Howmet Aerospace Inc. (HWM) Earnings Call Transcript & Summary

Okay. Good morning, everyone, and welcome to the Barclays -- 38th Annual Barclays Industrial Select Conference. We're pleased to kick it off this morning on the aerospace and defense side with Howmet Aerospace. Joining us from the company, we have John Plant and Tolga Oal, Co-CEOs; Ken Giacobbe, CFO; and PT Luther from Investor Relations. So in terms of some housekeeping items, on your screen, you should see audience response questions on the right, I believe it is. And on the left side, should be an e-mail, I think my e-mail, if you want to e-mail me directly any questions during the course of our fireside chat, and I will do my best to answer them. Again, my email is david.strauss@barclays.com. So with that, we'll go ahead and get started. Good morning to everyone. Thanks for joining us.

Good morning, David.

So John, we'll start talking about your guide. So you guided to flattish 2021 revenues. Obviously, you've done a good job breaking it out, you have the tough Q1 comp. But could you run through how you're getting to flat overall, maybe thinking about by end markets, so breaking down aerospace versus defense versus commercial transportation and then broader industrial? And then specifically on aerospace, if you think by the end of the year we're actually above kind of the bottom end of what has been the run rate.

Yes. So first of all, in terms of the first quarter, clearly, in Q1 of 2020, everything was running pretty well. Commercial aerospace was, I'm going to say, going extremely well, with the exception of the 737 MAX, which, as you know, production had been halted. But basically, whether it's other narrowbodies in Airbus A320, 321 and the widebody aircraft, plus defense and some of the industrial markets, they were all doing fairly well. Commercial transportation had shown a small dip in Q4 of '19 into Q1 of 2020. Well, basically, our revenues were at the run rate which gave us the, let's say, $7 billion approximate revenues annually. At the end of March, we did feel the first effects of COVID in terms of our customers closing plants. But -- and when I contrast that to a year on, clearly, commercial aerospace is the sector which has been hit hardest. And not surprisingly, when you put that as part of the mix of sales, revenues are down quarter-on-quarter, Q1 of '21 to Q1 of 2020. The guidance we provided, I just want to make sure it's understood in context. We actually called it baseline guidance, and that meant -- was meant to be meaningful in that we did try to set this is a baseline of what we think. And while it's fairly easy to give guidance for a quarter, currently, thinking out for a complete year is pretty tough when you're in the midst of the pandemic. And I'll say, some of our customers have been quite variable in holding to their production skylines, let's say, over the last year, 18 months. And so it's been particularly difficult estimating what the demand really will be by each customer, commercial aerospace being the most difficult, and that really is affected by the pandemic. And right now, the rollout of the vaccine and not just the availability of the, I'll say, vaccine itself, but also the process to get it to people's arms, the last step in the journey. And so with that uncertainty, leads us to, I'll say an unclear demand pattern both for domestic flights in the various geographies around the world, plus also international flights because of the quarantine restrictions around the world, which is a great impediment to international travel. So we try to give a guide. We call it baseline, and it does imply, if you look at our first quarter and if you just multiply it by 4, then you'd see clearly that the guide for the year anticipates some improvement in revenues per quarter as we go forward throughout the year. And I'll say, significantly, I think they would be higher in the second half of the year compared to the current run rate. It's our best estimate. It's, as I said, baseline for which we gave you an asymmetrical view around it, which was a fairly modest downside with potentially a more optimistic upside, but really depending upon the factors we've talked about. If I run around our end markets and start with defense, my guesstimate is that defense year-on-year will be fairly similar to maybe a little bit up. I doubt it will be quite as good as the run rate in the fourth quarter given that there is seasonality to defense sales commensurate with people, I'll say, spending it or losing it before the end of the financial year by some of the defense procurement agencies and customers. Industrial gas turbines should be solid both for the replacement market and for the OE build of turbines. I'm optimistic that oil and gas does start to improve given the robustness of the oil price. I see it's above $60 yesterday. So that's a remarkable move over the last few months and clearly an improving trend. And then I guess you talk about commercial transportation, which appears strong given the order intake into Class 8 trucks, both in the U.S. and in Europe. So for trucks and trailers, it's particularly strong at the moment. And should that order intake continue at the current rate, then that will lead us to, I think, a fairly strong 2021 and maybe even a stronger 2022 given the, I'll say, almost record months we've had in the last, say, 3 or 4 months for commercial trucks. And then that leaves us with commercial aerospace, which formerly was 60% of our sales going back to 2019 and now some 40% given the downdraft there. And then you probably need to break it apart into widebody or narrowbody, maybe with narrowbody recovering at a faster rate. We are encouraged by what we see in terms of predicted future schedules from Airbus on narrowbody. And Boeing, their current skyline for production does show improvements in production in the second half of this year and then again into 2022. But we're suitably cautious at this stage given the amount and frequency of change of the Boeing production plants that we've seen over the last, let's say, 18 months. And maybe I'll stop there just to allow you to -- say, to respond, David.

Yes. So before we move off of aero, could you touch on the MAX specifically first? How much -- I think back in 2019 -- late 2019, early 2020, you had quantified that as a couple of hundred million dollar headwind. Is that right in thinking about potentially the upside on the way back? I think you commented you're only at low single-digit rates today on the MAX. So maybe just update us there first. And then on the 87, where exactly you sit today, whether you think there will be some destocking beyond what you've already seen given what's going on there with Boeing.

Yes. I have to say, I've forgotten my reference points in terms of the annual revenue we supplied to MAX. I guess I could reverse engineer it while we're talking here from our -- from when it was 50 a month or 52 a month, like multiplied by the shipset value, et cetera, et cetera. I probably lost it when we've seen, first of all, production cease, and then it start back up at 7 a month, albeit when it did start back up at 7 a month in the second half of last year, we were supplying at less than half of that rate given the ability to build that aircraft out of inventory. And it became particularly difficult last year when we saw, I'm going to say, the different schedules by different parts depending on which tier in the supply chain we are. So we saw different levels of requirement, whether we're, say, through the engine manufacturers or through direct to Boeing in the structures area. And so I'm going to say 2020 for us on Boeing narrowbody was a year that we should really try to forget. And maybe that's why I've forgotten the annual revenue, but it was running at 50 -- 52 a month. There you go. I think the second thing you're asking about, 787, was it?

Exactly, yes.

Yes. Again, a difficult picture for Boeing. So on top of the 400-plus planes that are there for the 737, which we're, I'll say, watching every month to see what the liquidation rate of those is to be able to judge the robustness of the future build pattern. Similarly, on 787, there's some, I think, 80 aircraft which are now in inventory with a combination of both the demand for the aircraft, plus also the production issues of trying to cure some of the reported, I'll say, concerns or failures on the aircraft. We've received the latest schedules, which cut the rates, I think, to 5 a month. And so, obviously, that's a significant reduction for us from -- I'll say, it's been a progressive reduction from 12 to 10. So I think it was 7 and now 5. And each one of those cuts hurts us. And I think, as you know, where we've said a composite aircraft on average is worth more to us because our content growth when we go from a -- let's call, a metal-based aluminum aircraft to a composite, our value can double and triple then, obviously, a 787 is meaningful to us. When it's cut in, we'll just see the inventory effect of that as it goes through 2021. And all I can say is that we've taken account of it. It's in our baseline and hopefully feel secure that, that aircraft will back up in production and deliveries will occur over the next few months.

Okay. Great. Switching gears over to the defense side given how important it is today to your business. You obviously talk a lot about the F-35 being about 40% of the defense business. Can you discuss there what you're seeing from the delivery side versus maybe aftermarket in spares and what the outlook there is over the next couple of years as deliveries flatten out for the F-35? And then what else is the other 60% of defense? What else do you -- what else -- what other major programs you have within your defense portfolio besides the F-35?

Okay. So for the F-35, it's one where we've seen steady rate increases through last year. I think those rate increases will begin to -- say, to ameliorate or smooth out such that the OE demand will show some reduction in the acceleration, but it will be steady -- maybe steady to fractionally improving, especially given the production issues due to COVID in 2020. And then progressively, as that fleet of F-35s grows, then there will be increasing spares demand, and we do see that spares demand growing every year and accelerating quite well in the '23, '24, '25 area. And I think the spares demand by, say, '25, '26 will be almost as much as the OE demand today given the due to cycle of the aircraft. So it's a really good program for us and should be a very solid contributor to our defense sales going forward. In addition to that program, we also supply the F-14, 16, 18, 22s, all of those aircraft, and again, not just the -- any OE build is still -- it's the replacement part of the market for us as well, which is quite significant. We also supply rotorcraft engines and, indeed, looking forward to the release of the new heavy lift helicopter and the re-engining of those. I think it's the -- I think it's the big Sikorsky. I'm not quite sure now, forgotten again that one. But it's the -- it's a heavy lift helicopter, which, say, requires a new turbine. And we're very well positioned for that as well and have gone through all the approval process for it. So that's -- again, it's another chunk of our sales. And then -- and basically, for our engine business, whenever there's a turbine, it goes to military. We're pretty much feature on it given our market shares. So there's no other program which is out there as significant as a single entity as the F-35. But I guess neither should it be given the province of that build.

I want to switch over to the wheels business, obviously, had a -- that business has snapped back a decent amount, but we're still pretty far away from what were prior peak levels in 2019. So what's your latest thinking when wheels can get back from a revenue standpoint? It's obviously making great progress already from an EBITDA standpoint. And then obviously, the wheels business is not my area of expertise. Maybe help us a little bit with the competitive landscape there, who you compete with and what the competitive environment look like going forward. Could this business attract more in the way of competition?

Yes. First of all, for the markets, the comment that I made, I think it was in the summer of 2020, that we saw demand returning to similar levels of 2019 by 2022. I think that still holds. And current thinking is that 2023, there will be additional sales over and above that. So we do see us growing through our previous -- just fractionally under $1 billion, I think it's $970 million we exited 2019 with, and by 2023, we expect to be well over $1 billion given what we anticipate to be the current run rate for that business. We had capacitized for the increases. If you remember, in 2019, we put down well over $100 million of capital to allow the expansion, particularly in Europe, where we were essentially debottlenecked for the provision of aluminum wheels to that whole, say, geographic segment of the market and actually have positioned ourselves for some small incremental capacity in both Hungary and also Mexico as we see the opportunity to supply more in the future. For us, the way we define the market, it's not just what is our share of the aluminum market but also is the total truck market. So we always look at what's the penetration compared to steel wheels in both the U.S., Europe and in Asia. And then once we've got the penetration part of the equation sorted, then we look at what -- the aluminum market share. So we follow both metrics very closely. To give you a picture, we expect penetration improvement each year, let's say, 1% versus steel wheels in the North American market and somewhere between 1% and 2% in the European market with, I'll say, potential to grow a bit more given the previous capacity constraints there. In market share terms, we really have a very high market share. So incrementing that is a very small amount. The penetration improvement is probably a more important metric to watch there. In -- I'll say, in the Western markets, we have essentially one competitor which is owned by private equity. And that's been subject to some recapitalizations that have been necessary. That company is also in the steel wheel market, which is obviously contracting and probably having more stress. And then in Asia, there are multiple competitors, most of them being fairly small. I'll say, Chinese companies for the domestic Chinese market were -- for a large part, we operate in a different segment to them, more in the premium end of the Chinese market for both truck and bus. The only other dynamic which I point to for the commercial vehicle market is it's not just the improvements we get from either providing additional payload availability from the lightweighting, which is obviously really important to us. But the other dynamic that is going on is that as we see the institution of electric vehicles, electric trucks to the market, then -- and buses, each one of those essentially comes in with 100% market share of aluminum wheels. So the -- we expect the electrification or alternative fuels to be also a beneficial vector for us in terms of the direction of our sales.

Okay. That's great color. I understand a little bit better now.

Okay.

I wanted to move over to the margin side of things. So you had talked about over the summer that margins would bottom out in Q3 and then improve in Q4, and we should think about Q4 as a pretty good exit rate off of which you would build the -- build into 2021. You just did 22% to 23% EBITDA margins. In Q4, obviously, wheels had a great performance. And now you're talking about 100 basis point step down, I think, on average for the full year. So when we look at it, you obviously have the incremental cost savings, what looks to be some incremental price, potentially a more favorable mix with wheels being a bigger portion of the pie. So I think we asked this about 10 different ways on the Q4 call, but why isn't the EBITDA margin guidance conservative?