Howmet Aerospace Inc. (NYSE:HWM) Q4 2022 Earnings Call Transcript

Howmet Aerospace Inc. (NYSE:HWM) Q4 2022 Earnings Call Transcript February 14, 2023

Operator: Good morning, and welcome to the Howmet Aerospace Fourth Quarter and Full Year 2022 Earnings Conference Call. All participants will be in a listen-only mode today. After today’s presentation, there will be an opportunity to ask questions. Please note that this event is being recorded today. I would now like to turn the conference over to Paul Luther, Vice President of Investor Relations. Please, go ahead, sir.

Paul Luther: Thank you, Joe. Good morning, and welcome to the Howmet Aerospace fourth quarter and full year 2022 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 and EPS mean adjusted EBITDA, 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 Howmet Q4 earnings call. Let’s start by dealing with the headline numbers on slide four. For the fourth quarter, revenue accelerated as we exited the year, and it was above the high end of the guide at $1.51 billion, up 18% year-on-year. Commercial aerospace continues to be strong and was up 29% in the quarter. EBITDA was $336 million, at the high end of the guide. Revenue and EBITDA continued to improve sequentially for the sixth consecutive quarter. The strong operating EBITDA was mitigated by a couple of below-the-line items that Ken will cover in his commentary. Earnings per share was at guidance at $0.38, which benefited from the strong EBITDA and the Q4 tax rate, which mitigated the below-the-line items.

For the year, despite the choppy backlog, year-over-year revenue was up 14% and EBITDA was up 12%, which drove a healthy earnings per share growth of 39%. Moving to the balance sheet and cash flow. Free cash flow was within the guided range of $540 million and as commented on the previous earnings call, included an inventory build for commercial aerospace to help smooth production adds as we move between years. Despite the inventory build, free cash flow conversion continues to be strong at 91%. Liquidity is healthy, with year-end cash balance on hand of $792 million and this was after share buybacks, bond repurchases and dividends. In the quarter, an additional $65 million of common stock was repurchased and the full year repurchase of common stock was $400 million.

The December 2022 fully diluted share count exit rate was 418 million shares, which is an improvement of approximately 80 million shares since the start of 2019. This was accomplished while reducing net debt over the last four years as well. There was also some minor repurchases of bonds in Q4, taking the full year repurchases to $69 million. The bond repurchase program continued into the first quarter of 2023. And by the end of January, an additional $26 million of bonds were repurchased at a small discount to par. This continues our plan of reducing interest costs year-on-year. And going into 2023, it will be lower than 2022. And this is despites the global rising interest rate costs. Hence, we set ourselves up for a fundamentally different approach to most companies where interest costs will be lower for the coming year.

We’ve improved Howmet’s leverage ratio, which now stands at 2.6 times net debt to EBITDA compared to our long-term target of just under two turns. All of Howmet’s debt is unsecured and at fixed rates. Howmet’s $1.1 billion revolver is undrawn. At the top level, we were pleased with the year. We exceeded the initial EPS guide for the year again. And in the case of 2022, we faced an extremely choppy backlog of below build expectations of both aircraft and engines compared to initial expectations. Furthermore, the extraordinary uptick inflation overcome despite its margin impact and all of this talks to the performance and resiliency of Howmet. Ken will now detail the 2022 performance, and then I’ll cover the outlook after that.

Ken Giacobbe: Thank you, John. Please move to slide 5 for an overview of the markets. Revenue was up 18% year-over-year for the fourth quarter and up 14% for the full year. The commercial aerospace recovery continued throughout 2022, with fourth quarter commercial aerospace revenue up 29% year-over-year and up 28% for the full year, driven by engine products, engineered structures and the narrow-body recovery. Commercial aerospace has grown for seven consecutive quarters and stands at 48% of total revenue, but continues to be short of the pre-COVID level, which was 60% of total revenue. Defense Aerospace was up 13% in the fourth quarter, driven by year end seasonality and down 3% for the full year, driven by customer inventory corrections for the F-35.

Commercial transportation, which impacts forged wheels and fastening systems, was up 12% year-over-year in the fourth quarter and up 14% for the full year, driven by higher aluminum prices and higher volumes, partially offset by foreign currency. Finally, the industrial and other markets, which is composed of IGT, oil and gas and general industrial, was essentially flat for the fourth quarter and for the year. For the fourth quarter, within the industrial and other markets, oil and gas was up 22%, IGT was up 2% and general industrial was down 10% on a year-over-year basis. Now let’s move to slide 6. We will start with the P&L with a focus on enhanced profitability. For the fourth quarter, we had six consecutive quarters of growth in revenue, EBITDA and earnings per share.

Revenue, EBITDA and earnings per share exceeded or were in line with guidance. For the full year, revenue was up 9% year-over-year excluding material pass-through of approximately $225 million. EBITDA was $1.28 billion or up 12% year-over-year. Adjusting for the year-over-year material pass-through, EBITDA margin was 23.5%, and flow-through of incremental revenue to EBITDA was strong at approximately 30%. The full year operating tax rate was 22.5%, an improvement of 250 basis points year-over-year. Earnings per share was $1.40 for the year and up 39% year-over-year. The average diluted share count improved to a Q4 exit rate of 418 million shares. As John mentioned, the strong operating EBITDA and favorable tax rate in the fourth quarter were mitigated by a few items below the line.

The impact of foreign currency and deferred comp was $9 million pretax charge, as these items fluctuate based on market conditions. For the year, the impact of foreign currency was essentially breakeven and deferred comp was favorable. Final note on earnings. As expected, we did not have significant net headcount additions in the fourth quarter. However, we hired approximately 1,000 new employees to offset Q4 attrition and absorbed incremental training and production costs. Moving to the balance sheet. Free cash flow for the year was a record $540 million, including an inventory build of approximately $235 million, primarily for the commercial aerospace recovery. For 2022, as well as in every year since separation, we achieved free cash flow conversion of net income in excess of our long-term target of 90%.

Year-end cash balance was a healthy $792 million after approximately $513 million of capital allocation to common stock repurchases, 2024 bond repurchases and the quarterly dividends. Year-over-year net pension and OPEB liabilities were reduced by approximately $180 million, and cash contributions were reduced by approximately 50% or $56 million. Since 2019, net pension and OPEB liabilities have been reduced by approximately $470 million and gross pension and OPEB liabilities by approximately $1.4 billion. Net pension and OPEB liabilities now stand at less than 5% of Howmet’s market capitalization. Finally, net debt to EBITDA improved to a record low of 2.6 times, all bond debt is unsecured and at fixed rates, which will provide stability of interest rate expense in the future.

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Our next bond maturity is in October of 2024, and the $1 billion revolver is undrawn. Moving to capital allocation. We continue to be balanced in our approach. Capital expenditures were $193 million for the year and were approximately 75% of depreciation. Capital installed prior to COVID-19 puts us in a very strong position to support the expected commercial aerospace growth. Fourth quarter was the seventh consecutive quarter of common stock repurchases. For the year, we repurchased approximately 11.4 million shares of common stock for $400 million with an average acquisition price of $35.22 per share. Share buyback authority stands at $947 million. Moving to debt. We repurchased $69 million of our 2024 bonds last year with cash on hand. These repurchases will lower our annualized interest costs by approximately $4 million.

Moreover, we continue to repurchase 2024 bonds in January, with another $26 million of repurchases at a slight discount to par. Repurchases were made with cash on hand. Lastly, we continue to be confident in free cash flow. In the fourth quarter, the quarterly common stock dividend was doubled to $0.04 per share, dividends in 2022 were $44 million, and we expect to increase to approximately $68 million in 2023. Let’s move to slide 7 now to cover the segment results. Q4 was another solid quarter for engine products. Year-over-year revenue was 21% higher in the fourth quarter with commercial aerospace up 30%, driven by the narrow-body recovery. Defense Aerospace was up 17%, IGT was up 2%, and oil and gas was up 19%. EBITDA increased 26% year-over-year and margin improved 110 basis points to 26.1% despite the addition of new employees and the associated near-term training and production costs.

Let’s move to slide 8. Fastening Systems year-over-year revenue was 11% higher in the fourth quarter. Commercial aerospace was 17% higher, driven by the narrow-body recovery. Defense Aerospace was up 21% and Industrial was down 13%. Year-over-year segment EBITDA decreased 3% due to the addition of new employees and the near-term training and production costs. In the fourth quarter, Fasteners added approximately 200 new hires to offset 200 exits. Now let’s move to slide 9. Engineered Structures year-over-year revenue was up 21% in the fourth quarter, with commercial aerospace up 40%, driven by the narrow-body recovery was approximately $20 million of Russian titanium share gain. Gains were partially offset by the impact of production declines for the Boeing 787.

Segment EBITDA increased 10% year-over-year despite the inventory burn down of the F-35, and the continued zero to low build of the Boeing 787. Structures 2022 full year EBITDA margin was 14.1%, and was on par with 2019 levels when revenue was 37% higher. Finally, let’s move to slide 10. Forged Wheels year-over-year revenue was 14% higher in the fourth quarter. The $32 million increase in revenue year-over-year was almost entirely driven by higher aluminum prices. Commercial transportation demand remained strong, but volumes continue to be impacted by customer supply chain issues, limiting commercial truck production. Segment EBITDA was flat year-over-year as higher volumes were offset by the impact of unfavorable foreign currency, and primarily driven by the euro.

While the pass-through of higher aluminum prices did not impact EBITDA dollars, it did impact margin by approximately 300 basis points. Lastly, in the appendix on slide 15, we’ve included some assumptions around 2023. We expect non-service pension and OPEB expense to increase approximately $20 million year-over-year to approximately $40 million. The increase will unfavorably impact year-over-year earnings per share by approximately $0.04 per share and is mainly due to low asset returns impacting non-service costs, which are non-cash. In addition to the increase in pension expense of $20 million, we continue to expect miscellaneous other expenses, which are below the line be minimal at approximately $8 million for the year, but can be volatile within quarters.

Pension and OPEB cash contributions are expected to be flat with 2022 and approximately $56 million for the year. CapEx should be in the range of $230 million to $260 million, which continues to be less in depreciation and amortization, resulting in a net source of cash. Now let me turn it back over to John.

John Plant: Thanks, Ken. Let’s look at Commercial Aerospace first, which was up 28% this year. Airlines are experiencing strong growth for both domestic travel and now for international travel as well. Load factors are high in the US and Europe. China is now reopened and is increasing load factors at a rapid rate. This builds momentum on top of the increased Asia Pacific travel already seen. Backlogs of aircraft demand at Boeing and Airbus are at all-time highs for narrow-body aircraft. Wide-body demand is increasing rapidly, and further rate increases are expected. Airlines are bringing A380s back into service to meet international demand. This is clearly an inferior solution to having modern composite-based twin engine 787s or Airbus A350s with their vastly better fuel efficiency and lower carbon footprint.

The demand for improved emissions alone secures the increased build, never mind the huge demand for travel. While noting very favorable air travel demand conditions, Howmet does rely upon aircraft builds by Boeing and Airbus, while also considering that we’ll see rate increases for spares. Here, we’re going to take a cautious and conservative view of 2023 until we know more and see consistent aircraft build rate increases. For example, underpinning the full year 2023 guidance, our assumed monthly build rates are approximately 30 per month for the Boeing 737 MAX, 53 to 54 for Airbus A320, A321. Additionally, we have assumed approximately 30 Boeing 787 builds for the year and 65 to 70 Airbus A350 build for the year. Within these outline numbers, we expect to see strength improving in the second half.

These build assumptions underpin our assumed 17% Commercial Aerospace growth for the year. Now let me turn to other markets before commenting on inflation. In Defense, we expect to see low-single-digit increases in 2023 with less overhang to the F-35 structures inventory. Demand for the F-35 is strong and high builds are now expected throughout the remainder of the decade. This is further supported by both increased engine spares demand and upgrades of engines associated with the 2028 Block 4 requirements. Our business supports helicopters, drones and aerospace, which is a very healthy increase in revenue for us for these space-related programs. And at this increasing pace, I expect it will provide a lot more commentary on the space segment in the future.

Gas turbine revenues are expected to grow at single-digit growth, supported by an increase for the Agent class turbines. I believe that everyone is aware of our very balanced IGT business, which supports GE Power, Siemens Power and also Mitsubishi Heavy, which is another global business for Howmet. Oil and gas should remain strong at high single-digit growth or maybe low double-digit growth. General industrial is expected to be down in, say, low single-digits. Finally, we take a more cautious view of commercial transportation in our wheel segment, where the expectation is for reduced demand in the second half of 2023, notably in Europe. In aggregate, fundamental demand might be down 0.5 million wheels before the improvement of 250,000 wheels driven by penetration of aluminum wheels versus steel wheels and share improvement.

Sector growth continues in wheels, which will accelerate with future electrification of the truck sector, especially in Europe. Turning to material and inflationary costs. These remain volatile. We expect the combination of material, inflationary costs to be in the range of $70 million to $100 million for the year. As we did in 2022, our intent is to pass-through the majority of the inflationary costs. Let’s turn to some specific numbers now for the first quarter of the year. Revenue, we see at $1.5 billion, plus or minus $25 million, EBITDA of $335 million, plus or minus $10 million, EPS of $0.37, plus or minus $0.02. For the year, revenue of $6.1 billion, plus or minus $100 million, EBITDA of $1.375 billion, plus or minus $40 million and EPS of $1.60, plus or minus $0.07.

Earnings per share assumes continued capital allocation to common stock and bond repurchases, dependent upon market conditions. Our free cash flow guide is $615 million, plus or minus $35 million. We set our year up with appropriate caution given recent aircraft build volatility, while at the same time, noting fundamental — fundamentally strong demand which will see further increases as we plan our pathway through into 2024 and 2025. Now let’s turn to a summary. 2022 was another strong year for Howmet. Revenue increased by 14%, EBITDA by $140 million and 12%. Margins were above 22%, despite the extraordinary inflationary conditions. The effective tax rate improved to 22.5%, which is an improvement of 500 basis points from 2020. Earnings per share increased to $1.40 and by 39%.

Free cash flow increased to $540 million, despite the inventory build of approximately $235 million for Commercial Aerospace. $513 million of capital was deployed back to share buybacks, bond repurchases and dividends and the dividends were as you know, doubled. Liquidity is very strong. We have cash on hand of $792 million and a $1 billion undrawn revolver. Leverage improved from 3.1 times net debt-to-EBITDA to 2.6 times net debt-to-EBITDA. Compared to our initial 2022 guide, we overcame a really good amount of headwinds. We exceeded initial EPS guidance of $1.37 while navigating unstable aircraft builds. $225 million of material pass-through costs and above the initial estimate of $125 million, rapid non-metal inflation and new employee costs.

All the while, we strengthened our balance sheet, generated $540 million of free cash flow and deployed over $500 million to repurchases of bonds, dividends, et cetera. 2023 is expected to have strong growth and free cash flow generation. Since we expect similar challenges in 2022, we’ve taken a cautious conservative view until we have greater visibility regarding actual aircraft build rates. We look forward to above-trend growth in 2023, 2024 and 2025, and that will be reflected in additional profits and cash coming from the business. Thank you very much, and now let’s move to your questions.

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Q&A Session

Operator: We will now begin the question-and-answer session. And our first question here will come from Robert Stallard with Vertical Research. Please go ahead.

Robert Stallard: Thanks so much. Good morning.

John Plant: Hey, Rob.

Robert Stallard: John, a question for you on these OEM build rates. There’s obviously been quite a lot of talk about Airbus potentially elongating the ramp on the A320. I was wondering from your perspective, could this actually be a help in that it reduces risk, I mean you don’t have to add as much cost or labor as quickly as you would do normally and then ultimately, you could get better margins in that scenario?

John Plant: I think when you look back over the last few quarters, when we’ve had steadier build increases, drop-through has been significantly higher compared to those quarters where we’ve seen, I’ll say, urgent or rapid demand changes and also where we’ve been asked by customers to chop and change on production schedules to meet maybe availability of parts they have rather than a positive scheduled. And so you can see, I think, in our third quarter, drop-throughs were probably in the high 30s, maybe 39%. And you saw the — if you look at the tracker revenue changes in those quarters compared to the revenue changes in the higher quarters, then I think in the fourth quarter, it was — I can’t know exactly number let’s call it in the — below 30%.

So I think steady as you go does help us. At the same time, because of the base of employment that we have has been growing, then the increments — or incremental each step of the demand gets that much easier to accommodate compared to what we saw was, I think, extreme volatility in 2022. And I mean, in one sense, I’d like to expand the question a lot more broadly and talk about that volatility, but I don’t want to miss the point of your question, but essentially, I think steady plan for rate increases are really helpful to us. And that’s when we convert best, albeit we’re setting ourselves up to do that and hopefully take also advantage of additional demand should it come towards us.

Operator: And our next question will come from Kristine Liwag with Morgan Stanley. Please go ahead.

Kristine Liwag: Hey, John, I just want to follow-up on Rob’s question on production rates here. I mean, when we look at where the other supply chains are €“ is in production rates, you’ve got periods gearing towards 42 per month by year-end. I mean, Boeing reiterated their outlook of 50 per month for 2025 plus 2026. We saw, obviously, Monster Air, India order today. So why do you see so much volatility? I mean, historically, the engine supply chain needs to ramp up before the airframers. And so what am I missing? I would have thought that you guys would get more of a priority and you would get the orders in now in order to support 50 per month.

John Plant: Yes. I got to try to separate my comments between that which Howmet controls and that which is — I mean, therefore outside of our control. And when I look at last year, we started the year full of optimism and thought the 2022 was going to be really easy. And it didn’t quite turn out that way with lower fundamental volumes, which were masked by inflation recoveries. Inflation itself within the demand we had significant volatility in schedules from our customers. And as you know, when I spoke to you in the fall, we’ve seen cutbacks for engine business at the end of the third quarter and into the fourth quarter. And we ended up carrying probably $70 million to $100 million of additional inventory, which we had not planned or expected for because customers did not need those parts.