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

Good morning everyone. Welcome to the 41st Barclays Industrial Select Conference. We're kicking it off even earlier this morning demand for the conference. In terms of corporates was so strong, we had to have insert a new slot at 7:25. So we want to start off with a bang. So Howmet starting off the A&D track for us today. And we're pleased to have John Plant, Chairman and CEO of Howmet; and Ken Giacobbe, CFO; and PT Luther is also here as well. So thank you for coming down here again. Appreciate it.

Good morning.

So we'll kick it off pretty high level. I wanted to ask about your revenue growth guidance for this year, so 7% revenue growth. When you talk about how that breaks out by end markets, so aerospace, defense, industrial, commercial transportation?

Okay. So on commercial aero, we've assumed mid-teens, so 15%, plus or minus of growth there. Defense aerospace, mid-single digits, maybe a little bit higher. General industrial lower single digits. And then the commercial transportation and wheels business about minus 10% is the assumption. So we sort of put that in and blended out at about 7% plus or minus.

And on the aerospace aftermarket piece. You talked more about that and I think I've ever heard you speak about that on this last call. So maybe talk about where the aero aftermarket piece is today? And what do you see for the go-forward path here in terms of the aftermarket contributing to the revenue growth?

So I mean, in the last 2 or 3 years, the reference point was always the levels in 2019. And trust that was about an $800 million revenue mark, $400 million of commercial aerospace, say, spares and $400 million of defense, let's say, industrial gas turbine and spares. So roughly split equal between them. Clearly, during the COVID years, commercial aerospace spares [ coincidentally ] dried up and went to a run rate somewhere close to $100 million at one point. But let's say [ went down ] is, let's say, it's about more than half. And then during last year is that, that has now recovered. So if last year was something close to $400 million mark, but rising every quarter. So the exit rate of 2023 was at a higher rate than we had for the average of 2019. And the Defense and IGT business continued to grow. So it's about $600 million -- so it was about $1 billion last year. And we think that has the propensity to grow further because I think our defense spares are going to grow, IGT is going to grow and commercial aerospace is going to grow further in 2024. And then -- because you don't really know, but I'm thinking positively about this as an opportunity. And then I was trying to observe that beyond the mediacy of the thing, which is to say in the press at the moment, is time on wing and replacements of parts for the high-pressure turbines on both LEAP on geared turbofan engines, what I was trying to do is to separate that, what I call the small bubble effect over the next 2 or 3 years, solving some of the time [ monitoring ] distress issues in some of the harsher climates and where significant air pollution to the fact that it's our view that the newer engines, so think again LEAP and the geared turbo fan and compared to the predecessor engine, let's say, of the CFM or the V2500 is that -- those are going to experience a higher frequency of [ shop ] visits and essentially because the -- to get that fuel efficiency on any modern jet engine, you're having to run it at a hotter temperatures, higher pressures. And that inevitably produces not only a different type of configuration of turbine blade with more sophistication, but the wave is such that it's going to have a more frequent service interval. So I think that, that is a long-term trend for the next decade where we're going to see increasingly as those engines that we started, let's say, supplying in 2018, '19, as they come in for their initial shop visits, there could be at a higher frequency on a permanent basis. So they will never achieve quite the cycles we saw on the predecessor engines. So I was trying to get from that too -- there is an inbuilt additional service requirement that Howmet is going to receive and service for these engines, which is good news for us.

So I wanted to ask you about, of course, build rates. Last year, you had given guidance for the low 30s on the MAX and everyone thought you were conservative. I think you ended up being more right than wrong. This year, you're talking about 34 on average for the MAX and I think 56 for the A320 and 6 for the 787. Where are you today relative to those rates?

It's always difficult to be absolutely precise because if you take where we supply direct to the airframe manufacturers, for example, in our Fastener business, we operate on min-max systems and not just straightforward ERP [ polls to it ] in the quantity of aircraft. More so in our structures business, where obviously, there's certain -- only -- so many, let's say, [ spas ] in an aircraft and therefore it's more direct correlation according to the share we have. So it always ends up as being a slightly imprecise figure. But we did see during the second half of last year, Boeing, in particular, raised their build requirement rates on us that they had. And I'm going to say it's difficult to see this year that -- we can't see it further increase because that's not the case, but we also prepared ourselves in case they are slightly reduced. And you heard me talk on the earnings call a week or so ago, that we made allowance for not only a lower build rate than they're saying, but also should they decide they don't want to carry some of the inventory they're carrying today because they underbuilt fundamentally to that rate, [ so it is ] is that, that could come out of their system and they could cut us back. And we've had that occur in the past. So if you remember, 2022 in the fourth quarter, I think we were cut back significantly. It is overnight [ and just we ] starting in the September, October time and we felt that we got left holding the bag. And it's possible again. On the other hand, should things [ smooth out ] rate 38 achieved later this year and then it gets to 42 and I think good things in '25, then they'll need all the parts themselves. So there will be that problem of us having that inventory allowance in our working capital in the way we've done it. And so again, we've tried to take, I think, cautious assumptions to what we've talked about, such that we feel comfortable that we're not reliant upon somebody else's perturbations around within a degree or 2 and cause us to, just to say, oh, excuse me moment, we don't really want that.

So fair to think about you're above -- best you can tell, you're above on MAX specifically. You're above 34 a month now of Boeing's producing below that. And so as a result, you're cautious in terms of...

Yes. Absolutely.

Wanted to ask you about -- you talked about it on the call some share gain on the engine side that's committed, you're going to spend additional CapEx, I think here, this year and next year related to that. So could you tell us a little bit more -- expand a little bit more on what exactly that share gain relates to? Is that related to producing upgraded airfoils for LEAP and GTF?

It is essentially focused on turbine blades. And that doesn't give you much because its -- both engines have them. And we're seeing elevated requirements for, let's say, some of the time on wing issues for both. But it's more things which are going to come rather than we're experiencing it today because it takes a while for the engine manufacturers to respond. But we're pretty clear about the need for increased requirements to service the industry going forward. And it's a combination of today's turbine blades are rather more sophisticated than the previous asset once in terms of the quantity of different [ causes are ] in them. And then with the increased long-term service requirements that I've already talked about, never mind, I would say, the time line wing issue, and there is increased requirements that are going to put a significant load into the engine space going back a lot of spares. And we're just trying to make sure that we are ready for that. And I was trying to make sure that when I went out and said we're going to spend elevated CapEx, it wasn't like just on a management win. It's one where -- I mean, for me to be winning to part with that cash that's to be a very solid business case. We have a high-returning business. So I called out not just -- you can see what the EBITDA margins are, but in terms of our return on capital. So here we are investing in a very high return on capital business. But with making more of the same and in particular, then drawing your attention to the fact that it is contracted additional share and not just -- like floating in case they build increases or not. So assuming, let's say, Airbus would like to make a few more aircraft and so on then plus the spare requirements, we've got that sorted. Been willing to commit the capital. And in exchange, we wanted to have the additional share.

And this will manifest us off in your numbers in terms of the upside related to this, this is a 2026 benefit?

Yes, it is -- I mean we might get a little bit of production out in the back end of the fourth quarter of '25, but it does involve increasing our building footprint, a lot of capital equipment. We are going to make sure that it's the latest levels of automation that we do. We've begun to employ some aspects of the [ fashionable ] AI in terms of some of our testing routines. And so it's going to be the latest and greatest of what we do. And I think, David, you had the opportunity of seeing some of that in your visit to Whitehall plant in September, which you're able to write about. And so we're taking the very best of what we do in the latest manufacturing of all there and then trying to take it to another level. So I think it would be pretty impressive when we do it.

Structures, how is that business going in your view? Last, I think it was in Q2, you had the issue there. You had a good term for it. But what do you expect now in that business this year? And then maybe if you could also touch on titanium market share you've picked up? Is that behind us at this point? Is there more to go? Do you want additional titanium share?

So I think previous peak of earnings in that business was 14.2%. So that's pretty precise number. And I think last year, we exit, let's call it, 12.9% or 13%, give or take. So I wouldn't say as we're particularly pleased at where we were. On the other hand, given where the markets that we principally serve, which was wide-body market for titanium because, obviously, narrow-bodies are really more aluminum and metallic -- other metals based. It wasn't terrible. We're also been facing for some time in the case of Lockheed that they've been burning off inventory now for almost 2 years, where they had higher amounts of titanium [ bucket ] in particular and that continues into 2024. But hopefully, by the back end of the year, that will be over. And so we had that and then we had the spike of requirements because we had contracted to take up some of the VSMPO -- former VSMPO share from Russia as a result of the sanctions. And we had a difficult time during 2023. And I did call it out after the Q2 earnings that we face planted. And it wasn't ready -- one that is asked, but it wasn't ready. So it's been getting better. I think our exit rate was in the 13.5% range. So getting back close to our prior peak, but that just necessarily satisfy me. I do think there's the opportunity to take that business to higher margin rate in the future. And I'm hopeful that as we go through '24, as wide-body comes back as the burn off of the remaining F-35 inventory sitting in, I'll say, [indiscernible] comes about. And then us getting more efficient and maybe making some additional titanium requirements that are there is that it gets better. I'm not willing to invest in that business in terms of fundamental new capital to take on the titanium share. And it's a matter of where we allocate. And we're firm believers in how we allocate capital to those areas of the high returns. And for me, what I've said that the increasing investments that we would make, which would take CapEx in '24 to above depreciation, and it will be elevated again in '25, but we're still not going to cause us to miss plus or minus around a 90% conversion of net income. I don't intend to invest in the titanium business because of geopolitical risk essentially. And I mean, it's difficult to know what the shape of, let's say, the future American administration might be, but of course, it'd be possible that we could be friends with Russia again. And therefore, sanctions fall away. And with the low-cost production that they have, it would render useless any investments that we would make. So I would not do it on a risk basis. And also, we've got better choices of where we deploy capital. So I'm willing to invest, and we've taken some business on. But I'm also not rushing out to even over invest, because it takes a lot of working capital as titanium more so as a fixed capital. I'm not necessarily willing to go out there rush and try to gain huge swath of market share because like why would I do that? When I can earn double that level of return and profitability elsewhere in the business, which is far more defensible, far more protected by technology mode. And we just don't need to. So fill up what we've got, try to make it better than we do today, but don't go out of our way to chase the market.

Pricing, the opportunity is there, both this year and maybe in 2025. I think last year, your price -- your net price came in -- the upside was the highest we've seen thus far. Talk about the opportunity from here, how far you're through everything with regard to '24 and '25?

Okay. So '24 was a fairly healthy year for us. It was -- we saw that we were striding along well during the course of the year. I mean it's always easy to year buckets rather than quarters because if you take our first quarter, it's always our lowest one, some of which is down to -- we haven't necessarily finished off all the negotiations for the 1st of January. And sometimes, there are a few which are not on the calendar year. And then thirdly, in certain cases where if we are in areas and the things have been ordered in the previous year, in certain cases. And when we conclude our revised commercial arrangements on the LTA, then our customer is saying, we really should supply those at the pre-price increase condition. So that's why it's not even throughout the year, all of those different reasons. Having said that, it was a very healthy year. We -- the first time we broke the $100 million barrier. And it wasn't the largest book of renewal compared to, for example, 2021, the predecessor, I'll say biggest year. At the moment, I commented on the earnings call that we saw 2024 to be of a similar order as 2023, plus or minus, it could be a little bit below, it could be a bit above. So it's in that ZIP code. And we were actually slightly further ahead of completion, about 90% complete of what we thought for 2024. So we feel good order there in terms of being able to stand up to the approximate guide I've given and beginning to turn our minds now to 2025 -- '25 and '26 for those [ renewals ].

I wanted to ask about fastener -- profitability in the Fastener business. The margin trajectory has improved there, you placed leadership, I think it was close to a year ago. Whereas engine -- the engines business is well above pre-pandemic levels despite revenue still being below, Fastener margins -- yes, the revenue, of course, is below, but the margins are still well below. What is going on with that business? Are you pleased with the progress that we've seen recently? Do you still think that business has -- is capable of generating margins above prior peak levels?

I think prior peak was 27%, 28%. So that gives you the mark there. 2019 also had a different mix. I mean that was the years where you were seeing 787 at 13 or 14 a month and use that as a proxy for other composite-based wide-body aircraft. And we've came all the way down because of the cessation of build when Boeing stopped production of the 787 after their quality difficulties on that aircraft. And so just over a year ago, essentially, we were just at -- I think the low point because it was all essentially metallic-based fasteners, which don't have the value-added content in the same way that they are for the composite-based aircraft, where you're creating, as I've said in the past, Faraday cage for, say, the Lightning transmission around the aircraft. So nothing is exactly comparable, but certainly, as wide-body begins to improve, we'll see the mixed benefit of that as it comes back. So that's a good vector. But even when we're running around that, I'll say, 20% range, plus or minus, I didn't feel as though we were making the progress that we should in terms of, let's call it, manufacturing excellence, productivity nor will we necessarily behaving as well as we could in terms of our commercial arrangements, maybe getting a bit -- we weren't focused enough so that maybe want to change the leadership. So 20% isn't shabby. It shouldn't be -- it's not too shabby, but at the same time, I think it left a lot of money on the table, and we did change management. And I've been really pleased with the step-up and the focus and the momentum that we've seen in recent quarters there. And so -- and today, I think it comes of getting say those performance characteristics right in the business, plus I think we're beginning to see a little bit of benefit on the mix side. So it comes together, maybe a bit of hard work and a bit of luck. There's a lot of for you. And so it's nice to have got back to just above 22% returns in the last quarter.

So you rolled all together from a margin perspective, it sounds like you're still talking about -- there's some upside on structures. There's upside on fasteners, engines performing very well. I think you've kind of framed the business as a 30% incremental margin business, plus or minus 5%. I guess margins for the company have kind of been in the similar range for a couple of years now. You still see the potential for this -- the business as a whole to kind of break out and maybe generate better than 30% incremental margins on a go-forward basis?

I'm never used the word breakout. I do know that we've done a lot of really good things in the last couple of years. And optically, that's being masked by subject to inflation. And we saw, say, I think, 2022, just after the Ukraine war started metals cost us probably [ $0.25 ] billion, give or take, in that year. Add on to that a lot of nonmetals inflation. So I think freight rates, utilities, everything you can imagine, and you saw inflation spike in Europe points up to 12% and maybe 8% or 9% in the U.S. And so if you add it all together, it's $300 million, $400 million of inflation, and it's really hard to go out not only fully recover it, but you can't -- will you make inflation on profit center? The best you can do is a dollar for a dollar, as I say, and that cost us 100 basis points of drag. We didn't go down, but I'm also clear that without inflation is that would have been up significantly. And we saw the drag again in '23, and it's only probably 30 or 40 basis points. But -- so nothing like that. And I'm hopeful in 2024 is that with -- I mean we're seeing the latest metals prices have come down a little bit. So that's good. Inflation is clearly abating back to, I'll say, not the 2% level yet, but getting back at least the 4% or so. There's a lot of, let's say, some of those headwinds falling away. So that gives me optimism as I'm not fighting with one hand tied behind their back in terms of margin rates. So I might be a little bit more optimistic today, but it's -- surprise things, we've got to wait and see.

On cash and what you do with it?

Well, it's some [indiscernible] kidnap [ child ] I think, Ken, is it any of us?

I don't think so.

Now everyone was going to go off. In terms of cash, so you gave a healthy forecast for cash generation even with the additional CapEx. Last year, you returned about 50% of cash between dividend and buyback, but you had a lot to do with on the debt side of things. You don't have that this year. So does that cash return step up materially this year? Do you have a target in mind? Do you target returning 70%, 80%, 100% of potential?

I'm very clear that there's nothing else we absolutely need to do on the debt side. Let me just -- say [ we would do something ] so for us, it's unlikely that we would refinance the remaining $200 million stub of the '24 bonds. You can't really do an effective bond offering for that modest amount of money. So I [ must able to wrap ] that in with retrying at 2025. It's more likely we're paid off unless we see the Fed moves well and the 10-year yield curve comes down and we have an opportunity. But more likely than not, I'm sensing that, that will be more like towards the end of the year, but you never know. And so the most we pay that off that would be a couple of hundred million last year. I think the blend was like 70 million of dividends plus maybe 250 above of share buyback and then 475 -- 500 of debt pay down. So it's a lot of money, $800 million, I think. And -- but this year, I did see it flipping around. So the worst case is to be a couple of hundred million for debt, and you could assume that the share buyback and the debt would flip over, so closer to 400, 500 maybe of share buyback and it's possible we may pick the dividend up. That's the decision we're going to make later in the year. But all of those things, I think, are more likely the way that 2024 shapes out. I think we returned -- my view, all the money to shareholders because whether it's us paying down debt or buying shares back, the effect is on earnings per share increase and shareholders benefit. So I don't know if I would differentiate quite the same way that you do. I think we generated [ $680 ] million of cash last year, and we paid back or paid out to our shareholders through debt repayment or buyback and dividends, $800 million. So it's more than 100%. I'm a generous of a guy.

And there's nothing in your EPS guidance for what you do with the cash. That's kind of all to come?

Yes, more or less. I mean I think we anticipated on move on something, but it's not worth a lot. I'll talk about it.

So we have the audience response system that we can pull up? All right, chance to weigh in here. So do you currently own the stock? We'll run through these pretty quickly here. I've heard you on a little bit. All right. Next question. What is your general bias towards the stock right now? Next question, please. Through cycle EPS growth for Howmet? That's easy. I know the answer to this.

I think we've done like 5 years of compounding at about over 30%.

30% or 40%, yes.

And that's going to accelerate on all the share gains, right?

I don't know about that.

Next question, please. Now we touch on what to do with the cash, you'll get your answer here. Is there one more? That's it Okay. John, Ken, thank you very much. PT, Thank you. Thanks, everyone.