MTU Aero Engines AG (MTX) Earnings Call Transcript & Summary

Welcome to the conference call on MTU Aero Engines Preliminary Full Year Results for 2019. [Operator Instructions] The speakers of today's conference call are Mr. Reiner Winkler, Chief Executive Officer; and Mr. Peter Kameritsch, Chief Financial Officer. First, I'll hand over to Mr. Thomas Franz, vice President of Investor Relations, for some introductory words.

Good morning, ladies and gentlemen. Welcome to our conference call for the full year results for 2019. We will start with business and financial highlights presented by Reiner. Peter will give more details on our OEM and MRO segment. Following that, Reiner will give some information on our updated guidance for 2020. After that, we will open the call for questions. Let me now hand over to Reiner for the business highlights.

Yes. Thank you, Thomas, and welcome also from my side. Let's start with our business highlights. In 2019, the aviation industry benefited from a strong aftermarket -- from a strong market environment, with passenger traffic being up by more than 4%. Some updates on the GTF engine program. The current GTF order book comprises more than 10,000 engines, the latest major orders were from Wizz Air, Korean and also Tigerair. GTF deliveries were up by 20% in 2019. Today, more than 700 GTF-powered aircraft are in service, having performed over 5 million flight hours. In 2020, we will see a further increase in GTF deliveries. As already announced, we are working on an accelerated retrofit program for GTF engines with an earlier configuration. We are making good progress there, and I will give you some more details about the impact on our MRO business in a few minutes. Good news also from the wide-body segment. So in January, the Boeing 777X, powered by the GE9X engines, successfully performed its maiden flight. 2019 was another very successful year for our MRO division. In the independent business, we won contracts worth more than USD 7.5 billion. The biggest contracts that signed is JetBlue and United. At EME Aero, our brand-new Polish MRO joint venture with Lufthansa Technik, we successfully inducted the first GTF engine in December, and are planning to ramp up to full capacity by 2024. The key project in the military business is the next-generation fighter engine. We were able to sign a contract with Safran and will start R&D activities in 2020. And the inclusion in the German large-capped index tax in September 2019 was definitely a highlight for us. To see MTU being ranked among the top 30 publicly listed companies in Germany confirms, again, the underlying success story and the trust into our profitable growth strategy. As promised to our shareholders, we will continue to increase our dividend. We will propose a dividend of EUR 3.40 per share at this year's AGM on May 7, of course, subject to approval by Supervisory Board. This reflects an increase of roughly 20% compared to last year. Let me now switch to the key financials before I hand over to Peter for more details on the business segments. The group revenues increased by 1% to EUR 4.6 billion, driven mainly by the OEM segment. Adjusted for the change in the contracting and invoicing process at MTU Zhuhai and some U.S. dollar effects, the group revenues would have been up by 5% organically. Group EBIT increased by 13% to EUR 757 million, resulting in a margin of 16.4%. Net income, similar increase, to EUR 538 million. And the free cash flow increased by 77% to EUR 358 million, resulting in a cash conversion rate of 67%. Let's now have a look of these achievements compared to our latest guidance for 2019. Overall, we had a very good hit rate on our targets. We ended up slightly below our revenue guidance, mainly due to phasing of military revenues, slightly lower new engine deliveries as well as lower material content in the MRO division in Q4. The EBIT adjusted of EUR 757 million and net income of EUR 538 million were both slightly above our latest guidance. And the free cash flow and cash conversion rates were exactly in the expected range. Let me now hand over to Peter for a more detailed look into our business segments.

Yes. Thank you, Reiner, and good morning, everyone. Let me start with the OEM segment. OEM revenues were up 9% to roughly EUR 2 billion. Military revenues increased by 6% to roughly EUR 460 million, slightly below our full year expectations due to some phasing effects in Military MoU. Main revenue drivers for the EJ200 engine and the RB199 engine for the Tornado aircraft. Commercial business was up 10% to EUR 1.5 billion. Within that, organic OE sales were up high single digits for the full year. Ramp-up of our GTF platforms and a higher demand for GEnx engines compensated the expected reduction of V2500. Organic spare part sales were up high single digits for the full year, mainly driven by the V2500 engine platform. EBIT adjusted in the segment increased by 15% to almost EUR 500 million, resulting in a slightly better margin of roughly 25%. Let's have a look on the commercial MRO segment. Reported MRO revenues were down 3% to EUR 2.7 billion. However, as already pointed out in previous calls and also on 2 of our Capital Market Days, we report lower MRO revenues due to the change in the contracting and invoicing process for V2500 contracts at our MTU Zhuhai facility. Organic MRO revenues in U.S. dollars would have been up 7%. In the quarter, we saw organic revenues being up only 4%, due to a lower material content in the shop visits. EBIT adjusted increased by 9% to EUR 260 million, resulting in an overall EBIT margin in the segment of 9.6%. So having said that, let me now hand back to Reiner for a look on our guidance for 2020.

Yes. Thank you, Peter. For 2020, we faced some uncertainties based on the situation around the coronavirus. From the DAX point of view, we don't expect significant long-term impact on air traffic and related aftermarket business. But this clearly needs to be monitored, and we will update our guidance, if necessary, in the course of this year. So actually, our outlook for 2020 looks as follows: The military revenues will be up by a mid- single-digit number, due to some phasing effects from 2019 into 2020. Commercial OE will be up in the high single-digit percentage number, mainly driven by a further ramp-up of GTF. In commercial, spares are expected to be up mid- to high single digit. Main driver will be still to V2500. And as been indicated at the Investor and Analyst Day, we will accelerate the GTF retrofit program in 2020, including this GTF shop visits and revenues will increase in the low 20s. Within net, the core MRO business will increase high single digit, whereas the GTF MRO will contribute a low teens number to the overall MRO growth. Please have in mind that GTF work is a 0 margin business for MRO, and therefore, puts a slight headwind on the MRO EBIT margin. The EBIT adjusted on group level is expected to increase by a high single-digit number, and net income adjusted is expected to grow in line with EBIT adjusted. And the cash conversion rate is confirmed in the range of 70%.

So I think we are through with that. And we can start with the Q&A session.

[Operator Instructions] We will now take our first question from Mr. George Zhao from Bernstein.

Could you share the organic spare growth in Q4 for the 3 main programs? And in the past, within the legacy engines, you talked about flat growth. Is there a meaningful variation in the spare growth coming from the passenger aircraft rate versus military transports? And then we know military aircraft can be quite opaque. So how much visibility do you have around the expected aftermarket that gives you the confidence in the ability for the legacy engines to remain stable going forward?

I mean, spare parts still -- for the full year, we were up high single digits. So in Q4, spare parts were also up high single digits. So the main -- as you know, I mean, the main spare parts platforms for us V25, CF6 and the PW2000. So in Q4, so the growth pattern of the V25 was unchanged, so mid -- up mid-teens, CF6 and PW2000 were both flat to slightly down. So no change throughout the year in these two. I mean, on the V25, we have no exposure, obviously, to freighters. CF6 and PW2000s, so the behavior is very similar between passengers -- passengers -- passenger aircraft and freighter aircraft. So no doubt -- it's a rather flattish such development. Whereas, I mean, in the PW2000, more of the spare parts do come from passenger aircraft, obviously, and also from the military application, the C17s. So I mean, half of our spare parts volume in the PW2000s really stem from the exposure to the C17. So the share of -- for the share of spare parts coming from the -- from freight as in the PW2000s at a low. CF6, obviously, a bit higher. But up to now, no big difference between passengers and freighters. I mean, in the military and MRO, obviously, we had some phasing effects. I mean, you saw that -- I mean, the outcome of 2019 was a little bit below our expectations of 10%. And so that really comes from a later induction of shop visits for military engines. So we didn't see the billing in 2019 that will spill over to 2020. And so we have upgraded the guidance to 5% in 2020. Because we have a lower base in 2019, a little bit higher volume in 2020. So -- but in principle, we have a quite good visibility for 2020. But obviously, you can have some pushing for -- over a backward of engine inductions, that is definitely the case.

And our next question comes from Ms. Kerner from Barclays.

I have 3 questions. The first one, you talked about this acceleration in the GTF retrofit program. Can you share with us what's going to be the margin pressure coming through here in 2020? My second question is on your 2020 guidance. Can you share with us what exchange spot rate you're using for this 2020 guidance? And then my last question was, if you can share with us any color on your spare year-to-date performance, please?

So the easy one, 2020 guidance, is based on 115. So we didn't change that from our Capital Markets Day. But you see, I mean, the impact of the FX rate on earnings will be, I'd say, a little bit limited because, I mean, this -- having a look on our hedge book, so we are roughly 70% hedged for 2020. So there is some sensitivity, yes. But more on the expected revenue number and not so much on EBIT. Yes, maybe [ 2 million percent ] or something like that. Margin pressure coming from GTF, you saw that we have updated our MRO. Growth guidance, obviously, we said on our Capital Markets Day, high single-digit growth coming out of the core MRO business. And now we have added something like maybe -- so overall, MRO will grow in the low 20s. So the rest will come really from -- yes, from the retrofit program -- the accelerated retrofit program of the GTF. So 14%, 15% growth with basically a 0 margin. So we're going to see a little bit pressure on MRO margins and maybe we ended the year with 9.6%. So for the MRO division, so for 2020, MRO margin will be in the ballpark, 9%.

And our next question comes from Ms. Lemarie from Exane.

Also, I have 3, please. The first one, I'm a bit surprised by the strength of your equity results line, especially in Q4. So first question would be if there was any element of one-off there? Or if this is a sustainable basis? Second question is, I would expect MTU Zhuhai to represent a good share of this increase. So given the situation in China right now, could you help us assess any potential impacts if the coronavirus outbreak should last? Third question, on the GTF retrofit program, I mean, could you help us understand how you generate, what could be, roughly EUR 775 million of revenue from there? I mean, how much of the fleet retrofit are you responsible for on this one?

So I mean, let's start -- I mean, the strong equities front, really, as you mentioned, it really comes from an equity at MTU Zhuhai. So that's the case. We have also in the equity size, we have the profit that our -- that at least co-generate. So the leasing company for the PW1100 leasing fleet. So that is the second element of the strong equity results here. But the major part really comes from MTU Zhuhai.

On the situation in Zhuhai, I mean, due to this issue of this coronavirus, we closed the facility and extended a little bit the Chinese New Year holiday. But until, I think, February 9, more or less, 90% of the workforce is back and is more or less fully operating now. And it's difficult now to see what is maybe the full year impact. So as I said, now it's -- they are all booking again. And so we will see. And that's the reason why we said we will update in the course of the year. But it's definitely now too early on that. And the last question was on the...

The GTF. I mean -- we said, I mean, between 10% and 15% of the growth rate really comes from the GTF retrofit shop visits. So based on the EUR 2.7 billion we had in 2019, that is something like, let's say, EUR 400 million of revenues coming from GTF retrofits. And we do a quite -- a significant share of the retrofits. I mean, there's also a little bit of uncertainty, obviously, in that number because you don't know exactly what the material content is, how the labor -- how many labor hours you need to disassemble the engine to assemble the engine back. So that is -- that is the main point of our bandwidth, I would say, but -- and that business is built back to i.e. on a 0 profit basis. So -- and that dilutes the MRO margin. So the effect overall is around EUR 50 million to EUR 400 million of additional revenues coming out of that.

Your next question comes from Mr. Heelan from Bank of America.

You just coveted on Zhuhai, any potential impact from the coronavirus. Are -- in the commercial OEM business, have you seen any short-term impacts around spares or spares consumption across some of your customers?

Not yet. Definitely, nothing.

And your next question comes from Mr. Perry from JPMorgan.

I guess, my first question, I'm sorry, it's another Zhuhai question or China question. And I realize it's very difficult to answer. I believe Zhuhai has maybe 35% to 40% of its work from China Southern. I don't know if that's still the case. I had that in my notes. Is that still the case? And can you give us any color on what's going on with China Southern at the moment in terms of their flying activity? And what their sort of plans are -- that if you know what they are in the coming months? That would be the first one. And the second one is just your peer company, Airbus, is just putting a lot more money in to its pension at the moment. And I just wanted an update on what your situation was on your funding status, please?

On Zhuhai, I'm not sure I have the exact number, but I think domestic flights, they have reduced by more than 50% actually. But I don't know until what time they -- what day they'll stop flying. I'm not sure how long this will continue. But actually, it's roughly 50%. And you're right, it's roughly 35%, 40% of our business is coming from China Southern in Zhuhai. On the pension...

But we don't do pension funding. So we have the pension obligation -- we have the pension obligation on the balance sheet and pay the pension as we go through the year. So there's no -- we have no planned as such or something like that.

The next question comes from Mr. Humphrey from Morgan Stanley.

One question and one clarification really. The question is on the MRO business. Obviously, you've guided for a substantial amount of retrofit activity. Should we interpret that as a sign that actually you have capacity in your MRO business that may be deployed to, I guess, more profitable work once you're through that GTF retrofit program? Or is this in the nature of search capacity, how should we interpret that as a signal of your overall -- the overall capacity of your MRO network? And the second clarification, just on coronavirus again. You've indicated that you'll revisit through the year in the event that it becomes relevant. With that comment, do you mean if the situation with regard to the virus outbreak as we currently understand it worsens. And therefore, a whole new series of measures have to be introduced at companies in China? Or do you mean there has been some effect on the business to date, and we'll have to see how effectively, quickly we can make it up on a full year basis?

Starting with the first question on the retrofits. There's only limited number of retrofits will be done in the core MRO business -- locations. The majority will be made in other locations. So we have some -- we use some capacity we have in the OEM segment in Munich. And we also use capacity of the new joint venture with Lufthansa Technik to retrofit some of these GTF engines. And there's also a third location within the Pratt & Whitney network for that. So it's not -- let's say, there's no limitation for the other MRO business through that retrofit programs. The question on Zhuhai, again?

Sorry. It was -- should we -- when you when you say we'll have to revisit through the year to see what the impact has been, are you implying will revisit if the situation as we currently understand it with the virus outbreak changes and worsens? Or are you saying, there has been an impact for the part of Q1 for which airlines haven't been flying? And what -- we'll have to see how much of that we can make up on a full year basis? It's really a question about seasonal impact what should be factoring anything in for Q1 that then kind of gets -- that evens out over the course of the year?

I mean, what you're going to see is definitely -- you see -- you're going to see an impact in traffic numbers in Q1 and Q2. I mean, that you can expect that base -- I mean, all the Chinese airlines have reduced capacity. So domestic flights in China will suffer, the traffic in China will suffer. Also some international flights from and to China have been reduced, obviously. But how that exactly translates into our business, is we haven't seen anything yet, but we're going to monitor the situation how that will transfer to our business. But up till now, we haven't seen that.

And the next question comes from Mr. Hauenstein from DZ Bank.

Hauenstein, DZ Bank. Two questions left, please. May I ask why you did not include the retrofits already in your outlook comments you gave in November? Has there anything changed? Why you decided to put it in now and not before? And the second question I have, can you please give us an update regarding the CapEx plan for 2020 and maybe also for 2021? And to which number, does it all sum up at the end and maybe give some color on the bigger parts of it?