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

Good afternoon, everyone. Thank you for joining us. My name is Peter Arment. I'm the Senior Aerospace Defense Analyst here at Baird. We're delighted to have with us Howmet Aerospace this afternoon. And with us from Howmet Aerospace, we have John Plant, who's the Executive Chairman and Chief Executive Officer of Howmet. John, thank you for joining us.

Nice to be here. Peter.

It's great to have you. So we're going to jump right into Q&A. At a high level, I guess, John, it's been quite a year in aerospace. How are you thinking about commercial aerospace landscape as we're kind of exiting 2024, the overall health of kind of the supply chain, all things that you've kind of talked about. But anything that there's been like kind of a permanent damage to the global output of capabilities or leaving with the 2 plane makers?

Okay. So first of all, welcome. I'm going to do my best to answer the question about plane makers, but that's a tough one, given what's been a pretty turbulent year this year. I think everybody knows that aircraft manufacturers would like to make more production than they're currently being able to do. And certainly, 2024 has been yet another year where, I'd say, production plans have not been fulfilled. And you get into -- so like why might that be? Well, clearly, in the last month or 2, it's been because of strikes at Boeing. And prior to that is because of, let's say, a slowdown of production to improve quality with FAA oversight. And then if it's not that, then the word which is reached for so many times these days has been supply chain. And the question is, is that always the case, it's supply chain? And so yes, in certain circumstances, I'm convinced there have been supply issues. But at the same time, it's almost become the word of the day in response to any question, which is supply chain. And I reject the premise that supply chain is the cause of all the issues. And I really believe that there's a capability there to raise production. And so when I look forward into 2025, while I don't believe for a second it's going to be the state of grace that I've talked to in terms of smooth production with Boeing easily increasing their production quantities, starting with rate 38 or anything like that to a better future, and Airbus just goes up naturally from there, let's say, rate 50 to their 65. So it's not going to be straight line. There is going to be, I would say, some turmoil along the way, and it's difficult to be absolutely certain. But the one thing that I really am clear about is that 2025 is going to be a year where more aircraft are produced, probably not to the degree of increase that is being looked at by some of the external agencies, but aircraft production will increase. I think the supply chains that have been referred to are able to support much higher production than we have today. And we'll see the benefit of all of that. But it's not going to be night and day. So I think there's going to be further improvements as we get into 2026 and 2027. But to me, the fundamentals of a large backlog with supply chains easing, with aircraft manufacturers themselves improving their own labor utilization, training and output, all of that's going to occur. So I'm absolutely convinced that tomorrow is better than today. And for me, that's good.

Terrific. Yes, it's good. I like that. Well, one of the things that has come up recently in your most recent results was a discussion around spares. And how are you thinking about the relative mix of OE and aftermarket when we think about 2025 as an industry as a whole? And obviously, we're assuming there will be a higher OEM mix just given the comments you just said.

Well, what's going to be really good is that I think we're going to see both increased demand for spares and increased OE production. So in one sense, it doesn't really get better than that now, which ultimately turns out to be the greatest level of increase. I mean, that's a TBD. But if I were to look and take a guess, I think the demand for increased spares is fundamentally there. And therefore, I'm much clearer about what I think that increase might be. And that's borne of, first of all, CFM56 and V2500 of Pratt & Whitney, we are going to see increased demand for that because we haven't reached peak yet for the old aircraft. Then we're going to be -- have that demand supplemented by the, what I call, well-publicized time-on-wing issues for the current LEAP and geared turbofan engine, an increased frequency of shop visits. And then there's a longer-term trend of, I'll say, fundamentally increased shop visits for those newer engines over the next, I'll say, 1 or 2 decades. And so I think each builds on its own. And so while I don't think there's going to be a constant increase in percentage each year, but I'm clear that the dollar value of spares will improve, the rate of increase is going to be good. And there could be a year where OE production outpaces it because I don't think that's going to be even in terms of increase between '25, '26 or '27, but I'll bet on the spares weighting is going to improve for Howmet in terms of our total content of revenues because of what we see happening in the spares market.

Terrific. So '25 outlook is seemingly better all around. One of the things that came up on your third quarter call was IGT, which I don't think has been talked a lot about in recent times. Maybe you could just talk about a little bit of the opportunity that you talked about a little bit on Q3.

Well, I thought I'd better find a way of getting AI into the conversation. And I only mentioned the word once in our August call. So I would talk about it more in the future. So I think I mentioned it at least twice in our call in -- I'd say in November, so last week so it's pretty fresh in my mind. And maybe I'll mention it 3 times in the next call because it's guaranteed for $10 is the way I think about it. But I mean, talking on a more serious vein is that for me, clearly, the requirement for data centers in particular is increasing. And whether it's cloud storage or whether it's going to be the increases because of AI searches or just generally, I think everybody is -- you can -- I track it by looking at the property market and which property companies are building data centers, what's the scale of that increase in investment. And then for us, it's not a data center per se, but the electricity demand which comes from that build-out, which is so critical. And I think about it in that if an AI search takes 10x the electricity of a Google search, if the publicized, I must say, maybe backward-looking forecasts from 3 of the utility companies, which are in the states where these data centers are being built out, it's a very significant increase in gigawatts of electricity demand for them. And for us, that means more demand for our turbine blades that go into the industrial gas turbines. And I know the counter to that is well, what's IGT going to be as a percentage of electricity generation? Well, it comes, first of all, in 2 ways. One is certain of these data center campuses are going to have their own energy source because of the ability of the grid to provide that transmission capability won't be there. So it's going to be, whether it's aero derivatives or smaller gas turbines or even the large aging J-class turbine is going to be some of those which will be required for these data centers. But utility companies are also -- I was going to say, is part of the blend of electricity generation. And of course, in one sense, we don't know what will come from nuclear, but there's been no new permitting for nuclear, there had been one, I'll say, repurposing and refurbishment of Three Mile Island for Microsoft Energy. But given the demand, clearly, IGT was going to be up -- is going to be up. But I think the landscape changed again since last week. And what I mean by that is that we were there morning after the election, it's pretty clear, the result. But my guess is the amount of, I would say, provision of electricity from wind turbines might be a little bit less than we thought. And I think that the provision of electricity from gas turbines might be a little bit more. And it's not just going to be a U.S. phenomenon because we're going to be shipping liquefied natural gas to Europe as well, and they're going to use it for their gas turbines. And I think they need it. I mean, everybody is going to need it. And so it's a global phenomenon. And I expect that the major turbine manufacturers are going to be a beneficiary of all of that. And then because of them, we are the most significant supplier of blades for gas turbines in the world. And so for us, we're indifferent to -- is it a GE Vernova solution or a Siemens or a Mitsubishi Heavy or Ansaldo, is that we're the biggest supplier to each of those companies and we're building out a global network further. And when we have our next round of planning meetings, we had a second round planned for December. I think the landscape shifted again. And you get lucky sometimes in life, and we take a lot of problems on board, but this time, a little bit of luck is good.

Like a building tailwind for IGT?

Yes, because we've done nothing. We're just going to sit there and hopefully enjoy it. But we've taken our problems as well, like strikes and stuff.

So let's talk about Engine Products. It's 50% of your total kind of group sales. You've materially increased the EBITDA margins for the segment from -- it was 22% in 2019, you're now 30% plus. How much of the step-up is tied to operational execution, automation efforts, which we certainly saw at Whitehall and Cedar Rapids, price increases, market share gains from your closest competitors? How would you...

I think there's probably different emphasis at different points in the journey that we've had because I think margin rate also goes to the angle of increasing your top line. So sometimes, if the angle is too steep, you can end up with excess costs and labor training and, say, just materials management and expedites. At the same time, generally, more is better because you get the benefit of fixed cost leverage, and we've been pretty, I'll say, disciplined over fixed costs all the way through this, both during the COVID times and in the aftermath of the pandemic. We've had periods where we have accelerated labor recruitment because of the coming demand in periods where we've, I'll say, pull back and emphasize productivity. And if you look at 2024, then I think we have made significant strides forward in our productivity and also made some improvements in our recruitment and retention of employees, and turnover has been a little bit better than it was in 2023 and 2022, even though I'm not yet satisfied with it. And you've seen at our most extraordinary, you've seen one of our businesses, which is our fasteners business, where we'd put like 23%, 25% increase of revenue through with no increase in people, which is, I think, really, really impressive even though I probably shouldn't say it myself. But yes, I quite liked it. But I mean, it's never linear. And we know that we're going to prove or increase the rate of our recruitment in 2025 because of the capital investments we're making, the training required to get people ready. And if I look through the periods of time, we've had periods of accelerated margin improvement and periods of rate stability. It's not linear. And so I think that's what we have to plan for. Nothing ever moves totally in a straight line. But we've had mix improvements, content improvements, price improvements, productivity improvements, you name it. We've got it. And all the time been coping with some pretty tumultuous markets over the last 2 or 3 years.

Where would you say you are in that automation journey?

I should have mentioned automation. Thank goodness for you. You mentioned it twice now and reminding me politely that you've forgotten all about it. And we have emphasized a lot automation improvements. And it's been one to go to economics in the -- clearly, a machine produces repeatable performance and it doesn't require the same -- doesn't have the problems of recruitment and retention in quite the same way. It's also provided an avenue for upskilling our existing workforce and retraining and providing jobs, managing that automation with improved pay as well. So it's been beneficial for everybody. But now I think we're at the point where with the complexity of some of the parts we're making, that to do it with higher content of labor will be very problematic. And so we've been able to improve our production rates, and automation has played a large part in that. And to get the repeatability and in particular, the quality levels that we have to do because of the extreme tolerances of the parts we're making, particularly in the turbine section of the engine, automation has become essential. It's not an option. And to meet the requirements of what we're going to see on the, I'll say, the geared turbofan advantage engine or the, I'll say, the improved turbine parts in the LEAP engines, then automation is going to be fundamental to it. And as each generation has come along, we've tried to improve that. And certainly, for the investments and the couple of new buildings we've been constructing today and building out and capitalizing in '25, the level of automation is going to be taken to another level.

And that's, I guess, is that a big part of the CapEx, kind of the elevated CapEx that you're seeing for this year and a little bit next year? Is that part of it?

We've elevated the automation as a percentage of our capital significantly in '22, '23 and '24. '25 is more about capacity but we're not just putting in the same, it's not same old. We're combining both, say, capacity build-out with improved automation at the same time. So it's hard to pick that one apart. But we certainly have emphasized, and I could talk probably for minimum 30 minutes about the, I'll say, the improvements we've made in bringing a different way of thinking because -- to automation in aerospace because it's a different volume variety. It's not like canning. It's not like an automotive company. And that volume variety requires you to think differently to enable automation to occur.

Yes, yes. Let's talk a little bit about, I guess, the spares catalog for the F-35, similar margins, I guess, to conventional OEM sales. How do we think about the spares portfolio and F-35? Is it a more attractive margin perspective? Or is it just simply kind of the supply -- the supply requires kind of the parts to the MROs or how is that?

We supply the same prices for MRO, I'll say, destined product to the OE product. So there's no differentiation on price. We sell to, in this case, Pratt & Whitney at the same price. It does go to mix within it. And when we look at that on an LTA refreshment and what's the proportionality of where we apply economic differential. But the most important aspect is, given there's now 1,000 in '25 -- or is that even going to change obviously every month, of the numbers of F-35s around the world. And I quoted a number of like 600-plus F-35s destined for the European theater alone by 2030. I mean we're going to be, I think, approaching 2,000 sometime in the early 2030s. And that is a lot of fighter jets with obviously a fundamentally different duty cycle to a commercial jet. There was the frequency of shop visit is obviously much higher so by a significant factor. But just because of the expected maneuverability, the hovering capability and therefore, the heat soak through, I'll say, airflow management as the jet is just poised in the air and stable. So all of those things go to a fundamentally different requirement for both those -- that turbine and also the thermal performance and also the content point of those blades and therefore, goes to price as well. So it's going to be a great business over the next 10, 20 years. It's a long way of saying that.

Getting bigger and bigger. Yes.

It's getting bigger and it's going to last a long time.

Yes, yes. Let's move on to one where I think the margin performance is still really strong, but you are seeing a little bit of a softer top line on the Forged Wheels.

You had to bring it up in -- you just had to sort of spoil it by...

I got to look like I'm being tough up here. Come on.

Yes, I know.

But you've managed to keep really strong elevated margins, high 20s year-to-date despite kind of the guidance, which you've been very clear about, about that coming down. You expected that. But you also talked a lot about that you think it could be also short lived, but in terms of the snapback as we -- some of the mandates. But could you talk about the ability to kind of maintain elevated margins during this kind of the softer period?

Yes. Well, first of all, I mean, my estimate that we're going to see now continuing 20% reductions in Europe for the next couple of quarters and then maybe 10% in the U.S. So it's a little bit more, I'll say, severe. But we're probably seeing some inventory effect as we go through this, not just what changes by way of truck or trailer production because they trim their inventories. And then expecting some improvement because of the prebuys ready for the 2027 emissions increase requirements, which are significant in terms of the dollar value per truck. It's like an extra $15,000 or $20,000 per truck increase, which is really -- incentivize people to buy more and earlier. But we've been trying to really work hard to hold our margins. And it's always a combination of things, which is we did try to build up the temporary element of our workforce so that we could adjust manning. We also, during good times, try not to be totally self-sufficient. So we outsource certain of the processes. And then try to insource when food is scarce, let's say, when times are a little bit tougher, and use -- without totally moving the work inside, a balance so that we rebalance towards ourselves, so we keep our own plants working more. And that helps us manage our margin to a respectable -- I think a very respectable decremental margin that you've seen. Having said that, it's tough.

So basically, I think we're all rooting obviously, for hopefully Boeing getting recovery back going and the supply chain kind of healing itself. But one of the things that constantly comes up is that there's a need for new plane designs and there are clean sheets. And obviously, I don't think Boeing has the balance sheet to deal with that at this moment, but it does come up quite a bit. How do you think about -- is there propulsion technology advances? Is there any opportunities for new plane designs in this near term, let's call it the next 5 to 8 years?

Let me separate engine and airframe from that. So an engine is never static during its life, so they have a 20-, 30-year life. Then generally within 5 or 6 years, there's some form of upgrade. And the current upgrades, which a couple of years ago were meant to be really focused on, say, fuel efficiency, really the mission became more an improvement in robustness to deal with the time-on-wing issues in certain climates or certain countries where air pollution was that much greater, then the flying hours between shop visits was vastly reduced. So the robustness solution, which is the focus of what we're doing now, which starts hopefully, fairly soon on the LEAP-1A even though we're still not totally date certain yet on that. And then probably in certain quarters, future quarters from now, we'll be seeing that same change over in LEAP-1B. But then it's also on the geared turbofan, the introduction probably in the first half of next year, the improvements in content for the GTF advantage. So we've got all of that going on. But it doesn't stop there because probably, by the end of the decade, we'll be looking at the next steps to elevate the fuel efficiency or if not, for the emissions for that. So an engine never stays still. And while historically, it's also been used to keep out the PMA guys, today, the complexity of the turbine is such that it's -- I believe it's almost impossible to reverse engineer those parts anyway, and so it plays then to our strengths. And then maybe there's the rise engine to come or something else in terms of maybe the water-injected MTU technology. I mean, again, all to be decided. But in terms of airframe, there has been talk about putting back an MMA for Boeing or when does it start or when there is a need. And clearly, at some point, there will be an investment in a new platform. And what that will be is, I would say, who knows whether it goes composite in the way that more recent aircraft have become or at least composite wings on them if not more than that. And then what with the engine technology. So I don't think we're at that point of knowing and can be certain about it. And to some degree, neither does it matter because the backlog of current aircraft is so high. I mean if you place an order for an Airbus narrow-body today, you won't get it before 2032. And price for airframe manufacturers is very strong given that backlog. And the same for Boeing, maybe not that far out in the future, but still there's no economic case today, but I'm sure that whether it's in 1 year or 2, their lead time is to introduce a new airframe, I mean, that's significant, especially given today's FAA and the EASA certification requirements. So at some point, it will move. And then the question is, to what or whether there are partial upgrades to be made to the existing aircraft. But in one sense, for the next 5, 7 years, decade, there's no immediate need. And flying on, I think, on the new XLR for Airbus or even if you're flying on a new MAX, it's a pleasure.

Yes. All right. In the remaining minutes, let's talk about your balance sheet optionality. You've got your net leverage down to, I believe, was 1.6x, roughly below kind of the net leverage targets, too, that you've kind of always talked about from a balance sheet efficiency standpoint. So how should we think about kind of your thoughts around capital deployment or given that particularly M&A has not been part of your strategy in recent years?

Well, we said that at the end of '24, we hit what we think is a sort of target leverage of 1.5x. And I mean, you're never going to -- I'll say why I don't believe in this financial engineering just to go and borrow a lot of money to buy back stock. I think it's far better you generate the money and use that. And we're in the position of choice in so many dimensions at the moment, which is what do we think? Well, we think EBITDA is going up next year. So that would improve leverage. There's little to be done by way on the debt side. It could do a bit, but there's no big juice left in debt pay down without becoming fundamentally underleveraged. So far, we've been paying pretty much out of everything that we've earned. We sort of like that. I think we paid more to our shareholders last year than we earned, which is really good. And so what have we been doing? Well, the answer is we've been buying back stock, which I think goes to shareholders. I think paying down debt effectively goes to shareholders as well. And we've been increasing the dividend, and our dividend has probably increased 5x since '22. So it's still not exactly a great yield.

That's not your target to begin with, right?

No, we don't set out with a yield target. We wouldn't like it to degrade. But on the other hand, the rate of increase in dividend is quite extraordinary. But then so is everything else about Howmet. So I got to tell you, it's good. So what could you look forward to? The answer is, I think, increased share buyback, increased dividends, maybe debt paydown, hopefully a bit more EBITDA and revenue goes up.

More of the same and the story continues. Why don't we leave it there? I appreciate everyone joining us. John, thank you, as always. It's a pleasure.

Thank you.