Leonardo S.p.a. (LDO) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to our 9 months 2021 live Q&A session. I would like to inform you that the Q&A session will last 45 minutes. [Operator Instructions] Before taking your question, I would like to hand you over to our CEO, Alessandro Profumo, for some initial remarks. Thank you.

Thank you, Valeria, and good morning, everybody. Before starting the Q&A, I would like to highlight some key messages related to our presentation. We are pleased to report solid third quarter results and 9 months results for the group with continued good progress and strong and resilient performance in our military-governmental business, which, as you know, is 87% of our activities. It has not just been a recovery but it is a better place compared to before the pandemic in 2019. As I said, military-governmental now makes up 87% of our revenues this year. This progress has served to more than offset the challenges we have faced on the civil side, which are not new, as you know quite well, and very well known. In Aerostructures, we are seeing positive sign of market recovery in specific segments. We put in place actions to increase our industrial efficiency and flexibility to mitigate and reduce losses in the short and medium term and to secure Aerostructures' longer-term future. At group level, we are on track to deliver our guidance for the full year. Plus we continue to make important progresses on our firm commitment to ESG. All this makes us look forward positively. And I want to emphasize my strong confidence in our core business fundamentals, well positioned for the medium and long term. And with this, we are ready to take your questions. Thanks a lot.

[Operator Instructions] Our first question comes from Ben Heelan from Bank of America.

So my first question would be on Aerostructures and the detailed plan that you've given us. Can I ask -- did you say how are you feeling about the impact of Aerostructures on free operating cash flow this year? I think in the half year, you said it was in the kind of EUR 350 million range. Can you give us where you think it is now? And then how do you define gradual? So you've obviously said a gradual improvement through to 2025. I'm assuming that the breakeven by the end of 2025 is an EBITDA breakeven. So how are you defining gradual and how we should think about that? And then my second question would be -- you've seen a number of U.S. defense primes won in the past 1.5 weeks on supply chain constraints and budget growth in the U.S. for 2022. So I'm keen to understand what are you seeing? And how are you feeling about growth in the DRS business for 2022?

Ben, so we confirm in Aerostructures the cash absorption that we referred to in June. So for the current year, we expect to be at the lower end of the guidance range provided of EUR 350 million to EUR 400 million, so closer to EUR 350 million. In terms of how gradually the business will be improving, as you can fully appreciate, this is mainly a function of how fast the recovery in production rates will occur. Therefore, as of now, we expect to see more load towards the second half of the plan, where we do see, particularly on the B787, a stronger recovery in passenger traffic, international and in transatlantic passenger traffic, and long-haul market becoming stronger than we have experienced post COVID. On the breakeven, well, the breakeven is cash flow and EBITDA and economic terms is fairly aligned. So when you think about breakeven in 2025, you can think about breakeven in cash flow and economic terms approximately. On supply chain constraints and budgets, what we're seeing here in the U.S. -- so let me make a comment in general on supply chain. In supply chain, what we are seeing is a certain level of alert that we're closely monitoring, especially in some components of the electronics markets that you already are hearing from some of our peers. Chips manufacturers are clearly in a position of high demand and bottleneck the supply. As of now, we have not experienced any disruption, and we do not foresee material disruption for year-end. At the same time, the close monitoring is allowing us to engage with suppliers and extend duration of supplies. It is clearly an area of high attention for the group and for Leonardo DRS. We cannot exclude at the present time some impacts in terms of lead times and costs for next year. I think we'll be in a better position to give you a broader perspective in a couple of months. On the U.S. budget…

We said that on the U.S. budget, we are seeing, in any case, a stable or growing budget. It's clear to -- hopefully to you as well, but for us, for sure. We have presented the different areas in which DRS is focused. DRS is focusing, we cannot take -- say niche, but in areas which are growing more than the budget. So we are very confident on the growth rate of DRS. In any case -- and again, we presented to the market DRS some time ago. What is important to confirm and to say is the fact that for us in DRS, it's incredibly important to have this shift from development programs to production programs. So this is the reason why the EBITDA is growing by far more than the revenues. That will continue to grow than the market, the revenues. The EBITDA will grow by far more than that. So this is incredibly important to say. So we are seeing a continuous very positive trend in DRS. Sorry, one comment on the free operating cash flow of the -- and the EBITDA breakeven of the Aerostructures Division. This is not new from what we said in the past. So on the contrary, we are seeing some sign of improvement in some areas. Clearly, as Alessandra said, the 787 production rate will be one of the key elements. But you are invested as well in Boeing, so you know better than us what is going on in our key customers. It's important to say that when we said that the overall cash flow -- free operating cash flow generation of Leonardo will offset the action that is comprehensive of the Aerostructures Division. So there is, in our perspective, some positive sign. Nothing new on the negative side for Aerostructures.

Our next question comes from Andrew Humphrey from Morgan Stanley.

Maybe a couple of follow-ups on Aerostructures. Clearly, from your comments this morning, the recovery there is somewhat long dated and also appears to be reliant on an improvement in activity in widebody. Have the last 3 months led you to consider potential alternative options for that operation other than keeping them in-house? And then on DRS, I wanted to ask about how recent developments among the U.S. primes may have affected your strategic plans for that business. Clearly, you've been somewhat valuation sensitive on that. Has anything changed there?

Sorry, I will leave the floor to Valerio for Aerostructures. But on the legal side -- you said can you exit the business in reality. I've already said and we have already said many different times that we are a sole source for the 787 program. So we cannot exit the program. So this is legally very clear to us. So we are managing in -- within the contractual frame the business. We continue to have positive talks with Boeing, but it's not so easy to exit a business which is absorbing EUR 350 million of cash. If you ask me, this is a core business in the long run. It is not defense, so -- and we want to be focused on defense and security. But today, it is something which we have to manage as the best as we are doing. It is not possible today to say we will get out from the business. On DRS, the -- DRS, as I said before, continue to perform, in our perspective, incredibly well. So the market conditions are better than the financial market condition in the U.S. We continue to monitor them. But strategically, there are no changes in terms of our perspective. For us, U.S. remain an incredibly important market. On top of what we are doing with DRS, we have other businesses which are very successful, helicopters, defense electronics via U.K. with the former Lasertel, where we produce diodes for laser in an incredibly successful way. So for us, really U.S. is a very important market on top of DRS, and DRS is performing very well. I don't know if, Valerio, you want to add something on Aerostructures.

I think that as you heard before, really, we are not evaluating alternative options in the short term for several reasons that also Alessandro explained to you. We have now the constraint that we are a single source for the 787 sections. That could be an advantage in the future and in the long term for the program when it will ramp up. On the same time, while we are not analyzing alternative options, you've seen that we are working a lot on any opportunity we have in the short and in the medium term. And we have a lot of benefits already visible this year on the basis of our industrial plan, which is really robust and sustainable. We are mainly doing all that we can in order to improve profitability of each program, optimizing site and optimizing processes. So we are really ready for the future.

And could I sneak one more in. You previously indicated you'd expect to generate the entirety of the net debt, EUR 3.3 billion, I think, in free operating cash flow from '21 to '25. Apologies if I missed it. Is that target still in place with the higher cash burn numbers now in Aerostructures?

No, sorry, it's not higher. Why is it higher? It's not higher.

Okay. So these -- so the target includes this cash flow?

Exactly. As I said before, it's not higher. So when I said also in my opening remarks, for us, there is nothing new. So we are giving you all the elements on what we are doing in this division. But for us, it's not different from what we had in the past, on the contrary. We started saying, this year, we should be between EUR 350 million and EUR 400 million. And as Alessandra said, we are on the lower -- we are targeting the lower end of this range. So we are really incredibly focused on any activity within the division.

Let's take a few questions from the web. Alessandro Pozzi from Mediobanca is asking what are the assumptions behind the breakeven in Aerostructures in terms of production rates for B787 and ATR and whether the potential new program in China could also support this recovery. Which regions are supporting the recovery in ATR volumes? And when do you expect a recovery to pre-COVID levels? Then the second question is can you provide more color on the Italian PA cloud project and the potential revenues opportunity that you see there?

Okay. On the first question, really, on the Airbus program, you have seen that we are coming back and exceeding pre-COVID levels next year and in 2023. So on all the production rates relevant to Airbus program, we are in line and better than expected a few months ago. On the ATR, you are asking what we are planning. ATR is recovering faster than the regional markets itself. And this is really leveraging on its leadership in the regional market and the full versions that we have on the market. The cargo and the STOL that will be in place in a couple of years in end 2023, beginning '24. The rates we are including is that we expect ATR to come around 50 aircraft per year in a couple of years. So starting from '23, be around 50 and remain around above 50 going on the plan. Relevant to the 787, as Alessandro said, really, we are waiting Boeing indication on the rates. You understood that we are almost at an average value currently of 4 ships per month. And we are planning in our assumption not a sharp and strong increase in the next 2 years, waiting the solution of Boeing problems for delivery of the aircraft.

And on the PA cloud project?

On the cloud, as you know, this is an area where we have sent a proposal to the government, is mainly an infrastructure. There will be a tender so we are not allowed to say too much on that. As Leonardo, we are very happy to be part of this consortium because this is a real sign of the capabilities we have on the cybersecurity side, which is our main focus. So it is very important. We will be very active in the tender, but there will be other offers as well. You know that this is a PPP system where the first offer do have a sort of right of last offer in the sense that when the other offers will be on the market, we will have the possibility to analyze this offer and to match. So we have an advantage related to how the process is organized. On the recovery plan, we are also active in other areas. For us, for instance, global monitoring is incredibly important. It's an area on which Valerio is focused with a team which is working on that. For us, global monitoring is incredibly important because, again, this utilizes different technologies, we have, from the space domain to sensor, to command and control and artificial intelligence. So we are really active in these areas. And again, this is a demonstration of the fact that the investment we have done in digitalization, on one side, cloud computing and cyber security are important for us. The space domain also is very relevant.

Sorry, I -- really, my answer was incomplete. I have not touched at the point of COMAC that was included in the question. Really, in our aerostructure plan, we have not included opportunities in order to have a solid and robust plan. COMAC, in any case, it's an opportunity leveraging on our capabilities and technology strength even if we'll be out of the 5-year plan because we'll provide real impact starting from '25 onwards. So I would like only to emphasize that aerostructure plan is solid and robust because it does not include potential opportunities, and COMAC now is considered one of that.

Okay. We'll take other few questions from the web. Matteo Bonizzoni from Kepler Cheuvreux is asking about the target on the net debt at year-end, which is including disposals. And we are going to face EUR 606 million cash out for the acquisition of 25.1% stake in Hensoldt. So what are the disposals which we should expect by year-end?

We are working on them. We have ongoing talks with offerers. And as soon as we will have something discussed within the Board, we will have an official communication on that.

Okay. Then 3 questions from Celine Fornaro at UBS. Aerostructures, the cash loss of EUR 300 million, EUR 350 million, how do we think in terms of major milestones for the trajectory to cash breakeven and when? Is the 220 volume of 6, 7 per month relevant for ATR? Is it when BA picks up on deliveries? The second question is you said you keep delivering at 4 per month, but some suppliers have stopped. Is this a risk ahead of you? And how can this shipset unity of profitability has not changed from 1,406 given the depressed widebody market and fragilized customers? And please explain the situation with MPS. And how have you managed to ring-fence your financial exposure and risk?

Okay. Thank you, Valeria. Let me start answering Celine's first question. On the cash absorption for '21, we said that we were going to be around the low end of the range of EUR 350 million. Going forward, looking at a breakeven point, what are the main drivers? Well, as Alessandro and Valerio explained before, there are a number of key programs that are playing an important role. Clearly, B787 and ATR are important contributors. And B787 remains a major contributor because, as you have seen in our presentation, it accounts for the majority of the total turnover of the division. Now what we can confirm is that in the narrowbody in regional market, we do see evidence of recovery. Valerio mentioned that in Airbus next year, we are going to be already above pre-COVID levels. In ATR, it will take a bit longer. However, there is -- there are a number of options that we can leverage on ATR, expansion of the product portfolio, expansion into new markets. i.e., the STOL, the short takeoff and landing platform that will expand the market opportunities, getting into potentially 500 new airports; the cargo version that is opening up a very important and large portion of the market. So all of these are positive elements. Clearly, there is also going to be a recovery in the long-haul market. It will just take longer compared to the other ones because of the reasons that we are all reading about in the markets. The A220 is an important contributor on the Boeing side also because of the renegotiations -- on the Airbus side also because of the renegotiating -- the renegotiation that we have completed and finalized this year with the customer that has solidified and strengthened our margin position on the program. I'll pass it over to Valerio.

Really, you asked something on the rate of the 787 first. Yes, we are currently at a value of 4 as the average value of the 2021. We are not considering stopping production even if -- you know that a couple of years ago, we were running at 14 shipsets per month. So we have implemented several actions on people and skills optimization on the site, and you know that we are discussing with the unions for furlough for next year. But we are not considering a stop of the program. We, in any case, wait Boeing indication in terms of rates and in terms of solution of the reduction that we have now during the last month of this year. On the MPS, I think that you know that the supplier -- our supplier, who is a sub supplier, is under scrutiny by prosecutor. And in this regard, we can underline that the investigation is covered by confidentiality. And so no information could be disclosed. The company -- both Boeing and Leonardo are victims of potential misbehavior of the supplier, and they are working and cooperating with authorities in order to solve the issue. And up to now, we have no indication to provide.

Okay. We can go ahead from the web again. Zafar Khan from Societe Generale. Could you please provide a bit more color on your revised agreement with Airbus on the A220 program? Is it a price increase per unit? And when does it come into effect?

Yes. As anticipated by Alessandra, it is a price adjustment, we can say, which will be effective and will provide the impacts in our plan by the second half of 2023. And we have also the advantage of rate increase on the program and also on all the industrial activities that we have done in our Foggia plant. So we will benefit both of the -- our agreement and the closure of the settlement and industrial action on cost reduction and cost cutting and also rate increases. So it's a combination in our plan of 3 effects: the industrial one, the rate increase and the agreement closure that we have closed in the first 6 months of this year.

So it's important to add that is a win-win solution for us and Airbus because there is a different price but on different working packages. So -- and this is also the reason why the effect will be in 2023, the full effect of the agreement, because we give back some activities and we take some other activities. So that at the end, we will be more with a higher margin. We will be less costly for Airbus because they take back some other activities that will be done by other suppliers. So we are very -- so this is also very important for us because it gives an idea on how the relation with Airbus is positive because we found a solution which is positive for both of us.

I think that really, you are touching a point and we are touching a point about industrial transformation and efficiency actions. You -- we shall keep in mind that we have, during 2021, also a clear return of Leonardo production system, so our world-class manufacturing in all the sites. And also, we are strengthening the value of Leonardo labs, which are working in automation and working in industrial processes. So really, we are seeing on each plant and site the combination of several effects, the labs, our technologies and also Leonardo production system.

Okay. Let's take another question from the call.

Our next question comes from Nick Cunningham from Agency Partners.

Yes. I wanted to look at the -- if you like, the really big investment proposition, which is the EUR 3 billion of free cash flow, which can turn up earlier. So the key question is…

Sorry, we can't hear you.

Nick, we can't hear you. Can you please repeat it being closer to the mic, sorry?

Okay. I'll try and speak…

Now it's better, now it's better.

Great. Okay. I'll do this. Sorry about that. Yes. I wanted to look at the big investment proposition, the EUR 3 billion of cumulative free cash flow. And the question is, first of all, what's the phasing of that? Do we draw a straight line? And secondly, we can see that the delta that comes from the falling cash consumption in Aerostructures is maybe 1/3 of the total delta. So where does the rest of it come from? Is it assumptions about top line growth? Do you expect the margin to expand? Are there any sort of key risks that we should be aware of? And finally, is that -- are we looking at a peak in mid-decade of generating that free cash flow? Or is that sustainable?

Okay, Nick. So on the phasing of the cash flow generation, we have had the opportunity to discuss this. As you can appreciate, the phasing is more concentrated in the second half of the plan mainly as a result of the improvement in Aerostructures that is back-end loaded versus 2022 or '23. And it's a virtue -- it's a combination of a number of elements that you have also mentioned: a top line growth that we see continuing on a stable basis with increased profitability throughout the group. So there are a component -- there is a component also of margin expansion that we are going to leverage on as an effect of operating leverage and continuous improvement in profitability in the businesses as well as a very tight control on working capital. That will be -- will continue to be an area of maximum focus for the group. Now I have not caught well your peak question. When you refer to peak, is that peak cash flow? Is -- can you repeat that, please, Nick?

Yes, yes, certainly. Because there are some very big programs in -- within that, like Kuwait, for example, some of the very big helicopter programs. And as always for big defense contractors, those sort of peak and then fade. So on the basis of what you know now, does that cash flow fade out in the second half of the decade? Or do you have visibility of cash from other sources -- from other programs that are coming down the track?

Well, let me highlight for you that, for example, in 2021, there are no jumbo orders that we're booking. At the same time, we are delivering the same level of order intake of years where we did have jumbo orders, also last year, for example, with an important contract for customer support of helicopters. So there are clearly peculiarities, as you were highlighting, in the business mix and the order intake mix. But as of now, we do not see a risk of falling down in cash flow generation because of the lack of jumbo orders. I think what we are seeing throughout the group is a very well-diversified set of activities and programs worldwide on which we are constantly delivering on track, on time and continue to build for the future. If we think, for example, about defense electronics, there are a number of opportunities that we have in the pipeline that are based on international programs and also on domestic programs. And none of them account for more than 5%, 10% of the total. So clearly, this gives you a sense of how spread out our activities are, which is also a good sign in terms of risk mitigation overall.

It is also important to say that the large -- we have some large potential order but are not in the plan. So these are all opportunities on top of what we have in terms of plan.

Our next question comes from Harry Breach from Stifel.

Could I possibly just ask 3, hopefully, very, very small ones? First of all, just coming back to the quality issue relating to your subcontractor MPS on 787. I remember that in the press release you issued last month, you said that the cost would only be borne by MPS. Has that been confirmed to you by Boeing that there will be no liability for Leonardo at all? Secondly, can I just ask just technical one maybe for Alessandra? I just wondered -- the tax rate was effectively very low in the third quarter. Can you tell us just what we should assume for this year, for 2021, the tax rate overall and then what we should expect normalized for next year for 2022? And then maybe my final question, just really with helicopters. Obviously, third quarter revenue year-on-year, a little bit lower, some civil softness you talked about in the outlook. Is there anything in particular going on, on the civilian side in terms of deliveries, customer preferences or deferrals on that front?

Okay, Harry. I'll take the second and third question. On the tax rate, really no specific news. What you are seeing in the third quarter are peculiar effects but nothing relevant. Overall, the tax rate for the group in 2021 and going forward throughout the plan is expected to be around 25%. So I can confirm for you the target that we have expressed earlier in the year. On helicopters and the civil component of helicopters, well, the helicopters business, the picture that you see at the 9 months is really not telling us the true story and the true potential for the business throughout the year. There are -- there have been some natural and normal slippages into Q4 both in order intake as well as in deliveries that you see reflected in orders and revenues. On the contrary, what we do see on the civil side is a resurgence that is actually faster than what we had expected for '21, especially for the 139 platform, which remains a top platform for a number of buyers, both in the VIP domain, in the EMS and in the passenger transport business segments. So that remains a key opportunity for us. Clearly, the bouncing back to pre-COVID level will still require a few years. We see it around '23, '24. Nonetheless, the civil side is more resilient than expected.

And as Alessandra just said, mainly on the 139 platform, which, as you know, for us, is the best platform we have in terms of contribution.

Really, coming back on MPS and quality issue you said at the beginning, your first question. I said there is an investigation ongoing. And I can only confirm that we are working with Boeing in order to understand how to manage and that really, we are not going to provide any provision on MPS. And that -- probably you know that immediately when we have the communication of our affected parts, we have immediately withdrawn the supplier qualification.

Our final question comes from Martino De Ambroggi from Equita.

Two more questions on the aerostructure. The first is on restructuring costs. So does your recovery buffer factor in any additional restructuring costs and related cash out? Or are you okay with what you already did this year? So just to understand what your plan includes. And I clearly understand that you will not provide a guidance for next year, but as you mentioned, the recovery is mainly back-end loaded. So if I assume next year for Aerostructures stand-alone to have free cash flow negative between EUR 200 million and EUR 300 million, does it make sense?

Okay, Martino. On restructuring costs, as you may have seen, we booked in the third quarter financials a provision of approximately EUR 90 million for the preretirement schemes that we have agreed upon with the unions for approximately 500 people within the division. At the present stage, this is the plan, and this is the setup that we expect. So as of now, we do not expect any other restructurings in terms of rightsizing of the workforce on the division.

It's important to say that we -- the reduction in reality will be close to 1,000 because we moved 500 people to other divisions. So 500 is the number of people that will get out, and this is a provision. There is nothing else in the plan. So the number we have just presented are current with this reduction. And the total reduction for the division is 1,000, moving 500 people to other divisions.

On cash absorption from Aerostructures in '22, as I'm sure you will understand, as much as we would like to be helpful, there are a number of elements that we're finalizing, and this is a bit premature with respect to providing guidance. As we said, there is going to be a back-end loaded profile and some of the dynamics that we have seen in '21 will be replicated in '22 throughout the divisions. So a lot of things are gradually changing, but it will take time.

Really -- I would like really -- if it's not strictly connected to restructuring costs, I would like to clarify, if it was not clear, that you remember that our investment done in aerostructure on the ATR and the A220 have been included in our plan in the past, in the last 2 years and is included in the plan. So we are not really analyzing potential additional investment in order to sustain the plan that you have seen. Everything has been included and thought about in our actions.

With no further questions, I hand it back to our speaker team.

We're running out of time. So thank you for being with us today. As usual, the IR team is available for follow-up questions.

Many thanks to all of you.