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

Good morning. Thanks for joining us for our Ninth Annual Crédit Suisse Industrials Conference. I'm Brian Markovich, the North American Industrial Sector specialist. I'm pleased to present the management of Howmet this morning. With me is John Plant, Chairman and CEO; Ken Giacobbe, CFO; and PT Luther, Vice President of Investor Relations.

So let's just kick it off. Let's look at the industry environment. John, maybe you can start us out by summarizing the last quarter you reported? And then maybe some broad assumptions behind the overall preliminary 2022 revenue outlook of plus 12% to 15%?

Okay. So our third quarter, we consider to be quite positive in the fact that we said that was going to be the inflection point for Howmet in terms of moving to a growth phase. And indeed that did occur with revenues increasing and with commensurate healthy profitability putting us in the, I'd say, top decile of aerospace supply companies. And then we guided for the fourth quarter with, again, continued growth for this year and then also was bold enough to give a very preliminary, I think I called it guesstimate for 2022, and really that was to try to frame the bigger picture for the aerospace sector. So yes, I'll leave it at that and let you ask supplementals as you feel appropriate.

Sure. Maybe on the recovery, can you comment about the pace of recovery you expect in each of your businesses and just kind of the nuances around how each one is going to recover in your mind?

And So first of all, let me paint the bigger picture is that we did or I did say that we anticipated top line growth next year of between 12% and 15%. And it was a, say, fairly broad bandwidth. And I said we would finesse that for the company as we move into next year and report our fourth quarter and provide guidance in early February. Within that, what we do see is that the Engine business, which is the first mover in our business segments, will continue, I think, to improve next year. Within the confines of the first quarter will be fairly flat sequentially compared to the third and fourth quarters due to the particular features of the industry, which I'm happy to comment on and then move rapidly through Q2 and the second half of the year into further growth is what we anticipate. In terms of aerospace, we expect as our structures and fasteners business will follow that. Previously, I had said that, I thought fasteners would begin to show improvement in Q1. I think I called that out in the summer. But given, I think the circumstances around the 787, in particular, I chose to say it is possible that, that might be moving towards the back end of Q1 or into -- even into Q2 now in terms of a revenue move for that business. So that would be the sequence through. So engine first, structures and then fasteners before a broad-based, let's say, commercial aerospace recovery and growth, particularly starting, and then further improvements in Q2. So the bigger picture is that the inflection point occurred for us in the third quarter. So third and fourth quarters, again, good positive growth year-on-year and sequentially a little bit of a pause in the first part of next year following 2 quarters. So I think it's really an outstanding growth and then further recovery as we go through 2022. And that's based upon both anticipated aircraft build increases, there's also some recovery in the spares markets that I'll be happy to talk about.

Okay. Can we talk a little bit about the aero side, just the OE build rates that you're kind of building into your assumptions for '22 on the 737 MAX, the 320 and the 787?

Yes. So clearly, the critical feature of growth next year is the improvement in narrow-body builds, which we expect to be very significant. I'll start with Airbus because that's been a rather more solid picture of both, I'll say, holding the line at a certain build and then improvement from it. So in the case of Airbus, at the onset of the pandemic, they, after a week or 2, paused production. They called out a rate of 40 for the A320 and 321. And then they also said that, that would change in the summer of 2021 to 43, then to 45 and continue to show improvements in 2022 through, I think, it goes 47 next and then by mid-year -- into the midyear to third quarter in terms of 55 rate per month before further goes again in 2023. I think the maximum they called out on their skyline is currently 64, but with talk and indications that they may want to increase that into the mid-70s going forward. So clearly, moving from I'll say the 40s through to the mid-50s is a very healthy increase in revenues for us on the Airbus narrow-body aircraft. I think the other feature is we'll see the launch of the extended range 321 in early '23. So that gives us further impetus for growth in the future. On Boeing, it's been a difficult -- more difficult picture because the pandemic impact was also overlaid certification issues that I think everybody is very familiar with. So we started this year at a build of 7 per month with that increasing to 14 per month in the second half of the year. And it is anticipated that will go to the early 20s and then into the early 30s by midyear of 2022. And that's the assumptions that we think are balanced and feel fairly secure in those given the, I'll say, load factors, particularly in the domestic travel in almost every jurisdiction of the world.

Okay. And about the 787...

787, of course, is its own, I'll say, story, which is, again, the market overlay of international travel, but then with some very specific problems regarding certification or recertification of that aircraft. The original plan was for that to be cut to build a 5 per month in the second half of this year and then that to continue into next year, but there be some recovery there afterwards. In actual facts, what's happened is that the anticipated recertification has not yet occurred. I felt confident that it was coming. So I felt as though the issues that were reported from a particular Italian supplier in early summer have been essentially overcome and concluded. But it seems -- and then that was going to be followed with broader questions about the -- what state was the supply base in given the, I'll say, lack of certification of certain componentry that had been supplied from that Italian supplier. And that was worked through. In fact, how much was selected by both Boeing and the FAA for an audit, I think we were selected because we were expected to well. We completed that last month and showed after 3 days of intense audit, we passed with flying colors. So that was another good step in directing for both Boeing and for the FAA to gain confidence in the support of Boeing from the supply base. And then, of course, more recently, we've read some press articles concerning pigmented doors on that aircraft. And so it's become a little bit more clouded. So instead of that recertification happening at the back end of this year, I think it's more likely a Q1 issue. And therefore, the build that was anticipated was cut from 5 down to 2 in the fourth quarter of this year. But given the current problems, I mean, we know that -- certainly, as we see it, they had 90 days of 0 builds, and then they will start to start back up. And so we're not really sure exactly where it's at the moment. Clearly, compared to the componentry that they had ordered, there has to be some form of inventory correction during Q4 and probably Q1 of next year. And that's why I chose to say for our fasteners business that we would possibly see another couple of months delay before recovery.

Okay. Maybe we can shift to the commercial aftermarket or your aerospace spares. Can you talk about your expectations there, the latest COVID variant might throw a wrench into the recent reopening of the skies, but your thoughts on growth in 2022? When do you think commercial spares will be significant for you guys again? And what kind of visibility do you actually have into that market?

We started to see growth in the third quarter of this year for the spares, and that was across regional jet business, jet and also single-aisle. So that was positive for us. It was a significant percentage increase. But given the very low denominator in terms of absolute dollars, it wasn't something that we'd want to shout about because it was not significant in the revenues of Howmet. We expect that to continue to show improvement from that very low level in Q4 and in the first part of next year. But in terms of the question you asked, when do we think it become more meaningful, that really is more towards the second half of next year. And that's based upon the continued, I'll say, very robust, say, flights on narrow-body for domestic use around the world. But also, I think, as we all know, international flights have also been recommenced in many, I'll say, for many countries and continents, which is very positive. On the other hand, and therefore, we were thinking that's very good for us because to have the wide-body spares market begin to pick up had been very helpful in addition to the freight market. But Omicron, I don't know what it does. I have a view that says, I'll say, rather than uninformed view, I'm going to say, is a rider to it. but it's probably overblown by coming out in the press day after Thanksgiving, where there wasn't a lot of news. And so it was splashed across headlines around the world. And so we just hear a new word. I mean last, I'll say, 6 months ago, it was Delta, and that's come and seems to be gone. And now it's Omicron, and my view is that will come and go. And I don't see that we know enough at the moment to say it's really going to have a lasting effect on international travel. I don't see it having any effect on domestic travel at all. And so I think we have to try to separate ourselves from very newsworthy headlines. There's shouting from the rooftops about a new name. And maybe next month, they'll come up with something begin with P or an S or a T, it's like think of another letter, and let's splash it, and we get worried over almost over our own shadows at this point. So my view is all it's going to do is potentially at the most affect the annual recovery, but not the fact of recovery. So we need to put things in perspective.

That's helpful. Maybe we'll more over to defense. I think you've you called out a relatively flattish sales for next year given the rate pressures on F-35, but maybe disaggregate that a little bit, talk about where you're seeing growth as well as any other pressure points beyond F-35?

Yes. Well, F-35 is about 40% of our defense sales, so very significant. The rest of the other 60% is very solid and with some prospects of growth in the next couple of years coming from the, I'll say, certainly the re-engining for the heavy-duty rotorcraft business for the military. So that's positive. In terms of F-35 specifically and trying to pick that apart, the last couple of years, Lockheed has significantly underbuilt their original stated production. And in 2020, it was claimed to be COVID related to do with that with more of their own labor. This year, it's a combination of their own labor plus, I'll say, supply position. And so compared to the expectations of builds, then they've been below that. Previously, the anticipated, I'll say, this skyline for F-35 build has been one where it was going to be, I'll say, healthy, similar in 2022, but then declining there afterwards. But then Lockheed put out a plan, which said that they were going to flatten that builds. So rather than take it up and then take it down because they're taking up to high 160s would have been a very significant increase on the last couple of years. They would flatten it more like a 152 build, but I think it is or something like in the 150s. So the implication of that is that for those parts that they've already ordered for a higher level of build for the last couple of years, that I do see the potential for some inventory burn off. And the question is at what rate does that occur? On the other hand, the build itself compared to this year than last year will be higher. And so it's a pretty mixed picture to try and pick through. I did note that the engine build according to will be reduced. On the other hand, the spares content will be increased and is increasing given the numbers of aircraft on the ground through lack of spares packages, both for our own air force and for other country's air forces around the world. And so picking it all apart, ticking it back together, I'll give you the factors which are influencing it. So at this point, we say it's fairly flat, but with our normal seasonality where we'll see the defense sales for Howmet, we always -- is a little bit lighter in the first quarter and first half of the year and always a little bit heavier, particularly in the second half and fourth quarter of the year. This are normal seasonality in use it or lose it basis on military budgets. So I expect that to continue. So that will start a little bit light and then show increasing defense sales of F-35 sales in the back end of the year and then with the prospects of further growth in 2023.

Okay. Great. Maybe we'll shift to the Wheels business. Can you talk about the growth you're seeing there currently? And maybe talk about the larger opportunity for further market penetration in underpenetrated geographies, like Europe?

Yes. So specifically for here and now, there is no growth in that business in the second and third quarters, but it was not that there wasn't fundamental demand for trucks. The issue is one more of the supply chain, and that's the one segment of our business where, while it's not our supply chain, it's Howmet is the supply chain for the commercial truck manufacturers where they just can't get whether, let's call it, silicon or electronic parts or even shortages of glass and tires and resins and so on. So that build, which was intermittent in the second quarter, commercial truck manufacturers around the world, taking down their production almost haphazardly according to parts availability became a more sustained picture in the third quarter where some customers decided to abandon their third shifts waiting stabilization of this -- of their input supply position. When you look at the fundamental order intake, it's actually been very, very strong. So the backlog in that industry is probably the highest it's ever been. And so it gives us a picture of secure growth through '22 and '23 and with the potential of emissions issues to be sorted out in '24 back to even above level not build in 2023. So again, it's one where it's not a lack of fundamental demand. In fact, it's a truly outstanding picture for us. It's just a matter of our specific customers and can they build. Order intakes, I said, have been healthy from fleets into dealerships. Dealerships are actually held off taking orders until the '22 pricing lists are sorted out given the, I'll say, metals inflation, in particular. But next year's demand is very significant. I think it's all a question of what's the supply chain allow in terms of quantities we've built. So our picture is one of, I'll say, cautious start to the year, given I don't think there's anything magical about the 1st of January in terms of supply chain. But then again, an improving picture. So by the second half of next year, would have been truly in 15-plus, maybe 20 months of supply chain issues. And bit by bit, they are being sorted out. Capacity is being brought to bear both by the chip manufacturers and also in other sectors. And so the kinks, which have appeared in the supply chains, whether it's been low-cost country supply positions from Malaysia or Vietnam or China, those are all being ironed out and -- another 6 months. And I think the supply chain issues, which were really caused by, I'll say, the result of COVID where COVID giving excess demand for a period of time or the interruption in the supply chain, it's all being sorted out. And so again, keep the bigger picture in mind and what's currently topical, will begin to go away and they'll start building trucks commensurate with the demand, and we'll all be very happy.

On the truck demand in North America, there's an emission standard change that comes in 2024 and typically you have a prebuy ahead of that. So you could set up for a very strong 2023. Sometimes historically, they've been up to 400,000 trucks. Do you think that that's going to cause a big issue? Like will the supply chain be ready for something like that? Just your thoughts?

Again, it's a big question. I'm not sure as I'm best positioned to answer. I know that Howmet will be prepared and able. And given the margins that we have in that business, it would be truly, I'll say, a superb outcome for us.

Okay. What about growth in the other -- just the industrial markets, energy, IGT? Talk about the growth there, and it's not as big of a part of the business anymore. But the margin profile of that business when it's performing well, does that kind of fit in well with the rest of the portfolio margin lines?

Yes. IGT demand is very solid. We have -- it's the one probably hotspot in Howmet alone, where we've not been able to keep pace with customer demand where we have this unusual position of both good aftermarket sales because of the running of the existing turbine fleets, say, longer, particularly around the use of natural gas because its input price advantage. But then you combine that with a whole new generation of H and J class larger turbines, which are being brought to market. And that basically is a fundamental upside in those gas turbines often with dual or triple-use input fuels for them. But it's the same picture actually for aerospace, where with those new larger engines with the increased temperatures that they operate at, with the increased pressures that are involved, and Howmet has a particularly unique position in providing that size of turbine blade for those new turbines. Then it's a good business for us, and we are trying to increase our production, have been doing so this year in each quarter and expect it will continue to improve -- make improvements as we go into next year. The margin profile is very healthy, as you'd expect, going along with the #1 position in the world in that market. And so the question we're asking ourselves now is trying to have a long-range outlook for it to decide at what level of increased investments would be appropriate for that part of our -- for our business. Oil and gas is actually still been given the price run-up of oil, we thought it would have started to pick up a little bit more than it has, given increase in rig counts that have been going on, I mean we still are far less than we had in 2019. But our expectation is with -- even though oil has been volatile in recent months, peaking at just above $80 for West Texas and now in the $60s, is still much higher than it was a few months ago. And so we're optimistic that there may be a positive outcome for our oil and gas sector. But again, we're currently thinking we shouldn't plan on that. We're just hoping that it does.

Okay. Maybe we should move to the supply chain, the labor markets. As the aerospace market starts to pick up, both on the OE and the aftermarket side, just for Howmet, is your supply chain ready for the increases over the next couple of years? Do you think the overall supply chain is ready? And then as those things ramp up, talk about like labor -- turnover and labor, are you able to get enough people?

The broad question about supply chain, I think that we will be ready. It's difficult for me to comment regarding the wider supply chain for the whole of aerospace or surrounding narrow-body. I'm sure it's something that both Airbus and Boeing are working at sinuously at the moment and are intimately aware of the hotspots that they might face and therefore, we'll be prepared to commit both resource of people and money to address that. So I have no reason to believe at this point that the industry will be able to pick up to the stated rates as the mid-50s for Airbus, for narrow-body and in the 30s for Boeing. Turning to the specificity of the labor question. We've recruited in the last quarters of net 800 people. To get 800, we've had to recruit more than that because of natural wastage we have in the company even now. About 65% to 70% of those people have been people we've recalled either under recall rights from a union contract or recall people who previously worked with the company. And therefore, it's a 30% to 35% being fresh labor to Howmet. So far, we have not experienced any undue problems in recruitment of labor. Now whether that's because there are industrial workers or the aerospace sector rather than service sector employees, I don't really know. It did require us to change our base rate in a couple of plants to address the very low base rate issue, but it doesn't change the labor profile of cost for those plants and also the recruitment methods that we're applying. And so we've increasingly modernized ourselves in using social media for recruitment of labor. And that, combined with any rate issues that we've done and incentive arrangements, have meant that we've had no issues in getting that labor so far. And now does it continue? It's always -- it's a future event, so we don't know. But at this point in time, we have not experienced the labor issues that are reported again in the press. And I'm sure that they are real. But at the same time, how significant they would be for a relatively higher paid sector of the economy, I don't know. So we shouldn't extrapolate from news headlines, neither for labor nor Omicron in terms of [indiscernible] it's doomsday scenario, it's not. So I'm Mr. Optimistic.

Yes, yes. That's great. I think we're talking in on time, maybe if we could sneak 1 in on capital allocation, just debt paydowns or shuffling of the term structure of the debt, maybe you guys can talk about that a little bit?

Yes. I feel as though we've not only paid a lot of attention to our profitability and addressing the cost base to gain a margin, which at this stage of the business, to be in the, say, top decile of aerospace companies. We also paid at the same time, a lot of attention to our balance sheet. We've been able to do so because of the very healthy cash flows of the company, which I did comment, would be further improved next year. So we've taken the opportunity to pay down a significant amount of gross debt this year, getting close to $1 billion there. We've also refinanced part of our debt structure to meet the opportunity of a lower interest rate environment and also neutralized any premiums by just further debt pay down, so that the interest carrying costs are some, I think, $70-plus million less on a run rate basis, which I think is good and obviously helps our earnings per share calculations going forward with our free cash flow yield. Over and above that, we've also taken the opportunity, I think, over 200 million, the exact number Ken probably has, but maybe it's quite a bit more than that, but $200-plus million -- maybe 250-plus million share buyback, plus we've reinstated the dividend. So we've been very active on debt pay down, refinancing, reterming debt, improving its profile, reducing its carrying cost, buying stock back, reinstating of dividend. So great of activity. So maybe, Ken, you could comment on the exact number through the third quarter?

On the share buybacks, 225 million year-to-date through the third quarter.

Okay. And with that, guys, I think we're out of time. So...

Brian, thank you for your questions, and look forward to chatting again. Thank you.

Thanks, guys. Have a great day.

Thank you.

Bye-bye.