Arconic Inc (NYSE:ARNC) Q3 2018 Results Earnings Conference Call October 30, 2018 10:00 AM ET
Paul Luther - Director of IR
Charles Blankenship - CEO
Ken Giacobbe - EVP and CFO
Sam Pearlstein - Wells Fargo
Gautam Khanna - Cowen & Company
David Strauss - Barclays
Seth Seifman - JPMorgan
Rajeev Lalwani - Morgan Stanley
Chris Olin - Longbow Research
Josh Sullivan - Seaport Global
Gautam Khanna - Cowen & Company
Phil Gibbs - KeyBanc Capital
Brian Reilly - Barclays
Good day, ladies and gentlemen, and welcome to the Arconic's Third Quarter Earnings Conference Call. My name is Julie and I will be your operator for today. As a reminder, today’s conference is being recorded for replay purposes.
I would now like to turn the conference over to your host for today, Paul Luther, Director of Investor Relations. Please proceed.
Thank you, Julie. Good morning and welcome to Arconic's third quarter 2018 earnings conference call. I’m joined by Chip Blankenship, Chief Executive Officer; and Ken Giacobbe, Executive Vice President and Chief Financial Officer. After comments by Chip and Ken, we will take your questions.
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 addition, we have included some non-GAAP financial measures 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 Chip.
Good morning. Thank you for joining the call.
I’ll begin with an update on the strategy review and third quarter highlights, then Ken will take you through our financial results. I’ll conclude with guidance, and we will take your questions after that.
As a reminder, the goal of our strategy review is to develop actions that will enhance shareholder value, streamline the portfolio, tighten our strategic focus and strengthen our financial profile. We have completed significant milestones as reported last quarter; however, we are extending the scope and duration of this activity. We now anticipate completing the strategy review in the fourth quarter.
Two publicly-announced outcomes of earlier phases of the strategy review are already in motion. The sale process for the Building and Construction Systems business is well underway and has drawn robust interest. We signed an agreement to sell our Texarkana aluminum rolling mill to Ta Chen, monetizing a substantially idle facility for $300 million in cash, as well as $50 million in earn-out potential. This is one element of the GRP transformation and growth strategy that we are developing.
Before Ken takes you through the financial results, I’d like to share some highlights from the third quarter. Revenue was up 9% year-over-year, 7% organically. Volume was up in each segment. Earnings per share increased by 28% year-over-year. Segment operating profit was flat overall for EP&S with engines and fasteners posting growth, offset by performance shortfalls in structures. Segment operating profit increased for both GRP and TCS.
Adjusted free cash flow was $115 million, up from $41 million in 3Q the previous year. Working capital improved by eight days, ending the quarter at 54 days. Our liquidity remains strong with $1.5 billion cash on-hand and access to a total of $5.3 billion.
Now, I’ll turn it over to Ken.
Thank you, Chip.
I will move rather quickly through the slides, so that we can get to the updated annual guidance and your questions. We’ve also included several slides in the Appendix for added transparency.
Now, let’s move to Slide 5. Revenue for the third quarter came in at $3.5 billion, up $288 million or 9% year-over-year as aluminum prices accounted for $108 million or almost 40% of the increase. Revenue growth was driven by volume gains across all segments. All of our major markets were healthy. Organically, automotive is up 21%, aero engines is up 16% and aero defense is up 34% year-over-year.
Double-digit growth in these markets was supported by solid organic growth of 7% in the commercial transportation market and 5% in the building and construction market. Organic revenue, which adjusts for aluminum prices, currency, Tennessee Packaging and the divestiture of the Latin American Extrusions business was up $233 million or 7% for the quarter on a year-over-year basis. The reconciliation for organic revenue can be found on Slide 15 in the Appendix. We’ve also included year-over-year market growth rates on Slide 18 in the Appendix.
Excluding special items, operating income was $348 million in the third quarter, up $12 million or 4% year-over-year. The increase in operating income was driven by higher volumes across all the segments, particularly in aerospace in EP&S and automotive in GRP.
The higher volumes were offset by unfavorable aero engine mix, lower aero pricing principally in our Fasteners business and unfavorable net cost savings driven by transportation cost increases. The unfavorable net cost savings include the favorable impact of a lower annual incentive compensation accrual and an unfavorable impact of higher scrap sales.
Approximately 75% of the aero price reductions is with our Fasteners business. We’ve seen an increase in fastener volume and net cost savings. The net cost savings are driven by our low-cost country production strategy in Mexico, Morocco, Hungary and China.
The net impact of the price, volume and net cost savings is an increase in fastener operating profit dollars and a 90-basis-point margin improvement in the third quarter versus last year. The third quarter impact of higher aluminum prices unfavorably impacted operating income by only $1 million on a year-over-year basis and operating income margin by 30 basis points.
As you may recall, last year in the third quarter, we recorded a $46-million LIFO metal lag charge as aluminum prices increased in the quarter. This year, we recorded a $25-million LIFO metal lag charge, resulting in a favorable year-over-year impact of $21 million as aluminum prices decreased in the quarter. This favorable year-over-year impact was offset by higher scrap sales and higher operational impacts.
Although aluminum prices have come down sequentially, aluminum prices were still 15% higher in the quarter versus last year. Although there’s a lot of moving pieces in there, the net impact of higher aluminum prices versus last year was small and only $1 million unfavorable. The aluminum price impacts are detailed by segment on Slide 14 in the Appendix.
Operating income margin percent excluding special items was 9.9% for the third quarter, down 50 basis points year-over-year including an unfavorable 30-basis-point impact due to higher aluminum prices. We’ve also included the reconciliation of operating income excluding special items on Slide 28 in the Appendix.
As Chip mentioned, adjusted free cash flow generated in the third quarter was $115 million or $74 million more than the third quarter of 2017. The improved free-cash-flow generation was driven primarily by favorable operating working capital that drove the $70-million benefit year-over-year. Days working capital improved eight days on a year-over-year basis.
Lastly, compared to last year, lower pension contributions and lower interest rate payments partially offset the increase in capital expenditures. Two-thirds of the capital expenditure increase in the quarter was for return-seeking projects as we expanded our wheels facility in Hungary.
We also installed a horizontal heat treat in Davenport for industrial and aerospace markets and started the expansion of the aero engine capacity in Whitehall, Michigan and Morristown, Tennessee.
Diluted earnings per share excluding special items for the third quarter was up 28%. Lower pension and OPEB expenses, lower interest expense and a lower operational tax rate drove the improvement.
Now, let’s move to the segment results on Slide 6. In the third quarter EP&S’s revenue was $1.6 billion, an increase of 6% year-over-year. Organic revenue was up 6% due to volume growth in aero engines and aero defense. Segment operating profit was $238 million, relatively flat to the third quarter of 2017.
Growth in the aero engines and aero defense markets, as well as favorable impact from aluminum prices, was offset by unfavorable engine mix, lower aero pricing principally in our Fasteners business and manufacturing inefficiencies on the Structures business. Segment operating profit margin percent was 15.2%, down 100 basis points year-over-year, including a favorable 30-basis-point impact of higher aluminum prices.
In the third quarter, GRP’s revenue was $1.4 billion, an increase of 16% year-over-year. Organic revenue was up 9% due to volume growth in automotive, industrial and commercial transportation.
Segment operating profit was $74 million, up $10 million or 16% year-over-year, driven by strong volumes in automotive, industrial and commercial transportation, as well as favorable aluminum price impacts. These favorable impacts were partially offset by higher transportation costs and higher scrap volumes.
Segment operating profit margin was 5.2%, unchanged year-over-year, including a favorable 30-basis-point impact of aluminum prices. In the third quarter, TCS delivered revenue of $530 million, an increase of 1% year-over-year. Organically, revenue was up 8% as we continue to see strong growth in building and construction as well as commercial transportation.
Segment operating profit was $77 million, up $3 million or 4% year-over-year. Higher volume in commercial transportation and building and construction as well as net savings in favorable product mix were partially offset by an unfavorable aluminum price impact driven by mark-to-market losses on open hedges. Segment operating profit was 14.5%, up 40 basis points year-over-year, including a 280-basis-point negative impact of higher aluminum prices.
Now, let’s move to the third quarter key achievements on Slide 7. In EP&S, we continue to see unprecedented customer demand for our products. We remain focused on improving throughput and capacity to meet that demand. As a result, on a year-over-year basis, aero engines was up 15% and aero defense was up 38%.
In GRP, we continued to deliver strong growth in major markets. Automotive is up 20% organically, industrial is up 6% organically and commercial transportation is up 7% organically. In TCS, both of the major markets remain strong. Commercial transportation grew 8%, building construction, 7% both organically.
TCS continues to deliver improved margins despite headwinds from aluminum prices. In the third quarter, margin expanded by 4 0 basis points despite an unfavorable aluminum price impact of 280 basis points. And for the company in total, we continue to focus on managing our legacy liabilities as our pension and OPEB payments were $20 million higher on a year-to-date basis versus last year. Lastly, as a result of our actions this year, our unfunded pension and OPEB net liability has decreased $519 million since the start of 2018.
Before turning it back over to Chip, let me cover a few items that can be found in the Appendix. On Slide 11 in the Appendix we have summarized special items for the quarter. I’ll touch on some of these briefly.
Restructuring related special items resulted in income of $2 million pre-tax which consisted of the following four items. First, income of $28 million associated with the elimination of pre-Medicare retiree medical for U.S. non-bargain employees. Second, a charge of $15 million related to the consolidation and closure of a facility in Mexico.
Third, severance charges of $8 million for the elimination of 8 5 positions primarily in EP&S and corporate. And fourth, a charge of $4 million related to a pension settlement accounting for one of our smaller U.S. pension plans.
Also, in the third quarter, similar with previous quarters this year, we incurred a $5 million of external legal and other advisory costs related to Grenfell Tower, which are recorded in SG&A. As previously disclosed in our 10-Q, for the second quarter, the company recorded two discrete tax items in the third quarter, which explain the majority of the discrete tax items for the quarter.
First, we recorded a tax charge of $59 million related to an unfavorable decision from Spain’s National Court, which disallowed some certain interest deductions. In conjunction with that booking of the tax reserve, we had a related benefit of $29 million that was recorded representing Alcoa Corporation’s 49% share of the net liability pursuant to separation-related agreements.
Second, we recorded a tax benefit of $38 million after receiving notification from a foreign tax authority that our inquiry related to 2016 tax return was complete.
On Slide 12 in the Appendix, we provided an update on our capital structure as we continue to manage our debt and reduce our liabilities. We finished the quarter with approximately $1.5 billion up $80 million sequentially. Gross debt remains at $6.4 billion and net debt stands at $4.8 billion. Net debt to EBITDA continues to improve and stands at 2.4 times, which is an improvement of 28% since the fourth quarter of 2016.
Finally, I’d like to give you some context on aluminum price impacts for the remainder of the year. Our updated guidance that Chip will cover in a minute assumes that aluminum price of $25.20 per metric ton for the remainder of the year. The third-quarter average was slightly lower than that at $25.10 per metric ton with a downward trend throughout the quarter.
As a result of the lower aluminum prices experienced in the third quarter and the lower aluminum price assumption in the fourth quarter, the full-year average aluminum equates to about $25.61 per metric ton or roughly $100 per metric ton lower than our previous full-year view.
As a result of the revised aluminum assumption, our estimated unfavorable aluminum-price impact for year is now approximately $100 million, which is $30 million better than the previous estimate of approximately $130 million. We provided two slides in the Appendix to help you understand the revised aluminum price estimates and impacts.
Slide 16 in the Appendix will be familiar to you as it provides the detail of the LIFO charge by quarter and then Slide 17 in the Appendix provides a breakdown of the year-over-year unfavorable aluminum price impacts.
Briefly, a breakdown of the $30-million improvement from prior guidance associated for aluminum price can be broken down into a couple of components. First, the recent reduction in aluminum prices improved the year-over-year LIFO metal lag non-cash impact by $35 million. Second, our current estimate for the trading desk remains unchanged.
Third, scrap spreads, this one actually has gotten worse as they’ve doubled – more than doubled since the third quarter of last year. The current guidance is more unfavorable on scrap spreads by $20 million. The driver of this increase in scrap spreads is less scrap going to China due to Chinese imposed tariffs on imports.
Aluminum scrap has a tariff on it, going into China right now of about 25% and we expect that that will continue through the fourth quarter of 2018. Lastly, the change in our operational estimates is roughly in line with our sensitivities and has improved by $15 million from the prior guidance.
Finally, before turning it over to Chip to cover the 2018 annual guidance, I’d like to note that the updated assumptions used to derive the annual guidance can be found on Slide 13 in the Appendix.
With that, I will turn it over to Chip.
Thank you, Ken.
Before I provide updated guidance, I’ll share some news regarding a forging press in our Cleveland Works facility. Our 15,000-ton press experienced a hydraulic leak resulting from a cracked cylinder that caused operators to shut down the press. The length of the outage has not yet been determined but we do not anticipate return to service in the fourth quarter. We are moving work to other presses in the facility and working with our customers to prioritize shipments.
On the topic of guidance, we are raising and tightening our guidance range for the full year from the range of $1.17 to $1.27 to the new range of $1.28 to $1.34. This $0.07 to $0.11 increase reflects updated aluminum prices of $2,520 for fourth quarter, as Ken mentioned, decreased variable compensation accrual, operational improvements in engines, fasteners, GRP, wheels and BCS with pressure coming from the 15,000-ton press outage in structures.
With that, I’d like to open the line for your questions. Q&A.
[Operator Instructions] Our first question comes from the Sam Pearlstein from Wells Fargo. Your line is open.
Was wondering if you could update us on the performance in the Rings and Disks since you didn’t mention that. And certainly, during this last quarter we heard a lot from OEM customers and engine makers about on-time yield, et cetera, from various parts of the supply chain, so can you just talk a little bit about your own on-time performance versus past yields, really how you’re faring in that.
So, if we just get to the bottom line with the Rings and Disks, we feel like these operations are stabilizing. As I’ve said earlier, last quarter, we conserved resources into these locations and helped them with their operational capability.
Revenue is up 11% year-over-year for the quarter. This is actually the third consecutive quarter of adjusted operating income improvement from each of these operations in Rings and Disks.
We’ve taken some pretty substantial actions on in-sourcing, which reduces overall lead time, especially in the area of machining. We’ve reduced our costs there by over 50%, just by bringing those operations in-house with the also improvement in reducing lead time.
Our on-time delivery is up substantially in both Rings and Disks. So, I’d say as of now, we’re pleased with the progress. There’s more work to do. And the teams continue to put their shoulder to it and continue to improve.
As I’ve said before, really from being able to attack substantially the arrears position in Rings, we really need to bring on the 10-K press, which is under construction right now. We anticipate that in the first half of 2019 coming online. The team and the project bringing that to fruition is on schedule and on budget and we’re pleased with that progress. That would be my update on Rings and Disks, Sam.
And can you tell us a little bit about what happened in the engineered structures this quarter?
So, it really comes down to four categories, Sam. Manufacturing inefficiencies, outsourcing costs, transportation expedites because of a little bit of increased lead time with the inefficiencies and the outsourcing, and also raw material cost mostly in the area of vanadium. So, the master alloy addition that we had, AlV is up substantially year-over-year in terms of cost.
So, we’re attacking each of these areas mostly in terms of equipment OEE, sales, inventory and operations planning to make sure we’re putting the best mix possible through the factory to get the most out of the assets, as well as we’re increasing our utilization of scrap to lessen the need for AlV additions to the melt. So, we’ve got teams on it. We’re seeing improvement month over month and trying to bring that back in line.
Our next question comes from Gautam Khanna from Cowen & Company. Please go ahead.
I was wondering if you could just expand upon the 15,000-ton press, what products it makes and what the P&L impact will be from it being out and what the cost to repair will be, et cetera. Anything you can give us on absorption, opportunity cost of revenue and the like.
So, this is a press that’s dedicated almost completely to the aerospace arena. The customer, working with the customers, all of the parts are qualified on other presses in the facility and we’ve already he begun making those parts across the other presses in the Cleveland facility.
As far as the cost to repair it really is going to depend on what scope of action we choose to take. We want to make sure that the return-to-service condition of this press, we have a lot of confidence that it will run for a substantial period of time with high confidence to deliver for our customers. So, we’re taking the time to do the complete work scope and make sure we’ve got the right plan of attack on that.
We have the spare parts and the plans in terms of how to take this action that we’re developing, so we’re ready to act and we’ve already begun the process. We just need to make sure we have the work scope right for return to service.
And on top of that, Gautam, in terms of the P&L impact as Chip mentioned, we can move some of that production onto other qualified assets. However, we do have some absorption that we won’t be able to take. However, we’ve included that in the increased guidance that we’ve given for the year. So, we’re assuming that that absorption is lost and it’s been completely lost for the fourth quarter and that’s baked into the guidance.
And then, if you could just give us some color on what you’re doing at Rings and Disks. Do you have kind of the root cause identified on some of the challenges you’ve had on yield and the like and do you now have the personnel in place to scale whatever improvements you’ve identified across the entity? Where are we in terms of know-how at the facility?
Gautam, I’d say that we like very much our current state of progress. We have the – we’ve gotten some technical help from the rest of the Engines business. We have the quality team. That was one of the reasons we put Rings and Disks with our investment of Cast Engines business because that expertise for Six Sigma quality, daily management, problem solving, application of the Theory of Constraints, what are the bottlenecks, how do we solve them, how do we make sure that there’s - the sequential bottleneck is not going to starve the asset that we - lock the asset what we really want to focus on.
We’ve got the right people on the ground and we’ve seen double-digit improvements in daily and weekly output from these plants. First pass, yield up substantially and we like our progress, so I think we’ve got the right people on board to help make it happen.
Chip, any update to the free-cash-flow guidance for this fiscal of, I think, it was $250 million previously. What are you expecting?
We’re sticking with that $250 million, but I’ll turn it to Ken for any other color.
I think we made some good progress. You saw it on the days working capital improvement of eight days year-over-year. Some terrific work by our procurement organization renegotiating with our suppliers, particularly on the metal side. Inventory is showing improvement as well and receivables very high percent current on receivables, over 90%. So, we feel good about that, Gautam. We’re going to hold to the $250 million. You could call me conservative on that, but we’re going to hold to that number right now.
[Operator Instructions] Your next question comes from David Strauss from Barclays. Please go ahead.
Just want to see if you could give a little bit more color around extending the strategic review into the fourth quarter, what exactly you mean by addressing additional scenarios. I think previously you had said you were evaluating 25 product lines, maybe an update there in terms of how far through the 25 you actually are.
It’s been a robust process. We’ve had lots of dialogue with our board, with customers, with Arconic leaders, employees. I mean, the more I travel around and ask questions and observe really what our capabilities and strengths are, the more we learn and we ask further questions.
Really glad we embarked on such a holistic project. The dialogue has led us to really examine additional opportunities and perform more analysis. We’re looking at all those 25 product lines that you mentioned. We’re just trying to make sure we put our very best foot forward in our recommendations to the board and the output of the review. It’s very good work. It’s a big team effort. We’re just not quite done yet.
So, would the expectation be - I think you had been talking about you were going to share the outcome at Investor Day in Q3. Is the plan now to do an Investor Day in Q4?
I think we’re focused on wrapping up the study and getting our board approval and we’ll communicate kind of how we’re going to do that based on the output of that.
And as a follow-up, Ken, you talked about the pension improvement year-to-date in terms of under-funding situation. Could you talk about what that could mean in terms of – I guess, talk about what you’re thinking about for discount rate and where you’re running your rate of returns running year-to-date and what that might mean for pension expense next year and your contribution level.
What we’ve included in our estimate for the $519-million reduction was based on our original assumptions that the discount rate would be 3.75% and the asset returns would be 7%. We normally talk about what those actual rates are when we publish the K. Right. But what we’ve done is we looked internally.
As you know, discount rates have gone up. Maybe our asset returns aren’t in the 7% range, but we’ve done an estimate for the full year and we feel that the $519 million will stick for the remainder of the year. And really if you had to break that down, that net reduction is made up of really four major items.
We’ve made $288 million of pension contributions year-to-date. We froze the U.S. salaried and non-bargained plan that generated $136 million reduction. As we talked about in my opening comments there, we’ve eliminated retiree medical benefit. That was worth $32 million, and we’ve made OPEB payments of around $59 million. There’s other of about $4 million left, but that’s how we get to the $519 million and we’re confident that we’ll be able to hold that at the end of the year.
And our next question comes from Seth Seifman from JPMorgan. Please go ahead.
Chip, I wonder if we look at the Engineered Products business and we see $238 million of EBIT in the quarter, which is around what it was in Q2 if you add back the inventory write-down. There’s a lot of different puts and takes in terms of different pieces of the business growing versus shrinking and the outage you talked about versus operational improvement. At what point do you think we can see that number start to grow?
Well, let me take that one first and then I can turn it over to Chip. If we peel back within the EP&S business, the Engines business is growing year-over-year on an operating income basis. So, we’re happy with the progress there. We see it on the top line. We see it flowing to the bottom line. Same thing on the fastener side. I mentioned that earlier. Dollars are going up, percentage is going up.
Where we’ve got the challenge right now is in the Structures business that Chip talked about earlier. We have deployed SPAs to the key plants in that portfolio where we think we have opportunity. So, we see that we should have a sequential improvement in the Structures business Q4 versus Q3 that even includes the impact of the press outage, but we expect to see improvement in the fourth quarter.
And then, maybe as a follow-up, is there anything you can share about the Grenfell Tower liability and how that plays into the sale process of building and construction and whether that stays with the company or not.
Well, as of right now, Seth, we see no material update in the liabilities associated with the tragedy. Let’s just get that out there in the open. As for the sale process, that’s an ongoing process and we really don’t want to comment about the details of how we’re structuring that approach at this time.
Our next question comes from Rajeev Lalwani with Morgan Stanley. Please go ahead.
Two relatively-quick questions for you. One just a straightforward one. You did a nice job with selling the Texas rolling mill for $300 million or so despite no real profit there and how much more opportunity is there like that within Arconic overall that we’re just not aware of? That’s one.
And then, the other. On the EP&S side as we think about the business over the next maybe couple of years, can you just talk about on net do you see more of a pricing headwind or tailwind? I know you’ve got more content on next-gen platforms going forward. There’s also the dynamic of price step-downs from the engine and the structure OEMs.
Let me jump into it first. Just a couple of notes on Texarkana. I don’t think we have other assets. That was an idle asset for the most part. I don’t think we have any additional ones of that size. But you’re right, a $300-million sale with a $50-million earn-out. Just so you know, the net book value on that was about $62 million, so a very nice work by the team.
That was a big opportunity generated through our strategy review. And Ken’s right, there’s nothing other very large opportunity like that of an idle asset but we do see opportunity in each of these 25 business units for us to further prune and improve the portfolio returns going forward and there will be some actions that announced associated with the strategy review that reveal some additional value that can be monetized and improve our focus at the same time.
And on the EP&S side, just as far as pricing headwinds and tailwinds going forward, given all the puts and takes?
In EP&S, I think it’s a mixed bag of some pricing pressure in certain parts of the industry and certain parts of our portfolio, but also coupled with price-up opportunity in places where the industry is constrained and we have very high value to contribute.
Our next question comes from Chris Olin from Longbow Research. Please go ahead.
Just wanted to circle back on the pricing commentary and really more specifically what you were saying on aerospace fasteners. I guess I was just curious how the movement in pricing this year compares to previous years. Was the headwind in the second quarter? I don’t recall that. And I guess I’m just wondering if the pricing weakness has anything to do with the shakeup that’s going on within the distribution channel.
We’re continuing to get pricing pressure across the entire portfolio. We had pressure again in the prior quarter as well on fasteners but we’re trading off volume for that, so we’re getting incremental volume which is helping with absorption in the business but at the same time we’re moving some more of our production down into Mexico, Morocco and more of the standard fastener parts, so we’re getting labor arbitrage which is significant.
Some of that we share with our customers through the price impacts but net-net when you look at that labor arbitrage, look at the incremental volume we’re getting, giving up the price, it’s a net impact benefit on both a dollar and a percentage basis.
So that trade-off is working for us. So, if you look at the total pricing impact that we mentioned for the quarter, 75% of that is related to the Fasteners business. As Chip talked about in the other part of the business, you have puts and takes, but most of our differentiated product right knew now we’re able to either retain price or get some incremental price so tremendous amount of demand in the market.
Then, just shifting gears quickly. I realize you do have your hands full with the whole turnaround at Firth Rixson, but I guess I’m curious as to how you think about future isothermal forge capacity. And the reason I asked is because if you start looking at some of these numbers, it looks like capacity gets pretty tight three, four years out. I’m just wondering if that is a place you could see adding more capital or greater investments.
Look, Chris. As part of the strategy review, we are looking at how we serve the market with the isothermal forge we have at Savannah. We’re qualifying parts for customers right now and we’re evaluating further investment to what return we could get if we put additional capability and capacity around that press to be able to serve more volume.
So, no decisions at this time but we have proposals and plans in front of our strategy team, thinking about how we could serve that market. But right now, we’re focused on using the asset that we have as it stands to qualify parts and participate in that market.
Our next question comes from Josh Sullivan from Seaport Global. Please go ahead.
Just one on the automotive side. Given concerns around automotive SAAR rates, can you frame maybe how Arconic’s Automotive business would grow if we had a scenario where SAAR was down, say, 5% or something along those lines?
Well, the problem is, Josh, looking at the total SAAR’s percentage can be a little bit misleading for our business. The last breakdown that we had is if you carve is up, cars are down about 9%. Light truck, SUVs and vans are up 5%. That’s more of our sweet spot right now. We’re more in the light truck, SUV and van space.
So, it doesn’t impact our business as much. That’s why you’re seeing the organic growth rates of 20% in the business. Moreover, when we look at the aluminum content on, say, a light truck versus a car, it’s about 3X.
So, we’re comfortable with our position right now in terms of where we stand. It’s not to say that we’re moving away from cars; we’re actually bidding on a lot of new business in the cars section but we think there’s a lot more opportunity for us in the SUV and light truck space.
And then, just one on the expansion of the engine capacity at Whitehall. What percent increase is this? Does this provide you with any speculative capacity if OEMs do take up production skylines or is it just related to announced production rates at this point?
Our plans right now are to serve the business that we see going forward with our long-term contracts and the customer business that we’ve won. We do quite often reserve the ability to put more equipment in the expansion, to take advantage of potential upside. But we’re very careful with the capital outlay to make sure we have confidence in being able to get return on that investment.
Our next question comes from Gautam Khanna from Cowen & Company. Please go ahead.
Thanks for taking the follow-ups. A couple. Maybe I missed it. But the question regarding pension cash contributions in 2019. Did you actually give a number? I may have missed it if you did.
No, we did not.
Okay. Is there any framework you can give for what that might shake out to be?
So, the latest estimate is around $440 million.
And that’s for 2019?
Yes, that’s correct.
To follow up on the fastener discussion, I thought last quarter you guys were talking about mix, more non-aero versus aero. Did anything get incrementally worse than aero this quarter? I mean, did price actually deteriorate further? Were there contract resets or something else?
Not for the most part. Really, Gautam, what’s driving it is we’re getting more volume. We’re getting it on the industrial side. We’re getting it on the aero side. We’ve talked a lot about destocking in fasteners. Airbus has been coming down, but we’re getting more volume out of Boeing. When you push those two together it’s a net favorable.
So good net favorable on aero. Good industrial, really like what the team is doing around the net cost savings that we talked earlier and they’re getting the incremental volume. So, we’re happy with the Fasteners business.
And then, just on the 15,000 press, I know you mentioned aerospace products. Can you specify what types of products are made? I know you’re going to make up the volume elsewhere, but on the other presses, but just curious about the specific products.
These are aerospace wheels and some blades.
Okay. So, this is engine product?
Engines and airframe wheels and brakes.
Wheels. Okay. And last one, just someone asked about the KLX side, Boeing combination. Have you seen any impact yet on that or has there been any kind of change to purchase indications?
We haven’t seen any impact, Gautam.
Would you expect to or not?
We do not expect to. There’s always room for the unexpected but we don’t expect that.
[Operator Instructions] Our next question comes from Phil Gibbs from KeyBanc Capital. Please go ahead.
Chip, can you point to the mix headwinds that you’re talking about in engines and elaborate on that a little bit and when does that get better?
The mix headwind is really associated with legacy parts that are all the way down the learning curve as it were to the next-gen engine products, be it leap-geared turbo fan, this sort of product that we’re currently coming down the learning curve on and improving our profitability and our ability to serve the customers.
So, that’s a mix headwind. It’s not a big one. It’s just the part of the ramp we’re in and the new engine introduction process and the new part introduction process to support our customers.
And I think you mentioned that vanadium is a bit of a headwind and the question what specific products that would be hitting and is there potential for a pass-through of that material embedded within your existing contracts?
So, it’s a major alloying element in the alloy titanium 6%, 4%, 6% aluminum, 4% vanadium. So, that’s the product whether it’s sheet or plate or forgings coming out of our Structures business. That’s where the majority of it is. There’s some casting products associated with it but really the volume and what we’re seeing is where it’s associated with our titanium mill products and our Structures business. We are working with customers and other ways to abate that impact. Mostly focused on scrap utilization at this point.
There’s no way within the contracts to pass that increased cost through on that alloying element?
We have a variety of contractual terms and at this point some of our contracts do not allow that pass-through.
Yes. So, some do.
Some do, some don’t.
Some don’t. The net impact for the quarter was less than $3 million to give you, even though the price is more than doubled.
Our next question comes from Seth Seifman from JPMorgan. Please go ahead.
Chip, maybe to follow up on aero engines. If you can talk about how your share has been trending, maybe relative to your expectations three or six months ago. Are there any differences?
As far as trending, I mean, our share is pretty stable. We’re producing more than our contractual share on some parts and less than our share on others. It’s really in a constrained environment making as many parts as we possibly can and continuing to creep our assets as much as possible to provide the maximum number of parts to our customers.
What we’re seeing our customers do really is prioritize what they need and we’re focused on supporting their assembly and their overhaul process needs and making sure that we stay ahead of that. So, I mean, our overall share, we’re pleased with our share. Our focus right now with the full shop is trying to prioritize delivery to meet our customers’ most urgent requirements.
And then, this might be - this is probably over-simplifying things a bit, if you were to characterize what inning you’re in now in terms of having your capacity in aero engines on the narrow-body side directed towards new-generation engines versus the engines that are – that you’re stopping the GSM56 and the V2500. Where are we right now?
The new next-generation make up about 60% of the output of our investment cast business. But you’ve got to be careful because the legacy parts don’t go to zero. These are high usage parts in the overhaul business and the spares stream. So, we feel for a number of years will make very many of the last generation parts to serve that ongoing market and we will remain focused on that as well.
Our next question comes from Brian Reilly from Barclays. Please go ahead.
Real quick one from me and I appreciate it may be difficult to answer as you continue to go through strategic process. But is it possible to give on the balance sheet side guide posts around how you would think about capital allocation under versus various scenarios ratings you talked in the past about wanting to maybe get back to investment grade if that option is presented to you, that would be I think helpful for the fixed-income side. Thanks.
So, we’re split rated right now, first S&P has us at investment grade and Moody’s does not so we’re split rated right now. I think through the strategic review we spent a lot of time looking CapEx in a couple of different buckets, what it required for growth to meet the demand, what is required for productivity to get more volume through the plants and help our working capital at the same time. And then, lastly, a lot of work around the sustaining part just to keep the normal maintenance of the business going.
So, there’s been a lot of work in the 25 subsegments. I think we have some great visibility on that. We’ll be releasing more information as we complete the strategic review.
I guess, if I could just follow up quickly. As you talk about creating shareholder value, I appreciate a lot of that can come from organic avenues like you said investing on the CapEx side. But is that something where you look to shift some of the capital allocation to shareholders and maybe in that mindset BB ratings, high yield makes sense, or I guess, again, how do you think about that versus a desire to be investment grade?
We like being investment grade, but we look at the capital allocation based on relative returns and once we complete that strategic review, we’ll be able to communicate more information.
We have no further questions in queue at this time. And this does conclude today’s conference call, and you may now disconnect.