Safran SA (SAF) Earnings Call Transcript & Summary

Welcome to the Safran Q3 2022 Revenue Conference Call. At this time, I would like to turn the conference over to your host, Olivier Andries, Safran CEO; and Pascal Bantegnie, Group CFO. Mr. Andries, please go ahead.

Good morning, everyone, and thank you for joining us to this Q3 2022 revenue conference. I'm here with Pascal Bantegnie, our CFO. Let us go straight to Page 4 with a summary of our talking points today. Air traffic continued to improve in Q3. We expect now narrowbody ASK to fully recover its precrisis level -- 2019 level by 2023. The macroeconomic environment remains challenging. Supply chain difficulties to ramp up are still impacting our LEAP engines delivery plan, but we've made progress with a 54% increase in LEAP deliveries just with Q2. We are also facing inflation pressure notably in energy in Europe. Organic revenue growth was strong in Q3. We raised our full year 2022 outlook for revenue and free cash flow, thanks to solid growth in services and a new euro-dollar spot rate assumptions. We have entered into exclusive negotiations with Thales to acquire their electrical system activities. It is a complementary contribution to Safran's portfolio of activities, which would expand further in the area of electric power generation. I am now on Slide 5. Narrowbody ASK stood at around 86% of their 2019 level in Q3 2022, increasing sequentially and reflecting the strong summer season in North America and Europe. CFM flight cycles are at around 84% of 2019 level at mid-October. CFM flight cycles are above 2019 level in North America, Middle East and South America. In Europe, we are at 89% of 2019 level, which is very strong. And the only area where CFM flight cycles are still well below 2019 level is China. We are, as we speak, at 36% of 2019, which is above the low point reach mid-April, where we were at 20% of 2019 level, but traffic had reached around 80% during the summer. So as you can see, strong volatility remains in China. Narrowbody ASK was at 81% on average over 2019 level in the first 9 months of 2022. Retirement remains low: 75 aircraft in the first 9 months. Second generation of CFM56 powered aircraft are flown by the airlines. Fleet storage is decreasing. We are at 11.2% at the end of Q3 to be compared with 14.3% at the end of Q2. We continue to monitor closely air traffic recovery in China. I remind you that around 18% of our second-generation CFM56 fleet in service is in China. Recovery of narrowbody air traffic, notably in the U.S. and Europe and the utilization of second-generation CFM56 fleet provide confidence in the overall outlook for Safran. Let's go to Slide 6. Let me share with you some of the main business achievements during Q3. CFM delivered 347 LEAP engines in Q3, which is up sequentially plus 54% versus Q2. Civil aftermarket growth has been strong in Q3. We benefited from CFM56 spare parts, prebuying ahead of catalog list price escalation in November and some restocking effects. COMAC has certified the C919 aircraft in China. We will start deliveries of LEAP-1C engines in 2023. To name a few long-term service agreements we signed in Q3: in the helicopter business to support -- a contract to support over 900 Arriel helicopter engines operated by the U.S. Army; in landing gear, contracts to support A330, A320, A321 aircraft landing gear for Philippine Airlines as well as Cebu Pacific Air; in NacelleLife business, to support A330ceo [indiscernible] nacelles and A321neo nacelle for Cathay Pacific and A320neo nacelle for Spring Airlines. We signed a number of new contracts in Safran Seats both for online fit and retrofit, which highlights a renewed commercial momentum. I am now on Slide 7. In Q3, the activity is improving year-on-year and sequentially. Revenue is up 18% on an organic basis compared to Q3 2021. This improvement has been driven by services across all businesses and also by an increased LEAP OE delivery stream. Sequentially, revenue was at 8%, thanks to Propulsion and Aircraft Interiors activity. In the first 9 months, revenue increased also by 18% on an organic basis at EUR 13.4 billion. Let me now hand over to Pascal for more details on Q3 sales.

Thank you, Olivier, and good morning, everyone. Starting with FX trends. U.S. dollar trends in 2022 has been significant and it is at multi-decade highs. At close of the quarter, euro-USD rate was 0.97, which is down 15% year-to-date. We are taking advantage of that to continue purchasing hedges at attractive rates. With a book now of $50 billion, Safran is fully hedged until 2026. I'm pleased to provide an update of the overall hedge rate corridor over '23-'26, and this new profile is based on gradual improvements across the world curve reaching [ $1.12 ] at best in 2026, which is a $0.04 improvement compared to the previous expectation. Any single cent change in hedge rate translates into EUR 60 million in EBIT, and this will provide a further mitigating factor against rising inflation. The backdrop of a strong dollar is a dilutive impact on EBIT margin for the same euro EBIT. Any single cent change on spot rates translates to EUR 90 million of revenues on average with no margin. Turning now to Page 10. Q3 revenues stood at EUR 4.8 billion, which is a solid 18% organic growth or 30% when taking into account a positive translation impact from the stronger USD. Service activities were up 35%, which is 23% organic, mainly driven by civil aftermarket growth. OE was up 25%, 14% organic, driven notably by higher LEAP engine deliveries. Also, the net impact in revenue is not material. Change in scope reflects the divestment of both Enviro Systems and Arresting Systems as well as the acquisition of Orolia from July 2022. Let me now provide some details per activity on Slide 11. Propulsion, EUR 2.5 billion of revenue, up 26% organic. OE revenue was up 29% organic, supported by the solid increase in LEAP deliveries both year-over-year and sequentially. At the end of Q3, on a cumulative basis, total shipments of LEAP engines are now close to the full year 2021 total deliveries. Service revenues were up driven by a solid 36% growth in civil aftermarket. As indicated during our July call, growth is mainly driven by the CFM56 spare part sales. Again, volume of shop visits is up year-over-year and sequentially, but still below our initial assumptions. But we can confirm that revenue per shop visit is holding better than initially forecasted. We believe this is a consequence of some prebuying effect ahead of annual catalog with price escalation and some inventory rebuilds at shops or airlines. High thrust engines spare parts and services were also positive contributors to the civil aftermarket growth. Our full year target of 25% to 30% growth is confirmed. In Equipment, EUR 1.8 billion of revenue, up 7% organic. There was no growth on the OE side due to the continued low widebody build rates, but the good news in the quarter is the resumption of 787 deliveries. Services were up in equipment 19% with growth across the board from repair activities and landing gears, carbon brakes, nacelles to aerosystems. Aircraft Interiors, EUR 0.5 billion of sales, up 22% organic. OE revenue was up 20%. Most of that increase came from Cabin with a notable increase in galleys and lavatories for A320. Services revenue was up 28%, driven by cabin spare sales. In Seats, the commercial momentum is growing, but supply chain disruption negatively impacted deliveries in the quarter. Switching to Slide 12. Safran has 2 outstanding OCEANE maturing in '27 and '28 for a total of EUR 1.7 billion. These bonds carry a conversion right whereby the bond holders would be entitled to receive a number of new or existing ordinary Safran shares. In particular, the EUR 9.3 million OCEANE bonds issued in 2020 and maturing in 2027 currently carry a potential dilution of 2.18% of capital. With the current conversion price of EUR 107.26, we have a high probability of redemption at maturity and could even consider an early redemption from June 2024 if the stock trades above EUR 139 at that time. This is why we are launching a share repurchase program of up to 9.4 million shares with the aim to fully eliminate the risk of equity dilution from the outstanding 2027 convertible bonds. If market permits, this plan will be executed within the next 12 months. Until we fully execute this program, we do not intend to launch any other share buyback. We will also assess in due course the opportunity to hedge the potential dilution risk linked to the 2028 OCEANEs. Olivier, back to you.

Thank you, Pascal. Let me now conclude with our guidance for 2022. On the back of the 9 months performance, we are raising again our guidance. Adjusted revenue is now expected at around EUR 19 billion to reflect solid growth in services and a new euro-to-dollar spot rate assumption at 1.05. Free cash flow is now expected to be above EUR 2.4 billion. Adjusted recurring operating margin is expected to be at around 12.6% at the new 1.05 euro-to-dollar spot rate, which takes into account the impact of returning 100% of the optional profit sharing to French employees. At 1.18 euro-to-dollar spot rate, which was our initial spot rate assumption when we disclosed our guidance back in February, the margin would be slightly above 13%. We are confident in our ability to deliver this new guidance. Thank you for your attention. We are now ready to answer your questions.

[Operator Instructions] We have a first question from Victor [indiscernible]

I have 3, if I may, potentially. So my first question would be on the 56 of LEAP outlook into Q4 and into 2023. And interesting, in particular, if you could please provide details on the driver for the [ unshut ] full year guidance in civil aftermarket despite your strong performance in Q3 and the significantly higher pricing for part of Q4. On my math, your guidance implies a sequential decline in Q4 both in absolute dollar terms, but also in relative terms of 2019. My second question would be on LEAP OE, and if you could please give details about the drivers behind the swift recovery in deliveries in the quarter. And if this has changed your views on the supply chain at all. I think you were expecting a recovery in the supply chain by the end of 2023, where some of your partners and competitors see it by mid-2023. And then my final question would be on the clawback agreement that you struck with employees last year. And I think that you mentioned in your presentation that your margin guidance included the impact of returning to 100% of the optional profit sharing to French employees. And should we understand that this is a return to 100% of the precrisis practice or return to 100% of the capital level, which have been defined in the agreement?

Okay. I will take the first 2 and will let Pascal answer the third one on the clawback agreement. Outlook for Q4, our guidance assumes a Q4 2022 flattish versus Q4 2021. The reason for that being that the Q4 2021 has been very strong with a lot of prebuying of spare parts just in anticipation of the catalog price increase that has been focused last year in Q4. This year -- because we have announced the price increase at around 10% this year, we're seeing an anticipation of the prebuying effect of spare parts. So this has occurred starting in September. And this is why we have had a very strong Q3 2022. Now that may appear a little bit conservative. We'll see. We still remain in the 25% to 30% band for the civil aftermarket revenue growth in 2022 versus 2021, but I can say we'll be -- let's say, in the mid to the -- mid- to high range of these bands. Your second question relating to LEAP OE. Yes, the good news is that we have seen a strong increase of LEAP engine deliveries in -- sequentially in Q3 versus Q2, more than 50%, as we said. But I have to say we have just stabilized the depth for delay. We have not started yet the recovery and, let's say, the melting of the debt for delay. In our opinion, our -- the supply chain issues will remain up to the end of 2023.

On your third question, we have an agreement for the third year in a row with the French unions, whereby French employees have agreed to a significant cut in the profit sharing scheme that is in place. This year, in 2022, there was a clawback clause that was saying that should we trigger a certain level of EBIT margin this year in case of overshooting the EBIT margin guidance, then we would return EUR 1 for EUR 1 additional EBIT to French employees. So we have triggered the first trigger. This is why we will return 100% of what we call the optional profit sharing, called [Foreign Language] in French, which represents 0.3 points of margin, okay? We are not yet at the level of 2019. We will return to, let's say, normal profit sharing schemes in 2023. There is a second trigger in this clawback clause, which has not yet been achieved, which is about the additional contribution, which we call in French [Foreign Language], which is part of the agreement we have with French union. So to answer your question, we are not yet at the level of 2019.

The next question comes from Robert Stallard from Vertical Research.

I have a couple of questions. First of all, to follow up on the previous question on LEAP OE deliveries, Boeing said -- I think it was yesterday, that engine deliveries are the pacing item on the 737 at the moment. When do you think you'll be back to where Boeing wants you to be in terms of their target of 31 a month on the 737? And then secondly, on your discussions with Thales on the acquisition, when do you think this will close? And what sort of financial impact do you think that will have?

I'll take the first one, Robert. Yes, Boeing has declared that the engine is a pacing item. We are late with Boeing as we are late with Airbus on deliveries. Boeing basically is planning to deliver 31 aircraft a month. We are on this plan. But the point is basically when is going to be the date of ramping up to 38 a month, you know that this is planned for 2023. So this is currently in discussion with Boeing. But yes, we are impacting both airframes deliveries. Now to be -- we are late. This is probably -- we are probably not the only equipment being late. I mean, once again, the supply chain issue is overwhelming across the board in the aerospace industry, but we have to recognize we are late. .

And the second question, we expect to close the Thales electrical activities acquisition during Q1 next year. We've said that the sales they had in 2021 was about EUR 120 million, so a year ago. The profit level is in line with Safran Electrical and Power within the Equipment branch where it will be consolidated. I remind you that this is the fourth acquisition in that field in the past 10 years. We started with the acquisition of Goodrich Electrical Power Systems, then Eaton primary distribution system, within Zodiac, acquired some good activities in distribution. And now this is, I would say, one of the ultimate technology bricks that was missing in our portfolio. So we will have, thanks to that acquisition, a wide business in electrical activities ranging from generation, distribution and conversion.

The next question comes from George Zhao from Bernstein.

On revenue per shop visit, in the past you talked about the gains from pricing, slightly offset by USM usage. So as we think about the 10% price increase that's set to take effect this year, how do you think about the net impacts on revenue per shop visit going into next year? And if that pricing increase, does that nearly preserve the margins given that the costs are also increasing significantly? Or are you achieving higher margins as a result of these announced pricing increase? And second quick one, spare engine deliveries, are they still running above normal? And if so, when do you expect that to normalize?

George, we are not going to elaborate today on 2023. But as Pascal has outlined, the volume of shop visits this year is going to be lower than what we expected initially at the start of the year. And this is mainly coming from China and the volatility in the Chinese domestic air traffic. And we have also the impact of the Ukrainian-Russian war, where we are not going to sell any spare parts to Russia. So the volume of shop visit will be lower. But the good news is that the revenue per shop visit is going to be higher than what we expected initially for some reasons. One is that, and this is good news, we see a pickup of the content of the work scope. The work scope is increasing again, which is good news. And this is -- I think this is an effect, an impact that is going to last obviously next year. So this is good news. We have seen, as we said, the impact of the pre-buying focused on Q3, but this is also improving the situation. And we've seen also an impact of the building of inventory within the shops because this inventory had been consumed during the pandemic. So all in all, we're aligned. I mean, we are aligned because there is a good compensation of balance between those 2 effects and we are aligned with our initial expectations for the global revenues of aftermarket sales.

Sorry -- just on the second question on spare engines.

Spare engines?

The spare engine. Yes, we are going to deliver more spare engines this year than we expected initially. But basically, we are always in the same range as -- I mean, we are within a band which is usual, but we are going to deliver more spare engines this year than initially expected.

The next question comes from Tristan Sanson from BNP Paribas.

A couple of ones. I just wanted to have a bit more details on the optional employee profit sharing. So to understand well, based on the initial guidance you were planning at 13% margin -- or you would have achieved -- a bit more than 13% plus 30 bps that is today given back to employees. So maybe you are trading for 13.4%, 13.5%. And you say today and the new guidance is converting to 12.6%. Can you confirm that is it the value? And you said there's another layer that can be triggered. Can you tell us what is the maximum level of outperformance that can be absorbed by this next figure? So if we want you to achieve 12.7% or 12.8% or 12.9% then that you need to do 40, 50, 60 bps incremental that would be helpful? Second question was, you're giving at the same time $1 billion to shareholders through buyback and would support employees, which should, I guess, help in the salary negotiations with unions. Can you tell us how they are progressing today and how they are relating the labor cost inflation for 2023 as a consequence? And finally, a quick one. You -- Pascal, you said that you were considering that you are fully hedged until 2026, and you gave a pretty clear guidance of your actual level of forwards for the years to come or [indiscernible] years to come. Can you tell us at what kind of OE deliveries you consider that you are fully hedged? And I'm not going to ask about actual OE rates for Airbus and Boeing, but tracking total production for LEAP deliveries, is it [indiscernible] engines? What's the order magnitude we should have in mind?

Okay. So let me take the first one. Your understanding is right. we have been able to cross the first trigger of overperformance in terms of EBIT margin. This is why we are returning 100% of the optional profit sharing. As I said, it means 0.3% of margin, meaning that the underlying EBIT performance is 13.4%. We can't report 13.4% because we are returning that money 1:1 to employees. And we have the second trigger starting higher than that, which would -- if we were to cross that trigger, would return maybe an additional 0.4%, 0.5% of margin. So all in all, we will always report a bit more than 13% of EBIT margin. But if we were to overperform even higher than what we think, then we would return that money to employees only.

To be precise, that's applied to the previous FX environment, so it's [ now 12.6% ].

Yes, absolutely. It's -- this calculation is made on the spot rate of 1.18, correct. Maybe I'll take the third one on FX. We are fully hedged until 2026 with an improvement of as much as EUR 0.04 compared to the previous guidance. Remember that at the Capital Market Day, all our financial trajectory was based on a spot rate of EUR 1.20, but on the hedge rate of EUR 1.16. So if we can achieve EUR 1.12, it will be a EUR 0.04 improvement. This is based on the LEAP deliveries on an annual basis at the time of, I would say, north of 2,000 engines, as we've said during the Capital Market Day. So this underlying assumption is unchanged.

On the discussion with the employees, we have that, along the year, discussion with the trade unions and the employee representative in the course of the year. I remind you in France -- especially in France in 2022, on average, we have increased the salaries by 4%. So it's been 3% that we have announced at the start of the year. And we have -- basically, we've complemented that by an additional 1% on average, focused on the low wedges in June. We have not started the discussion for next year. We are going to start those discussion for -- in January. And of course, we can expect the representatives to tell us that inflation is high, et cetera, and their expectation is going to be for, let's say, a higher than usual salary increase. But the negotiations have not started yet.

The next question comes from Ben Heelan from Bank of America.

So 2 for me. I come back, Olivier, on the comments you made on aftermarket because flat in Q4 given the price increases that have been discussed, it seems quite a weak level. So I get the comp is very, very difficult. But is there anything in terms of volumes being negative in Q4 that we need to be aware of? Or is it fair to say that, that's a relatively conservative view? That would be the first. And then secondly, in Q3, we saw a big sequential improvement in LEAP deliveries. How should we be thinking about LEAP deliveries into Q4? Is it fair to see another sequential improvement? Or should we be thinking around the same level as Q3?

Yes. Maybe I'll take the first one, then on the aftermarket. We have experienced the same seasonality in the past years where Q4 was the strongest quarter given that the price escalation is always taking place on the 1st of November. We believe this year that some sales have been pulled forward into Q3 because we've seen abnormally high level of sales in Q3. So this is why we stick with our full year guidance. Maybe the seasonality will be slightly different this year. So Q4 should be flattish, which means flat to slightly up. Is there a potential upside there? We'd see at the end of the year. At this point in time, as Olivier said, we believe we will be in the mid to the high end of the range. .

Ben, our LEAP OE deliveries, the expectation is that Q4 should be similar to Q3.

The next question comes from David Perry from JPMorgan.

So I've got 3, please. The first one is just to clarify your message on the new FX hedging, please, Pascal. Because you keep talking about EUR 0.04. You've said it a couple of times as the sort of better rate. That really implies you're targeting the EUR 1.12, whereas the slide shows EUR 1.12 to EUR 1.14. So can I just tie down, do you think we should all be putting EUR 1.12 into the model? That's the first question. The second question, maybe for you, Olivier. You talked about Boeing deliveries. But I believe on the call 2 days ago, this sort of 31 a month that you alluded to, Olivier, it's 20 for production and 10 a month is coming out of inventory. So they really are delivering at a very -- sorry, producing, excuse me, at a very low rate. So I'm just surprised that you are struggling at those levels. So maybe if you could comment on that. And then my third one, I don't know if it's a comment or a question, maybe it's both, if you'll indulge me. But in my view, a share buyback to offset the convertible bond is not really a share buyback. And I don't know about other brokers. I already had it in my model because you had to do it anyway. You always have to neutralize that convertible bond. To me, that's different to the messaging you've given since the CMD about capital returns. So why wouldn't you be doing a share buyback over and above the buyback to neutralize the convertible bond?

Okay. I'll take the first one. Yes, you're right. I'm not ending up here a corridor of EUR 1.12 to EUR 1.14, meaning that EUR 1.12 is achievable. So EUR 1.12 compared to EUR 1.16 million is a EUR 0.04 improvement at best. This is what the hedge book can deliver in the coming years.

And David, yes, as I said, the good news is we've picked up late deliveries versus Q2, but this is not enough. It's not enough. We are not yet recovering our debt for delay, and we are still struggling on castings, especially in the U.S. And when I say we, I'm talking about CFM. Once again, this is a combination of Safran and GE. So we need both to deliver the complete engines. So we are struggling with casting in the U.S. We are struggling with some key components as well, especially electronic components. So it's an everyday battle to deliver to Boeing and to Airbus as well. Same -- this is the same struggle. .

On the third one, I'll take it. We are fully aware that the share repurchase program that we are announcing today is to avoid any equity dilution in the future. And this is not a straight share buyback where we would cancel shares and have a direct relative impact. We've already said that in 2022, given the agreements we have with the French unions in France, it was inadequate to launch a straight share buyback. The social and political context in France prevents us to announce any such straight buyback in 2022. So that's why we delay any potential straight share buyback. So first, we will execute this almost EUR 1 billion share repurchase program to avoid the dilution of the OCEANE. And we'll see later on if we are able to announce such a straight share buyback in the future. .

So just to clarify, the -- you think it's unlikely in the whole of 2023 that you'd have any share buyback over and above the OCEANE one? Or is it possible? .