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

Okay. Let's get started. I'm Doug Harned, Bernstein's global aerospace and defense analyst. And I'm really happy to have here with us, John Plant, the Chairman and CEO of Howmet.

And I think, John, maybe just to start off, perhaps you could just give us an overview of how you're looking at -- how you look at the company right now, the markets and what you see as sort of your biggest opportunities and challenges over the next 5 years?

I guess I'll start off with quite a broad comment is that the last 2 or 3 years have been, I'd say, fairly turbulent in terms of, I'll say, the stop-start that we're seeing, particularly on the commercial aerospace side. And through that period, we've done, I think, reasonably well. And the only good thing I can think about, let's come of that, is that whatever demand hasn't been fulfilled by aircraft production, because we know it's been fairly intermittent is that, that demand has moved to the right. And so as I always thought that 2022 or 2023 or 2024 were going to be like 3 years of, let's say, excess growth above a normal level of growth for the industry. And if I picked that at maybe a 4% level. It's just moved to the right. Then it's '23, '24, '25. Now it's '24, '25, '26. So maybe it's '26, '27, '28. I don't really know. All I know is the -- on commercial aero, the backlog is truly extraordinary. There's a [ first 4 ] new aircraft. The fleet is aged. And certainly, with the pressure on for fuel efficiency. And the carbon footprint purposes, which is probably more significant in Europe than maybe the U.S., but the answer is [indiscernible] global. So it's really is a global phenomenon is that even if there was a dip in passenger demand, I still think there's a very robust demand for replacement commercial aircraft. So that really is the bigger picture, I think, that we're looking at. So I still remain optimistic that we move through this period of, I'll say, difficult because we know that one of the aircraft manufacturers is struggling on output again. And all you just know is that at some point, that gets fixed and tomorrow is going to be better than today. That's how I compare myself as I said, because everybody needs a little bit of, I'll say, how does things look and that's just tomorrow is better than today.

Well, yes, it's interesting to say that, because if I look at how you all did in Q1, we're sitting here looking at that manufacturer of Boeing with some real issues, dropping their production rate on the MAX, dropping it on the 787, yet Howmet comes through and not only gives an impressive Q1, but you raised guidance. And that surprised a lot of people. It didn't surprise you that your performance and your outlook is that good even given the Boeing problems?

Well, I start off by saying, I mean, of course, I don't think Boeing knew that they were going to have the difficulties that they had during that period of time, because they were still, I'd say, a narrow body still on 737 scheduling out of 38. And originally, it may be struggling to build great 30. The anticipation they will be lifting production to, was it 42 or 47 later this year. And of course, it hasn't quite worked out like that. But we were the beneficiary of, let's say, that, I'll say, a robust level of parts scheduling in the first quarter. And because of the, say, door plug issue with Alaska Airlines, which is well reported, so I don't really have any comments on that. It caused us to have to think about, let's replan our whole year. And those the words I used on the earnings call. So all the things that we've gone through in the fall of 2023 and looking at, we said let's go back and just reexamine all of the assumptions from what was going to be like in the defense business, which was strong in Q1. It was a 12% stronger than we had imagined. Then we looked at our IGT business and what it wasn't great in Q1, I still said I think we're going to be at least a mid-single-digit growth this year. And then over and above that, the weakness which we thought was going to happen in commercial wheels business didn't happen. So that was strong. And then, of course, given the fact that if new aircraft aren't going to be produced, therefore, the existing fleet is going to have to work that much harder. We reexamined all of our assumptions around the spares parts of the business and thought fit that, that would be at least -- well, I think I called out maybe it's $100 million, $120 million, which was more than the -- I use that at least $100 million where it's significantly more than that was the effect of the Boeing cut off made our guidance assumption. So by redoing all of those assumptions, plus our assumption on oil and gas, I mean, every one of those came together and said, we think that given the strength of Q1, what we thought was going to happen in the second quarter, it led us to a logical conclusion that we could be bold enough or crazy enough, whichever one you want to pick to say the year is going to be better than we originally thought. Let's put it down to bold enough, not crazy because crazy doesn't sound as good.

I agree with that. But your change in outlook for Boeing from 34 a month to 20 a month for the year, I mean, that was a big change, and I feel it's surprising that, that was only on the order of $100 million headwind.

I said it's at least $100 million. I didn't give you the exact number. So I never want you to be able to reverse engineer our set values by aircraft. But if you can assume it's not $200 million, which well above $100 million, I think, I mean it was well above. So I did use those words. But I try to steer people away from getting exact numbers around set values. So I don't really want people to like plugging models of what every shipset value for each aircraft and trying to work it all out. I think this leads them down to a level of detail that is not necessarily helpful. Keep in mind what I'm saying about the big picture, what's developing in the -- by segments and sectors that we serve. And we've tended to achieve that, which we said we've done. So keep those things in mind, rather than pour over the shipset value, X dollars or 5% more than that [indiscernible] less, it's like don't bother.

Well, if you consider, though, the 34 to 20, the 20 a month assumption, if you run that through the rest of the year for Boeing, that's a fairly negative outlook compared to what they're talking about now. Is that conservatism? Do you -- are you able to -- if you see that change, is it easy to flex in terms of what your rate is?

I think I must say, get the answer that should Boeing produce 38? That's great. And we'll be able to keep you in part. So you're not going to have production interruption on either the airframe or on the engine side because of Howmet. Let me say we rely on a lot of slot in terms of our manufacturing capacity. We have inventory. We have the flex over time. We've also been carried on with our recruitment in the first quarter. So trying to put ourselves on a vision where we can. But as I probably use the expression, we do treat guidance seriously and try to give something which we think we can do. And so I just felt it appropriate in the lack of certainty, because I don't know how certain Boeing are themselves about exactly how many they're going to produce. And that's not trying to do anything about saying it's difficult for maybe them to know exactly, given it seems as though maybe they're not doing traveled work anymore and what are the consequence of that, because it's been around for so long. And when you look at the deliveries and therefore reverse out what's [indiscernible], I mean production seems to be single digits. So I don't really know exactly what the production is. And so I can't tell you that 20 is right. I just don't know that. It's a assumption that gave everybody the ability for -- if you think it's going to be more than that, then you can be additive to what we said. And if you think it could be less, then you can decrement, just try to give you a framing of assumption that guided you where we'd pitch for our level of guidance. And it was no more than providing that as a benchmark for you to estimate from, because we don't know.

Also, you're supplying into GE and Safran rather than -- engine products rather than direct to Boeing, too. So there's sort of a governor in there in a sense?

Yes. And it's -- again, while GE has taken the decision to downscale the production on, I think, the LEAP-1B. Let's say -- I would say roughly half of our business, it doesn't affect us, because we have a large outlet of spares requirements. And therefore, we just keep on producing peak on the turbine blade side. For our structural casting business, clearly, we see the effect of that, because the aftermarket is very small by comparison, and it's mainly an OE business. So we try to balance all that. So we recognize that on the engine side, the rate will be above the 20. And let's say, the airframe side, it could be less than. So it's just trying to peg something. It's pretty inexact.

Well, if I think about on the Engine Products side and go back to I think, it was Q4, where you said that you would gain some market share. And I was trying to figure out what that was, because you've -- on the new products, you've got a hot section, you've got very high market share. So where are you gaining share from?

I didn't identify the customer.

No, you did not.

And people have tried to make an assessment of that. And I've chosen not to, because we're still working and trying to improve everywhere, but we have signaled that we're going to kick up our capital investment. And in saying that, we were going, let's say, from now just over $200 million to something closer to $300 million. And within the -- we'll obviously continue to assess that as we go through the year. But that's moving it up from, let's say, I don't know, 3.25% of revenue to 4%. And so it's a significant step for us. And in doing that, I wanted to give some perspective, because I don't think you're going to make those sort of change of scale of growth investments. without trying to provide context. And I think the context needs to be -- it's not just on a whim. It's not just because we are hopeful. The answer is, this is backed by hard contracts. And therefore, I think that's an important clarity to provide investors with. And secondly, because I also wanted to say, but while I truly believe organic growth is better than acquisitive growth, we still need to talk to you about cash flow. And so we also said, by the way, it's not going to deflect us from our 90% of net income plus or minus. So we have the last -- couple of years of 100%, last 2 years, it'll be like 90% plus or minus. So it's not going to deflect us for that. So I'm trying to give like an overall perspective as we can increase our growth rate. We can deploy this capital yes, of course, we're going to have to pay for it, but it's not going to deflect us from our goals of free cash flow yield. And therefore, this is good for Howmet. Trying to give you that overall rounded picture. So -- and it's a long way from saying, oh no, I'm by the way, no, I didn't identify the customer. So It It's clear, it's real, it's tangible, and I'm infused by it. But I get infused by lots of things.

Yes. But I guess what you're saying here is that you have a very rational way of determining the you have to raise production some, because you've identified share gains that are real.

Yes. It's not based upon I've got some loose assumption about maybe there'll be additional service part, because of the, let's say, time on wind bubble or anything like that, It comes and it goes and therefore, are we left with stranded capital. That's not the case. It's clear eyed, very deterministic application of capital and also a good return on capital business for us, even though I know that the -- I have to earn a good rate of return because of its capital intensity.

Yes. Now on the aftermarket, so you've got -- I mean, as you mentioned before, you've got legacy airplanes staying in service longer, because people are behind. At the same time, you've also got LEAP engines, GTF engines, particularly those in harsh environments coming in early for replacement blades. Can you characterize what you're seeing? And I know things aren't directly identified as aftermarket or OE when you deliver them. But what's -- what are you seeing? What's your sense on each of those on the new generation blades and the legacy ones in terms of how obviously legacy ones are all aftermarket? But what's happening with the aftermarket?

So my assessment is, I mean, it's not going to be everybody's, but my assessment is the conditions that the engines are operating in, which is to gain that ultimately the fuel efficiency, then having to operate at temperatures and pressures, which are some more exacting than in the past. And the complexity of the turbine blades in terms of the airflow and necessary multiple calls inside a very different to yesterday's CFM56. And so that in itself is producing a different duty cycle. Now when you say all of that, the current seeming experience. And again, I'm doing it from data reported, which is if you look at the number of cycles that were obtained or obtained by a more mature CFM56 or V2500, then today's number of cycles of use on the aircraft are much reduced. And I note on average, and the average is depending on in certain countries with it's a maybe less harsh environments, higher in some of the countries that are very much lower. And so I think about it as a kin like car, which is being driving for fuel efficiency, where the pressure and the optimization of the fuel is such that you pressurize it, you ignite it, and then you get the outcome. The conditions inside the engine are more exacting and harsh. And so I think of it as that the frequency of shop visits for the engines, there's some new engines today, are going to be more frequent than in the past. Now it's an assumption. And none of us know exactly where we'll end up with us when LEAP matures, when GTF matures, because I mean they're still young in their lives, where CFM has been rounding the 50th anniversary of the CFM very shortly, maybe in the next -- this month. And so you've got that dynamic going on. So I think it's a long-term trend where the frequency of shop visits will be higher. Clearly, the turbine blades today are at a different content level, price points as the blaze of yesterday. And then we've got the particular, I call moment in time where because we're in that initial phase of those engines where the robustness hasn't been quite what was imagined and therefore, you've got this a time line wing, which is again well reported. In terms of maybe that's just a little bit of a 2-year, 3-year bubble, which is probably on top of a long-term trend of increase. So that's how we look at it. So where does that produce? I think if everything was normal growth, then maybe on average, we'll be probably seeing a higher aftermarket higher service growth because of all of this than we've seen in the past. Having said that, because of the volatility of aircraft build. And so for example, if Boeing were to go from, I don't know what number you pick, 20, 25, 30 to 50? Or is it more for Airbus go up to 65, 75. I mean that's a significant increase in rate of growth also. So which one wins that race aftermarket, we don't know. All we know is that it seems like tomorrow, we're going to have more aircraft produced than today, more engines produced and probably the aftermarket is going to see the growth as well more than historically. So it's all good outcomes, I think.

Yes. And it's interesting. I mean, this morning, Larry call talked about -- I asked him about long term where he thought LLPs would be on the LEAP. And they believe that those will be similar ultimately to CFM56. However, whether that's true or whether it's not true, that's with blades that aren't in service yet. So in the next few years, I would think you're going to continue to have these coming in at a much more rapid clip than we saw on the...

I think we think so, of course, CFM's had 30, 40, 50 years of development through multiple cycles of improvement. And I don't think for 1 second, it's like 1 and done today's engines, I think they're going to be -- maybe there's been an increased focus on robustness compared to fuel efficiency that is going to be fuel efficiency. I think there's going to be multiple developments to come over the next few years, next maybe once every 5, 6 years of development. And so all that's to come. And then maybe there's also technology change as well. I don't know which year it will be like things like the Royce and/or is it the MTU solutions for the GTF engine, et cetera. So there's lots of changes that are going to occur.

When you're -- so I look at U.S. in a very unique position right now in terms of where you are in the hot section of the engine on the new platforms. And it seems and even if you go to defense, certainly on F-35, where you have sort of 100% of the engine. How do you think about pricing? Because it seems like you have tremendous pricing power here given the unique position you're in. So what I'm interested in is how you think about pricing where -- the negotiations with the customer where you're in a pretty good position?

We just try to have a balanced discussion. I mean, I don't think at any point -- if you go back over the history of the F-35, originally, we were not planned at 100%. We were like a 70%, competitor was at 30% as it was, the competitor wasn't certified, and we filled in for that 30%. And then because of, say, parts were never qualified. We concluded with our customer that we'd be at 100%. And we created the conditions for the dual source for the DoD or for that customer by having split production. There's so much of the production being in 1 Howmet plant in 1 state and another Howmet plant in the other site, therefore, producing that security of supply by having them completely dislocated from each other. So if something -- if there's a fire or there was some other external incidents that we would be able to maintain some production capability. And -- and we've done that through several other programs since trying to be respectful of a DoD dual source ideal compared to the capability. But going back to the original question, which was trying to maintain I don't think that we should do anything apart from say we say I think we are not in a price deflationary situation, but being modest and consistent year-to-year. And so where we've called out in our Qs and Ks and originally earnings calls where we don't talk about it now, we've just applied a consistent policy of refresh and renewal never being overly aggressive, never being too timid, but trying to be balanced in that approach and saying these are things to -- for us to be able to reinvest in the business to keep driving the technology. And that's really important to us and nothing to the industry. So we're doing things like how we can, for example, eliminate whole drilling on turbine blades, which is significant for our customers, because it can eliminate a whole raft of inventory in the system. But that's not where we start. We actually start with the complexity of some of the shapes are -- it actually, you are unable to bring a drill or an EDM machining to actually create the hole. And therefore, if we can cast them in, then that produces a level of sophistication of airflow, which otherwise has been unattainable. So to have those level of investments on which we're deploying in what's coming up in the next few years in [indiscernible] on the military side, is that that's an extraordinary level of capability, which takes again a reinvestment in R&D, which you need to have the right returns to be able to do. And so when we look at that, we look at our coatings and then we bring it all together by trying to create the conditions whereby we can cast and shape the holes. So if you drill a hole, they're always around. And that's not necessarily the optimal flow for air. We want to create the creation where air comes out of the turbine blade and actually clings to the surface of the blade. And you do that by shaping the hole, the exit path and the rate of velocity of the airflow. And so those things are really, I think, at the cutting edge of what can be done to do that, it requires investment to do that, you've got to earn the right return. So I think trying to do that consistently, not go crazy in a [indiscernible] point in time. That's what we're trying to do, Doug. So we'll be a good partner to our customers and to the industry need and to enable us to achieve the fuel efficiency and carbon footprints that we all want for the future.

Well, in Engine Products, you've...

I got quite wistful then. I was getting quite wistful about it.

I could tell that.

Which stuff I believe in, because I do think we need to pay attention to it.

Well, in Engine Products, you've been getting margins sort of in the 23%, 24% range. But if you think about opportunities from pricing and you think about operating leverage as your volumes grow, and then I would add to this, and we talked about it before, the fact that your automation can allow you yields that potentially are much higher than you got before. If you think of those levers, can you at all quantify what the opportunity is going to be in terms of margin expansion?

Well, not really, no. Because I really have never in my history of trying to lead companies, done a couple or 3 now. And I've always resisted the opportunity provided to predict what margins might be in the future, because I genuinely don't know all the circumstances, which we'll face. You've certainly face exogenous events that you have no control over, and it can make you look very foolish. I don't control how many planes are going to be made. So there's so much, which we don't know. And therefore, why should I assume a level of prescience and knowledge that I just don't have. So we keep working away to try to make things better. And there's things which were really important to us. So I really believe the application of automation into aerospace is vital for the industry, because everything that requires, let's say, an artisanal skill that's going to, therefore, introduce that human variability into the production process is probably not the best. And so for us to drive quality and repeatable performance, then we do have to automate. And having lines of people with fine scalpel tools, trimming wax, parts coming out of [indiscernible] that's not really how things should be, because then the downstream yields as we come to the final process before -- after we've cast, those yields and the defects appear then. And so it's really important to go all the way back upstream and keep focusing on automating whether it's your, let's say, the molding machines, the application temperature, the waxes, the -- I'll say, casting process itself or the shell process, doing it by robot control. And then at the end of the process now, we -- I've got to fit the word AI in some wax. I'm told that's good these days. And So we're using a lot of AI in terms of both some of the developments we're doing in terms of material science, but also in our test sets are now rather than scan them by camera and then direct X-ray. We just moved the files digitally, and we have people now not employed to look at them, because the success of doing it by digital means is such that the -- across the AI system and the computer control means that it never gets tired. It doesn't need to go to the bathroom. There's no errors made. And so it's proven to be very effective for us in terms of improving those yields. But it's hard work and it's more capital intensive. And then go back to -- if it's capital intensive, you got to earn the right returns, et cetera, et cetera. But ultimately, it makes the product, the repeatability, delivery performance and consistency of quality that much better. Now we have our moments. We're not free of defects, because it's still there. But my goodness me, we are trying to improve and keep driving ourselves technologically on the product technology I've talked about, like casting holes, et cetera, and also on the manufacturing side. And it's evident not in just our turbine airport both in our rings plants and indeed, in our fastener plants and the emphasis on repeatability, automation and trying to take the human error out of the system is really important to us.

Now on fasteners. I remember back 2007, 787, one of the biggest problems on the 787 that delayed its introduction was fasteners. And those were the fasteners, what was then Alcoa, now you, and it was the development of the fasteners to deal with electromagnetic issues on the wing. So you develop Howmet as Alcoa developed these fasteners for composites. That is now a pretty, I think, powerful product set. You've talked about growth in wide-bodies. Can you talk about kind of the importance of the 787, which is a little slower than it should be right now and the A350 in terms of growth in your fasteners demand?

Well, first of all, I actually did not know that we had caused problems in 2007. It's like that's to me the past. And the only thing that I can...