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

So we have the Howmet Aerospace team on the -- up next. We have Ken, Barbie and John Plant, who's Chairman and CEO. So this...

And I'm not Barbie.

No, you're not Barbie. John, thanks so much for being here and Ken as well. You guys have raised the sales guide in both Q1 and Q2, which has been a function of both just better performance and stronger outlook, including aerospace build rates. Just to get things started, it might be helpful if you could provide your view on the state of affairs of the aerospace industry and what's going on with the OEM hiccups, production rate ramps from here. And then we'll get into it.

Okay. So I think where we are is everybody wants to be producing more because of the fundamental demand from airlines is so strong. And normally, when those conditions exist, it's life is really good in that production rates go up and additional revenues and profits are made. But we're not really there at the moment and the question is why. And it's more the issue of production constraints, I think, which have been talked about a lot but starts with the difficulties of producing at rates for aircraft. And essentially, that's a narrow-body discussion at the moment because that's where the demand has fundamentally been for the last couple of years. And then the question is the roving reasons for why production has been constrained. So I think in one sense, the outcomes have been, I would say, speaking for Howmet, really good in that our results have been, I think, fairly strong and increasing the revenue level, the profitability level, the cash flow. And yet we haven't yet seen the real benefits of that strong aircraft production. So there's more to come. The backlog has increased. So the demand for future years of '24, '25, '26 are going to be stronger than we'd really anticipated because the constraints, which have existed for the last couple of years. And so I think fundamentally, things are set very well for further improvements in performance of the company and set well in the sense that we know that our customers really do want to make more, and so those are really good conditions to have. And the question becomes when can we achieve these improved rates and therefore, the drop-through of profitability.

I read these questions last week, but they're stale already. So on the narrow-body side, production rate ramps are most visible there. I wrote about engine OEMs being potentially the hurdle; and obviously, your intimacy there, you know what's going on. So if you could talk about maybe their hurdles, but obviously, there's more hurdles over the last 2 weeks. So kind of how do you think about narrow-body rate ramps from here? And how is that embedded into Howmet's guide?

I'm not aware that engine production has fundamentally held aircraft production. At this point, I'd not say it hasn't been tight. But the engine manufacturers appear to be increasing rate, and as an example, I think GE are talking about going from just over 1,000 engines or the LEAP engines to 1,700 this year. And that's obviously a large step-up. Having said that, 1,700 really only gets you to, say, the stated rates that aircraft are being produced at, so clearly, more is required and there will be more requirement for engine production next year and similarly, at Pratt & Whitney for the geared turbofan. And so at the moment, my view is engine production is coming up. They're keeping at rate but fundamentally, also need to make more, but have not been one of the fundamental constraints on aircraft production so far. In addition to the normal rate of production, there does appear to be a case for an increase in requirements for spares given the -- our stage of life cycle of those newer engines or the newer LEAPs or the newer GTFs, we've read and I'm sure you've read a lot about what their -- I'll say, what their cycle rate is or their flight rate is. And therefore, it's not as good yet as the predecessor engines, which they're replacing, of the CFM or the V2500. And so I think that produces a rate of spares demand, which is going to be elevated -- is elevated. And then more recently, we've read about the time on wing issues, where certainly for harsh climates, there does appear to be a case where there's going to have to be replacement campaigns for some of the combustor parts and some of the turbine blades that are most affected by the temperature issues from the pollutants and all the particulates that are hitting those blade at the first few stages of the turbine blades. And so my expectation is probably even stronger than maybe we previously thought is when I talked about our spares business now reaching -- for this year, we took it from 75% to 95% of 2019 levels. And if you just do the math, clearly, that implies a very strong exit rate in the second half. It does look well set as we go into '24 and '25 as those blades will require a higher rate of replacement than maybe previously thought.

Just on that spares point, you said 95% on the aero side and defends well above 2019 level. So what does that actually mean? Like you're -- can you maybe talk about how that translates into sales and profits and cash?

If you take 2019, we were about $800 million. And you guided that -- say that's either at 12% of -- or 15% of what was Howmet's total sales or you can look at it, maybe it's in that 25% to 30% of the commercial aero sales. So pick which one you'd like to use. Already, that's running above the 2019 levels because the demand for spares for defense and for industrial gas turbines and oil and gas is considerably above 2019 levels and will show further increases next year because as the population of F-35s or the Parker F-35s increases every year. And given the duty cycle of those turbine blades on the aircraft, clearly, the spares demand is getting to be a very significant revenue for us. And in fact, I think I'm on record of saying, by 2025, the spares demand on that particular aircraft will be greater than the OE demand. So that sets us up well for many years going forward. So already, 2023 is above 2019 levels in total spares. And clearly, that continues because the rate of requirements on the commercial side will be higher again in '24 and then higher again in '25.

Let's talk wide-bodies. You might not remember that you said this, but you did on your last earnings call. So you could step away if you don't want to recommit to this comment. But you said something along the lines of Boeing's hopeful for 10 per month on the 787 with A350 heading to 9 a month, but you think fundamental demand could be higher than that. So given your -- tease that out a little bit. And given the mix element, in the margin equation, how does that factor into fasteners and structures profitability?

I don't think I want to step away from it, so I'm not going to use the political expression as I misspoke or you misheard or something like that. No, I actually did say it, and I do believe it. I think fundamental demand on wide-body is going to be strong. I think the order intake on 787, in particular, truly underpins the desire of Boeing to get to rate 10. Of course, we're still left with that loose statement. Is it '25, '26? And so it's -- we don't know which year they're really talking about. But assuming that the demand is there, which I really believe it is, then rate 10 requirements appears to be -- is very solid. And I think I got carried away and said I can even do the case for actually being higher than that just because the order intake has been so strong. Maybe borne of the COVID years or maybe just borne of the resurgence of international travel, I don't know. Again, while order intake on the Airbus A350 hasn't been as strong as the 787, I still think it fundamentally underpins the increase to 9 a month and possibly higher. But I'm certainly stronger on the 787 than the A350 but willing to totally believe. And I rarely say willing to totally.

I just totally saw Boeing walk in by the way.

Did I see Boeing? Well, I didn't know. I don't know who that is who just walked in. But the answer is I believe it. And I mean -- and in the earnings call before that or the one before that, I even said I think the 787 is a fundamentally good aircraft. I got carried away. But what do I know about aircraft production? I struggle with making a blade.

Let's talk incrementals. You target 30% to 40%.

Shoot, I thought you've forgotten that part of the question.

No, no, we're so -- I'm kind of skipping a question. But you've targeted 30% to 40% incrementals, and I think you're going to be in the mid-20s this year. But over the last 18 months, you've hired 2,200 net hires. So talk to us about hiring in advance of rates increasing and holding that labor, training that labor. How does that impact your profitability levels? And as we look into 2024 and beyond, how are you thinking about the structural margin opportunity?

I think you, first of all, start with, I'd say, more philosophical discussion around incrementals. I said I think last year, what I saw was 35% plus or minus 5%. And this year, I said more like 30% plus or minus 5% because as things, I'd say, move on, your capacity utilizations change. Your, say, ratio of available capacity, having to put additional capacities in and shifts in, changes also with the elevated demand that we're seeing. And you've seen Howmet, which I think is one of the untold stories of Howmet is how we are increasing above aircraft build every year. The thing which we haven't done yet is to come out and give a definitive statement of how much will be above aircraft build each year. But most important thing is we're increasing our content and share and therefore, good. Turning now to your -- like what does it mean in terms of mix. I think certainly a statement from Howmet but I think really more for the industry is wide-body profitability tends to be a little bit better than narrow-body profitability. Certainly, the use of composites in those wide-bodies does mean you have a different suite of structural components, a lot more use of titanium in the structures compared to aluminum. And then also the fastener suites that go with them to provide the -- so I'll use the expression, the Faraday cage before for flight-type fasteners. That's, again, a large step-up in value and therefore, a positive mix in terms of profitability. And then it doesn't stop there because I've already said, if it's titanium, it's our structures business. If it's the fastener suite, it's our fasteners business. But also if you look at the componentry that goes into the wide-body engines, they're a little bit -- obviously, they're bigger but more exacting, and the volume variety equation is different, and profitability is also a little bit higher. So wide-body equals good mix. And so next year, while it's not revolutionary, I do think that the percentage increase in wide-body is greater than the percentage increase in narrow-body, although both are increasing. And I think we see it played again in '25 maybe to be an even bigger degree, where I do see the wide-body mix really begin to step up as we go into '25 and '26. So I think having volume behind you, having positive mix behind you is obviously very healthy conditions to have.

How about the hires that you've been -- the net hires, 2,200? I think 865 this year. Do you think that's weighing on margins? Or am I just...

I think it has. And we've gone from a situation where we've been recalling labor that have previously worked with us or part of union agreements to ingesting fresh labor. And some of the stability around that labor ingestation hasn't been as good as we'd like it to be. I don't think those issues are unique to have. I think it's been very much an industry issue of trying to get people trained and efficient. Some of our componentry does take years to become proficient at. But I think the -- where we've taken on labor, apart from where we got, I think, caught at the end of last year, where we were making at rate, maybe some of the other suppliers weren't and therefore, build wasn't as good as we imagined it would be. And therefore, as people corrected their inventories, we got caught in Q4 of last year really starting in -- this time last year at September, and so we actually shared a little bit of labor at the end of last year. But having said that, we did start early on the labor recruitment side. I think it's paid dividends for us because I think the level of delivered quality from Howmet has been, I think, very good, not -- again, not perfect but very good. And our delivery performance has been excellent. And I think that, at the moment, when demand is high, we have good metrics around quality, and delivery plays well to all of the other aspects of our business, which is then the ability to satisfy demand, to gain share and really be a little bit stronger commercially.

For all intents and purposes, you're an OE play. OE plays are long-term agreements with no pricing. But when you're the only one that could deliver and deliver on time, how do you think about your contract negotiations and your pricing opportunity from here?

Well, I remember 2021, where the questions then were -- well, demand is in a dumpster. Therefore, your ability to prices is obviously fundamentally impaired. And as you saw, that wasn't the case. I really believe that the level of technology, which Howmet provides, deserves the -- I'll say, the price positioning and to the value we deliver to the industry. And we'd be consistent. And so I don't know if it changes for when, let's say, demand was scarce back at the times of -- desperate times of COVID or with a fundamental overcapacity and now we're in the conditions where demand is very high, but I also don't think that's ever going to change anything. I think it's a consistent application of what's the right value for the parts we deliver and the ability to really improve the performance of the aircraft and in particular, the engine of some of those parts. So when -- let's say, when customers are facing elevated temperature, in example, and you couldn't have better examples than the issues that have been highlighted with the time on wing issues, and so if engines are running -- I got to be careful about what exactly I say, but in terms of a few hundred degrees higher than anticipated. Then, we bring the technologies, which are the products we know can perform well at those elevated temperatures. And without getting too far in terms of where does the military operate compared to the, I say, commercial aircraft engines is that if you think about what we've produced for the F-35, where it's, on average, 1,000 degrees higher temperature performance, clearly, we have the technologies to improve and make those turbines able to withstand the problems of, I'll say, particulate and combustor holes being blocked and therefore, a few hundred degrees higher. And so as things are spec-ed higher, we bring to then another level of technology, which also again improves the content and value proposition for Howmet.

I'm going to ask Ken one if that's okay, Ken.

Sure, you can ask all to Ken.

The next several are for Ken now. On margins -- this is a tough one, that's why I'm asking him. Q2...

You go straight for is -- Kenny's margins, tell us how good they're going to be.

Well, just Q2 margins, the structures issues, you guys had some. I thought, Ken, when we talked afterwards, you did a really great job explaining what the issue was and how it's sort of going to improve from here. Is that still in line with your expectations? What are you seeing there?

Yes, a couple of things. First, I'd say there were a couple of things that happened in the second quarter. Still, Howmet exceeded the high end of the guide on revenue, EBITDA and earnings per share. So even with a couple of bumps in the road, one was on our wheels business. We had a supplier strike, which impacted the business, still delivered a 27% EBITDA margin. It's really good. Structures, we had one issue in one plant that we feel that has been resolved for the most part, but again, it was isolated in one plant. I think we're past that right now. Neither the Howmet team or the structures team felt good about that, but it was a small part of the Howmet portfolio.

It's great. John, back to you. R&D dollars, where are you spending it? You can't use the F-35 example.

No.

No, that -- I wrote that in. And how do you think about the return on investment? Obviously, it's really hard to measure share gains because your biggest competitor is privately held. So can you talk to us a little bit about that?

Certainly, we've been increasing the amount of money we're spending on technology. Only part of it goes through the R&D line. We've put a lot through our cost of goods sold line, which makes it more difficult to get at. We've been increasing it both in absolute terms and also as a fraction, is a percentage of revenue because I think it does -- it is one of the important differentiators that we have. And with the demand for, I'll say, temperature pressure performance of engines, the demand for it is not just for fuel efficiency but emissions, which I think is going to increase significantly, then spending those dollars to achieve different sophistication of airflow is really important. So I think the game has moved on from can you produce single crystal turbine blades and then sort of into like can you produce big ones versus little ones because, again, it's like holding those requirements over, I'll say, a larger blade is actually a lot more complicated than the short-turbine blades. If you can imagine a 4-foot-long single crystal turbine blade, it's truly different and the process, technologies that you use to go through it to achieve that and the yields that are so important. But I think when you look at all the things which we're doing, which is basically now to control airflow and how you achieve the chambering to allow those [indiscernible] chambers to be formed inside the blade and in particular, how you control the outlet of air from the turbine blades, either at its tip or over its surfaces and really to try to hold the air molecules on the blade surfaces to, again, to shape the exit pass and trajectories. These are all difficult things to do. And to do it in -- with single crystal technology, I think that's where the game is at, and that's going to become increasingly important as we talk about emissions and carbon footprint for the future, all of which basically means you're going to -- you have to be far more careful over the use of jet fuel. And really, despite all the talk about alternative engine technologies, of using electric-based, battery-based technologies or hydrogen really realistically for the next 20, 30, 40 years, it's going to be a fossil fuel-based industry, and you look at just the generation of technology. So there's a lot to be done just in taking today's engine technology, making it robust to meet the conditions it's at and then to elevate it. And basically, we upgrade, with the engine manufacturers, those engines every 5 to 7 years. And so in the -- those engines will look different again in 2030 and 2035 than they do today.

Talk to me more about the immediate term because I like games. So you're winning the spares game because you're at 95% levels, because of the engine time on wing issues. Is there additional content with like GTF advantage and the GE LEAP changes that they're making? Or is it more longer term?

No, as those improvements, let's say, manifest themselves in the market over the next, let's say, 1 or 2 years and there's a different path for each engine manufacturer, then those changes to achieve today's elevated temperatures are going to require more sophisticated turbine blades. And therefore, with that goes a different content level and price point. And so it's not one where it's way into the future; and therefore, it is mystical decade and 2 decades. It's like, no, it's here and it's now, and it's happening real time.

We've got 30 seconds, so one more. What do you do with your cash? Free cash flow midpoint is $635 million, 90% conversion.

I just gave it away mainly to shareholders.

Okay. 25% dividend raise?

We got carried away with another dividend increase. We've been knocking our debt into great shape. I don't know if you noticed but we got -- just got another upgrade from the rating [ gains ], so we're now 2 notches above investment grade from 1 agency and hopefully, with a bit more to come. And then basically, we just give the rest of the money to shareholders and we buy shares kind of consistent basis.

Great. Thank you very much, John. Thanks, Ken.

Thank you.

Thank you.

Thank you all.