Titanium Metals: Demand Taking Off

Newcomers are headed for an airport near you. The Airbus A380, currently the world's biggest passenger aircraft, made its maiden voyage March 19. The behemoth can seat as many as 555 passengers. Not to be outdone, rival Boeing plans to launch the 787 Dreamliner, a large, fuel-efficient carrier, by May 2008.

Whether Airbus or Boeing rules the skies, the manufacturers will need more titanium. The metal will account for about 22% of the total weight of the Boeing 787. To produce a single A380, Airbus requires about 77 tons of titanium, which is as strong as steel, about 45% lighter and corrosive resistant.

The titanium industry has been on a tear over the past two years. The price for milled titanium has more than doubled in that period. And shares of titanium producers have flourished with the price surge. In 2006, the stock of titanium producer Allegheny Technologies (symbol ATI) was the top-performing component of the Standard & Poor's 500-stock index, with a 151% return.

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Don't expect the boom to fizzle, says Banc of America analyst Kuni Chen. Aircraft orders and industrial demand from China will keep titanium supplies tight for at least the next three years, he says. The sustained need for the light-weight metal presents opportunities for investors. Among the three publicly traded U.S. titanium producers - Allegheny, RTI International and Titanium Metals -- Chen sees Titanium Metals (TIE) as the clear winner.

Titanium is produced in three basic steps. First, the ore is reduced into a porous "sponge" form. Then, titanium sponge and scrap is melted down to form ingot. Finally, that ingot is milled to make billets and bars. While the capacity to produce sponge should grow rapidly with demand, the capacity to melt and mill titanium will be a bottleneck, Chen says, and he expects the market for milled products to remain tight for several more years. Chen estimates that aerospace manufacturers have a backlog of more than 5,000 aircraft and will require more titanium production to fulfill those orders.

Among its competitors, Titanium Metals is in the best position to take advantage of higher prices and stronger demand, Chen says. Only 39% of Titanium Metals sales are under long-term price contracts while more than half of RTI's sales and about 70% of Allegheny's sales are under contact. That means that if titanium prices increase, Titanium Metals will benefit more from the rise than its rivals. Chen sees existing Titanium Metals contracts being renewed at higher rates and new contracts won on better terms because of increased demand.

Just to keep up with Boeing orders, Titanium Metals will have to boost production in its mills by 50% over the next two years, Chen says. He forecasts that Titanium Metals will generate more cash from its operations than Allegheny and RTI and use the money to expand its production.

Chen's call is not without risk. Commodity investments are volatile. Prices could fall apart if the industry boosts its capacity to produce melted and milled titanium, if Boeing and Airbus experience productions delays or if there are any negative shocks to aircraft demand or to China's economy.

Shares of Titanium Metals climbed 2%, to $35.38, on March 20. It trades at 23 times the $1.50 per share Chen expects the company to earn in 2007. He suggests that investors buy on price dips and thinks the stock is worth $41.