Kaiser Aluminum Corporation (KALU) Earnings Call Transcript & Summary

Good afternoon, everyone, and welcome back to our next session. I'm pleased today to host the next discussion with Kaiser Aluminum. Presenting from Kaiser, we've got Keith Harvey, President and Chief Executive Officer. Keith, thanks for joining us today.

Thank you.

Before we get into the Q&A though, I do want to turn it over to you for any opening remarks you've got.

Certainly. Well, first of all, Emily, thanks for having us here today. It's great to be back in the city. For those of you who don't know, Kaiser Aluminum, we're a North American-based company focused on semi-fabricated products. And we've -- as most have had a very interesting year and challenge as we go through the high inflationary and all the challenges we've had with supply chain issues -- and at the end of our third quarter, we had discussed about what our outlook for demand was expected to be in the fourth quarter. And we also had an outlook of just of what we expected results to look like, and we referenced that those would be similar to the first half of the year. Based on some trends that have come down through October, we now think that the outlook is going to be more similar to the third quarter that we had just last quarter. And so with that, we're still working through some of those high inflationary issues and some of the off-fall of some of those challenges we had on supply chain. So I just wanted to get that out there. And then happy to be back to you with questions.

Great. Thanks, Keith. And we'll certainly unpack a little bit of that in effect. But maybe let's talk big picture then. Aluminum has been a metal that has been frequently discussed this conference. And the last panel we did have focused a lot on sort of green metals. Maybe as you think about your end market space and the relevance of aluminum in some of the industries, you talk that you deliver into. Maybe talk about what the demand outlook is looking like for packaging, aerospace, autos and then engineering as well.

Yes, certainly. And Emily just hit on the major markets that we participate. We're in packaging, aerospace in all sections, commercial, defense and business jet. We're also focused on automotive growth and with the general engineering type products. Demand for us, demand and sustainability sort of go forward with us. Of course, in the automotive side, we're focused on the extrusion side of the business, the applications that we have there. Of course, with the significant move to EVs, we're seeing a lot more applications. However, that industry continues to take its likes from managing all the supply chain issues they're going through. So the demand has been flat. We expect to have some of these supply chain issues resolved next year, so that should see an uptick. And of course, we're quoting on new programs, which all are heavily aluminum-centric. Moving to packaging. Packaging is on a significant upward move towards aluminum as a substrate. We see pet falling off, quite frankly, from a sustainability perspective, especially from all the end users and ultimately, the customers. So we're seeing a strong way. We expect that to continue very strong out through the end of the decade.  So we have some investments coming on in the new facility work that we purchased about 18 months ago, new investments to help meet some of that demand and go forward. So really a bright future ahead of us on packaging. From an aerospace perspective, of course, through COVID, we were heavily impacted. Our value-added revenue was down approximately 40% from the high point of 2019, and we had record sales and so forth in the first quarter of 2020, but then COVID drastically changed the outlook. We are seeing a good recovery continue in aerospace. Each quarter has continued to grow in strength. Of course, we get outlook for declarations a year ahead or so. So we're seeing positive growth that's coming up in Aero. So we see that returning in late '23, early '24 back to the 2019 levels. But really excited about what the growth that's recovery, the recovery that's taking place with air passenger miles. And we really believe we're back on a 3% growth rate once we get back up to the 2019 levels. So really positive news for us there. We have potential expansion plans coming on to meet that growth and are prepared for it and welcoming it back. And then finally, on the general industrial side, we've had significant -- it's actually been up almost 60% this year, greater than last year, and last year was a record for us for the last 30 or 40 years. So extremely strong demand. A lot of that from the strength of the market returning. But a lot of that also was, I think, exasperated by the supply chain challenges from offshore. So a lot of folks saw that having so much of that exposure to offshore really was detrimental to the uptick that they had. So we're seeing a resurgence on reshoring and at least more movement back to domestic supply. So we think that that's going to continue. We had some softening that was taking place on one of our products, which is somewhat of a canary in the coal mine for us. But the growth in that product had been unsustainable anyway. And for the most part for what we're seeing going into next year, long lead times in our mills still have good, strong demand. We've really seen no off-fall of any significance.

Fantastic. And then maybe if we think about the industry that you are and is actually quite consolidated. So we haven't seen a lot of growth there recently. But perhaps on the packaging side of the equation, there have been a couple of new announcements around new capacity there. Now you've obviously just come back into the packaging segment not too long ago in Warrick. But as you think about all that new capacity that's coming online, are there any concerns around oversupply in the '25, '26 time horizon? And then second part of the question is, how does Kaiser fit in with your broader portfolio of other end markets as well?

Certainly. Well, this year, there's actually been 3 announcements of planned investments -- each one of these in excess of $2 billion. These are -- we haven't had new rolling mills built in this country in the last 30 or 40 years. And so we see them coming in. Now why is that? Well, the packaging market, as I said, is extremely strong and expected to continue to grow, especially with sustainability, moving aluminum to the substrate of choice. So as they look at that marketplace, the industry right now, North American market is being subsidized with imports of over 1 billion pounds today, and that continues to rise every year. So it's -- and actually, the structure that the can makers would prefer is to have the domestic supply close to the domestic can-making capability. Reasoning for that is closed loop recycling, which is really the big focus of what we're working on. It's really not easy to do that with imports. So I can see the domestic capacity coming on, which basically will displace the imports that are taking -- that are coming on. And that's when and if these -- all of these announcements come through. Now as it relates to Kaiser Aluminum, we look at the cost of new facilities. We look at our acquisition price that we made. We feel very good about this. This facility has been supplying the beverage and food can industry for over 50 years on the acquisition that we made. We have strong customer relationships and very focused. So it's a reliable existing supply base that's pretty much treasured by our customers. And as we have focused on the business of moving in some of the announcements that have come place are not purely packaging plays. So part of that capacity is moving toward automotive. Part of that is moving to general industrial and others. So not all of the capacity is focused on packaging.  And so when we step back and take a look from our perspective of how we're going to participate here, our focus is really on moving to the coated product segment of the industry. And why do we like that? Well, Kaiser's mantra is really try to focus on very differentiated areas that we can defend, grab premiums out of and put it at a good defensive position. We see that opportunity with coated products. We have 3 coated lines already at the facility. The fourth one has been put in place, and we hope to have in by the end of 2022 -- or -- yes, excuse me, by the end. And so we're moving forward with our strategy. We think that's a strong defensible position. We think that others are going to be focused on more of the can body and other attributes in those -- in that market. And we see ourselves just putting ourselves an even stronger position than where we exist today.

Maybe as a follow-up to that pace, and we want to talk about the investment in the roll coat line that you've just discussed there. Maybe can you talk about what could be the incremental margin? Or what's the uplift in terms of this coated product relative to the body of the can sheet?

So with this investment that we're putting in place and it will enable us to take another 25% of the capacity existing there and move that toward coated type applications. Those applications have considerable margin enhancement over the can body at our business and for us and really haven't discussed the margin potential yet, but it's significant. It greatly exceeds our cost of capital, and our customers have embraced our move on this strategy. So it's a significant uplift for us. The -- we think the upside can be 2x what the existing facility is able to deliver from a profit perspective. And so we're very excited about getting that out there. We have been inking contracts to this throughout -- towards the end of the decade. We still got some significant discussions underway, but customers are -- seem excited about those. We began the investment back into the industry, and we're seeing follow-on to that, and that's the message we received from our customers. More of a strategic partnership. And so they're willing to look at investment and helping us pay for those investments with returns in order to get some of this investment in North America. So we feel that we're on the right track there.

Maybe one more as a follow-up to that. Certainly, the coating product is the premium product here. But as you think about some of the new capacity coming online, is it as easy enough for a competitor to simply put another coating line in and they could take share? Or do you have a different -- an additional built around the particular product out of Warrick?

Well, some interesting the way the plants are laid out, the new plants coming in, and I would say that they're -- we'll wait to hear a lot, but most focus is generally on like the Logan mill which really focuses on wide with heavy coils, big thick coils to put up, and they focus on the can body. And the significant amount of the volume associated with beverage can, for instance, is in the body of the can. So you put that in perspective, they're going to put that in. They have to basically subsidize their operation and put to roll smaller coils, smaller with coils to run that. We're set up to do that at Warrick. So it's a natural outlet for our facility, our equipment and the measurements that we have. So we feel very confident that we can go in and basically get extremely efficient on those products, and again, be prepared to be able to defend that. We defend that not necessarily on price. Our focus is to go in and defend on ridiculous customer service and focus and the quality of the products that we make. So we're going to dig ourselves in pretty deep the way we've done in every other business that we have, and that's the plan.

Fantastic. Maybe focusing on work itself then. And so it does seem that we've turned the corner on some of the operating issues there with the new magnesium contracts that you've signed and alternate hot metal sources. Maybe this will draw into some of the opening remarks that you made, but are you now running at full capacity? And are there any sort of lingering issues as it relates to Warrick in 4Q and then as you look into early 2023?

So we've had a difficult year with supply chain issues that continued through most of the year to impact what our capability out there. It impacted volume. It impacted efficiencies. It impacted cost that we had to endure and take on due to some of the supply chain issues we had. We feel that the majority of those major supply chain issues are behind us. We put a lot of work into really diversifying our supply base and putting in optionality to where we're not as reliant on some providers as we were -- and so with that, I'm encouraged, we were concerned. We -- the company had to declare on the warrant business, the packaging business, force majeure in the third quarter. We did that at the beginning. We were able to exit force majeure in the end of the third quarter, and then we were looking toward more normal operations as a result, especially from a demand side.  The good news there is that we have seen the demand come back in line with our expectations. So it reaffirms the strong secular growth that's underway in packaging. And as I said, we're fairly subscribed -- fully subscribed for next year. The challenge that we have been facing and we chase this, we've faced this in many of our other businesses. And I think in any manufacturing environment this year is really chasing these costs, these high inflationary costs that impact all aspects of our business. Last year, it seems like labor was our challenge. And labor continues -- will continue to be a challenge, but those are pretty much under control. This year, it's been the supply chain issues. It's been the inflationary costs that we're having and really the challenge of passing these through. And as when we purchased this business, especially the packaging business, they were on more annual on resetting the price and so forth. So we've been moving our customers to move to reset prices on a quarterly basis, much closer to when those costs are incurred. That's what we do in all our other businesses. We've been successful here. There's -- we've not completed the process. There is a general lag of when these costs are hitting and when we're able to recoup these costs. And those are some of the issues that we're challenged with a round of my comment for the fourth quarter, especially.

No, understood. Maybe sticking on the cost theme though, you have been successful in pushing through. I think it was the alloying costs. It sounds like on a quarterly basis. But anything else that you've seen spike that it is taking a bit longer than the quarterly lag to get across?

I would say the answer to that, [ Alice ], is everything is going up. So gloves, rolling mills use a lot of lubricant. Rolling mill lubricant has gone through the roof. I could name 10 or 15 things that we're encouraged. And when you look at these, these costs are significant. There's significant cost. And while we have -- we were comfortable in that we have a pass-through mechanism the concern there is just the robustness of that and how fast these costs have come. So we're playing catch-up on a number of these things. Now we're working in the new contractual discussions and things to move these things much quicker than what that industry has done in the past. If you look at the other side of our business, on the aerospace, the general engineering and in the automotive. We've been very successful in setting up our contracts and making sure that those pass through, we've made moved through metal containment. That's our mantra tier. We try to derisk all the issues pass-through metal. And of course, now there's a lot of other things associated. So now you're looking at PPI and increases and so forth. So we're in a lag, and we're playing catch-up on that. But we're working on those focused issues. We've got numbers that support it, and our customers are being receptive in how we try to manage those moving forward.

Maybe talking to the revenue side of the equation then and some of those contracts that you've talked about and the ability to pass through those higher costs more quickly. I think we took a look at the third quarter, your value-added revenue on a dollar per pound basis stepped up and a little bit of it was mix. But as you think about the 2023 outlook, how much more of that inflation that you're seeing currently is going to get pushed through there? And then maybe as we then think about the margin, are you seeing anything on the cost side from a spot perspective that is starting to ease that would drive potential for margin expansion next year?

Well, on the spot side of the business, and that's mainly in our general engineering side. What I like about that is we're able to move those through those costs through very quickly. So we've put surcharges on freight. We put surcharges on energy. We're moving through all those costs, especially those that are out of our control very quickly. Now when you move to programs in aerospace and when you move or multiyears, packaging had been multiyears, you have a period of time in which you have to absorb some of that and move it through. What good dialogue we've really been having is that the industry hasn't experienced this type of inflationary rise in decades. And while some formulas and things expectations in the past so for instance, aerospace is returning and growing. And we're out through the end of the decade with our contractual obligation.  So we have meaningful ability to pass through a number of these through those. And so we have the same in automotive. GE is passed through. So the packaging is really the area that we have to go focus. We purchased this facility. It had a number of existing contracts in place. And while we were okay with the fact that we had pass-through opportunities there, these costs that have come through so fast this year have proved to be a significant challenge to get all these costs passed through. So in our contract discussions underway right now, those are being implemented and discussed and understanding what the future may be. And in our businesses, we can't expect to -- we always plan for the downside. So we expect as something of the challenges that this year has provided to us. And that's why we look at strong liquidity and all the other things that we put in place to manage through those. But we have some opportunity for improvement on the packaging side of the business, and we're executing that right now.

Great. Maybe pivoting to some of something that's not packaging, but you are spending or you are investing in a couple of new projects. We talked about Warrick already, but I did want to give you the opportunity to discuss what's happening at Trentwood. I think there's some -- you had a couple of growth phases there already. You're looking at another one. What should we be expecting from that expansion project?

Sure. So we -- over the last 11 or 12 years, we've actually had 6 major expansions at the facility there. And that business really services the aerospace plate and the general engineering plate, of which we've had very strong demand move forward. So as we executed 6 very large projects really in the middle of being sold out during that whole period. And we did that very well. So as we moved towards 2020 before COVID, we actually were ready to pull the trigger on Phase 7. That growth opportunity is about $225 million, at least at the time. All these costs have gone up. And -- but the derivative of that was to provide us with an additional 20%, 25% of additional capacity. So we put that project on the shelf as we hit into the COVID impact on aero obviously and so forth.  So we're sitting there with that opportunity. We know what the investment is. It's been engineered already. We've done 6 others successful. But we don't want to bite off too much at the time. We're a fairly conservative company. And so what we've said is we're going to wait for absolute truth as to when that investment needs to take place. whether that happens, I think that investment should happen over the next 2 to 3 years. And at some point, depending on lead times for equipment, we may have to pull that. But that expenditure doesn't all come at once like a roll coat line. This is a multi-phase type investment, really could do it over 3 or 4 increments. And -- but the good news is our customers are talking about long-term growth returning and so forth. So at the proper time, we're positioned very well to implement and execute that growth strategy.

Shifting maybe to capital allocation then. And I do want to talk about the way you guys are allocating our capital. You have a dividend policy in place. but your leverage is also a little higher than what it has historically been through cycle after the Warrick acquisition there. So maybe talk through how you're balancing the CapEx pace, the dividend growth and the deleveraging towards that sub 2x net debt-to-EBITDA target?

Yes. Okay. We've been very consistent in the priority of capital within the company, and it continues. The first priority for us is organic growth. So we understand these. There's less risk in these type of investments. And for those to provide strong growth beyond our cost of capital, those are the ones we like to make. And so we've really focused on a company in that -- from that perspective over the last 15 years, especially. The second priority is to be able to make an acquisition at the right time. So I can say that over the last 15 years, we've looked at no less than 10 major opportunities to make an investment and grow the company make an acquisition. The Warrick acquisition was the first one that we felt that checked all the boxes within our filters and our understanding and our ability to differentiate. It checked all the boxes, plus we felt that it was an attractive price for an asset in the particular market that it was. So we pulled that trigger about 18 months ago.  Our third priority has been continuing the dividend. So we've been very focused on delivering that over the last 11 years. I think for the last 11 years, we've had an increase on the dividend. We increased the dividend 12% in 2020, 7.5%, '21 -- excuse me, '22. So we've been committed to that. We've gone through some difficult times from a market, but that's back to us making sure that we have strong liquidity. We think that that dividend really sets us out in our space. We're the only one in our space that's providing one. So we have a strong commitment to that dividend. And then finally, if all 3 other priorities have been satisfied, we return the excess cash to shareholders. We demonstrated that in the late '17, '18 and '19 that we delivered. At those times, we didn't have projects. We didn't have the ability to put cash towards growth. And so we delivered that. We've turned back. I think we purchased back 3 million or 4 million shares of the company. over that period. So we've stayed focused on that capital being our priority. The other mantra we have as a company is that if we make an acquisition and that drives the debt to equity up very high net debt that we focus, it becomes a priority for us over the next 2 years or so to really move that back down to an acceptable level to us the acceptable levels at 2x. And so that will be a priority for us. And we hope to do that through EBITDA growth mainly and other things.

I'm going to turn it over to the audience in a short moment, if there's any questions, gather them now. But maybe we'll kick off, we'll start with one -- I'll finish up with one more. And that's just on ESG. Clearly, aluminum is a fantastic ESG story. But how does Kaiser think about sustainability? Perhaps can you share some of the efforts that you do have in place? You've got a KaiserSelect product suite. And then the other piece I wanted to touch on was the recyclability of aluminum. How much scrap are you currently consuming and where do you expect that to grow?

Right. Right. No. Well, quite frankly, the sustainability really if you look at aluminum as a substrate, it really is at the core of sustainability. So we're part of the process of delivering additional sustainability. It also, from that perspective, and from a number of things, right, we think the products that we provide to our customers enable them to lighten their automobiles, for instance. The ability to deliver KaiserSelect products to customers allow them to focus on reducing their scope 1, 2 and 3, especially their scope 3 because from our perspective, we deliver products that they can machine better and are more efficient at running through the operation. When you look at our facility and what we use across -- even beyond packaging, we look at recycled scrap as a big component of the process of making aluminum. Why do we do that? Well, it's about -- takes about 10% of the energy required to melt aluminum as opposed to making virgin material from our casters. So that's in itself quite a deliverance. And what we're able to do, especially in packaging is we have end customers that are really demanding sustainability. They want recyclability to really upwards of 70%, 80% of the product. And so they're looking for us as the raw material supplier to really provide those types of things.  Well, that's actually in concert with what we want to do. If we use more scrap, we actually get a reduction okay, from the Midwest spot prices. So we get a discount if we use scrap. If we go towards buying prime or if we buy in it that rolling in, we actually pay a premium. So our raw material costs go up. So be able to supply more recycled material, and it fits the whole thing. So all the investments that we're doing today, we're looking at how those impact sustainability targets. We -- by the way, we've initiated intensity targets for looking at our outlook for the long term. We have the targets that we put in place targets that we can measure target that technology allows us to achieve on our carbon footprint, and those are in place. And we already have action plans of how we're going to anticipate and execute those. So the whole story really is an alignment for us. We see that as an opportunity. it's important to our shareholders. We know that. So from a shareholder perspective, we have delivered targets that we believe helped get us to a carbon-free environment as technology allows us to get there.

Great. We'll take questions from the audience. I've got one more, if I might squeeze one in then.

Okay.

And this is really a bigger picture question. And it's around sort of the China reopening. Obviously, you're a consumer of aluminum metal -- and as you think about what's changed in the last couple of weeks, we've got potential line of sight to China demand increasing over the next couple of quarters. As you're going out there and purchasing primary metal, are you seeing any tightness in availability? Or are you anticipating any of that to close problems into the next year?

Yes. We've already secured our positions. We have a very diverse supply base that's geographically just as diverse. So we really don't rely on China, but we know that China could influence the markets. So we've already secured the position. So from a P1020, which is our raw aluminum that we bring in, I'm not concerned at all. One concern that impacts the industry. And it doesn't us at the moment because I'll explain in just a second, but it's the high purity alloying that takes place. So we recently had a manufacturer that close one of their smelters. And that smelter was one of the key, if not the only key supplier of high purity alloy. And we use those type of high purities in making our aerospace products. So knowing that, that had taken place, we were a little concerned about what that availability would be because not all smelters around the world will make these products. But that's -- it's helpful for us. We have long term. We've been buying these types of products for over 70 years. We have very strong relationships there. So we secured very quickly the requirements we need. So -- but with our experiences with magnesium this year with all the global politics that are taking place and things, we're not taking any of our supply for granted. So even above aluminum, above mag, we're looking at all our products, ensuring that we have a very diverse supply base. It threw our business off strongly this year by not being prepared with that. Those type of challenges continue. I get a call every week from one of our suppliers on some products, from gas to lubes to whatever, declaring force majeure, inability to supply. So we really have to spread that around and be very focused. We are in Kaiser looking at our raw material supply going forward. So it's going to be a challenging environment. I don't see it changing anytime soon. So we're stepping up to the new real. And I believe that we're -- that we've covered ourselves, but we'll see.

Great. Well, thank you, Keith, for your time. And thank you, everyone, for your time and attention today. Thanks for joining us [ and your insight ].

Well, thanks for having us.

Of course.

Great. Have a great day.