How about a Pairs Trade?

Anyone who reads this blog knows that I am currently short TIE and expecting them to miss Q3 earnings. However, I also believe that TIE will have an improved 2008 and I will eventually get long again. Well, today's conference call from RTI gave me the ability to make going long TIE happen in the next month. After Q3 earnings, I plan to get long TIE and short RTI. This "pairs trade" hedges everything else going on in the market and allows me to profit on TIE doing better than RTI over the next year.

SuperScenario is the most respected poster on the TIE Investor Village Message Board and today he gave a great synopsis of the RTI conference call (the bullets below) that I want to share:

• RTI’s average price per pound will decline about 8%-10% in 2008. Caveat: RTI’s contracts/prices are very different from ATI’s and TIE’s. RTI’s pricing tends to lag the spot market by about 14 months - - far more than ATIs (perhaps 3-6 months), and TIE’s (perhaps 6-7 months on spot, with LTA’s principally repricing once a year).
• Average 2008 gross margin will be about the same as 2007 YTD at 33%
• Bulk weldable scrap is presently $7-$8, unchanged from last Quarter.
• Spot business will be about 15%-20% of RTI’s total in 2008.
• CapEx will be huge in 2008 at about $260 Million (2007 will be $80 Million).
• Interest income of about $0.03/Quarter (Q3 actual) will swing to large additional interest expense, reducing Quarterly EPS by about $0.14/Quarter by the end of 2008, gradually as the Quarters roll forward (Super's estimates).
• Sponge (Japanese) cost will increase just under 10% (say, 8%-9%) in 2008, reflecting the end of RTI’s old, below-market, Japanese sponge contract at the end of this year. So next year’s increase is not reflective of market prices (which have plunged), but reflects the expiration of RTI’s old cheap contract. RTI will enjoy some cost offset with the lower 2008 costs of scrap.
• Nothing new here, but RTI mentioned/confirmed that its raw materials sourcing is roughly 1/3 Japanese sponge, 1/3 Kazakh sponge (to be provided by Airbus beginning in 2008), and 1/3 scrap.
• RTI expects a lower margin in Q4, with volume increasing to perhaps 4.2 Million pounds (up from 3.9 Million pounds in Q3 - - I’ll believe it when I see it), with a shift to billet product.
• RTI continues to say business is hurt by “inventory destocking” by titanium distributors. Still, after 15 months.
• Although capacity will increase by about 36% by Q2 of 2008 (to about 22.5 Million pounds, up from about 16.5 pounds at present), next year’s tonnage will only increase about 13%, from about 15.5 Million pounds in 2007, to about 17.5 Million pounds in 2008. The effective capacity for 2008 (reflecting the midyear increase) will be about 18.5 Million pounds, so 2008 sales will likely be about 95% of capacity.
• From all this I [Super] get 2008 EPS of about $3.90 - - virtually unchanged from this year’s analyst consensus of $4.09 - - but way below the anlaysts’ consensus of $5.19 for 2008.

Super's analysis above has led him to short RTI for 2008. On the surface, I tend to agree with him. I will be doing a little research in the meantime, but I expect to be joining him in an RTI short position with a twist - I plan to hedge this with a TIE long position.