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

Great. Welcome back to the aerospace defense track of the 2022 JPMorgan Industrials Conference. Seth Seifman, the U.S. aerospace defense analyst. And we are very grateful to have with us management from Howmet, and we have John Plant, the CEO; and Ken Giacobbe, CFO; as well as PT Luther from IR. And I think maybe John and Ken, we'll just jump right into the questions. Okay?

Sounds good.

Thanks for being here. I think maybe -- since I've been getting lots and lots of questions about titanium over the past couple of weeks, maybe I'll start off and ask you a bunch of questions about titanium. And they're all pretty much variations of a similar question, which is how should we be thinking about what happens here as Russian titanium becomes unavailable to Boeing and Airbus and other aerospace manufacturers, and what type of opportunity that opens up for Howmet.

Well, clearly, the opportunity is there. It will probably be phased in over time, assuming that the sanctions on VSMPO in Russia continue. And my assumption is that they will. If not the sanctions and the quality certification has been withdrawn. And so it makes their products unavailable for use to say, to Boeing or to Airbus. I mean, it's possible they may find a way around those certification issues, but I doubt it. And also maybe there would be some form of backlash if I say -- that was circumvented the rules in some way. So my assumption is that there will be an opportunity. It's probably going to be influenced by the degree of inventory held at the aircraft manufacturers and the sub-suppliers. I think Boeing have indicated they have a couple of years or more, how much of that is down to the fact that they had a security stock for titanium? And how much is it due to a lower build rate of 787 and other aircraft. And therefore, those stocks have built up. It's hard to say, but let's assume there's a couple of years of supply there. And of course, it always depends upon the balance of what that inventory may be, how much is plate, how much is forgings, and a similar calculus for Airbus, albeit our view is that the inventory is rather lower at Airbus, and therefore, the urgency may be a little bit higher. But either way, if you think about it, especially if you go into the forgings, which are tool parts, then those have to be tooled and certified rather more quickly compared to the more commoditized plate business. And so at this point, we see the opportunity. We have been in dialogue with both -- with both customers of the aircraft manufacturers. And indeed, other customers that use titanium, whether it's from the, I'll say, engine business or wider in industrial opportunities for us. So it's clear there. Our stance is one where our clear preference or requirement is that we have a long-term agreement with our customers because it makes no sense for us to consider facilizing, recruiting and putting in place supply chain availability from our, for example, our sponge manufacturers to provide it for just a temporary period of time. And so the contracts in our view, would have to be of significant duration. And that generation to commence once inventory is a big in exhausted and volume taken, so that's the dialogue we're in at the moment with our customers.

And how do we think about the difficulty of standing up the capability in titanium forgings or taking on the work that's at VSMPO now in terms of the duration of time that, that takes to establish the capability and get qualified at the level of investment that's required to do that incrementally versus your current investment plans?

I think the good news for Howmet is that there are certain forging parts which are already tooled, and let's say, for the large part, it's only a matter of just doing the last finishing touches to many of those tools before we to bring them into production. And that would provide a more rapid response than possibly thought. Again, it requires certification of the base titanium alloy. And we would be pretty indifferent between using our own titanium or indeed taking titanium from some of our customers' stock, whether it's consigned or sold to us. And so that would be our thought about it. We would not plan to invest any fresh capital neither in forging capabilities nor in our rolling mill because, first of all, those would be very significant capital assets. And secondly, I doubt that's even a multiyear contract will be sufficient for us to feel comfortable regarding the amortization of that capital. And so I think our stance viewed at the moment is it's more likely that we would only be willing to make available and sell capacity, which we have rather than installing anything fresh and deal with this under those limitations.

Right. Okay. And so the likelihood then is probably that the -- what VSMPO is providing in terms of forgings would need to be -- if how that was involved, there would have to be others involved, too. Is it such that it exceeds your existing capability?

It's not certain yet. It probably does. At the same time, I think what you have to print in mind -- into this equation is what size of forging capital assets are required, we do have some quite unique capabilities. So I think it's more in the frame of a national asset. So if you take the 50,000-ton press we have in Ohio, which we used to forge, for example, the bulkheads for the F-35, then it's going to be assets -- an asset of that size or maybe even a 33,000 or 35,000 ton press that would be required to be utilized. And the build time and commissioning time for such an asset would be years, probably 5 years. Just because it has scale, to give you some appreciation of it, it goes down 4 or 5 stories below ground and equivalent aboveground, and it would be hard to dream of replicating that for many years. And so that scale and uniqueness would probably advantage us in many ways.

I'm going to throw this out there, but I'm not sure you're going to answer it. I think Boeing had put out a release some time ago talking about doing something on the order of $27 billion of business with VSMPO over 30 years. So let's say, $1 billion a year round numbers. And I have no idea if that changes over time, or if those are real dollars or nominal dollars or anything like that, but let's say it's about $1 billion a year. When you think about -- not necessarily for exclusively for Howmet, not or forgings or anything like that, but when you think about the opportunity that's out there for alternative titanium suppliers to go out and get, is it on that order?

I guess it must be, if but I don't really know the exact data. Assuming it is of that sort of magnitude, then clearly, we can take on maybe a substantial part of that, depends upon future aircraft volumes, of course. And maybe you've got to get into the splits of narrow-bodies and wide bodies again, and we all know that wide bodies currently fairly depressed. But certainly, it would be an attractive potential opportunity. When I think about our structures business, which is possibly a misnomer that we really do some very sophisticated both forging for, say, structural parts, but also things like wheels or fan blades or even some engine components is that, that business, I think, in 2019 was probably around about $1.2 billion could have been a little bit higher. And last year, it was more like 700 and something million. So clearly, a tremendous downdraft in terms of volume that we've experienced because of the reduced aircraft build. So the important thing is, first of all, we have capacity. Second thing is we've done sufficient work in that business of improving it, both from a structural cost and efficiency point of view. In fact, our EBITDA margins, which were 14% last year, our [indiscernible] is quite remarkable that we're able to attain the same profitability in 2021 as we did in '19 despite that volume downdraft. And clearly, if we are able to put more volume through it, particularly more volume of the same parts, which require no investment, then the opportunity to drive that to where I think it belongs, which is more of a high teens EBITDA business is probably there before us if I say, eventually Boeing, Airbus and some other manufacturers decide to take some titanium from the U.S. and the defense manufacturers do in terms of buying U.S. and maybe this will cause us to have some business of note of scale with Boeing rather than imported from Russia.

Okay.

So it's a long way of saying it's a good business, which should get better and volume can only help. And a bit of throughput when you've put a lot of cost efficiency, you spent a lot of money in terms of preventative maintenance to make sure that during the pandemic, this equipment can run and run well, it's of interest to us.

Okay. Maybe to move to another metal, there's been a great deal of volatility in nickel pricing recently. And it's something that's been all over the headlines, but it's also a place where I know that Howmet has pass-throughs and long-term contracts. And so is there a reason to think about any impact from the volatility in the nickel market on the business, whether that's in aerospace and engines or in forged wheels. But where -- I guess that would be more of an aluminum question, but metal price volatility and the business.

Well, clearly, volatility in any input cost is pretty unwelcoming in any manufacturing business. And just to the point where I thought that maybe we are moving beyond COVID and discussions about Delta variants and Omicron, and all we've got to do is -- all we've got to do. It sounds small, really, but to manage an upturn, which you cannot be pretty exacting in its own right, and how we differentiate ourselves in that regard. Then, of course, comes further commodity input metals inflation and other energy inflation really associated with discrete war. And so it's quite fascinating that how things change, and how you need to react to a lot of other different dimensions as we go into 2022. The impact for us, if you think about the guidance we gave, which was at a midpoint, I think 23% EBITDA margins -- we said those were after taking on the chain maybe 40 or 50 basis points of pass-through metal inflation headwind, which is basically we get $1 of metal for -- metal recovery for $1 of cost. Clearly, in one sense, I'd like to get more. On the other hand, when metal goes down, I have to give more back, so maybe you have to be careful what you wish for. And so my thought really has been with the increases in inflationary conditions, it's just another factor, another headwind to take on. And our thought is still to have what I call the conversation. So last year, we were able to put maybe a couple of hundred basis points of margin and take on the headwind of, let's say, very significant rises in aluminum prices. And obviously, other metals moved as well last year. But now we're in new charter once again. So aluminum's continue to escalate at a fairly rapid pace. Nickel trading was halted a couple of days ago. And it fact a few days ago still is halted, I believe, maybe starting up again tomorrow. And so that's also producing, let's say, input volatility plus rising metal input prices, which then will recover and our recovery escalators range from, let's say, for the most part between 1 and 6 months. I mean there's a couple of outliers, but 1 and 6 months depending upon the type of metal and the, I'll say, agreements with our customer. And so if I take aluminum, which you referred to as originally, we -- given the rise in aluminum prices during the second half of last year, when we repriced for 1st of January, we really advised that in the early part of this year it would be a headwind to that business. Maybe in the second half, if aluminum stabilized or it went down, then it would be actually a tailwind, which would be a nice condition to be in given the very substantial rises we've been in the last 18 months. But of course, it's continued to lift. And so maybe the second half will continue to be a headwind. But at the moment, we're still clinging to the idea that with the recovery mechanisms in place dealing with all the other inflationary conditions, we can have what I call the end conversation, try to go through this, achieve the level of profitability that allows us to hold or improve margins again from last year. Obviously, we'll be reassessing all of this as we move through because nobody today has a crystal ball over exactly where all of these conditions will eventually settle. And if you look at the volatility of oil as an example, from 60 to 90 to 140 was it back into the mid-90s. So I mean things are moving around, it's a rapid piece. Indeed, if you look at the differentiated level of energy inflation in the world, so with Europe being far higher in terms of energy prices and movement natural gas prices than the U.S., it's all to do with self-reliance within the continent. So some quite fascinating dynamics to play, which just means it makes life more to richer, more interesting, another challenge. It's just part of life. So I try to say in like a calm manner, which like is just a fact, just deal with it.

Very, very even, great .

I don't think it to me anyway if I started to get looking perturbed or anxious, which I wouldn't be anyway, but there you go.

Good. Before we move on beyond the metal questions, is there any other question on this topic than anybody has from the audience? Okay. Maybe we'll move on, and let's talk about aircraft production a little bit. We've had various reports out over the past couple of weeks about this. Leonardo, I think, restarted 787 production. Has your expectation for 7 -- sorry, 787 production. Has your expectation for 787 production evolved at all over the past several weeks since the earnings call?

Not really. We await with interest the recertification date or date when each aircraft will commence recertification. Nothing to add to what I said at the earnings call, which is immediately, we don't know. Clearly, we'd like it to be sooner rather than later. So April would be great, but it may be the summer. We really don't know.

Okay. And then on the 37, it seems that the move to 31 a month at Boeing may be slipping further into the year, maybe even into the second half as the deliveries were kind of light in February. I guess are you starting to think differently about LEAP-1B this year?

I don't think so. I mean I'm not sure that what you said is accurate. There's any slippage. So I think the timing or the phraseology was a little bit loose around it will be Q2, which could mean first of April, it could mean end of June. So it's pretty difficult to know exactly. And also, you get lots of extraneous information coming in. So our view has been we'll measure everything off right '21. I heard some comment that overall we built Boeing so they, 27, was it last month or something. I take all these things where I hear a not number thrown out. I don't know what creams to give it or not. My choice of words is such that I know in Q4, we were still operating at about a 10% point right below the stated then bill for Boeing. Thought for Q1 would be to be a similar 10 percentage points below, both for any structural parts and also for engine parts, for say, LEAP-1B. And then as and when it reaches the 31, so I'm still just saying it's middle of Q2, sometime. I don't know where it's early May, late May, but pick that as a date. And at that point, I think we'll probably be more on rate, line for line with a set of parts equals an engine equals an aircraft, et cetera. So that's the thought process. But clearly, there can be variations around that. But at the moment, it seems to be the view is certainly that we're working to it sometime during the second quarter. I'd take no particular note of deliveries in a particular month or not. I tend to look for the good stuff occasionally as well. So there I am thinking to myself because I need to touch on to something, Seth, so I always get depressed talking to you. Just so I throw that out. But just give me a positive line. So yesterday, I read some report that there was an unconfirmed sighting of a Boeing 737 flying through Hawaii in Shanghai Airlines colors that was on its way to some Ireland off Shanghai, where they're going to do something and then sell it. So I thought that's really good news. So that's the start of the floodgates opening for China though maybe they don't have that much domestic travel. That's really good. And then let's -- but the positive side to all this is that, we're all familiar with the issues of the oil price. But if you just think about the impetus not only for emissions, but also a lighter carbon footprint and the need for fuel efficiency and therefore, economics with jet fuel coming off, let's say, $100 a barrel, that's going to really drive in my view, an increased urgency to have more modern fleets of aircraft because those airlines with older fleets are going to find it much more difficult to compete against competitive ticket prices. And so I'm the optimist, there's going to be solid demand. It's going to grow. We're going to go above 2019 levels with the combined narrow body by the end of '23. That's good. I've got to give set a bit of a pep talk occasionally.

You got open path. So I guess on the LEAP-1A, I guess where are you now? And given the lead times, if Airbus is going to be at 65 a month in the middle of '23, when do you need to be there?

Expect I can judge at the moment we are right on rate for both the 1A and the geared turbofan engine. And so the rise to 55 by the middle of this year and 65 by next, so -- because of the way the inventory has played out, I think we are rising now rapidly towards that level. And for 65 to be achieved by the middle of next year, then I feel as though we'll be at 65 engine sets really starting at the beginning of Q1 next year, basically 6 months earlier. So I think that's where we need to be. And that's been part of the thought process. So the hiring in of labor. So as you know, we started in Q2 last year with our process. And by the end of the year, we've net added 950 people, which was -- principally for our engine business. We're seeing, I'll say, very approximately a similar number of 900 for this year, give or take, 100 either side and starting to actually increase our recruitment more broadly. But just being it right back. So I think we're fairly confident in the Airbus rate lift to 55 and 65 and see that as an opportunity. We'll be building at rate higher earlier. And we could even be adding inventory to the system as well over and above that because coming from where we've been in the, I'll say, mid-30s at some point on Airbus narrow-body through to 65. I mean that's a large increase. And also, obviously, there are some of just -- I mean, I think you're aware some of those engines are being updated along the way as the 321 comes in the extended range, et cetera.

Okay. Very good. And then I know it's a small part of the business, but the spares are coming off of a low base. How is the recovery proceeding with oil spares?

I'm on record from the last earnings call saying, I think we're going to see about a 30% increase in commercial aerospace spares this year. So I always bifurcate our spare sales team, defense and industrial, which is, I'll say, the one segment, which we say lumped together and then commercial aero and commercial aero, I think at least a 30% increase year-on-year for the year for the benefit now. Last year, we saw increases in the second half, but a significant increase was such a low dollar value. You didn't really notice it that much. But if we keep knocking in 30% pluses, 40% maybe, who knows, increases during this year and then continued to next year, it becomes a meaningful number. And so it's all, I say it's all good.

Okay. And in the -- out in the spot market, there's been a lot of talk about the inability of forgings, makers to keep up, and we haven't heard any of that from Howmet. And so is there an opportunity in the spot market for you guys to capitalize on some of that?

I think it's possible that some opportunities may come over the next year or so. So when I think about our capabilities at the moment, we -- I think, are in an okay condition for the most in terms of our supply situation. I've no doubt that during the next couple of years, we'll find our moments of stress here or there for certain parts. But fundamentally, given the additional capacity that we put into place in 2 engine plants in -- by the end of 2019, I think we're in a relatively good condition. So far, volumes haven't been such that there is any spot business available. But as these volumes do rise, then I expect that will occur because it always does when either none of parts were provided by one of our competitors or maybe they were mis-scheduled. And so that will occur, but we're not relying on that in our current views going forward. I guess should it will occur, and we can fulfill that would be good because obviously, we price for providing that level of service and capability.

Maybe just to round out the end markets in forged wheels, which is a little bit outside my area of expertise. But as we think about the supply chain for truck build recovering, is that -- is the kind of second half recovery picture that you had for that business still on track?

I think it is. Of course, it's a future event, and therefore, there's always uncertainty. When I look at the production levels in the first quarter that we're just going through right now, it does seem as though we have a little bit more stability in the supply situation. So we are seeing less, let's say, unscheduled interruptions where at the moment's notice that truck manufacturer will not have parts and closed down, and therefore, that's obviously difficult for us to cope with because we'll have the labor, the parts, et cetera, available, which was a really high feature of what we were experiencing, certainly during the summer of last year. I think a combination of some of the shifts have been altered or reduced and put that together with some easing of the supply chain. And so we see clearance of some trucks which were built with our parts. We're seeing a lot of those cleared. And so I think parts are beginning to flow. Clearly, it's still a difficult situation. I read the lead times of semiconductors haven't actually improved. On the other hand, aggregate volumes, I believe, have increased. It's just lead times against delivery. So as it was anything with a consistent effort, then things begin to improve. I think the waning of COVID, certainly the West, but hopefully, globally over the next few months would also help. Our view is by the second half. We will see increased availability. It doesn't mean to say that we'll be in an easy period because I think we'll still be having some difficulties here or there. I'm confident enough to believe that, for example, Q2 volumes will be a little bit higher than we are currently having and again, looking forward to that. And again, how it plays out in the second half, I'm yet to be determined, but I feel as though it's going to be a better second half than the first half. Increased availability will occur. And I think maybe naively, but I'm really hoping that a lot of this is done by the end of this year. And I'm expecting that when the truck manufacturers open their books to receiving new orders because at the moment, they are not taking many orders from fleets because if you were to order a new truck today, you're looking at probably 15 months now, it could be 18 months before you got the truck. So people aren't taking new orders in because like when can we deliver if we are late, are we facing any claims? And then secondly, what's the price of the truck and is what happens to commodities over that period. So that uncertainty is leading to truck manufacturers not taking orders. It doesn't mean to say that they aren't there, and they're needed. So my expectation is that with the increased supply situation -- improved supply situation over the balance of the year, '23 is going to be a really healthy year for us. We won't see the normal pull-through in the North American market from the emissions regs changes for 2024 and in terms of a prebuild because there just won't be capacity to be able to prebuild, and therefore, '24 will be another very solid and good year. So looking out, I just see gradually improving volumes this year, and likely to be followed by 2 really excellent years and '25 is too far out to worry about just yet to think about.

Okay, very good.

And then this we just say you were plug in. We did announce our new 36 pound wheel, pushing the technology front here once again. So again, that provides either more payload or more fuel efficiency. And then we announced the launch of our new cover product, which basically is an aluminum product that goes on the outside of the aluminum wheels fastened by a fastener would you believe from Howmet as well. So that's another good added value for us. Revenue synergies between divisions and then that also -- in fact, the payback for those curves in terms of fuel efficiency is actually half of the wheel. So it's a really good product for us to sell to our customers.

Very good. Maybe John or Ken, when we look at last year, the company converted 10% of sales into free cash, probably do a little bit better than 11% this year. Aero and forged wheels presumably recover as we move forward, which you think would create some opportunities for that percentage to move higher. Is that sustainable kind of nicely in the double digits there to be converting that much sales into cash?

When I think about the vectors of -- for us for cash flow, I have to say they all look fairly positive. And we've made a massive improvement in the drag from our interest costs of our debt structure last year with several actions taken to both reduce gross and net debt and improve our leverage. We're not seeing such an active year this year, but I still suspect we'll do some things which will make further rate improvements there. I think the big thing, which maybe hasn't really been fully appreciated just yet is the massive change regarding the use of cash for our pension liabilities compared to the expense. So 2 years ago, let's just make the math you say, $230 million of cash used against a $30 million expense of USD 200 million cash drag. This year, we've guided you to, let's say, again, let's say, $30 million of expense, maybe $50 million or $60 million, I think it could be $50 million or $60 million guide on cash expense. So going from a 200-plus cash drag to a $30 million cash drag is like, that's revolutionary in terms of the opportunity for free cash flow. So you put those things together, plus I don't think that we need to be spending at the rate of depreciation for capital expenditure, not this year, not next year. And I suspect probably not the year after, but again, it will depend upon the angle of the commercial aerospace recovery. If things get really good, I might actually enjoy that, if I could ever get back to spending 1 to 1 for capital to be -- because if I spend 4% of our revenues on capital, but I'll make it up now, just throw a number out there, if I could do 24 to make the math real simple, then that's a 20% below sort of cash. And I can understand that's good.

I just want to say what about elevated working capital.

Certainly, there's the -- when I think about what's the biggest single item for me to think about in terms of a drag against the free cash flow, in particular, look into next year and the year after, then depending upon the increase in revenues, what's the working capital drag. And so my current thought is that working capital drag will be there, certainly for 2023. And that's the single biggest item that I can see that pulls down some of the other good stuff. I don't think it changes what Seth was driving out and the ability to go through a double-digit free cash flow conversions compared to revenue. But I'm willing to accept that working capital -- on the other hand, I got -- if I have to -- I think I'd enjoy the upswing on the volume. Thank you very much because then that gives me so many other leverage opportunities to our fixed cost base, that again, maybe I'd like that sort of problem. So it's nothing to worry about to put a bit of working capital into a business because I assume we're still bring some efficiencies out in particularly on our inventory side. Yes. I mean it depends upon the exit rate for this year. What will our accounts receivable be in the fourth quarter. Again, at the moment, we're assuming there is a drag because of being more back-end loaded, but that's assumed in the guidance we've given you.

I guess maybe 2 -- we're inside a 2 minutes here so to zoom out a little bit. Now that you're in the CEO role in an open-ended capacity right now, there's been a lot that you and your team have achieved or Howmet over the last 3 years. What are the primary things that you feel like are left to do?

I think, first of all, let me just what -- where are we? I think that we've made a few changes to the team. It's been one where people have be more than willing to step up to the challenges we face. I see a fundamental rise in confidence in the company. And maybe that's also helped with some of the performance side. So when I think about what would I like to see more solidly either guided to or stated, I mean, if we could get to a stage where we're saying, as we have done, but maybe it's more important to say what we will do is how much above aircraft build will we be able to convert revenues at. I think to be able to grow above that is an important thing to maybe clearly be able to articulate that. I think we might have done it earlier, hadn't heard all these turbines in all of the other factors going on with build or no build conditions of certain customers. When I think about the leverage of the company, I think it would be great to see approaching maybe 2 or better. And I think we'll be returning a lot of money to shareholders. And I think our legacy liabilities will be basically in a shape, where there's no drag left between expense and cash. And basically, we're taking on the well-run, highly converting cash machine that is really recognized to be at the forefront of technological capability by our customers. We're making the appropriate investments. So we have an arrangement. Customers are happy and that flows all the way through to our shareholders. And maybe one day, when I have become a little bit older, maybe I won't be around. But right now, I think I'm okay, open-ended doesn't mean forever. At the same time, it's open ended. I mean I always serve at the pleasure of the Board and the shareholders.

Excellent. And so with that, we're out of time, so we'll leave it there. John, I feel better now. Thanks for -- thanks for your help.

Thank you.

And thanks for being here, guys. We appreciate it. Thank you. Thanks, earnings everybody.