, their manufacturing capabilities are unique, but at the end of the day, they are simply a commodity manufacturer, for which substitutes are plenty.
Switching Costs: Switching costs for products they sell to companies like Boeing are high because they go through rigorous qualifications and time-consuming tests. This creates somewhat of a switching cost, but competitors do compete with them.
Network Effects : Network effects don’t play much role in the business.
Cost Advantage : As discussed earlier, the company doesn’t have much of a cost advantage but does have a regional cost advantage in North America, where it controls much of the source of raw materials it uses.

Overall, the company does have certain advantages that help keep the returns above average but are not big enough to be considered a wide moat. Also, its performance depends heavily on economic conditions as a lot of revenue comes from industries like aerospace, automobile, and energy. Hence, I have assigned the company a moat rating of 2 out of 5.

Risks to the Moat:

The primary risk to the company is technological obsolescence of their product, especially their components in the defense, and aerospace sectors. In recent times, many companies are focusing on lighter materials and composite-based materials that could be the next generation of aircraft materials. This might erode the demand for the company’s older generation materials and hurt its margins.
Changes in regulations, especially those related to defense, energy, or manufacturing would directly affect the business, increasing its expenses and putting a cap on its prices.
Since the company serves a lot of commodity-based industries, they are especially vulnerable to a drop in prices. Also, high-input costs could greatly harm the margins, and the company may not have the ability to transfer the extra costs to the consumer, and their overall profitability will be reduced.

Business Resilience:

Even with multiple risks discussed, the company is expected to perform well because of increased demand from aircraft manufacturers for its products. Also, they are continuously innovating and investing in R&D, to mitigate the technological risks. They also have the ability to cut costs and improve production efficiency to counter inflation.

Understandability: The business of producing complex alloys with extremely specific processes and selling it into very demanding industries is not an easy concept to understand and it requires some domain-specific knowledge. Also, the financial statements have been volatile, and requires extra effort to comprehend all the one-time items, which does make the company a bit difficult to understand. Hence, I will rate it at a 3 out of 5 for understandability.

Balance Sheet Health: The company’s balance sheet has improved significantly in the past few quarters, and it has been shown that they are trying to bring down debt, which is good, and the company’s equity and cash reserves have both improved in recent times. However, there is still a lot of debt, making debt sustainability a risk, but given the positive movement, the overall health of the balance sheet is okay. Overall, we will rate it as 4 out of 5.