Howmet Aerospace Inc. (NYSE:HWM) Q3 2023 Earnings Call Transcript

Howmet Aerospace Inc. (NYSE:HWM) Q3 2023 Earnings Call Transcript November 2, 2023

Operator: Good day and welcome to the Third Quarter 2023 Howmet Aerospace Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Paul Luther, Vice President of Investor Relations. Please go ahead.

Paul Luther: Thank you, Betsy. Good morning and welcome to the Howmet Aerospace third quarter 2023 results conference call. I’m joined by John Plant, Executive Chairman and Chief Executive Officer; and Ken Giacobbe, Executive Vice President and Chief Financial Officer. After comments by John and Ken, we will have a question-and-answer session. I would like to remind you that today’s discussion will contain forward-looking statements relating to future events and expectations. You can find factors that could cause the company’s actual results to differ materially from these projections listed in today’s presentation and earnings press release and in our most recent SEC filings. In today’s presentation references to EBITDA, operating income, and EPS mean adjusted EBITDA excluding special items, adjusted operating income excluding special items, and adjusted EPS excluding special items.

These measures are among the non-GAAP financial measures that we’ve included in our discussion. Reconciliations to the most directly comparable GAAP financial measures can be found in today’s press release and in the appendix in today’s presentation. With that I’d like to turn the call over to John.

John Plant: Thanks P.T. and welcome everybody to the Q3 earnings call. The results for the third quarter were solid in all respects and exceeded the guidance given in August, which itself was a further increase on that provided in May and February. Sales of $1.658 billion, increase of 16% year-over-year. EBITDA was $382 million, an increase of 18%. EBITDA margin increased to a headline rate of 23%. Margin rate improvements reflect the continuing good work in all segments. I would like to note fasteners with not a sequential quarterly improvement of 230 basis points and additionally, the structure segment had a 320 basis points recovery from the Q2 rate. Howmet’s year-over-year revenue increase flowed through to incremental EBITDA margin at a rate of 28%, which was in line with the guidance.

Operating income increased by 22% year-over-year and operating income margin was 19%. Continued topline growth and healthy margins generated an earnings per share increase of 28%. Free cash flow was healthy at $132 million and help drive shareholder-friendly actions including gross debt retirement of $200 million share buyback of $25 million. Lastly, we also announced a 25% increase in the dividend on top of last year’s 50% increase. Having provided this top-level summary, I’ll pass the call to Ken to provide further details of revenue by end market and the results by business segments.

Ken Giacobbe: Thank you, John. Let’s move to Slide 5. All markets continue to be healthy with revenue in the third quarter, up 16% year-over-year and 1% sequentially. As expected sequential revenue growth was impacted by normal third quarter seasonality. Commercial aerospace increased 23% year-over-year, driven by all three aerospace segments. Commercial Aerospace has grown for 10 consecutive quarters and stands at 49% of total revenue. Commercial Aerospace growth continues to be robust supported by demand for new more fuel-efficient aircraft as well as increased spares demand. Defense Aerospace was up 13% year-over-year driven by the F-35 and Legacy Fighter programs. Commercial Transportation which impacts both forged wheels in the Fastening Systems segment was up 7% year-over-year driven by higher volumes.

Commercial Transportation remains resilient, despite normal seasonality. Finally, the industrial and other markets were up 10% year-over-year driven by oil and gas up 29%, General Industrial up 8% and IGT up 4%, in summary, another very strong quarter across all of our end markets. Now let’s move to Slide 6, for more details on the third quarter results. Starting with the P&L and enhanced profitability revenue, EBITDA, EBITDA margin and earnings per share all exceeded the high-end of guidance. Revenue was $1.658 billion up 16% year-over-year. EBITDA was $382 million up 18% year-over-year, while absorbing near-term costs associated with net headcount conditions of approximately 645 employees. The Engine segment drove a majority of the increase by adding approximately 500 employees.

Year-to-date net debt count additions are just over 1500 employees. We continue to increase headcount for the expected revenue ramp. EBITDA margin was strong at 23%, despite absorbing the headcount additions. Adjusting for year-over-year inflationary cost pass-through of approximately $15 million EBITDA margin was 23.3% in the flow-through of segment incremental revenue to EBITDA was at approximately 28% year-over-year which is right in line with our guidance. Earnings per share, was strong at $0.46 per share, up 28% year-over-year. The third quarter reason represents the ninth consecutive quarter with growth in revenue EBITDA and earnings per share. Next is the balance sheet. The balance sheet continues to strengthen, while returning cash to key stakeholders.

The ending cash balance was $425 million after generating $132 million of free cash flow. In the quarter, $242 million of cash on hand was allocated to debt reduction, common stock repurchases and dividends. Net debt to EBITDA improved to a record low, of 2.3 times. All bond debt is unsecured and at fixed rates which will provide stability of interest rate expense in the future. Our next bond maturity of $705 million is due in October of 2024. Howmet’s improved financial leverage and strong cash generation were reflected in Fitch’s August credit upgrade from BBB- to BBB, two notches into investment grade. Moreover Moody’s upgraded Howmet’s outlook from stable to positive in September. The balance sheet continues to strengthen and is recognized with the rating agency upgrades.

Finally, moving to capital allocation, we continue to be balanced in our approach. In the quarter capital expenditures were $59 million which continues to be less than depreciation and amortization. In the third quarter we reduced debt by another $200 million. Year-to-date, we have reduced debt by approximately $376 million, which will lower annualized interest expense by approximately $19 million. We also repurchased $25 million of common stock in the third quarter at an average price of $49.32 per share. This was the 10th consecutive quarter of common stock repurchases. Share buyback authority from the Board stands at $797 million. Since separation in 2020, we have repurchased more than $1 billion of common stock. We exited the third quarter with a diluted share count of 414 million shares.

Finally, we continue to be confident in free cash flow. In the third quarter, the quarterly stock dividend was $0.04 per share. The quarterly stock dividend will be increased by 25% in the fourth quarter to $0.05 per share. Now let’s move to slide 7 to go through the segment results for the third quarter. The Engine Products segment continued its strong performance. Revenue was $798 million, an increase of 17% year-over-year. Commercial aerospace was up 15% and Defense Aerospace is up 33% with both markets driven by higher build rates and spares growth. Oil and gas was up 33% and IGP was up 4% as demand continues to be strong. As expected, Q3 sequential revenue was down 3% driven by seasonal vacations. EBITDA increased 18% year-over-year to $219 million.

The EBITDA margin increased 20 basis points both year-over-year and sequentially to 27.4%, while absorbing approximately 500 net new employees. We are pleased with the continued strong performance of the engines team. Now let’s move to slide 8. Fastening Systems year-over-year revenue increased 20%. Commercial aerospace was up 34%, including the impact of the emerging wide-body recovery. Commercial Transportation was up 6%. General Industrial was up 7% and Defense Aerospace was down 5%. Year-over-year segment EBITDA increased 19% EBITDA margin was 21.8% and is improved 320 basis points over the last two quarters. Please move to slide 9. Engineered Structures year-over-year revenue was up 18% with commercial aerospace up 33%, driven by build rates and approximately $30 million of Russian titanium share gain.

Defense Aerospace was down 20% year-over-year. Sequentially, Engineered Structures improved production rates and revenue was up 14%, which was in line with our expectation of 10% to 15%. Segment EBITDA increased 7% year-over-year. Sequentially EBITDA margin improved 320 basis points to 13.2% despite absorbing approximately 145 net new employees in the third quarter. Q3 was good recovery by the structures team and we continue to expect further improvement in margins. Let’s move to slide 10. Forged Wheels year-over-year revenue increased 7%. The $19 million increase in revenue year-over-year was driven by a 13% increase in volume, partially offset by lower aluminum prices. Segment EBITDA increased 20% year-over-year driven by the higher volumes.

EBITDA margin increased 290 basis points primarily due to the impact of higher volumes and lower aluminum prices. Finally, let’s move to slide 11. Our balance sheet continues to be a source of strength with healthy cash flow supporting a $200 million debt reduction in Q3. The $1.25 billion October 2024 debt tower was inherited from Alcoa Inc. and has been reduced to $705 million with cash on hand. Since the separation in 2020, we have paid down gross debt by approximately $2.15 billion with cash on hand and have lowered annualized interest costs by more than $120 million. Gross debt now stands at $3.8 billion. All long-term debt continues to be unsecured and at fixed rates. We will continue to focus on improving our capital structure and liquidity.

Lastly, before turning it back to John, let me highlight one item. In the appendix slide 18 covers our operational tax rate which was approximately 22.8% year-to-date. The midpoint of our guidance represents a 500 basis point improvement in the operational tax rate since the separation in 2020. Strong performance by the tax [Indiscernible] and we continue to be focused on further improvements in our operational tax rate. Now, let me turn it back to John for the outlook and summary.

John Plant: Thanks, Ken. So let’s move to slide 12 and talk about the outlook for the next quarter and year-end. So first of all regarding commercial aerospace, airline load factors continued to show improvement in resilience. Factory improvement for international travel notably in Asia also continues to increase. Domestic airline activity continues to be above 2019 levels in the Western countries. Given these load factors and the continued restriction of aircraft builds, the fleet of existing aircraft are having to work much harder. This is leading to robustness in the engine spares market which is further increased by the fact that the deployment in recent years of new engine technologies which are currently operating with increased replacement parts due to lower time on wing.

You look worried about this and you can be assured that Howmet is playing its path and supporting both the technology upgrades and the high-pressure turbine and through providing additional service parts. This will continue over the next two to three years and probably beyond. Moving on commercial aerospace to the defense market. This market is also showing strength with the start of the gradual buildup of engine spares over the next two to three years to support the F-35 program for which the fleet now stands at 975 aircraft and growing. These increases more than offset the continued lockhead inventory correction in our structures business. Other markets of IGT and oil and gas continue to be very healthy. In commercial truck and trailer builds and order intake continued to be good despite the lower freight rates and increased price of diesel fuel.

We continue to be cautious though as we look forward until we see several months of data for new 2024 orders, which the order books have only been opened for a month. The initial month was good. But we also know that orders can be canceled depending upon how the broader economy moves in recent months. In aggregate, we see limited risk of aircraft demand from both the commercial aircraft market and defense markets. The two markets aggregate to approximately 65% of our revenue and that moves up to 80% excluding the commercial transportation business. Beyond the fundamental demand from airlines, clearly we rely upon aircraft manufacturers being able to produce and build up the stated and scheduled quality of aircraft, particularly narrow-body aircraft.

Looking forward into 2024, we envisage growth to be in the 7% range plus or minus a percentage point. The headline sales number for 2024 is likely to be approximately $7 billion. This will be further refined when we see the achieved Q4 build rates from Boeing and Airbus with the confirmed plans going into 2024. All of this will be provided in further detail in February, along with the assumed build rates. Our standard is normally one of caution. Moving specifically to the fourth quarter of 2023. We see revenue about $1.635 billion plus or minus $15 million, EBITDA $375 million plus or minus $5 million, earnings per share at $0.45 plus or minus $0.01. Regarding the full year 2023, revenues increased by about $100 million from $6.44 billion to $6.54 billion plus or minus $15 million.

EBITDA has increased by a further $40 million to $1.485 billion plus or minus $5 million. Earnings per share has increased by $0.07 to $1.77 plus or minus $0.01. Free cash flow is at $635 million plus or minus $35 million. In summary, we see strong performance with healthy liquidity and an increased guide for the remainder of the year. We consider the year-to-date progress to be very good, despite the continued choppy build conditions in commercial aerospace. We are comforted by the fact that any build misses by aircraft manufacturers who have moved into backlog, given the very strong underlying demand for travel and in particular the absolute requirements for fuel efficient engines and fuel efficient aircraft with an overarching mandate of reduced carbon emissions.

Our full year guide of $1.77 earnings per share is an increase of 26% year-over-year. This builds on the 2022 versus 2021 increase of 39%. Currently in 2023, we repurchased $376 million of debt and brought back $150 million of common stock. Our net leverage has further improved in Q3 and is heading towards approximately two times net debt to EBITDA by year-end. All of the debt actions help accomplish our goal of reduced interest rate burden in both 2023 and also going into 2024 with further improved cash flow yield, despite the increase generally of interest rates. Thanks everybody. And now let’s move to your questions.

See also 14 Best Cyclical Stocks To Invest In and 12 Best Free Accounting Software in 2023.

Q&A Session

Operator: We will now begin the question-and-answer session [Operator Instructions] The first question today comes from Kristine Liwag with Morgan Stanley. Please go ahead.

Q – Kristine Liwag: Hey, good morning, everyone.

John Plant: Hi, Kristine.

Q – Kristine Liwag: John, Ken or PT I guess with the 7% revenue increase for your 2024 initial outlook, what does it imply for aircraft production rates for the Boeing 737, 787 and the Airbus A320 and A350. And also when you talk to your customers, how much visibility are you getting for the ramp?

John Plant: Okay. I guess that’s the big one Kristine. So let me just talk generally about the 7%, first of all. Within that, assumption is a mid-teens assumed increase in commercial aero. And more like single-digit increases in industrial, things like AGT oil and gas and general and other, while an assumed high single-digit decrease in commercial transportation. So basically, in our client solid defense solid general industrial markets healthy increase in commercial aerospace that reduced by a high single-digit assumption on commercial or transportation. That’s roughly now applying. I’m going to say, we see assumed build rates in let’s say forecasting agencies. For the most part, we can see that they’re going to increase both wide-body and body fractional increase in mix next year.

At the moment, specifically, for Boeing 737 is what you assumed. You asked a question about our assumption is that it’s somewhere between the mid-30s and 40 somewhere in that region. We don’t want to pit it specifically at this point, you can assume that’s within the range plus or minus I gave. It’s really important that we see Boeing achieved the rate 38, which we know is going to be prior to now it hasn’t really happened that doesn’t seem to be happening just yet, but we know it’s going to be very soon. But we’re not yet ready to believe and input into our guidance even though we can supply a rate 42 should Boeing be in a position to build at that rate.

Q – Kristine Liwag: Great. Thanks for the color.

John Plant: Thank you.

Operator: The next question comes from Robert Spingarn with Melius Research. Please go ahead.

Scott Mikus: Hi. Scott Mikus on for Rob Spingarn. John or Ken, I wanted to ask you a little bit about pension contributions for next year. And also, just given the work you’ve done there, are you considering any sort of risk transfer to get rid of the pension liability and improve free cash conversion?

John Plant: We’ve been working at pension liabilities for several years now and we’ve indeed taken over the last five years from where we started several billion out of that net liability of gross liabilities rather and we’ve always been focused on taking ROS and net debt together. Otherwise, you just leave yourself open to interest rate risk and mortality risk and we’ve managed it down now to I think about $750 million for pension and healthcare certainly in that region. And so it’s now, let’s say tiny traction of our market cap and therefore essentially is not relevant. At the same time, while I’ve noted one of the company maybe a couple have continued in prioritizing this. I’m not yet at that point willing to consider that.

It’s not that, it’s off the table because I think it would be something which would be useful to do. But at the same time, I think at this current time there’s other better uses of our cash and also I’m not willing to leverage to enable that to occur. So essentially, we are aware of it. We continue to work at our plans. I can see us potentially picking off one or two and do partial initiation either within a plant or in a total of a plan but you shouldn’t expect to see that liability extend. We wish to not to pay the premiums to insurance companies to enable that at this point in time. I think that may come over the next say three to five years at some point but not yet. And the assumption we have for next year is that the cash contributions will be a little bit higher than this year but at this point not material.

Scott Mikus: Okay. Thanks. I’ll stick with one question.

John Plant: Thank you.

Operator: The next question comes from David Strauss with Barclays.

John Plant: Hey, David.

David Strauss: John, you mentioned your work on upgraded blades. I wanted to see if you could give a little more color there around the timing of when you when you think you’ll be producing upgrading — producing and delivering upgraded blades to both GE and Pratt?

John Plant: So both for the GTF advantage engine upgrade and for the LEAP 1B upgrades. Those have been something that we’ve been working on for several years now. And the — and if anything let’s say a little bit later into production than originally envisaged although that is pushed back and timing have not been a result of Howmet not being ready. So we’re in good shape. I commented in the past that increased performance in the high-pressure turbine leads to increased complexity and with that is value. And we certainly have been intimate with the engine manufacturers to improve the performance as the engine temperatures have seemed to be higher than originally envisaged and therefore to help improve timeline wing. I feel there’s though specific timing for both what was really called — now that has a different code name for GE.

And I think for the advantage for Pratt & Whitney you’re best asking them for pipeline disclosure rather than myself because we have an agreed plan but that can and has been varied according to the specific needs of those engine manufacturers at this point in time?

David Strauss: Okay. Fair enough. I’ll ask them.

John Plant: Thank you. It’s far better David.

David Strauss: And then Ken I guess a two-parter for you. Just quick comments on working capital through the end of this year. It looks like you’re kind of a pretty big reversal benefit in Q4 and thoughts on that into 2024? And then pension expense you brought down a little bit for 2023 but what are you looking at for 2024? Thanks.

John Plant: I’m going to comment on the working capital first, and then let Ken amplify and then Ken can totally deal with the pension side. And the reason why, I want to talk about the working capital because it’s also tied up with the specific operations and status of they have met different business units are. So first of all, in terms of working capital I mean AR or account receivable and accounts payable they just move on the days assumption. So, if revenue goes up David, as it has then clearly, we have more dollars tied up in receivables than we had but that’s a good answer, because it’s whatever day it is and I don’t know, if we’ve ever disclosed it we can back engineer it. But our days are pretty constant. And so because revenue went up a few more dollars went on, but the days in receivables exactly the same payment payables.

The big wildcard on what gap is always inventory. And so far inventory is still elevated more elevated than I would like but just because our flight [ph] hasn’t been taken up where it should be at this point in time. So it moves with the, I will say status within each business of where we are operationally and in terms of start from let’s say, volume recovery. So if you take our Wheels segment, which was the first division to show volume increase manning and then moving through towards stability and now smoothness of production. Our days of inventory are in really good shape. And indeed, I believe we’re at close to low-class level. If I look at our engine business, which is our second division out of the gate in terms of building of revenue, increasing manning and that’s continuing to increase.

We have gradually been smoothing out production albeit, we’re not in the same level yet, as we are in Wheels. And so what we see is gradual improvements in efficiency of our inventory holding days is on hand. And I think that will continuing to improve again in the fourth quarter and into next year. So I’m pleased, with the trajectory but we’re not yet at where we need to be on our engine business. In terms of fasteners and structures those are very different points. Fasteners has been later in the cycle in terms of volume pickup. As you know, we’ve been recruiting this year building it up. And you’ve seen first of all the margin begin to respond to that and also mix and production efficiency. And also you’ve seen a little bit of a calming of recruitment, in that business in the last few months ultimate still in that we say recruitment mode and replacement mode for employees, but trying to improve efficiency.