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

Good morning, everyone. We're going to get started here with our next victim. Howmet Aerospace, John Plant, Chairman and CEO; and Ken Giacobbe, CFO; also PT Luther from IR is here. So thank you for supporting the conference coming down here. I appreciate it. And as a quick reminder, you have the QR code at your table, people online can also participate in providing feedback. We would appreciate if you could take the time to do that.

So John will kick it off here. So I wanted to run through, you obviously have 3 aero businesses. You've got engines, fastener, structures. Each kind of declined at a different level. During the pandemic, we're seeing different kind of recovery signals out of each of them. Can -- fasteners have started, balance engines, balance structures. Now you're talking about going down. Can you just talk about the different dynamics that are playing out in each of those aero businesses?

Yes. So the major theme running through all of the businesses, I think you can appreciate is the recovery of narrow-body. And so that's consistent. And we have seen increasing fill in of orders even as recently as the last month or so helping a new trajectory of 2022. Given the engine parts tend to be a longer lead time item, then we saw demand start to improve in the second half of last year, trying to get ready for the increases in production as we are another tier behind the airframe manufacturer. And then that continues through then our structural part, which is really, I'll say, fasteners initially. So I think we're seeing the start of those improvements now in 2022. And I think the situation of our structures business is -- while seeing improvements in demand in narrow-body, the specific issues of, I would say, composite aircraft, which would really meet 787 for Boeing. And obviously, the F-35, as we eliminate the inventory overhang that weighs on that business in the first part of 2022. So that would be the picture there. So there is no way we're not seeing the improvement in narrow-body, it's just specifically for large structural forgings then those are current investment to very specific items separate to the recovery in commercial aerospace, specifically Boeing 787 issue followed by F-35.

So on MAX and 787, any additional visibility relative to what you talked about with Q4 in terms of production rates for you guys?

No. The improvements that are here today and that we think are coming tomorrow is the rate improvements for the 737 going from, let's say, I'm going to call it, second half of last year in the 14s now to -- into the early [ 20s ]. And we believe to the 31 rate in the next quarter or two, again, it's always a bit loose. It's never like it's going to be a specific month. And so I'm not quite sure exactly why, but that appears to be happening, and as I said we're getting order infill. It's also noticeable that in recent quarters, the gap between airframe completion and our supply has also been tight. So if we were, let's say, 30% below rate in Q2 of last year, it's maybe got to 10% below rate in Q4. And cautiously, we've said 10% below rate this quarter, but should Boeing go to 31 in Q2 or during Q2, then I think we'll be line-on-line set of -- [ partly was an ] aircraft. And we have not -- we don't have a skyline, but there are murmurings of Boeing thinking about maybe increasing the rates for the 737 later in the year, or early '23 [ back ] and more than I'll say early, I'll say, discussion rather than anything firm. So that would give that clarity regarding 737 as best as we've got it. On 787, less so. The comments I made on our fourth quarter results in early February still hold. We don't have great visibility into when production will effectively recommence for that aircraft. It's hard for us to see if they're really making 1 or 2 a month that stated. But I think as I try to say then, the aircraft is fundamentally good aircraft. I think airlines need it to get the right economics for international travel. So I mean I think it has a great future. We just got to have patience to work through the situation and hopefully, Q2 or is it Q3, the production will commence again. And I think it has to, otherwise, the supply base will shrivel. And it would be very difficult for it to get restarted if it really goes to 0 for a protracted period of time.

So on the MAX, you highlighted that you've been building below Boeing's rate. You talked about getting back. But would there be a period -- would you expect there to be a period, and so when were you actually building ahead or building above the Boeing rate?

If I look at the LEAP-1A and B is a narrow-body engines, it's useful to talk to put things into context. Then you can see already the significant call both for LEAP-1A and for the [ Geared Turbofan ] and to support Airbus production. And so there is no inventory left. And I think if Airbus are to raise from 47 to 55 and certainly go to 65 during 2023, that inventory has to be put back in the system. On Boeing, said for LEAP-1B specifically talking to the engine program, then we are below rate. My expectation, as I said, it will be on rate when they moved to 31. And then the question is where does it go? I think there's a couple of signals we need to have increased confidence. One is aircraft are starting to be delivered in China rather than recertified in China. That would be helpful because I think that will guide the future rate of production. And I think if you get both Boeing lifting and with the increase then we're going to see inventory build because there isn't enough inventory in the system for aircraft manufacturers to have security of building without seeing that inventory in their plants well before the increases are -- as they schedule in. So my expectation is that during the second half of this year sometime, and certainly as we go into early '23, is that we're going to be having to build above rate just because of the future rate increases that are coming. And I guess because I would like to do that, those will be happy times indeed because everybody benefits from a bit of volume. It takes a lot of stress out of the system, and I could do with a little bit less stress.

Speaking of stress, chatter out there about shortages, castings, forgings, just tell us where you are, how you're progressing the ramp up, labor availability, your capacity, how you feel about ahead of the ramp?

So what we try to do, starting really in the second quarter last year was to recognize that the rate increases were coming. And we gave public information regarding the recruitment that we've done. And by the end of the year, I think we exited with a net just below 1,000 people additional that recruited essentially, for the most part of that into our engine business. And so we were trying to recruit in advance to train or retrain where people can recall, so we could prepare well. Further to that, we also took it upon ourselves to build some inventory for high -- fast-moving parts, which you can see in more narrow-body than anything else because we still had inventory overhang on widebody. And so we plan, and I think it will be -- seems to be a good call that we put in some tens of millions of inventory such that we could buffer ourselves for the expected lift that we'll get. And so we've tried to really be able to support our customers as the rate increases occur. Now what do I expect over the next year, 2 years, clearly amongst the tens of thousands of parts that we supply. I wouldn't be surprised it's fine that we have some stretches here or there. I've read a lot of, let's call it, press or commentary around shortages, particularly in castings and forgings. And I think a really good part about that is that now seems to be recognized how difficult these parts are. And the amount of time it takes for us to gain the skills to have the right level of quality, the right yield to give us the rates that we can -- need to supply because producing one of these parts, while it's difficult is actually the easiest part of what's done in the industry. To produce at rates and achieving a yield which is necessary to have good economics, that's the really tough part for these. And when you look at the most sophisticated parts which are -- have multiple cores, which are held within microns inside, let's say, a [indiscernible] and you're pouring and growing multi-metal crystals inside. These are the likely extremely difficult and controlling temperatures throughout all of these castings as they are, let's say, growing on and manufactured then to have that recognition is great. And clearly, because during the downturn, probably people maybe forgot how difficult things were. Skills were lost as labor was trimmed to get the right economics, to survive and thrive during the crisis.

So you did -- at the prior peak, you had about $4 billion in aero revenue. We all talk about volumes getting back to prior peak in '23, '24. But obviously, the mix is going to likely look...

I'm glad you raised that point, David...

What does that mean for your ability to get back to a similar kind of revenues level?

So I think the dynamics are that -- at the moment, I see skylines out there possibly getting total aircraft production, maybe 24 or 25, at a similar rate of 2019. And I think we have to take out of 3 factors within that. So I tried to say last year, but clearly not very elegantly, I try to say things like all things being equal.

We skipped over that part.

Yes. Because I think it's a really important phrase because meaning -- all things being equal means that all of the other parts of our business being the same. And also, all things being equal also means that the mix might be the same. But what I did comment is with the improvements in our commercial economics with the improvements in content and the content for us grows whenever you move from a metallic-based aircraft to a composite-based aircraft. So for example, when we go from the 777 to the 777X maybe next year, then as those wings become composites, then there will be a large improvement in the set value because of the titanium structures and the fastener suites we do plus a different engine, which will be more fuel efficient and therefore, content. So that's how we grow content between price, content and the overall commercial position and share. Then all things being equal, our revenues would be higher in -- at the same time in aircraft production. Now of course, mix plays into [ this all ] because if, for example, there were a few hundred less wide-bodies and a few hundred more narrow bodies within that total, clearly, the fact that they are big widebodies, there's a higher ship set at value. So maybe 3x the quantity of fasteners, but also a different level of sophistication of fastener would be required for 787 compared to a 737. So there will be a ship set value difference. And therefore, there would be less wide-bodies more narrow-bodies would be an adverse mix. So you play that against the other 2 factors. But all things being equal, we'd be well above, David. We have an inside joke with David and myself because David wrote in his report that our revenues are going to be so much superior. And I just -- please remember all things being equal is an important phrase.

I got it now. Slow learner.

And maybe I should speak more directly. I think I'll try to speak directly, but maybe I speak in ellipsis sometimes...

We hear what we want to hear.

Same with me and my wife. I only hear what I want to hear.

The Wheels business maybe touch on a couple of things. The supply chain, aluminum prices and emission standards.

Okay. So I think everybody knows the supply chain throughout the automotive industry, the commercial truck industry and the many other industries have had volatility last year. And whether it's been chip shortages, resin shortages, rubber, glass or even the ability to transport parts around the world because of container availability has produced these stresses. And I think we're all familiar with the huge amount of containers, which have been moved from transatlantic shipments to transpacific shipments, so -- and the rate difference. There's so much going on. So that has caused, obviously, supply interruption to our customers and they've not built, which has affected our revenues. And it's still going on. I mean there are signs, it gets a little bit better because many of those trucks, which are built and ship in part waiting missing equipment now being cleared. But nevertheless, production is still intermittent with down days, a short notice within the, I'll say, that segment. And so my thought is that does improve. The dynamics are such that order intake is actually constrained by customers. They're not taking orders from fleets at the moment because they can't commit to delivery. So if you wanted to buy a new truck, for example, you wouldn't be able to take delivery of it for well over 12 months now. So like I said, why would I take more orders in when I can't deliver them. And also what's the price that I'm going to deliver it at because you commit price and what's the question, what's the commodity prices a year from now? So my thought is, as the supply chain issues ease, maybe as even the shipping container issue eases then things will get better progressively during this year. And again, I'm going to be more second half than first half. And then it sets up '23 to be a really solid year for the commercial truck industry. And then the other dynamic is around '24. There's new emissions regs in the U.S., and those regulations normally caused prebuy. But because there's fundamentally no capacity to allow bill for a prebuy, then '24 is going to be good as well, in my view, and already we see some of our customers talking about very solid 2024 as well. So that's really good for us. It helps us plan our production. And I'm optimistic that conversion will be excellent for that business. In terms of the input price of aluminum, that's the only segment which is affected by aluminum. The rest of the materials we buy essentially super nickel alloys and the parts that go into the nickel, cobalt, rhenium plus, obviously, titanium sponge. But while all have increased the -- increases in aluminum have been extreme. So we've gone from $1,900 a ton of LME plus Midwest premiums in -- let say, as we exited, let's say, 2019 or is it 2020, it went $3,500 a ton at the end of 2021 with a bit of weakness shown in December, but now things have moved on again. It's now over $4,000 a ton, and that feeds through to us. So it's a margin rate issue, it's not an absolute dollar issue. So our plan, which was whatever problem -- because we never give guidance by segment, but we will produce more profit in our Wheels business in 2022 than we did in 2021. The absolute dollars will be higher. But at the moment, it's hard to see that the margin rate will be that much improved, given the fact that while I was optimistic about the back half because metal has moved, again, it's now $4,200 a ton and it can't be helped by the tensions around Ukraine. Well, I think it's more than tensions now. I mean I think some, let's say, tanks are moving. And with RUSAL in Russia, then clearly, the likelihood that aluminum moves yet again. And so unless the Chinese restart some of their, I'll say, production in smelters then aluminum will rise. And so the benefit I thought we would get on rate in the second half may not occur. But it won't affect the dollars, the profit will be there, the cash flow will be there. And so all of that will be good.

Any sense of what that $125 million, was that baked in this year, what that number might...

Well, it's going to be higher, I think. I mean, loosely, I said $125 million plus. I mean, originally, I'd have said $125 million to $150 million, it could be more like. I'll tell you that number when you tell me what metal is going to be 3 or 6 months from now, it seems like a fool's game to guess it at the moment. We're not -- I don't control the oil price nor do I control the aluminum prices nor the Ukraine, but I got to make guidance and all the rest of it. So I just want to tell you my problems.

I'm not going to ask you any question on pricing and what '23 looks like and '24 and '25, but excellent. What I want to get at is...

So no more questions then?

What changed -- what did you do or what changed that allowed you the -- not only the ability to be asked for positive price. What did you do from a -- my view is that quality, on-time delivery, those things had to have changed to allow you to go in and ask for price. And what I'm getting at is how lasting is this? Because the question I always get asked is, these pricing gains can't go on forever.

I mean I don't know why that statement is made. So while, for example, coming from automotive. I did previously, worked for many years, in what was deemed to be a price deflationary industry, albeit, we always took a fairly firm position on price. But most importantly, the more rapid change of technology allowed us to continuously bring new products to market where we were setting new price points [ forth ]. I think the first job of the CEO is to look after the revenue line and the cost line subsequently because I think everything starts with revenue. I don't mean by that, having the right products, the right levels of technology and the right attitude commercially around price and recognizing the value of your product. And I think that's really, really important. So when trying to examine what was Arconic and Howmet because it wasn't confined just to the aerospace market. I saw levels of technological capability, which were very high. And I thought we were truly differentiated. I saw us being able to produce certain parts which no competitor could match. And I didn't think there was any reason for us to reduce price in the first instance. And the more I looked at it and tried to understand. So I think against my responsibility to understand where we're truly differentiated and where we're not, there's all different points in any company and try to get to grips with that and to understand what made us the company that we are or can be. And with that, I was convinced that there was pricing opportunity. And the system that we had inside the company also didn't really focus on it at all. The decisions around it were still buried at a very low level in the organization that didn't have visibility, whereas it's very obvious to me that in the case where the majority of our contracts are on long-term agreements and they come for renewal, then we should be examining each of those contracts or what changes have happened in volumes and variety and also, let's say, the technology we bring to the industry. So it starts with the process change. And I was -- I still look at every quarter for every business what LTAs are coming up. And we have a very active dialogue on how we should position for those. And so I see it more of a process change than anything else. So I don't see why the situation doesn't endure. You see that we were able to do this in 2019 and 2020. And I remember being asked multiple times, well, isn't it more difficult now there's excess capacity and we show we're capable. And then further gains last year and things are tightening at the moment. So certainly, delivery, I think, is going to be the premium. And so there's even less reason to consider deflationary conditions. So when the improvements that we have made, and I really know that our customers have recognized the improvements in both quality and delivery, then that enables you to have some of the conversations that we've been having. So I see it as part of a whole system of not just quality and delivery but more importantly, starting off with understanding the technology and process and differentiation that we bring to the industry. And that's more of what I want to focus on than anything else.

So in the last couple of minutes we have left, I want to ask about cash, Ken can hop in here. So I wanted to ask about guide, I think this year, $575 million, $675 million, is that correct? But pre-pandemic, you talked about $700 million for the company. How do you see the free cash flow power of the business today versus then when you were talking about $700 million. And obviously, the capital structure, pension.

I've actually become more convinced that the words cash machine and how many of the cash machine is actually more apt today than it was then. Because I think the things we've been able to achieve with reterming our debt, reprofiling for the interest carrying costs and therefore, improvements in free cash flow yield from that. If you look at, I think, the quite remarkable change we've made in our both gross and net pension liabilities, we're using very little cash to do so. So we usually start being a small part of it. So I think when you contrast the current situation where let's say, we have $20 million of expense and $50 million of cash flow to support those legacy plans, to [ when ] years ago, where it was $20 million of expense and $220 million or $240 million of cash outflow. Then that was very different. So again, I think the success that we've had of addressing those liabilities, addressing the debt structure of the company improving the margin rate, every one of those things is being very positive towards the cash flow yield of the company. And I think today, I don't think the change which we made last year is yet fully appreciated by the market in that singular move from $220 million or $240 million of cash to $120 million to $60 million what we've guided this year. I mean that's just extraordinary and leads to just cash flowing. So -- and one thing I really like is to see the profits of the company translated into cash because that shows you how high quality those earnings really are. And just for a little bit of lightheartedness, my nickname from previous [indiscernible] was Johnny Cash Plant, by the way. I had the middle moniker, the C in my name is for Johnny Cash. I don't know why I share these things because you only beat me around the head with them later when I refer to you that on the next call.

So the last one I want to hit on, what do you do with the cash?

I want to spend it.

Well, you've done some buybacks, you've reintroduced the dividend. But I think at this point, you don't have any sort of target out there in terms of cash flow return to shareholders, some free cash or anything like that. So just how you're thinking about the progression from here on that?

I mean, clearly, the cash flow we're going to generate this year absents us, having a rush of blood to the head, I see the majority of that going towards completing further buybacks of the company. I think we will consider during the year, whether we should improve the dividend a bit. But again, that will be a very minor part of any cash drag on the company. And I recognize that at some point because buybacks are always -- are they here today, gone tomorrow, they're pretty transitory. It would be useful to try to articulate a more permanent, I'll say, disposition of cash in terms of allocation. But I don't think we're there yet. I think we need to see more evidence of the improvements in the aerospace industry. I think we already gave a lot of detail. I think we provide a level of guidance that is absent from a lot of our peers. And so I think the next phase of our development will be seeing those cash flows materialize in an even improved way, and then maybe a more clear articulation of the permanent allocation strategy going forward.

We see the [indiscernible] response question. It doesn't look like it.

We can -- I'd rather you all just say, [indiscernible]. It's obvious to me.

How many people responded here.

100% certain EPS is going to be above the peers. That's really great. Because I think -- I mean, just the guidance we've given is very obvious to me, it's above the peers.

That's a lot higher.

Yes.

Okay. That's a wrap. Thanks.

Thank you, David. Thanks, everybody.