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

Good day, everyone. Sorry for being a few minutes late. On the Aerospace and Defense track, we have Howmet and we have John Plant, CEO; and Kenneth Giacobbe, CFO. Any forward-looking disclosures [indiscernible] you'd like to make, or should we go ahead.

We disclaim this.

Okay. So, I want to start with one high-level one that I get a lot from people, which is --you get lumped in, I think, with a broader Percept PCP, ATI, among others. How do you think that your technology and products that differentiates you? How should investors be looking at you differently relative to what's happened with PCP in the past when they were public, and we all knew about it what ETI's doing today?

I don't really see the comparison with ATI in the -- I think, technology profile of what we do is very different. The margin profile of what comes out and maybe the cash flow is very different. So, I'm not clear why you say what you do. And so, I think those must be relatively uninformed investors would be my...my conversations are how I compare to what PCP used to do... I mean I can understand more of the comparison to precision cast parts and -- which is very difficult to provide comparisons to -- now it's been in the private domain for, I don't know, 7, 8 years. And so -- but in terms of profile, I mean, they produce investment castings. They're probably #1 in structural castings where we say, second place, we'd be #1 in turbine airfoils and they would be maybe #2. We're both in fast as we're #1. But essentially, when I -- if I give the broadest answer to your question, like how do we think of ourselves. We tend to be either #1 or #2, and we're like 85% of our revenues were in that position. And so quite different to, I'll say, other companies in the aerospace supply base and with 2 differentiated moats for what we do. Airfoils, airfoil, structural castings, other engine parts, which we don't tend to talk a lot about, also our suite of faster products, our structural products in tuning titanium forgings. Again, we provide mill product, again, quite different to most. Okay. You touch on -- and also clear if I look at the margin profile of the company, we -- our growth profile is whether you measure it in total or just in commercial aerospace striding ahead of the industry. Our EBITDA margins are quite respectful in that 22%, 23% range. Our free cash flow yield is high. Probably one of the most important differentiators is the EBITDA minus CapEx. So, I think that's the fundamental differentiator to many other companies. And that's probably an unutilized metric, I think, compared to most. And so -- and the free cash that we throw off, which is available. And our numbers are after everything, including, let's say, pension contributions is only pure generated cash flow from the company.

Could you touch on your ability to hire what you're seeing from your -- in terms of your own attrition how the kind of average tenure of your manufactured production employees has changed over the course of the last how experienced are they today on average versus pre-pandemic?

I think one of the hallmarks of how Matt has been the relatively low turnover in general that we've experienced. The -- I'll say, where our manufacturing plants are has given us probably a slightly below average employee turnover for the bulk of the workforce. Having said that, in the last 2 years, and in particular, in 2022, we did see elevated attrition and turnover mainly from the new hires. So, it hasn't been as from the bulk of the workforce. But in terms of us ingesting maybe 1,000 people in 2021, 70% coming from people who've been with the company previously with either recall rights or people have been employed with us, that was a fairly steady group of labor and only 30% new employees. In 2022, when that flips to more 30-70. We did see elevated turnover amongst the new hires to a point where I will freely admit it was I was unhappy with that. Even so, we were able to hire the exquisite numbers. So, we got the headline numbers, we're very satisfactory in terms of we could hire. But the retention of people having spent the money in the hiring process, the training process, which is normally about 12 weeks, then putting them into a work environment and scrapping off parts of the yield. And then with the elevated turnover ten-departing and it's like Vincent repeat. So, I was fundamentally unhappy with that for the company. And dealers though, to some degree, we left money on the table because of that. Some of it, I will say, maybe understandable in the post-Covid world and some of it, I think that we could have done a better job in screening, introducing employees to the company through the hiring screening, making sure they understood what it was like working in a manufacturing plant or in the heavy metal plants that we have. And it's very different for anybody that's previously been in light manufacturing or in the service industry. And I feel as though we may be missed something there. So, where people generally were saying they were struggling with hiring. We didn't but the quality and retention rates of those new hires left something to be desired. And probably, if I'm going to be self-critical, it causes problems. Having said that, in the grand scheme of things, it's like a fraction of a fraction, really in terms of our results.

And what are your hiring plans for this year? I mean where are you hiring when relative to bill rates, obviously, you guided to somewhat conservative appears to be conservative kind of build rates for yourselves relative to what we're hearing from others. Where have you hired to in terms of being able to accommodate those build rates, how many hires you planned for this year?

In terms of a net hiring rate for our manufacturing workforce, we -- I'll say it 100 was $950 million in 21 million close to 1,500 people net in 2022. And depending upon the eventual growth rate because obviously, we don't know exactly where the production and revenues will land at this point, but somewhere between, I'll say, 1,200 and 1,800 or 1,300, 1,700. So, I think if you took the midpoint similar sort of level to last year would be my anticipation. And obviously, it's also some of us judging what 2024 is going to be, what the run rate into 24%. So, it's a pretty, I'll say, just a generally loose directional number at this point. So, the best way is similar levels to last year.

So, touching on bill rates and your forecast, I mean, we've obviously now heard from Airbus and know what they're playing for, for at least for deliveries for on the bus side doesn't -- it seems like you're fairly obviously, taking into account that you're going to lead them. It doesn't -- it seems like you're fairly in line there. But obviously, on the Boeing side with MAX, it seems like you're conservative relative to what others are saying. So I guess, what are you seeing that makes you take that conservative view?

Of course, I'm not making any commentary on either Airbus or wings actual build rates. I'm really commenting upon what HMS has built into its guidance. And so, I would like, of course, as many engines and as many aircraft we produce as possible. So -- and I tried to say on last week's earnings call is that should the build rates materialize at other suppliers or even some of the aircraft manufacturers have commented on, then our revenues would be higher. And obviously, that would be a good position for us to be in and we'd probably be at the higher end of those hiring numbers I mentioned. But when we called it out, we all heard about Airbus going to 55% and then was at 65% by the middle of the year, which is pushed out as we pushed out again. And so, we called out at about, I think, 53%, 54%, which is sub the 55% level. I'm not sure because it changes every time there's like an update. In the case of Boeing, it's been difficult to really know. When we heard from the earnings call that did reduce production because of if, let's say, 30-something aircraft were delivered, take off that, we should deliver from inventory, there may be only 20 were being produced in Q3 and maybe it's a high number in Q4 in the high 20s, but is that -- it wasn't at the rate 31% and wasn't at the rate of 38% where talked about going to. And so again, we are unsure whether the lift that maybe occurred in Q4 were that's sustainable in Q1 and Q2. So, we just called out a number and said our guidance is based upon 30 million. If they do rates 33, 35, 38, and I saw in some commentary from other suppliers saying they're going to build rate 38 in July and 42 in October. I mean that would be good. And we think we could step up and be on pace with that. Initially, we have the inventory because we've got inventory on hand to supply. And also, we have a production capacity which we can flex fairly readily. So, I'm not in any sense, concerned about meeting rates, whether it's for aircraft build rate or engine rates. And it's just a number for a guide. And I think I tried to call it out as what I think is a conservative level.

In your confidence, in your supply chain that supplies to you, your confidence today versus 3 months ago, 6 months ago, and their ability to ramp up along with that?

So, for the most part, we purchased base metal and therefore, have not experienced there's quite the same degree of difficulty that many other suppliers have done. The area where we have struggled has been on where we buy alloy metal from other people where they've optimized it and put it into some alloy form and there's been occasions where you [indiscernible] David, where maybe a press has gone out or recently a fire has occurred in one of the after-competitive process plants. So, that has produced the areas where we've had difficulties, nothing where it's caused us to have huge problems. But at the same time, I'll say, production interruption, poor sequencing through our plants, we've seen all of that, yes. And what we would like to do, where are doing is try to put in some raw material buffers to be able to protect ourselves more, particularly as what we think where build rates are heading in the future, which is up.

Your EBITDA margin guidance for this year, is relatively flat. There are a lot of moving pieces within that most significantly, I think, raw material pass-through inflation, all that. So, I guess you talked about 22.5% last year, but it was really 23.5% as we back out the $225 million. How do we compare what you're -- because I think this year, you're talking about maybe $70 million to $100 million in this year's number that you would back out…

The easiest way of thinking about it is that last year, we -- getting $1 for $1 is the -- it obviously pressures the margin rate. Again, I think we differentiated ourselves to many other companies which struggled to recover infusion at all. So, getting $1 for $1 was, I think, a great credit for the company and shows the, I'll say, moats we've built around ourselves in terms of agreements with customers. So, 100 basis points was the number for last year. Our assumption this year is inflation broadly, let's call it $100 million, and therefore, comparative of that might be 50 or 60 basis points compared to last year's 100% of headwinds. We think we can compensate for all of that. And should the volumes materialize, which are possible, then with the, I think the incremental margins that will come from that because we're not going to change anything in terms of fixed open a fairly high incremental margin on those increased revenues, then I think our margin rates could well end up at the closer to the 23% should that occur, but it's like assuredness don't know in the guide is for the conservative build 2.5%, good free cash flow conversion, Life is good. It's solid. And if life gets better, it will be really good.

And so, within the margin guide or the margin progress that you've seen thus far, I mean, engine products has really carried the day. Margins are above where they were pre-pandemic even though the volumes are lower. So, talk about what's going on there. And I guess, compare to that, obviously, fasteners has been more challenged from a volume perspective. But would you have expected -- are fastener margins where you would think they should be based on where the volume is today? Or do you think that business should be performing better?

Yes. So, in terms of lead through, if you look at our business, the products tend to lead by a volume increment in engine because it's a leading item into aircraft manufacturing with longer lead times than our faster parts. So, I think we'll benefit from further volume increases in vasa as that comes through. The variation between the margin rates of narrow-body and wide-body are more significant in our faster products than they are in the engine. I mean there is differentiation on both. But when you think about -- I mean, a turbine for a wide-body turbine for a narrow body, the answer is it's a turbine's got blades. You've got a different volume and variety and therefore, cut turn around the technology and pricing, which would favor widebody. But in the case of the aircraft compared to the narrow body, the stories will be in about composite-based aircraft and a composite aircraft compared to metallic-based aircraft has a fundamentally different faster suite of proxy of simple metallic passes compared to more sophisticated fasteners that will adapt to the resin services, make the current electrical connections to the titanium structures provide the flow pass for lightning strikes and therefore provide you with the Faraday cage around the engine and the value proposition is fundamentally different. Therefore, if you go back to 2019, when maybe Airbus A350s were at, I don't know, 8, 9, 10 months 787s were maybe 12, 13, 14 a month. That's a very different proposition to where we've been, where it's been 5 on the A350, it's been at, I'll say, call it 1, maybe 1 on a month on the 787. And so, when you have an increase in metallic -- in volume rapidly and a decrease, you've actually got not just one is growing and one's not, one that is actually changing in the mix profile very differently. And so, what I'm hopeful for is not necessary for '23. We moving to '24 and '25, where I do see widebody coming back much more strongly. Because think the fundamental demand is there for the composite-based aircraft because there's almost not crony but shouting need for those aircraft because airlines are ordering, they are desperate to get them because there's no suitable answer in terms of either fuel efficiency or carbon footprint from buying an Airbus A380, a huge metallic based for engine aircraft or a Boeing 747, you need a composite-based 787 or A350, when that mix changes, I do expect that to be a beneficial scenario for our fastener business. And where eventually gets to -- obviously, it depends on many other moving factors, but certainly, that mix effect will be beneficial to us.

I want to touch on wheels for a minute. A bunch of different things going on there. You've had supply chain challenges. What's going on from a macro standpoint in Europe. You saw a big backlog that they have to get the manufacturers have to get through. You have the mission change. How does that all -- you're forecasting the business down, but is that more just kind of is there any evidence out there that you would point to that the business will actually decline this year? Or is it more just a gut and conservatism?

So far, I have no evidence that says it's going to be down, if I made it up. What's my sentiment, I feel that given the actions of the European Central Bank and the Federal Reserve in terms of raising interest rates somewhere that has to have a calming effect on the economy and transportation and maybe more -- not say maybe for commercial truck, but certainly in the trailer and distribution markets. It is more of a sense that where it could affect us. And so, I think caution is probably a better way to set the business up. And so, it's what I think may happen in the second half of the year. If I actually look at the dynamic of the business, I mean, a year ago, we were in that stop-start where we'd have interruptions almost once a week from a different customer each week where they were halting production, and so we were in an inability to deliver. That was disruptive. Again, not because of our performance, but they were unable to get the electronics or glass or resins or tires. In the second half of the year, I think those customers maybe said we've had enough of the stop-start. And I mean, I remember one in September said, we're going to take our third shift off and just except we're going to build on 2 shifts. And again, obviously, that's like it was better than the stop-start, but not really good that you're seeing that level of disruption to the build. As of right now, actually, things have smoothed out. And so, we're not seeing anywhere near the degree of interruptions that we saw in the first half of last year. volume is actually quite robust at the moment. How much of that is just for innate demand or whether it's just living off the backlog because fleets have won an enormous amount of trucks, and there's probably enough trucks to be for the whole year, both in North America and Europe. So, it actually looks quite reasonable at the moment. But the question then becomes what's the effect on the economy generally. And so, it's just a note of caution. So my guess, if it was like 5% or 6% down on revenue, the bulk of that would be because of the metal, which is a non-value item for us because it's a pass-through item. So that doesn't matter. And I called out and I gave guidance on the call, which I said maybe it's 0.5 million less because of volume, we'd probably bring half of that back 250,000 because of content growth steel wheels because our market share penetration against deals there's still ways to go. And so, it's not the biggest effect, but at the same time, there's a case of saying there isn't really an effect. And as we move into '24, there's limited ability for the truck manufacturers to build ahead this year, and therefore, '24 be fairly robust. So, it really is just a feeling of where it could be. And it's just part of the company. It's like it's a lesser part of how met than, let's say, the industrial part of other aerospace supply companies is. So, I don't think we should get overly fixated, but it is a shorter run cycle business than the commercial or defense side of our business. So, we noted there's no evidence I can give you that there's a slowdown. Sorry, that's why I said I made it up.

Take position. So you've targeted...

And if it doesn't happen, then life's going to be good because we're not changing the cost base because I can't because we're making everything we can right now, and it will continue. It will be good.

So, you've targeted this 90% free cash flow conversion. Why -- but at the same time, you've talked about CapEx below D&A, low cash taxes, pension contribution, I think, over time, should decline, maybe some more upside on working capital. What's -- why -- I guess, why isn't it better than that over the long term?

The last couple of years, it has been better like 120, 140. It's like good but I'll take the mode wearing a better growth rate condition. So, last year, until we had that effect on inventory because of customer orders pull back from us in late in the year. So, we were shipping, we held some in inventory, and that took us down to the 92%, 95%, which is very respectable against the long-term top best-in-class aerospace supply companies at 90% over the long term, that is a superb level, top decile. We've been there. We are there. We're above there. And last year, we put in -- I mean, what turned out to be excessive working capital, part of which I'd layout customers putting back to manage their own year-end balance sheet and the lack of build where there have been a commitment to take part at a higher rate. And as you know, engines weren't made and aircraft manufacturers. So, I'd say it's understandable, but it's -- we're still 90% plus or really good. Now, in the year when where we are this year, my assumption is on the cautious volumes that we have -- we talked about earlier, is that inventory will be liquidated and therefore, that will be a source of cash. So that's good. But on the other hand, the volumes tended to be higher, then maybe that inventory will be required. And so, because of what the exit rate was the trajectory into '24, which I'm hoping is good. And therefore, that won't be a source of cash, but it doesn't matter because I'll be making all the profits on the pull-through of those additional revenues. And quite honestly, the profit I'll make on those revenues is going to be a lot more than I'll do from the liquidation of inventory. So, it's set well and it's either solid or if volumes are higher, it's going to be even better. Cash contribution to the pension plan this year will be similar to last even though the expense is higher because of the way that the asset returns work. It's only a $0.04 hit compared to other companies, which have a much bigger number. And, I think now the whole pension question, which used to be fairly large is like in a small little box like irrelevant in the scope of Hermes.

So, last one quickly. So with your EBITDA growth, you're naturally delivering at a pretty quick pace. You're getting to the point now where more options are available in terms of what you do with the cash. You've been somewhat constrained, I think, in terms of what you could do from a share repurchase standpoint, those restrictions are now off. You have these maturities over the next couple of years or you have to deal with just your big question. How are you approaching all how are you thinking about this? And I asked you this question last year. Do you have in mind or at some point pointing out a target for free cash flow return, what percentage of free cash flow you would look to return over the long term?

Yes. If you actually look at what we've done, I mean, essentially all of our cash flow has been distributed to create value to shareholders. You can see that again last year, even though we ended with a very healthy cash balance of close to $800 million. When I look at the priorities going forward, clearly, as you say, we have no basket restrictions, which is, I say, always a good position to be in. In terms of where I think leverage is headed, I mean, we've come down -- as we set upon separation, we set the Arconic corporate with a very low level of leverage higher leverage of hard debt into Hamed. We've delivered significantly. I think we were going to be getting close to 2.5x this year. We ended up 2.6% that ended up well even if we did nothing on the debt side, we would be trending to a better position by the end of '23 for sure. And broadly, my objective is, I feel as though at 2x, I'm comfortable, I would never want to get better at 1.5x because of an inefficient balance sheet. But being a little bit better than where we are today is good. It's going to happen naturally because of the growth of EBITDA. And the only thing I've got to work out now, is what's the best value for shareholders. Is it more stock repurchase? Is it to take something off the next debt maturity, where is the balance in all of that, try to put the company in a really good zone. So that's -- I've been very conscious that I want to drive the drag of interest costs down on the company. We've come from $350 million of interest to $300 million to $200 something now down to like $230 million, give or take, last year. And we're in this very unique position where there's very few companies in the face of the dramatic change in interest rates and drag of them, is that we actually have a lower interest drag in '23 than we had in '22. And so, I mean I'd like that trend to continue. And if I can do that and combine with, at some point, I'll refi the 24 bonds and maybe you will get the last rating gains to give us investment grade, and that will give us another step down in the interest rate costs that we will refi into. So, it's all good. And whether it's accretion because of lower interest drag and therefore, it's earnings per share increase in that or if it's buying stock back and then an expectance of that, either which way it's going to be good, and I'll make the call in the interest of shareholders to create the highest value.

You'll get some -- we're going to now go to the audience participation, so you'll get some help here. Yes, if you could key in your -- we'll go on and start the clock now we're late. This first question to you on the stock?

Answered all the questions.

That's good. [indiscernible] Next question, please.

Yes. By the way, that's 60%, you really should and you should right now.

Through cycle EPS growth relative to peers.

I see beat 40% last year and then what's going to happen this year.

And last year, a lot of people were then respond because we had the [indiscernible] this year. I think this is the question. Yes, here you go. I'll tell you what to do, John.

Thank you. Advice is always good.

[indiscernible]. John, Ken, thank you very much.

David. Thank you. Thanks, everybody.

Thank you.