Hexcel Corporation (NYSE:HXL) Q1 2023 Earnings Call Transcript

Hexcel Corporation (NYSE:HXL) Q1 2023 Earnings Call Transcript April 25, 2023

Hexcel Corporation beats earnings expectations. Reported EPS is $0.5, expectations were $0.38.

Operator: Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hexcel First Quarter 2023 Earnings Conference Call. All lines have been placed on mute, to prevent any background noise. After the speaker’s remarks there’ll be a question-and-answer session. . Thank you. Patrick Winterlich, Chief Financial Officer, you may begin your conference.

Patrick Winterlich: Thanks, Rob. Good morning, everyone. Welcome to Hexcel Corporation’s first quarter 2023 earnings conference call. Before beginning, let me cover the formalities. I want to remind everyone about the safe harbor provisions related to any forward-looking statements we may make during the course of this call. Certain statements contained in this call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. They involve estimates, assumptions, judgments and uncertainties caused by a variety of factors that could cause future actual results or outcomes to differ materially from our forward-looking statements today. Such factors are detailed in the company’s SEC filings and last night’s news release.

A replay of this call will be available on the Investor Relations page of our website. Lastly, this call is being recorded by Hexcel Corporation and is copyrighted material. It cannot be recorded or rebroadcast without our express permission. Your participation on this call constitutes your consent to that request. With me today are Nick Stanage, our Chairman, CEO and President; and Kurt Goddard, our Vice President of Investor Relations. The purpose of the call is to review our first quarter 2023 results detailed in our news release issued yesterday. Now let me turn the call over to Nick.

Nick Stanage: Thanks, Patrick. Good morning, everyone, and thank you for joining us today as we share our first quarter 2023 results. Our first quarter results reflect a strong recovery in demand with overall sales up 18% year-over-year, bolstered by a 30% increase in Commercial Aerospace sales. We delivered strong margin leverage on the increased production volumes, leading to a robust operating income for the fourth quarter. The strong demand for new aircraft is clear with a combined backlog for Airbus and Boeing now at roughly 12,600 aircraft. Airline orders are increasing for new, lightweight, composite-intensive planes to replace older, less fuel-efficient fleets and to meet growth in passenger demand. Indications are that domestic air travel has not stopped accelerating in recent months despite inflation, and now many expect that passenger demand could recover to 2019 levels by the end of this year as China reopens.

International air travel is also coming back strongly, including both leisure and business and is recovering more quickly than many had expected. During the first quarter of 2023 alone, there have been six different widebody orders and options announced from Asia, the Middle East and Europe, for a total of 215 widebody aircraft for Airbus and Boeing. Announced orders or options for narrowbodies, including the Airbus A320neo family, the A220 and the Boeing 737 MAX remains strong and steady at 464 aircraft in the first quarter. We remain aligned with our customers and ready to support their growing demand. We recognize though that there are broader challenges in the aerospace industry relating to supply chain constraints, labor shortages and workforce and experience, and we are staying vigilant and agile in order to provide support as required to our customers.

Yet while our optimism may be tempered by these factors, we could not be more pleased to start 2023 with such positive momentum. Our confidence is strong as we reaffirm our full year 2023 guidance that we provided in January. Now let me highlight some of the results, and Patrick will then provide more detail on the numbers. Commercial Aerospace sales of $285 million increased 30% compared to the first quarter of 2022, led by growth in the Airbus A350 and A320neo programs. Other Commercial Aerospace increased more than 23% for the first quarter on expanding business jet demand. The outlook for narrowbodies, widebodies and business jets is extremely encouraging. They are all growing and creating further demand for more Hexcel composite material.

Space & Defense sales of $126 million increased 7.6% in constant currency with growth across a number of platforms globally, including fixed-wing aircraft and both military and civilian rotorcraft. We see a period of increased space and defense spending, including Europe and Asia Pacific, which for the first quarter of 2023 represented approximately one-third of our total Space & Defense sales. Total Industrial sales of $47 million decreased about 9% in constant currency due to lower wind energy sales that were partially offset by sales growth and recreation, automotive and general industrial markets. Marine continues as an emerging growth market for us. And in fact, this week at the JEC World Trade Show in Paris, Hexcel was recognized along with one of our customers and a consortium of other partners for our work on new composite technologies for the marine sector that will eventually lead to quieter and more environmentally sustainable cruise and cargo ships.

As with every quarter, I want to thank our One Hexcel team for their focus on execution and efficiency through operational excellence, ensuring that we deliver quality products to our customers on time. The labor market remains tight and certainly the necessary talent takes longer to find. Yet we have been filling jobs both on the plant floor and in our offices with great success over the past several months as job seekers are attracted to our collaborative culture and our compelling business outlook with our sustainability-oriented light leading products. Our success as a company is not just what we do, but how we do it. Our growth position today is supported by how Hexcel managed during the downturn by quickly ramping down yet without sitting still.

A prime example of that is our decision to invest in a new research and development site adjacent to our largest carbon fiber and matrix plant in North America and Salt Lake City, Utah, which some of you have visited on previous Investor Days. We broke ground in October 2021, and then on March 22 of this year, our Center of Research and Technology Excellence officially opened. Customers from about 20 companies joined us for an event where we celebrated with local public officials and employees with everyone having the chance to tour our state-of-the-art labs and meet our researchers and scientists who now are calling this remarkable innovation center their home. With about 100,000 square feet of floor space, our new R&T center of excellence provides us with an amazing opportunity to expand our research and broaden our technology portfolio.

It is also an ideal platform for us to collaborate with our customers on the latest innovation and lightweight, sustainable solutions and the latest developments in carbon fiber and matrix technologies for aerospace Space and Defense and industrial applications. It will quickly become a showcase that demonstrates our world-leading composite technology. Lastly, as you read in our news release last night, we are reaffirming our guidance at $1.725 billion to $1.825 billion in sales for 2023 with adjusted diluted earnings per share of $1.70 to $1.90. Our guidance on free cash flow is to generate more than $140 million while continuing to manage accrued capital expenditures with approximately $90 million of sales forecasted. Now I’ll turn it over to Patrick to provide more details on the numbers.

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Patrick Winterlich: Thank you, Nick. As a reminder, the majority of our sales are denominated in dollars. However, our cost base is a mix of dollars, euros and British pounds as we have a significant manufacturing presence in Europe. As a result, when the dollar strengthens against the euro and the pound, our sales translate lower while our costs also translate lower, leading to a net benefit to our margins. Conversely, a weak dollar is a headwind to our financial results. We hedge this currency exposure over a 10-quarter horizon to protect our operating income. As a result, currency changes are laid into financial results over time. As a reminder, the year-over-year sales comparisons I will provide are in constant currency, which thereby remove the foreign exchange impact to sales.

Turning to our three markets. Commercial Aerospace represented approximately 62% of total first quarter 2023 sales. First quarter Commercial Aerospace sales of $284.5 million increased 30% compared to the first quarter of 2022, led by both the Airbus A350 and A320neo programs. Airbus raised the production rate of the A350 in early 2023, which led to increased first quarter sales, including some restocking. The Other Commercial Aerospace category grew 23.5%, led by strength in business jets. I would like to highlight that our first quarter 2023 business jet sales exceeded pre-pandemic levels, which is supported by the growing secular adoption of composites for lightweighting by business jet manufacturers. Space and Defense represented 28% of first quarter sales and totalled $126.2 million, increasing 7.6% from the same period in 2022.

The growth continues to be across multiple platforms globally, including fixed-wing aircraft and both military and civilian rotorcraft, partially offset by softer space sales. Industrial comprised 10% of first quarter 2023 sales. Industrial sales totalled $47 million, decreasing 9.1% compared to the first quarter of 2022 on lower wind energy sales. As we mentioned last quarter, wind energy sales stabilized in the second half of 2022. Recreation, automotive and other general industrial sales grew year-over-year. On a consolidated basis, gross margin for the quarter was 27.9% compared to 22.3% in the first quarter of 2022. Higher production levels and robust margin leverage were the principal drivers of this strong performance. However, I want to caution that the gross margin this quarter was particularly strong for a number of reasons; sales mix was favourable with strong demand for Hexcel fiber-rich products; there was a favourable absorption impact as a result of increasing finished goods inventory; and foreign exchange was also a tailwind this quarter due to the significant dollar strength compared to the first quarter of 2022.

As a percentage of sales, selling, general and administrative expenses and R&D expenses were 14.1% in the first quarter compared to 14.2% in the first quarter of 2022. Consistent with past trends, first quarter SG&A expenses were elevated on stock-based compensation. So SG&A is expected to moderate for the remainder of the year. R&D expenses were higher on more material development costs as we pursue new opportunities with our innovative composite lightweighting solutions. Adjusted operating income in the first quarter was $63 million or 13.8% of sales compared to $31.1 million or 8% of sales in the comparable prior year period. The year-over-year impact of exchange rates in the first quarter to adjusted operating income was favourable by approximately 80 basis points.

Now turning to our two segments. The Composite Materials segment represented 83% of total sales and generated an 18.4% operating margin, strengthening year-over-year on higher sales and production volume as well as mix. The operating margin in the comparable prior year period was 12.9%. The Engineered Products segment, which is comprised of our structures and engineered core businesses, represented 17% of total sales and generated a 14.9% operating income margin as compared to 13.7% in the comparable prior year period. The effective tax rate for the first quarter of 2023 was 21.9%. Net cash used for operating activities in Q1 2023 was $23.4 million compared to a use of $19 million in the first quarter of 2022. Working capital was a use of cash of $104 million in the first quarter to support higher sales.

This working capital increase was consistent with expectations and path trends as working capital increased $74.3 million in the first quarter of 2022. Capital expenditures on an accrual basis were $16.8 million in the first quarter of 2023 compared to $11.1 million in the prior year period. As previously disclosed, 2023 capital expenditure included further construction related to the partially completed carbon fiber line at our facility at Decatur, Alabama to support future growth. Free cash flow was negative $41.5 million in the first quarter of 2023, which was similar to the negative $39.9 million in the prior year period. For an alternative metric of cash generation, adjusted EBITDA in the first quarter of 2023 was $106.6 million, up 44.6% from $73.7 million in the first quarter of 2022.

I am pleased to let you know that we have just renewed and extended the maturity date of our bank-syndicated $750 million revolver to April 2028. The terms and conditions were basically unchanged with two key revisions to highlight. First is that the borrowing base rate was revised from LIBOR to SOFR as expected. The other change is beneficial to Hexcel as the leverage covenant calculation was revised to net debt whereas, previously, it was measured on a gross debt basis. Successfully concluding this refinancing during a period of banking turmoil speaks to the financial strength of Hexcel and the support of our bank group. The Board of Directors declared a $0.125 quarterly dividend yesterday, payable to stockholders of record as of May 5 with a payment date of May 12.

We did not repurchase any common stock during the first quarter of 2023. The remaining authorization under the share repurchase program on March 31, 2023 was $217 million. As Nick stated, our full year 2023 guidance is reaffirmed. With that, let me turn the call back to Nick

Nick Stanage: Thanks, Patrick. We welcome the return to growth and ramp-up in programs. Our customer relationships have never been better, thanks in part to our flexibility, transparency and reliability. Pent-up demand for air travel is loading up seats on airplanes, which is expanding backlog for new, more fuel-efficient aircraft. And as the market recovers, Hexcel benefits from the continued penetration of lightweight composite materials as well as our never-ending commitment to innovate with our customers on new materials and solutions for next-generation programs. Supply chain issues remain a watch item for us as they do for most other suppliers in our industry. However, global demand for advanced composite technology from lighter-weight, stronger and more durable materials in all of our markets is growing.

And our technology and products remain unrivalled in our industry. The disciplined actions we have taken and our focus on execution will ensure that Hexcel continues providing long-term shareholder value. Rob that concludes our prepared remarks. We’re now ready to take questions.

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Q&A Session

Operator: Your first question comes from the line of John McNulty from BMO Capital Markets. Your line is open.

John McNulty: Yes, good morning. Thanks for taking my question. So a question regarding the maintenance of your full year guide. So your first quarter came in really strong. And it did sound like maybe there was a little bit of continued restocking of inventory, so maybe that is part of the answer. But I guess when we think about the seasonality of the business, your strength in the first quarter would imply maybe a better range for the full year. So I guess, can you help us to understand maybe some of the puts and takes there or some of your conservatism as to the full year guide and no changes there?

Nick Stanage: Yes, John. Well, thanks for the question. First off, clearly, we started the year strong, and we’re seeing improvements in many of the supply chain aspects that are creating some uncertainty and continued pressure in the industry. So for one, we’re early in the year. We just gave guidance in January and the guidance has pretty wide ranges on it. So the tweak it at this point in time, just didn’t make sense to us. Secondly, the supply chain risks not necessarily only to us but for other components that could ultimately impact build rate ramps, I can’t say those have gone away. They’re still there, and we probably are taking a conservative view on that and some of the other shortages that are driving some challenges in various areas of discrete part manufacturing within the industry. So maybe a little bit conservative, but at this point in the year, that’s really the position we want to take and convey.

John McNulty: Got it. Fair enough. And maybe just as a follow-up, your balance sheet strengthened a lot. Your leverage, if I’m looking at it right, is now below 2 times. And you actually have that maybe better covenant flexibility as well. So how should we think about cash flows and the uses as we go forward? Can we see maybe a push into buying back some stock throughout the year? Or are there opportunities on the M&A front just given your strength maybe relative to others out there where maybe that’s more attractive? I guess maybe you can give us some color around that.

Nick Stanage: Yes. So I’d say it’s unfortunately for you, maybe a boring answer, but it’s consistently what we’ve said for quite a few quarters, certainly since I’ve been talking and sharing our earnings results. First and foremost, our team are pushing innovation, new technologies, innovative new fibers, new processing, new solutions for our customers to help them not only on existing platforms and various derivatives that are being worked to prepare for the next generation of platforms. There’s also new programs out there that awards are not set yet, for example, on the Valor 280 or many military programs that we continue to work and continue to innovate. So organic growth is priority number one. Priority number two is we really look at the M&A landscape.

We look at bolt-ons. We look at our technology portfolio and how we might expand that to be able to offer our customers even broader, more value-driving solutions for their lightweight needs. And that pipeline, we’ve been looking at that continually. We’re disciplined. We’re very selective. But that’s how I look at number two. And then lastly, we always look at our balance sheet. We look at our debt ratio and we review with our Board on a regular basis our dividend strategy and our share buyback strategy. And as you see, the cash generation is ramping up as our sales grow. So I would expect we’ll continue to look at all three of those priorities. And without guiding to definitively, I’d say all of them are in play going forward.

John McNulty: Great, thanks very much for the color.

Nick Stanage: Thank you, John.

Operator: Your next question comes from the line of Rob Spingarn from Melius Research. Your line is open.

Robert Spingarn: Hi, good morning. Nick, obviously, just on the back of that last question, strong numbers here in the first quarter. And you talked about the OE on the build rates. But I wanted to get a little bit more specific and see if you could take us through your plans for the major programs, A320, A350, 737, 787, et cetera. And I’m particularly focused on the MAX because there’s talk of higher rates, but what we’re not clear on is whether some of those aircraft are mods coming out of Moses Lake. And therefore, you wouldn’t participate because you’re already — those aircraft are already largely built from a Hexcel perspective. So that’s essentially the question. What is — how do rates flow throughout the year on those programs for you?

Nick Stanage: Well, let me start with Boeing. I mean, there’s a lot of momentum and positive news coming out of Boeing. I know they had the recent issue that we’re working through with Spirit. But just before that, they’re really looking at potentially getting to a point of increasing rates from where they have been, around the low 30s. So we feel real good about the MAX. We see China continuing to issue reports that make it more comfortable for airlines to take new MAX deliveries. And we know Boeing have inventory that have been built and structured from the Chinese market, so that would be another tailwind that would help the MAX. So the aircraft, obviously, with the orders you’re seeing, the length of time it takes to get a new aircraft, there are plenty of demand for the MAX as the supply chain stabilizes and Boeing can increase rates.

So that’s the MAX. On 787 — and I would point out, even though we highlighted the A350 and the A320neo, we were up year-over-year on the MAX and the 787. We were up sequentially on both those platforms. So I don’t want to diminish the strength of Boeing, we just called out the biggest market drivers for the revenue dollars. If you look at the 787, again, it was up. It has been at low rates. We saw a nice uptick in Q1. And again, Boeing is targeting to be closer to 5% by the end of the year. So we do expect that to continue to provide strength going forward. So to the Airbus side, if you look at the A220, orders continue to come in strongly. We have a nice position there. 320neo is on a glide path to ramp up to the mid-60s by the end of next year, still targeting to be in the mid-70s by 2025-time frame.

So continued growth, strong positions we have there. And then the A350 has recently moved up to six. And Airbus has been vocal and public on targeting the ramp up to nine per month by the end of 2025. The A330neo, where again we have strong position is that per month, and we see that maintaining a consistent level going forward. So overall, we still see tailwinds on build rates. And again, we’re very bullish on the market with the caveat that the supply chain is still questionable with respect to how quickly it can ramp up and if it might impact build rates in the next 12, 24 months.