Safran SA (OTCPK:SAFRF) Q3 2016 Earnings Conference Call October 24, 2016 12:30 PM ET
Philippe Petitcolin - CEO
Bernard Delpit - CFO
Christian Laughlin - Bernstein
Olivier Brochet - Credit Suisse
Tristan Sanson - Exane BNP Paribas
Ben Heelan - Bank of America Merrill Lynch
David Perry - JP Morgan
Christophe Menard - Kepler Cheuvreux
Harry Breach - Raymond James
Ladies and gentlemen, welcome to the Safran Third Quarter 2016 Revenue Conference Call. I now hand over to Mr. Philippe Petitcolin, CEO and Mr. Bernard Delpit, Group CFO.
Mr. Petitcolin, please go ahead.
Good afternoon, everybody. Thank you for being with us tonight. It is the first time we are going to make a presentation not being together. I'm currently in Cincinnati in the U.S. and Bernard is at the headquarters of Safran in France. So I hope that all this is going to go well in terms of connection and understanding.
There are four main messages I would like to pass to start with. The first one is related to our security business, as we enter into exclusive negotiation with Advent International for the sale of all our identity and security activities, and this is comes after our decision to sell our detection business to Smiths a couple of months ago. The value is €2.425 billion and we expect the transaction to be closed in 2017. As you will see in the presentation which is going to follow, we have now to put this business, the Safran Identity and Security business as discontinued preparation for 2016.
The second big message is related to the execution of the LEAPs program all of them. The LEAP-1A is now in service with 2 airlines and its going fine. The production ramp up on the LEAP is on track and we’ll come back a little bit on this point later on.
The third message relates -- we don’t think a lot about our military business, but we are extremely pleased of the sale by Dassault, construction of 36 Rafale to India. We are one of the three partners of the Rafale team and this is going to bring a good business for us over the next coming years.
And finally my last key message is related to our overall performance. The first nine months of the year are in line with our annual target and we will confirm and reconfirm our target for the year. The figure a little bit more in detail into revenue highlight. Two main changes, first one is related to security and identity, which is not any more included in our continuing operation. The second one is related to our space business, which from July 1st is no longer in revenue, if you compare with the third quarter of 2015, it represented 110 million in the third quarter of 2015. So since the 1st of July no more space business in our continuing operation.
The revenue for the first nine months is in continuing operation at €11.5 billion, compared to €11.2 in 2015, which represents an organic growth of 3.8% and if we were using and adding the security we would be at an organic growth over 4%. Q3 is in organic a reduction of 0.8%. Mainly three items impacted the revenue for Q3. The first one and the biggest one is, we did not record any sale of M88 military engine, we delivered engines, but as now we are selling these engines and the airplanes outside of France, they are not yet recorded in sales and just this impacts more than €60 million or €70 million sales for Q3.
The two other items are related to the helicopter business, the Propulsion helicopter business, which is down compared to last year. And finally our commercial MRO business was not that great during the third quarter. A little bit more time on the LEAP, LEAP-1A is in service now, we delivered 22 engines in Q3. As of last week, we were at 40 engines delivered, we deliver roughly 4-5 engines a week. Today there are two more airlines which are coming for entry into service, the next one I believe is going to be Frontier in the U.S. and the performance seen by the operators since by the airlines is really good and we are very pleased with the engines and all the feedback we get are very, very positive.
In terms of development nothing to add from last time. We are in line with the development of their LEAP-1B, at the performance which is requested by the customer and we are still expecting an entry into service of this new engine something during the first half of 2017. LEAP-1C we are in line and we are waiting for our customer for the first light. If we look at CFM, we are still doing great in terms of production. We have record deliveries during the first nine month of this year of 1,293 engines, which is again a record and in the meantime since beginning of the year, we booked 841 new CFM56 engine bringing us to market share at Airbus over 80%. We have received in the beginning of the year 1,354 orders for the LEAP bringing the total orders and backlog over 11,000 engines.
In defense, we have gone through a grand opening of our new R&D center in France, which is a consolidation of all our capabilities in defense for inertial navigation system, tactical drones and optronics systems, we have 1,200 people in this new center. And another business which is also doing extremely well is our carbon brake system which is getting more and more new customers and new orders for Boeing and Airbus.
This is what I wanted to highlight. I am going now to let Bernard to talk about revenue before coming back for the main expectations for the year. Bernard?
Thank you Philip. I will start with Page 9 with the FX situation which is stable for the spot rate of Euro against dollar compared to 2015 Q3. The hedge rate remains unchanged at $1.24 and we have some negative translation impact in our sales due to the GBP.
Slide 10, year-to-date growth already explained by Philip, just some more comments, 3.8% organic growth comes from aerospace as defense was negative. FX impact negligible as the GBP conversion impact is mitigated by hedged currencies. And scope impact year-to-date relates to space activities in Q3. That are now equity accounted through our return venture with Airbus.
On Page 11, the same comments apply to Slide 11 on Q3, slightly negative organic variation of 0.8% explained by the phasing of our Rafale engine deliveries, zero in Q3 versus eight in Q3, 2015. FX slightly negative in Q3 due to GBP conversion impact stronger than the benefit from hedging and the scoping back still relates to our launcher activities.
Page 12, let’s spend some time on that because it shows how it works with all the changes in scope. Continuing activities that are without security activities are growing at 3.8% or 2.9% including of the negative impact of our launcher activities. This continued activities for reference only are growing at 6.7%. So no big gap between organic change for continuing activities or for the 2015 pro forma activities of Safran.
Aerospace propulsion is up 4.7%, with OE up 2.6% and services up 6.1%. Equipment is up 4.3% and breakdown is up 1% for OE and 12.8% for services. So it makes services growth at 7.6% for our aerospace activities, both propulsion and equipment including 5% of civil engines. Defense is negative 5%, we have been bothering you with the end of the contract with the French DOD, it’s again the case here and it affects optronics.
Some additional comments, propulsion will benefit from higher volumes of CFM56. Equipment OE is up that hit by lower volumes of A-330 and services are up, but still a tight situation for the helicopter market with services down almost 10%. Same logic applies to Q3 on Page 13, negative reported growth explained by launcher activities now equity accounted. Slightly negative organic growth due to the phasing of Rafale engines deliveries.
All the comments are on the slide, CFM56 deliveries are up growing contribution of equipment services, strong growth of military services. Headwinds coming from helicopter services and MRO that explains the situation of civil aftermarket.
On Page 14, some update on our hedging policy. First, we have increased our hedging for 2018. $1.9 billion to be hedged in Q4 to finish the year and second we have improved our hedge rate for the next three years for $0.01 every year. That means that 2017 is now hedged at 121 and the range for 2018 and 2019 is narrowed between 119 and respectively 117 and 115 for the next years as reflected on Page 15 which has been updated since our Capital Market Day.
That’s it for me now. I leave the floor to Philip, for the year’s outlook.
Thank you, Bernard. Key assumptions for 2016. There are two changes on our assumptions which are related to the change of the scope of our businesses with Safran Identity and Security now excluded from our business in terms of continuing operations. So, the reduction of our self-funding R&D is going to be reduced between €100 million and €150 million and our sustained tangible CapEx will be below €800 million.
The other assumptions remained the same from our last discussions. With all of this in mind, we reconfirm our 2016 outlook with an organic revenue growth in the low single-digit compared to 2015. The recurring operating income to increase by around 5% with a further increase in margin rates compared to 2015 and free cash flow representing more than 40% of our recurring operating income.
Thank you very much for listening to us. Now we're ready, Bernard and I for any questions you may have.
Thank you, Sir. [Operator Instructions] The first question is coming from Christian Laughlin, Bernstein. Sir, please go ahead.
Just two questions from me, both relating to the civil aftermarket. One, if you could just elaborate a little bit on the comments in the press release about MRO sales declining, as opposed to the spare sales actually growing in the period, could you just elaborate on what drove that, was it loss of market share for certain engine types, or just lower unit volumes across the board going through shops?
And then secondly -- and related to that all too if I could talk about Q4, if you think Q4 is going to display a similar trend or if you'll see some recurring on the MRO side? And then secondly, if could just provide some commentary on overall trends effecting overhauls with respect to both scope and unit volumes that you're seeing?
I will try to answer this question. When we say that the MRO business dropped little bit in Q3, there are two main reasons, the first one is the turnaround time, the TAT as we call it was too long. Vacation period didn't end. But we had too long turnaround time to overhaul the engines. And the second one is coming from some shortages, we got on spares for wide body engine. So, these two effects add negative impact on the strength of the MRO.
As we said on our press release, the volume of spare parts increased during this third quarter, so the overall business which is a bit down is not -- was not impacted by the spare parts, but just by the work -- labor work on the MRO. The second part of your question is related to the scope. We didn't see any kind of reduction of value per shop visit. We are still -- as we said three months ago, we are still a bit flattish in terms of quantity of shop visits, but the unit value per shop visit is still extremely good and has not reduced at all since beginning of the year.
Okay, that's helpful. Thank you very much.
Thank you. The next question is coming from Olivier Brochet with Credit Suisse. Sir, please go ahead.
I will go for quick three questions please. The first one on spare engines, now that you are very close to the yearend how do you see 2016 versus 2015, please? And second, on the impact of the space launcher deconsolidation, you said in H1 that there would be a slight positive impact on the operating income. Is this now integrated in the guidance of around 5% growth that you are giving today? And the last question on the disposal of Morpho, if you have any more thoughts about the use of the cash that you will get sometime in 2017? Thank you.
I will let Bernard answer the question on space and I will try to answer Olivier, the two others.
Okay, so I think I believe the revenues of or I would say the profit coming from ASL is taken into account in our guidance for 2016, as they are now continuing activities and we take that into account. I don’t know if it will be a big number in terms of increase, but we are still running for that, yes.
Okay, thank you.
Your first question regarding to spare engines, we are still doing extremely well for spare engines for CFM, and we are just starting of course as a business from spare engines for the LEAP. I don’t have the exact number of spare engines on CFM of last year, but I would guess that basically we would be in same level in 2016 compared to 2015, which is surprising because the airlines are still as you know buying a lot of CFM and you were expecting a few years ago that this level would reduce, but we are doing extremely well and we are getting more and more order for CFM spare engine.
Regarding the LEAP, we just started, we delivered some LEAP spare engines during the third quarter and of course this number is going to grow. To give you the exact number, I am in the U.S. and I don’t have it with me, but globally if you take CFM plus LEAP I would guess that this number is higher in 2016 compared to 2015. But again it's a bit too early to give you these exact number. But those businesses in terms of spare engine are doing extremely well.
Regarding your last question on the disposal, as you know we only let just signed the exclusivity to proceed with Advent which is the Oberthur shareholder. We would anticipate that board with review all the options, once it has approved our medium-term planed and our 2017 budget, you will have to balance of course legitimate goals of shareholders return with maintaining a sufficient flexibility to grow in financially disciplined and strategically sensible manner.
So globally it's too early to tell you, but the voice of the shareholders will be taken as it should.
Good. Thank you very much.
Thank you. The next question is coming from Tristan Sanson, Exane BNP Paribas. Sir, please go ahead.
Few questions to add that would be small details. First one, if you can come back on the pull back of MRO in Q3, I've understood the first impact. I'm not sure I understood the second one, about the wideness of it. So, if you can re-explain that, that would be helpful. And I didn’t understand either whether it was just one quarter issue or whether the issue of turnaround could actually also have an impact on the Q4 MRO performance.
The second question is on the M88 engines. Same I would like to understand whether the revenue recognition issue is just a one quarter issue, or whether it can last a bit longer until the aircraft are delivered maybe to Egypt for instance? Third one would be on the small nacelles, down 23% in Q3. Can you remind us what the size of that business actually of the full year, rough order for the magnitude and explain to us where this business is going?
And final one is on supply chain. You alluded to that, I think, deciding that the ramp up of the LEAP was going fine. Of course there is a lot of focus on that issue right now And after the warning of your peer, Pratt & Whitney, can you tell us -- remind us what you’re buying today from Alcoa as suppliers for the LEAP program and how do you make sure that what’s happening on the product engine doesn’t happen on the LEAP in the next 12-18 months? Thank you.
It’s not a single small question, that’s a lot of question. Regarding the MRO, I was telling you that our turnaround time had been too long during the third quarter, it’s behind us now. I mean we have worked in order to reduce this turnaround time that you take to overhaul the engines. It was related to vacations especially in France. And we had to put a bit more management pressure and on all of these, this is something behind us.
The second point I mentioned was the shortage of small -- of some part for the GE90 engine. Again, we had shortage of some part, we didn’t expect so many to be replaced. It’s a business where it’s not always crystal clear on the quantity of part you are going to need, because you don’t know exactly what’s going to be replaced on an engine and we had a shortage, which is again behind us. So we are going to recover, but I cannot guarantee you that we will recover all of this before year end.
This is the answer to the first question. The small nacelles business, which is in reduction of 10% is coming basically from BizJet. The BizJet business is down and our nacelles business is of course directly impacted, because we are one of the big suppliers of nacelles for BizJet. As you know, we avoid business sales, they often too -- the aircraft manufacturers, but very often to the engine manufacturer, because operational systems, engines plus nacelles, are offered directly by the engine manufacturer.
We are down by 10%, which is basically in line with the business, or even a bit lower than the reduction of the business. The size of this business it’s in the range of, I would say couple of $100 million. Total of our nacelles business, which is itself over €1 billion of sales, my -- again I don’t have the number -- the exact number with me, but I would say that the small nacelles business is in the range of [technical difficulty].
By the way, the IR team will answer to you, Tristan.
Okay. Thank you.
The third question is related to Alcoa. There are [multiple speakers].
No, I just wanted to answer the question on the [multiple speakers].
We buy some forging from Alcoa and we have been impacted a little bit like all our competitors by the Tornado which happened in Savannah, Georgia. Because the plant which was a bit impacted by shortages was the one based in Savannah, Georgia. We ask people over there full time to support our needs and so far I don’t target any specific problem with Alcoa.
Regarding M88, I will let Bernard give you the answer on when we are going to be able to recognize this revenue.
I think that basically we have phasing issues because we have nine engines year-to-date delivered, but all of them were delivered in the first half of 2016 and in 2015 we had eight engines delivered and all of them were delivered in Q3 and we will deliver another two units I think in Q4. So basically, we will have the same net worth and volume of M88 in 2016 compared to 2015, but we’ve delivered in a different phasing.
Okay, that’s very clear. Thank you so much for all your answers.
Thank you. The next question is coming from Ben Heelan, Bank of America Merrill Lynch. Please go ahead sir.
I just had a couple of questions. First one was, if there is anything specific driving the changing guidance around the self-funded R&D? I think previously it was a decline of 100 million or so, 100 to 150. So just wondering if there was anything we can read, to reach ’17 for that. And then in terms of Q3 civil aftermarket, is there a way to quantify the headwind from the two specific issues that you’ve mentioned or could you let us know what spares grew in the quarter? And then thirdly is there an initial view into aftermarket into 2017? Do you see risks of any changing in trends? Thank you.
I will let Bernard answer the R&D question and I will come back on your question on the aftermarket.
Yes, the answer to the first question is very simple. We guide now for the R&D and CapEx on -- for continuing activities only. So there is no change in the guidance, but the guidance is given for continuing activities only. So it excludes now Securities, that’s why you have a slight change in the numbers.
Regarding the question on aftermarket, you asked how do we foresee this business over the year. We keep our guidance which was basically an increase of around 7% for the year. We set low -- high single digit, so high single-digit was basically something between 7% and 9%. Three months ago I told you that were on the lower end of that guidance and I keep the same opinion as of today. We will be in the low end of that guidance, we still have a lot to do in Q4, it’s still a challenge. But so far I believe we are in line with this guidance, but to be honest it is a challenge.
Regarding 2017, we expect to grow, our model has no change. The engines are flying a lot. We know that many of them will have to go through overhaul and shop visits. So we expect -- it’s too early of course to give you a guidance for 2017, but we are extremely optimistic for the medium and the long-term and medium term starting in 2017.
Thank you. The next question is coming from David Perry, JP Morgan. Sir, please go ahead.
I have just one question on the free cash flow guidance because I think the -- if you get the same amount as [indiscernible] you should be getting about 250 million deposit in the second half on the Indian Rafale. I mean you haven’t really changed your free cash flow guidance. I am correct in understanding or have I missed something?
David, I will answer the question. No we haven’t missed anything. No, you haven't missed anything, we haven't changed our free cash guidance. I mean it's always -- there is always some uncertainty because of payments of such contracts, but we keep exactly the same guidance, that been the 40% -- above 40% conversion ratio against EBIT.
But is that just you're being conservative, I mean should we take our road estimate and add the 250 million or do you think that [multiple speakers].
I mean that was taken into account in our initial guidance. So, that was already factored in. And that's why there was no change. I mean the delivery planning of the M88 of the Rafael engine was taken into account. We knew that it would happen that way in Q3, so there is no change.
Thank you. The next question is coming from Christophe Menard, Kepler Cheuvreux. Sir, please go ahead.
I have three questions. The first one is, is it possible to comment on the LEAP cost in Q3, if there're any comment or is it in line with your expectation? The second is again on the cash conversion, just -- I mean it's very marginal but Security in the full year last year was positive -- free cash flow contributing, and so do you see there is any kind of marginal upside, the fact that you are maintaining the guidance, does it mean that's -- I mean the point is, is there anything to read or anything to exploit from that security margin positive free cash flow that you generate over the year. What does it really mean for you, free cash flow guidance?
And the last point is on the nacelles for A380 and Boeing 777 for the reduction of the production rate, they were intended in your calculation when you issued the kind of guidance you gave us at Capital Market Day?
Christophe, I would let Bernard answer the first two questions and I will answer the one on the nacelles.
On LEAP cost [multiple speakers], it's too early to tell, frankly. We will update you at the end of the year on the cost reduction program. So, we have nothing new to add today. In terms of cash, well as we keep the same guidance even if we exclude discontinuing activities and positive cash coming from Rafael, that means that we will offset this impact by an improved cash flow in other businesses.
And can you say in which businesses?
No, I mean it's across the board.
Regarding the business of the nacelles, I don't know if you remember Christophe that we said during the Capital Market Day that business of the Rafael, it was really a big change with the win of the nacelles -- full nacelles of the A320 Neo [technical difficulty] engine and the nacelles of the A330 Neo, and that these two programs alone, just these new programs by 2020 will represent more than 50% of the total sales of our nacelles.
So, yes, we had anticipated some reductions in the nacelle of the A380 and it is something that we have taken into consideration when we gave you our forecast and our guidance during the Capital Market Day.
Thank you, gentlemen. The next question is coming from Harry Breach, Raymond James. Sir, please go ahead.
Just a couple of quick ones, just firstly and you might have seen Greg Hayes commenting September about five parts he had on the PW1000 that were causing him pain. Can you give us some feeling about supplier execution on LEAP? Are there any part shortages at the moment or are you happy at the way the supply chain is performing?
Then the next question forgive me you responded to this in yours to Christophe's question, but that was one can you give you us any feel at the moment for the cost curve that you are experiencing so far on the LEAP program and how that's going? Thank you.
Regarding the supply chain and the long-term of the LEAP, question is, am I happy, no I'm not happy because it's a challenge every day. When you have this kind of contracts, you have challenges every day operational challenges. We prepared ourselves extremely well a long time ago in order to reduce the risk as much as possible, and when things happen, minimize as much as possible the impact on the production chain.
So this is where we are today, we are able to deliver their engines at an acceptable speed for our customers. We have already delivered as I said bit earlier over 40 engines, we will have to deliver this year a total of above 100 engines and next year it's 500, as you know we have suppliers which have problems every day, but we are with them. Either we have our own parts or they are coming from outside and so far it's doing okay, it's going even good. So this is where we are.
We are delivering about four engines a week now, we are launching in production if I just take we have this one between five and six week, so we are really in this production ramp up and so far we are able to put at the final assembly the quality of parts which are needed. So if it's difficult to say I will not tell it’s a piece of cake, it's easy, everything is going fine. But on the other hand it is doing well, it’s doing okay. And we are aware we were expecting to be in terms of production ramp up, in terms of problems, in terms of challenges a year ago.
So it's always difficult to say I'm happy, because if I tell you I'm happy and I have a big problem tomorrow that nobody knows today but so far yes we are doing fine and we are again in line with the requirements of our customers.
Regarding the cost, I think Bernard didn’t answer Christophe’s -- the question of Christophe as you were expecting. So I will let him re answer where we are in the cost of the LEAP. But we are in the production, again it's fine, it’s really fine.
In terms of cost, I would say that we are just at the beginning of the journey because we have obtain to reduce our cost by 40% between now and at the end of the first phase of the transition. In July I said that we were a bit late on these roadmap, but I also said that in the guidance we now include depreciation of WIP. So when I look at the initial ID that was to say that the negative impact of fleet on the gross margin would be in the region of 1%, it didn’t include one -- basis point I mean of EBIT at the group level. I didn’t take into account the depreciation of WIP and now I will take it in the guidance.
So I would say we are at the beginning of the journey and will have a lot in our plate to reduce the cost to where we want to be next year. I think now we will take the last question.
And so for the moment there are no further questions, Sir.
Great, well that's good news. Okay, with that said I think Philippe we can end the discussion.
Yes. You should not have said this is the last question, nobody wants to ask the last question. Okay, so thank you very much everybody for spending time with us this evening. Have a good evening and talk to you soon. Thank you very much.
Ladies and gentlemen, this concludes the program. Thank you all for your participation. You many now disconnect.
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