Kaiser Aluminum Corporation (KALU) Earnings Call Transcript & Summary

Hi. Good afternoon, everyone. Thanks for joining us here for Goldman Sachs' Leveraged Finance Conference. I'm Karl Blunden. I run our high-yield metals and mining research effort here at Goldman. I'm very happy to have with us here Kaiser Aluminum and in particular, Jack Hockema, who's Kaiser's Chairman and CEO. We have about 30 minutes together today. And the way we're planning to use the time is we'll start with some slides that Jack is going to run through. We'll then shift to Q&A. I have a couple of questions of my own. [Operator Instructions] So with those introductory remarks, Jack, thank you very much for being here, and looking forward to your comments today.

[Audio Gap] Reconciliations of non-GAAP financial information are -- in our discussion are included in our earnings release and in the investor presentation on our website, kaiseraluminum.com, where we have a comprehensive information regarding the business. Turning to Slide 3 and our key credit highlights. We have leading positions in attractive growing market segments that have barriers to entry and where we have a defensible competitive position. We have long-standing relationships with blue-chip customers that I'll go through here in a minute. Our business model has reduced exposure to metal price. Approximately 85% of our metal cost is passed through to customers, and the other 15% is passed through with a lag. We have strong liquidity and cash flow and balanced capital allocation, and our liquidity provides a safety net for times of economic adversity like we're experiencing now. And along with low leverage, we have financial strength and flexibility to be proactive throughout the business cycle. Turning to Slide 4. Our focus is on demanding applications where we have a defensible competitive position in all 3 major market segments we are well positioned as a leader. Aerospace and high-strength applications are approximately 60% of our business. Roughly 60% of that 60% slice is commercial aerospace, 20% is defense, and the other 20% is aviation and industrial applications. Automotive is approximately 11%. We have strong demand growth driven by increasing aluminum extrusion content in vehicles. We serve 27% general engineering slice of the pie through service centers where we are differentiated as the premier domestic supplier for these applications. Turning to Slide 5. Our blue-chip customer base. Roughly 50% of our business goes through OEMs and 50% through service centers. The service centers, in particular, we have long, deep relationships, many of which go back 75 years to the beginning of the company. Similarly, on the OEM side, we also have long, deep relationships with the brand names that you see here on the left of Slide #5. Turning to Slide 6. We have a long track record of strong financial performance going back to 2005 with a 4% compound annual growth rate on our value-added revenue and an 8% compound annual growth rate on our EBITDA. Turning to Slide 7 and our long-standing business cycle strategy, which is to always be prepared for unexpected economic adversity. Execution of the strategy depends upon 4 key points: first, providing superior customer satisfaction to be this preferred supplier. Second, flexing aggressively our variable costs. While we flex with changes in the business level, our financial strength enables us to avoid survival level -- survival mode cost cuts that would erode our competitive strength. Third, we retain a strong safety -- liquidity safety net that sustains and enhances our competitive position during a downturn. And fourth, we maintain conservative leverage for financial flexibility and access to capital. The last 2 points are -- mentioned here are elaborated on Slide 8. As we just mentioned, the financial strategy are 2 key elements of the business cycle strategy. Number one, we assure that our liquidity is always sufficient to address an economic downturn. We currently have approximately $1 billion of liquidity, which provides a strong safety net and a foundation to be proactive as opportunities occur. Number two is to maintain leverage at or below 2x net debt to normalized EBITDA. We allow greater than 2x for strategic initiatives if there's a clear plan to delever to 2x or less. Turning to Slide 9 and the current situation. With the current economic uncertainty, liquidity is king, and we have taken actions to preserve liquidity. We suspended share repurchases in mid-March, reflecting variable cost with changing business activity. We're currently limiting capital spending to sustaining projects, which average approximately $35 million per year. And in February, we announced a $375 million multiyear project at Trentwood and indicated at the time that the timing would be subject to market conditions. We'll continue to monitor market conditions to decide the timing of various modules contained within this project, including the initial $145 million project for a new plate stretcher. Turning to Slide 10 and the 2020 outlook. Our -- during April earnings call, we suspended our outlook for 2020, although we provided our thoughts on value-added revenue for approximately 1/2 of our business. We expect value-added revenue for commercial aerospace applications that represent approximately 1/3 of our total business to be down 20% to 25% from 2019. And we expect that value-added revenue for our defense applications that represent 10% to 15% of total value-added revenue to trend up in 2020. When combined, these 2 represent approximately 50% of our total business and are expected to be down 15% to 20% from last year. Turning to Slide 11 and our balanced capital allocation priorities. As mentioned earlier, our sustaining CapEx is roughly $35 million per year. Also, as mentioned earlier, share repurchases are our last priority to be exercised only when we have excess liquidity and leverage consistent with our financial strategy. We suspended share repurchases in mid-March. Turning to Slide 12 and inorganic investments. Acquisitions are discretionary as we expect that our current business model has legs well into the future. During the recession, there may be potential acquisitions to consider. We will adhere to the same disciplined approach, and we'll employ the same filters we applied in evaluating prior potential acquisitions. It must be a business that we understand, must be capable of achieving a defensible competitive position, must have a transaction price consistent with creating long-term shareholder value and must meet our liquidity safety net and leverage guidelines. Turning to Slide 13. The company is well positioned with financial and competitive strength and a conservative capital structure. We have a strong safety net to address the current economic adversity. Our philosophy is that economic adversity is the opportune time for a well-prepared company to expand relative competitive strength as we did in 2009, and we will seek to do the same this time. Karl, that concludes my remarks.

Thanks, Jack. Just wanted to shift now. I think you covered a lot of ground there, so we'll dig into various different parts of that. [Operator Instructions] I think, Jack, you and I spoke about a month ago, maybe more than a month ago at the Goldman Sachs Industrials & Materials Conference. We spoke about a lack of visibility into demand at the time. If I can ask you to go into what you've seen in the last 5 weeks, what have you learned? What's going better than expected? What's potentially going worse than expected from a demand standpoint?

Sure. Well, I think pretty much things are unfolding as we expected. In aerospace, Boeing and Airbus continue to issue public comments. They're now both indicating they're expecting this is going to last 2 to 4 years. And we've been anticipating that this might be an extended downturn as well. We're well prepared with -- for that with our liquidity and with our business cycle strategy that we're always prepared for a downturn such as this. We also expect, based on past history, that automotive and industrial applications will respond much more quickly than aerospace. Typically, when aerospace has a downturn, it has lasted for a few years. Also typically, automotive comes back to the prerecession year within 1 or 2 years after a downturn. Similarly, industrial does as well as has been widely reported in the public information, both auto, now that they're past the assembly plant shutdowns, auto is beginning to rebound and industrial demand is strengthening as well. We'll provide a lot more detail on this on our earnings call coming up later here in July, but that's kind of the high-level view. Is this a swoosh? Or is it a V? Too soon to tell. But clearly, we're starting to see recovery.

Jack, just following up on auto. Have you seen that auto demand has -- and what are the customers saying? Is there some pent-up element of that as folks were not really out buying for the last little while? Or as we see this recovery coming through, is that more of a reflection of real demand in the economy and just better confidence than we had thought we'd see a couple of months ago?

Yes. Well, I think it's difficult to tell. The forecast that we use, IHS is the primary external forecast that we use. They're still looking at build rates in the 12s. I think they were 12.2% or 12.3% a month or 2 ago. They're now about -- around 12.4%, I think, is in the outlook for North American builds for the year, which again would be, frankly, compared to history, a relatively modest downturn for automotive. What that's driven by, I don't know, there's a lot of publicity out there. Maybe there's pent-up demand. Maybe it's a lot of people concerned about mass transit and looking more at individual vehicles. But I still think it's way too soon to tell. We're just in the early stages here.

Got you. Look, you mentioned on aero that you'd expect the slowdown or at least the customers are saying could have a 2- to 4-year slowdown. When you think about Kaiser's ability to earn during that period in time, you have a pretty heavy component of variable costs. How do you manage through that 2- to 4-year period, whilst fully maintaining the ability to grow market share while keeping costs low?

Well, first of all, we have the $1 billion -- or probably $1 billion of liquidity. So we have a very strong safety that frankly goes beyond the safety net. It's really the ability to be opportunistic and grow. We also have enough strength. There's no need. We're flexing with business level -- business activity level, but we're not cutting into the muscle here. We're keeping all of our strength. And frankly, part of the rationale for building the liquidity with the $350 million debt offering is, in our experience, especially in the industrial, the general engineering sector, these rebounds and also automotive can be very, very sharp rebounds. And if a company isn't well prepared, if they've sliced to the bone in a downturn, they have real difficulty responding. And again, that can create opportunities as well. So we're well positioned to seize opportunities as they go forward, both from a financial standpoint and in terms of having all of our resources intact. We're ready to react however the markets develop here.

And so I was taking a look at expectations for EBITDA just on a Bloomberg consensus basis. It does look like expectations take Kaiser back to close to pre-COVID levels as you get towards '22, '23. Based on the timing of an arrow down, it looks like it could extend beyond that. Could you talk about some of the levers that you have to grow earnings even in a down volume, maybe its market share given the stronger balance sheet and attacking business?

Yes. Well, certainly, we positioned ourselves as a preferred supplier in all of the segments that we supply. And we frankly expect that we're going to go down less than most in the downturn here. And again, depending on how the recovery unfolds, we expect that we'll do well in a recovery as well. So we're very well positioned with our customers. We're well positioned, as I just said, to take advantage of opportunities as they occur. We think we're going to be better positioned than anybody. So we're very confident here. We've run a multitude of scenarios on economic recoveries. We're prepared for just about anything, the downturn and the recovery. So we're prepared for just about anything. And we have our game plan, and we know how we'll play the cards once the cards are dealt.

Just shifting to M&A. And I think you mentioned in the slides that during -- you've acted, in the past, proactively during down cycles. Interested in your view of how much M&A could play a part in growth right now. I know there's a large M&A going on right now in the aluminum space with Novelis and Aleris, potentially some assets there becoming available. How do you look at the types of assets that might come available there? And then just more generally, too?

Sure. Well, in general, we're back to no change. We're very confident in our business model as it stands today. We're confident that we'll create very strong long-term shareholder returns with this business model. So we're not frantic to do acquisitions. However, we're well positioned to do those. We're typically a preferred buyer. We look for businesses that we understand and businesses that would be complementary to what we have. That's the macro filter. And then we have a much finer screen that we go through once we start looking at an asset. We don't like to talk about specific assets, but the Lewisport asset is public information. Clearly, that would fit those first 2 criteria. So people could expect that we'll certainly look to be involved in that process. Where it goes from there depends on due diligence and just working through the process and seeing how much of a fit there may be and what that business might be worth to us versus what it might be worth to others.

Funding for acquisitions is probably a bit of a case-by-case basis question. But what's your preferred approach there? The secured markets would almost always be open to a company like Kaiser. You've done unsecured debt just recently. How do you balance flexibility with cost? And are there other sources of funding that you'd look at for, for larger M&A?

Sure. Well, first of all, we have a lot of dry powder now. So it's -- I said we've run a multitude of scenarios, and we're confident with that multitude of scenarios that we've got a lot of dry powder to do organic investments going forward as well as inorganic investments. So -- but if there's -- if we do something of a magnitude that would require additional debt, we're confident that the credit markets will be open to us. All of our debt is unsecured. We still have a lot of capacity, we think, for unsecured debt, but clearly would have capacity for secured debt as well. So we're very confident in our ability to finance anything that would be within the realm of what we would consider in terms of an acquisition.

I mean it sounds like -- you highlighted the Trentwood capacity expansion a bit earlier in your remarks. It sounds like you have options both internally and externally. I'd just be interested in your thinking about -- are those 2 things that -- could you pursue M&A at the same time as doing the CapEx spend at Trentwood? Or are those essentially competing with each other at this point?

No. When we announced the Trentwood, $375 million expansion, we said it was dependent upon market conditions. Obviously, market conditions changed dramatically just a few weeks after we announced that $375 million expansion. So we've delayed that, are pushing it far to the right. And it really will depend primarily on the aerospace cycle. There's general engineering capacity there as well, but it's aerospace that would really dictate when we start that -- those projects up again. But we're -- they're pushed far to the right. We don't see those competing with other opportunities that we'll have at this point.

Got it. Just finally on cash uses. At some point, we come out of this down cycle and cash flow steps up to a new level. Where does -- buybacks and dividends, where do they fall in your priority bucket?

Yes. Well, we've been very clear for a long time on our capital allocation priorities. Number one is organic investment. Number two is inorganic or M&A. Number three is the regular dividend. We've -- we're sustaining the regular dividend. As I said, we've run a myriad of economic scenarios here. Even in the most severe black swan cases, we're confident that we can sustain the dividend for several years going forward. And then fourth on that list is share repurchases. We have 2 criteria for share repurchases. One is we must have excess cash beyond the liquidity safety net required for adverse economic conditions. And number two, we won't do share repurchases that cause us to breach our net debt leverage criteria.

I just wanted to shift to a couple of longer-term questions at this point in time. So ESG is something that comes up a lot. It comes up a lot in the aluminum space with the benefits there relative to some other materials. I want to get a sense for how much focus there is on ESG internally, how important that is to your forward outlook. And then we can probably follow up on what benefits you see for the materials you're working with aluminum relative to the competing set.

Well, we like to say we were ESG before ESG became fashionable. When Keith Harvey and I and others put together our value system and our strategies back 20 years ago, ESG was already a key cornerstone -- going back to 2020, a key cornerstone of what our value system represents. We're very proud of what we've done historically, and we'll continue to do. We are very environmentally friendly. And aluminum is an environmentally friendly material, as you mentioned here. In terms of the social, we have, perhaps, the best union relationships, certainly, in the industry and maybe in all industry; very, very strong relationships with our unions; very good relationships with our employees, deep training programs. We'd match our executive talent development programs against any Fortune 100 company even though we're a small company. So we've built these practices and have done these things over the long term. Governance. Our lead director, who we recruited from UCLA when I went to the director training program back before we emerged from bankruptcy. We recruited the person that heads that program, Al Osborne, who's a recognized expert on corporate governance. So as far as we're concerned, we're always on the leading edge in terms of corporate governance. So again, we've been ESG before anyone began talking about this. We have an extensive ESG report on our website that Melinda and others here -- but Melinda was the primary author of that website. So you can see on the website our commitment to ESG as a pillar of our foundation, our value system in the company.

Yes. I think it's important to think about how that has -- how that flows downstream, too, right, to your customers who are choosing your materials for lower weight and, therefore, gains from an emission standpoint, but probably also from kind of recyclability and just better environmental impact. When you think about the -- your forecast for automotive penetration or aluminum longer term, be interested in our customers are thinking about that these days relative to the cost of retooling and the competition from high-strength steel and autos.

No. We're very confident. And again, we're focused on aluminum extrusions. And aluminum extrusions actually had a 5% compound growth rate in demand going clear back to 1990, well before the CAFE regs kicked in. So -- and we and the industry are forecasting a 5% to 6% CAGR in terms of content growth in North America over the next 5 to 10 years. So we see that trend continuing, the lightweighting. We've seen some nuances there, if you will. The body and white auto body sheet was forecasted 3 or 4 years ago to be double-digit growth rates. It's now down into the mid- to high single-digit growth rates. Part of that is the successful pushback of high-strength steel. In the extrusions sector, we were anticipating 3 or 4 years ago that high-strength steels would reduce the aluminum penetration or the aluminum growth in bumpers. That's turned out not to be the case. The aluminum has come up with some developments here, and we're competing very effectively with high-strength steel. So we're very, very comfortable with that 5% to 6% compound growth rate continuing for aluminum extrusions as a key lightweighting initiative for the auto industry.

I'm just going to bounce down to a couple of questions that are coming in from investors over the line. Could you update us on your working capital expectations, given that it looks like the reopening ramp is occurring faster than expected a couple of months ago?

Yes. So in terms of working capital, we get this question a lot and some people who are thinking about free cash flow. However, our focus -- and you heard it all through my prepared remarks and through my Q&A here, our focus is on liquidity. And our revolver is asset-based. So the access to our revolver is a function of our working capital. So in the downturn, when we were throwing off working capital, that was generating cash, but at the same time, our borrowing base is reduced, so it really doesn't have a material impact on our liquidity. The converse as we start to go into a recovery here where cash is being consumed by working capital, as working capital goes up, our borrowing base goes up. So our liquidity is not impacted. So the key metric we're looking at is liquidity in terms of our ability to -- for our safety net as well as to be proactive. The working capital really is pretty much a neutral in terms of how we're positioned with liquidity.

Another one here. This is a follow-up from a recent earnings call. On a recent earnings call, Kaiser indicated that the full commitments reflected in original contract declaration will be met in their entirety. I think this is referring mostly to the aero side of the business. Could you provide a bit more info on what that means?

Yes. So -- yes, so what we indicated is on the earnings call that we expected commercial aerospace value-added revenue this year to be down 20% to 25%, we'll go to that. I'm not going to give any new information, but we'll give a lot more information on the second quarter earnings call in terms of our outlook for commercial aerospace as well as a much more robust outlook. We've got enough information now that we can give a clear picture of what we're expecting for the rest of the year here and maybe even some general outlook going beyond that.

Probably the last one we have time for here. This is a longer-term one. Folks are looking at your slide on Page 10 for the value-added revenue mix for 2020, the red and gray pie there, commercial aero and defense versus auto, industrial and other aero. How do you see that transitioning over the next 3 to 5 years?

Well, typically -- or based on what I've said about commercial aerospace being probably a 2- to 4-year scenario in terms of being depressed, that 1/3 of our business is going to decline as a share of the mix as we go through time here. We expect defense, which is roughly 1/8 or 12% -- 10% to 15% of our business. We expect defense is going to continue to grow. And we think that auto will continue to grow with economic recovery as well as the 5% CAGR. In terms of content growth -- the industry content growth, we think we'll do better than that. And the industrial sector will recover more rapidly than aerospace. So quickly -- so obviously, the commercial aerospace portion of that pie will become a smaller portion, and all of the others will become larger.

I think that's about time. We have 1 or 2 minutes. I'll turn it back to you, Jack, for anything that we may have missed. It sounds like you have some information to discuss on the earnings call when that comes around. But anything that we should take home with us at this point in time, I'll turn it to you.

No. I think the real takeaway here is that we never know when a downturn is coming, but we're prepared for it. That's our business strategy. And we were prepared for this downturn. We don't like being in a downturn, but we think that we're better positioned than just about anyone in our space for this downturn. Not only to weather the downturn, but more importantly, we're starting to turn our focus to opportunities going forward. Be those organic opportunities or inorganic opportunities, we think we're going to have good opportunity to differentiate our business as we go forward. And longer term, we continue to remain very confident that we're going to generate strong returns for our shareholders over the long term.

Thanks very much for your comments and for joining us. And I'd like to thank the audience also for dialing into the Goldman Leveraged Finance Conference. Be in touch with any questions. Thank you.

Thanks, Karl.