Curtiss-Wright Corporation (CW) Earnings Call Transcript & Summary

Well, great. Thank you, everyone, for joining our next panelists. We have this afternoon, Curtiss-Wright. And at Curtiss-Wright, we've got Lynn Bamford, Chairman and CEO, welcome Lynn. And we've also got Chris Farkas, VP and CFO. Welcome, Chris.

Yes. Thank you.

Yes. Great. So before we start, I'll read disclosures. For inform disclosures, please use the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative. So great. Sorry. Housekeeping. I said that like 20 times so far. So thank you.

And Lynn when did you -- so we've got the nuclear power market, I'll just dive right into Q&A. It seems like the industry is at a pretty interesting inflection point with a possibility for potentially above growth opportunity for Curtiss-Wright. I mean when you look at the nuclear power generation market. How is the legislative or socioeconomic landscape changed or the geopolitics to support growth in this business?

Well, thank you for that question. Obviously, an exciting day to day with our press release that we'll come to. But before I begin, I do want to make comments that we will make some forward-looking statements as we're discussing here to those in days or due to risk as explained in our SEC filings. But with that, on to the topic at hand. So I think it was interesting today with some of the individual meetings and for the nuclear portion of our business clearly has got a lot of great growth ahead of it, and it's a pretty exciting time from a lot of different dynamics. But starting with your first question of what's changed. I think globally, the world has come to realize to reach our carbon 3 goals that nuclear needs to play a role in that. And I think that's becoming accepted much more broadly. It doesn't mean there's universal enthusiasm for it, but people understand it's got a very important role to play. And as people learn, they understand there's a lot of really safe technologies being developed out there. And I think evidence of this is if you look inside of just the U.S. and the infrastructure bill and the inflation reduction bill and even in the chips bill, there's a lot of funding that's going to be directed at supporting the reemergence of our nuclear industry and the sustainment of the plants that exists in the U.S. today. I think there's a real -- a lot of announcements out of different states, the desires not to shut down the existing fleet. And so -- and there's a lot of money in these bills to support that and money for new development. So here in the U.S., I think we've probably all seen these various acts get passed. And the impact that they're going to have to bolster this industry. And then I think if you turn to Europe, and the situation going on in Ukraine and the Free World's galvanization to not be dependent on Russian energy of all types is driving them to really accelerate their move to build out their nuclear infrastructure and even countries like Germany have been pretty staunchly saying they're going to get out of nuclear are stepping back and giving pause for cause in that direction. So I'd say globally, in the free world, people understand the importance of nuclear in a different way and recognize it in a different way than really 5 and 10 years ago.

Yes. And I would just say, I think about 10 years ago, there was a dream of a nuclear renaissance that kind of didn't come about. So how is it different this time? How much of this realization that we need to have nuclear as part of this green future? Like how has that really evolved? And are you seeing orders come through from these announcements of life extensions for power plants in the U.S. and abroad?

Yes. 10 years ago, Fukushima happened and that surely put a dampening effect on what was an expected renaissance. And I think it's important to note that first is the stopping of the shutting. We've seen examples of that already in this country and a lot of declarations. That will drive these subsequent license renewals, which is good work for us and give us a stable base of reactors to do our aftermarket. And so that's very good, and the commitments are being made. I think also when you look at the AP1000 plant with all passive safety systems, and then even more so looking to the Gen 4 plants and the safety of the new designs that it's really -- it's a different type of technology with a different risk factor. And so I think as the world comes to understand that, their acceptance of these -- the nuclear positions across their territories will be greatly enhanced. And also, it's being counterbalanced that I think the realness of carbon energy production that now you're really risk balancing it against something in a different -- very different way than was really generally accepted 10 years ago.

That's really helpful color. And if we could parse out these 2 opportunities, you kind of touched on this nuclear aftermarket, and we've got the new build opportunity. So free focus on the nuclear aftermarket portion. I mean historically, that's a low single-digit growth for you. if you factor in all these opportunities, how high can that business grow? And when would you anticipate that to actually hit their numbers.

Yes. So we absolutely feel like the dynamics in this industry are going to drive a very different growth rate than what we have experienced over the recent past. And I mean you start out most -- the largest portion of that business is the aftermarket work that's been chasing the declining number of reactors. We believe, at this point, the number of nuclear reactors in the U.S. alone is going to stabilize. And so we've managed to grow that business with a shrinking plant base. And so you stabilize that plant base that's just great. And then these plants go for their subsequent license renewals from 60 years to 80 years, and that drives incremental work. It's not the same on every plant. So a little hard to qualify -- quantify how much that will be per plant, but it's absolutely good business for Curtiss-Wright. So those are 2 tailwinds. That's more near term. We're already seeing early order flow from subsequent license renewal activity and the extension life of these plants. So that's probably here and now. We've talked with the announcement this morning with our strategic supplier agreement with X-energy is just really exciting for something. It's something we're very -- very much glad that it could be put out publicly today, so we can speak about it here. We are targeting $100 million plus content per 4 pack of a plant. So this is equivalent to really in the nature of what our AP1000 business is that has been so significant for Curtiss-Wright over time. And it's an interesting design. We've previously spoke about content with new scale, and we're working broadly across the industry to secure content on other reactors. That work is going to ramp during this decade that we're doing development work with these companies now. So planning, designing, that type of work will produce the content for X-energy for the ARDP funded reactor in -- through the middle of this decade and into the back half of this decade and hope to see new orders flow during that time frame. And maybe I'll turn it over to Chris to talk about the AP1000, which is the other part of the new build.

Sure. So Lynn talked about Gen 4 technologies and small modular reactors in the aftermarket. You also probably know if you've been following Curtiss-Wright that we are aligned with Westinghouse to provide reactor coolant pumps for the AP1000 power plant, which is Gen 3-plus technology. It's the safest technology that exists that's out there on the market today, has entirely passive safety systems. So as you look at events like what happened in Fukushima, that's not something that's going to happen with this power plant. And there has been a lot of interest for that high megawatt per square foot output that those plants offer in Eastern Europe. We've had interest from Poland, Bulgaria, Romania, Czechoslovakia, and Westinghouse over the past 12 months has entered into numerous memorandums of agreement and strategic supply agreements with those countries and operators within those countries to eventually deploy those technologies. Poland requested a -- that we complete a budgetary RFP for 24 RCPs recently. And with the desire to build out 6 plants in Poland, they have a publicly declared time line of wanting to have that power on the grid in 2033, back that up to hard concrete in 2028. That puts an order. Typically, we would receive our orders before that hard concrete 40 months in advance that could put an order in the 2024 time frame. We said 3 to 5 years just to be conservative. But if you know from that business, the last time we sold an order, and we're at the tail end of that contract is $28 million per RCP, a $450 million contract for 16 RCPs, very, very profitable business. We said 23-plus, plus percent margin. That's as far as we're willing to go with our disclosure on that. So if you think about 16 RCPs at 450, 24 RCPs would be much more. So -- and Westinghouse is doing a lot of things to align itself and with EP&C construction to set themselves up for this landscape. And as Lynn had pointed out, there's been a lot of reasons to move towards this technology not only to meet our carbon-free emissions, but for the power generation stability, for where we're heading in our needs for power, but then most importantly, since the conflict broke out, energy independent. So that could pull that time line up. I think it's a very exciting time for that technology and it could be a lightning rod to Curtiss-Wright's organic growth here in the next several years.

And Chris, I just want to follow up with what you said about the order activity. So are you saying that you expect an AP1000 order in 2024?

I'm saying that there's a possibility that you could see one as soon as 2024. I think that the time line for construction, if Poland keeps to what they have publicly declared, that's when we would expect an order. But we've known from working in the industry for a very, very long period of time. They never quite moves as fast as you wanted to. So we've said 3 to 5 years is what we came out within our February call.

Okay. And then when we look at the last AP1000 here in the U.S., I mean, Westinghouse U.S. really struggled with that. How is Poland approaching the E&C portion of the build differently than what we've seen in the U.S. event their programs from experiencing the same type of cost overruns that we've seen in the U.S.?

Well, I think one of the things that's really interesting, and there's been some MIT studies that have been produced on nuclear power and construction. And if you back up to the Gen 2 technologies, and these are first-of-a-kind Gen 3 technologies that are getting built here in the U.S., and we've got over 500,000 hours of operation on the plants that are over in China. So I think it's really just a matter of accelerating through the learning curve and establishing these plants, and that happens very, very quickly. So the first time you produce whether it's an aircraft engine or whether you produce a reactor and obviously dramatically different technologies, but there's a steep learning curve. And I think that setting up those EP&C construction contractors and Hitachi's 1 and then also BPMI. They've got years of experience in doing this and just getting far enough ahead in advanced planning I think, is going to go a long way towards ensuring that those plants go up faster and much more cost effectively.

Great. Thanks Chris, for the color. And Lynn, maybe now switching gears to supply chain. I mean you've highlighted supply chain disruptions, particularly in defense electronics. In the last call, you talked about potentially this easing in the third quarter. Can you give us an update on what you're seeing for the supply chain?

Yes. So honestly, we've seen the supply chain situation bouncing back to normal at a slightly slower rate than we anticipated and have continued to see some decommits still going on in the third quarter. We are seeing good signs, too. I mean some lead times are coming down. We've had a few times where people have told us they can pull in material earlier than they had previously anticipated. But I really did think we would be pretty much through the decommit period at this point, which is just the part that's very disruptive to the business because you've laid out plans and you don't get all the parts you want to make things. So it seems like this is going to carry on. I know I listened to other people who talk about it, and I think it's going to carry on into 2023. It is stabilizing. I do want to emphasize that's the area of the business, the other supply chain disruptions elsewhere in the business. but that's really our focal point of where we're seeing revenue impact in this year. And hence, we lowered the defense electronics guidance in the last segment, largely driven by this. The business is healthy. It's really executing on its strategies and winning new business. This is all timing of revenues. We don't feel any of this is lost revenue. So that's the positive side, while we do continue to work through this. And I don't know, Chris, you've got some statistics, maybe you could throw some color on that.

Well, I agree with you. I mean this is really just a matter of the availability of electronic components. It's not a resource constraint. I think earlier this year, when we first started out, there was a little bit of concern with the continuing resolution going 180 days. We did see some delays in orders. I think when the continuing resolution ended, the orders came back at a rapid pace, slowed down again, not saying that there's a direct correlation between government defense outlays and what we were experiencing in the first half of the year, but they certainly were down in the first half year-over-year. We saw some improvements in July and August. And we've seen some very encouraging order patterns in these businesses. So backlog is strong. Fundamentally, these businesses and the orders are there. It's really just whether or not those components come in the door and it's a dynamic issue. So it's timing, and we're working actively with our suppliers to understand when those components are going to be coming in the door. We had some encouraging things happened in the month of July, where we were talking to suppliers. We saw decommit rates decline. We saw some key suppliers of critical electronic components come back and actually accelerate schedules. So something we hadn't seen in the past 12 to 18 months. But it is truly a dynamic issue. There's a lot going on there. And as soon as that material comes in the door, we're ready. We've been putting capacity in place, whether that's key critical resources and material handling inspection. We bought test equipment in certain areas to eliminate potential bottlenecks. We're preparing for a big ramp. We normally have one in the fourth quarter. This one will be certainly bigger. And we're optimistic that we'll start to continue to see some more positive signs that this issue will alleviate itself, probably not going to completely go away. We'll likely see this until the middle of 2023 and I don't know that the lead times will ever get back to where they were prior to that time.

And I mean we're hearing about chip shortage for a while. Can you share with us any color in terms of the source of the problem for your suppliers? Are they facing material issue? Is it a labor constraint? Is it capacity? Why are they struggling to meet the demand that you have? Because I mean -- and by the way, for the defense industry, right, defense demand didn't really slow down during COVID. So why are they surprised that there's more volume demand?

I think it's really the commercial sectors and the amount of electronics consumed during COVID isolations and stuff is just absolutely driven the demand to them that they have the same capacity they have. They have lost significant impact capacity. I'm sure struggling with staffing as most companies are to ramp up and to increase output. But again, I think there's early discussions and data points that commercial demand has started slowing should and that should ease up capacity and make it easier for us to get our time line. So again, we -- it is trending in the right direction. And one thing worth commenting on is with this in this dynamic environment, the team has really done a good job with our customer base and making sure we understand what's critical to our customers to get products to the war fighters and we're driving our priorities that way. And the team has done a good job on that. So the most important end aspect of this as we work through the situation.

Thank, Lynn. And on defense, we saw the '22 budget. We saw the initial 2023 budget. I mean we're seeing growth on top of the U.S. domestic growth, I think folks are saying '23 budget could be up 8% to 10%. And then we also have the European defense spending that could potentially increase as well. Can you help us understand where in your portfolio you expect to benefit the most from all these higher funding and plus-ups?

Yes. So it's really great team what's going on with the commitment to defense budgets here and more across the NATO countries. And I'll just started in the U.S. that the President's budget that he submitted for 2023 is up 4%. The markups have it up another 4% or 5%. So high single digits growth in the defense budget. And again, that's great. We also going to look where that money is going and a lot going to RDT&E and to procurement, which is right where we win our business from. So really good growth across the Army, the Air Force and Navy, I think has the highest increase in procurement. That's the biggest portion of our business. So it's good to see that being foreshadowed. So good budget increases and good for us across aerodefense, a lot of electronic warfare and ISR systems, which fits right into our defense electronics suite point in the army. We continue to see strong support for the network modernization, which is important to our PacStar team. And so really good alignment with where we're winning businesses. And of course, the Columbia cash remains the highest priority across the DoD and strong support for the ship facilities. So that's very solid. When I look at the commitments to increase spending across European countries that's good for Curtiss-Wright in 2 different ways. We have a European footprint of businesses in Europe that do business directly with the European defense industry. And largely, those businesses are tied to ground vehicles, which has surely come into a spotlight of the criticality of maintaining that for the protection of your country. And as that's -- a lot of that money will be spent indigenously across the European countries. I think we have great relationships there to benefit from that for the ground vehicle build-outs. We have press releases with Rheinmetall that we've built a very strong partnership with that is going to really be the backbone for us being able to scale there. And then there's also things like many of those countries are talking about buying F-35s. And that money comes through the U.S. to us, but kind of the side aspect of that is, as the different countries have F-35, they want to set up their own flight test program. And that's really good business for Curtiss-Wright from our TTC acquisition a handful of years ago. So there's really -- I look across our portfolio and really see good dynamics internationally and nationally that should provide this very strong growth in the middle of this decade and beyond.

Great. And on the shipbuilding side, when we look at the Virginia-class submarine build, it's pretty steady. You mentioned Colombia. That's an incremental step-up. And now we've got this August, right? Where you've got the Australian submarine instead of buying from the French is going to be the U.K. U.S. quite controversial from what I read to this change. What does that mean for Curtiss-Wright? I mean, are you guys providing the reactor coolant pumps for these submarines? What's the contract structure? What's the opportunity? And when do we -- do you think we'll get more details on what this partnership actually means?

Yes. That's really -- I mean, for our Navy business, which is a pretty steady low mid-single-digit type of growth, this really stands the chance of taking that business and really accelerating the growth. They're talking about buying 10 to 12 of those. They have not declared yet whether it will be a Virginia or an astute I mean, Virginia is a more modern sub. So there's a lot of conventional wisdom that says it will be that. . We're very public that our power plant content on Virginia is $75 million. And so assuming that is the power plant that is part of the sub, that's a real good, solid growth vector for us in the back part of this year. So there's -- they're required to put forth the plan by the end of first quarter 2023. So there's really not been a lot that's been publicly declared about how they're going to implement this. And so -- but I think that's going to become clear in the next 6 months, and we feel really good that that's going to be another growth driver for us going forward.

Okay. And Lynn, this $75 million that you mentioned, is that just for this year? Or is that the total opportunity per...

Sorry, that is the content per Virginia sub for...

[indiscernible] over it.

Yes. And they're building them continuously. And so if the quantities went up, that's a significant more business for us.

Okay. Wonderful. And then when you look at the commercial aerospace business, I mean, you've got growth in defense, but you've also got significant growth in terms of the recovery of the aerospace cycle, and then you also have some opportunity industrials. So first on aerospace, can you provide more color on what you're seeing in the rebound of the market and remind us your exposure narrow-body versus wide-body and when you expect the market to recover to prior peak levels?

We've really been pleased with what we've seen across our commercial aerospace business. We're seeing really solid growth in both our shorter-term and our longer-term business. So it seems very solid both across narrow-body and wide-body. Our narrow body is 60%, our wide-body is 40%. Is there a difference in profitability? No, not really. So I mean, they're both really in the sweet spot where we think that business should be. Our order book is up 30% year-over-year in our commercial aerospace business, just as a proof point of what we're seeing in that space, and we feel really good about that. But not to just only focus -- our focus is growth and long-term growth. And some things that are going on in that team that are going to be more than maintaining our content on those platforms and as they rebound in 2023, '24, '25 for wide-bodies to be more than just riding that rebound growth, which is great, and we love it. But we announced that during the Farnborough Airshow for a win new actuation system with Airbus on the A350. This is a new class of business that we've never done this type of work with Airbus, and we see it as an on-sight into really being able to expand out our footprint and the type of business we build -- we have with Airbus. So we're really excited about that as a growth accelerant in that area. We're working with them on their UpNext program for the wing of the future. So that's much more long term, but it shows the kind of capabilities we have that we're a valued supplier on a program like that. And we also announced earlier this year our win with Eviation the first all-electric aircraft to really make sure we're positioning ourselves for content on the commercial aerospace of decades to come and doing the work today to be positioned for that. Maybe I'll have Chris talk about the general industrial.

Sure. The -- well, when you look at our general industrial markets, I mean, they're benefiting in a couple of different ways. First, it's a bounce back from the pandemic and second, with the infrastructure bill, there's been an increase in need for construction vehicles. But then there's also some longer-term trends in just simply the electrification of vehicles that we're benefiting from. This last year, in 2021, we actually doubled our order book. It was a record high for orders. And entered into this year, and the order book has been very strong. It hasn't been quite as strong as what we saw this last year, but still much better than where we were in 2020 and back at that -- comfortably those 2019 levels. I think as we look forward in this market, this year, we're growing in that 6% to 8% range, our second fastest growing market. And we've got some kind of interesting alignment, I think that's helping us with that growth rate. I know there's some difficulties in these markets in different geographic regions across the world. But as you look at our business and break that down, we've got a good concentration in on-highway in Class 8 and Class 7 vehicles, but we're mostly concentrated in North America, where the growth rates are still good. When you look at off-highway and construction and ag, we're mostly in North America and Europe and rates are good there as well. And that vehicle market for us is growing at the high single digits this year. Now we also have kind of an industrial automation and services portion, which is maybe about 1/3 of our overall general industrial market, and that's growing above GDP mid-single-digit rates this year. And so very pleased with the direction of that market. I mean, obviously, we're watching our order book very cautiously. There's a lot of talk about recession and being prepared for a recession. We're in close alignment with our customers, the likes of Caterpillar, Allison and John Deere and hearing what they have to say. And we think that between the infrastructure bill, the trends that are happening within the electrification of vehicles, and we're really well positioned. And then I would only add that as you look at Curtiss-Wright throughout our history, this has been a very, very agile business. We faced recessions in the past and have been able to do remarkable things to preserve our margins. And we're always preparing thinking about the next step and we'll have that recession playbook in hand should something like that happen. But right now, all indications are very stable.

Chris. And Lynn, the A350 win that you mentioned, I'd like to go back to that because it's a little bit of a surprise because it's a mid-life of the program. How did that come about? How did you expand your market share and win that new actuation system for the A350?

I think they wanted some upgrades to the cargo doors to support larger and different-sized cargoes. And so it was a midlife redesign. And we had been working our way. Really, if people who have listened to our calls, we've made comment over the past year that we're really working to increase the types of business we can do with Airbus. And so wanted to press releases, they were very supportive of it as a real first step in the ground on some really major new subsystems that we hope to build with them on future aircraft going forward.

Great. And maybe on capital allocation, since 2016, you guys -- the 6 of the last 7 acquisitions have been in aerospace and defense. When you think about future acquisitions, what's the balance that you're searching between industrial, aero, commercial or power? And how should we think about that?

So we definitely -- and broadly speaking, we are very clear in stating our top use for capital is target M&A, but very disciplined M&A to -- we've added Safran to the portfolio, as you said, in other defense products. So we like defense properties. We like defense electronic properties. It's our most profitable portion of the business. So that's definitely a focus. But I think really something that has a little strength for Curtis-Wright is having these different end markets, we can look at acquisitions across various end markets and really pick out the gems that are in different end markets and we're not limited to one space. And so we look across our end markets as we build out our nuclear footprint and see this great-looking future for our nuclear business, adding properties that would help us win content on these Gen 4 plants is something we'd be open to. As Chris just talked about, our electric vehicle content is something we see an absolutely great future for, building out capabilities there is something we would look for, specialized technologies in commercial aerospace, things that we'd really own the IP and also products there, a lot of times you can take them to commercial aerospace and the other end markets, which is something that we've put a lot of work in on the past 1.5 years, is really making sure what we have technologies that were initially developed for one end market, but have applicability elsewhere. We use our sales footprint to make sure we try and see if there's a new market to take those technologies for. So we really like technologies that we can sell across multiple end markets. So that's really kind of the thinking. And then clearly, we have to be able to see the financial fit that they're going to be able to maybe not on year 1, but in the near future, be accretive to the financial targets that we drive forward in our organization.

Great. And how's the M&A environment we've seen from the Department of Defense a bit more M&A commentary, do you think that hurts your ability to close some of these deals? And if you're not able to find a target, how important is share buyback.?

Yes. So I really feel like Curtiss-Wright largely will be not impacted by some of the restrictions that we've seen with some of the deals with Lockheed and not to go into them where they put up road blocks. I don't -- I think there's lots of targets out there that we would not have that kind of obstacle. So I don't see that as being a blocker to us. The summer is always a little bit light in deal book activity, and that was true this summer. But really part of our approach to M&A is not to just wait for books to come through bankers, but to continuously work with companies that are in private hands and have them when they're ready to sell the side just to give -- to work with Curtis-Wright in an exclusive manner. So that's really our focus. And I do think we've got an active pipeline. We've got properties where -- and diligence with right now. And I think we'll continue to bring properties across the pipeline. But as you've seen, we're big believers in share buyback, too. We've been very active over the past 2 years, $350 million last year alone and $200 million in the year of the pandemic. So -- and it's not an either/or kind of trade-off. That's not how we think of it. We're really thinking of the cost of capital and the best use of capital and bringing value to our shareholders.

Well, wonderful. Well, thank you very much, Lynn. Thank you, Chris. This concludes our Curtiss-Wright presentation this afternoon.

Thank you, everyone.

Thank you.