Howmet Aerospace Inc. (NYSE:HWM) Credit Suisse 9th Annual Global Industrials Conference December 1, 2021 10:10 AM ET
John Plant – Chairman and Chief Executive Officer
Ken Giacobbe – Chief Financial Officer
Conference Call Participants
Brian Markovich – Credit Suisse
Good morning. Thanks for joining us for our 9th Annual Credit Suisse Industrials Conference. I'm Brian Markovich, the North American industrial sector specialist. I'm pleased to present the management of Howmet this morning. With me is John Plant, Chairman and CEO; Ken Giacobbe, CFO; and PT Luther, Vice President of Investor Relations. So let's just kick it off. Let's look at the industry environment. John, maybe you can start this out by summarizing the last quarter you reported and then maybe some broad assumptions behind your preliminary 2022 revenue outlook of plus 12% to 15%.
Okay. So last quarter we considered to be quite positive in the fact that we said that was going to be the inflection point for Howmet in terms of moving to a growth phase. And indeed that did occur with revenues increasing and with commensurate healthy profitability put us in the, I say, top decile of aerospace supply companies. And then we guided for the fourth quarter with again continued growth for this year. And then also was bold enough to give a very preliminary, I think, I called it guesstimate for 2022 and really that was try to frame the bigger picture for the aerospace sector. So, yes, I'll leave it at that and let you ask supplemental as you feel appropriate.
Sure. Maybe on the recovery, can you comment about the pace of recovery you expect in each of your businesses and just kind of the nuances around how each one is going to recover in your mind?
Yes. So, first of all, let me paint the bigger pictures that we did or I did say that we anticipated top-line growth next year between 12% and 15% and it was a say fairly broad bandwidth and I said we will finish that for the company as we move into next year and report our fourth quarter and provide guidance in early February. Within that what we do see is that the engine business, which is the first mover in our business segments will continue, I think, to improve next year within the confines of, I said, the first quarter will be fairly flat sequentially compared to the certain fourth quarters due to the particular features of the industry, which I'll happy to comment on and then move rapidly through Q2 and the second half of the year into further growth is what we anticipate.
In terms of aerospace, we expected our Structures and Fasteners business will follow that. Previously I had said, I thought Fasteners would begin to show improvement in Q1. I think I call that out in the summer, but given I think the circumstances around the 787 in particular I chose to say it's possible that that might be moving towards the backend of Q1 or into even into Q2 now in terms of revenue move for that business. So that would be the sequence through. So Engine first, Structures and then Fasteners before have been broad based let's say commercial aerospace recovery and growth, particularly starting and then further improvements in Q2.
So the bigger picture is the inflection point occurred for us in the third quarter. So third and fourth quarters again good positive growth year-on-year and sequentially, a little bit of a pause in the first part of next year following two quarters I think have really outstanding growth and then further recovery as we go through 2022. And that's based upon both anticipated aircraft build increases plus also some recovery in the spares markets that I'll be happy to talk about.
Okay. Can we talk a little bit about the aero side just the OE build rates that you're kind of building into your assumptions for 2022 on the 737 MAX, the 320 and the 787?
Yes. So, clearly, the critical feature of growth next year is the improvements in narrow-body build, which we expect to be very significant. I'll start with Airbus because that's been a rather more solid picture of that both I'll say holding the line at a certain build and then improvements from it. So in the case of Airbus, the onset of the pandemic they after a week or two has paused the production, they called out a rate of 40 for the A320 and 321. And then they also said that that would change in the summer of 2021 to 43 and then to 45 and continue to share improvements in 2022 through I think it goes 47 next and then by mid-year – into the mid-year to third quarter in terms of 55 rate per month before further growth again in 2023. I think the maximum that called out on their skyline is currently 64, but with talk and indications that they may want to increase that into the mid-70s going forward.
So clearly moving from, I'll say the 40s through to the mid-50s is a very healthy increase in revenues for us on the Airbus narrow-body aircraft. I think the other feature is we'll see the launch of the extended range 321 in early 2023. So that gives us further impetus for growth in the future. On Boeing, it's been a difficult, more difficult picture because the pandemic impact was also overlay in certification issues that I think everybody is very familiar with. So we started this year at a build of seven per month with that increasing to 14 per month in the second half of the year. And it is anticipated that we'll go to the early 20s and then into the early 30s by mid-year of 2022. And that's the assumptions that we think are balanced and feel fairly secure in those given the, I'll say, load factors particularly in the domestic travel in almost every jurisdiction of the world.
Okay. And about the 787…
787, of course, has its own, I'll say, story which is again the market overlay of international travel, but then with some very specific problems regarding certification or recertification of aircraft. The original plan for that to be cut to build a five per month in the second half of this year and then that's continuing to next year, but then with some recovery there afterwards. In actual facts what's happened is that the anticipated recertification has not yet occurred. I felt confident that it was coming. So I felt as though the issues that were reported from a particular Italian supplier in early summer had been essentially overcome and concluded, but it seems and then that was going to be followed with broader questions about the what state was the supply base in given the I'll say lack of certification of certain componentry that had been supplied from that Italian supplier.
And that was worked through in fact Howmet was selected by both Boeing and the FAA for an audit. I think we would expect because we were expected to be show well. We completed that last month and showed after three days of intense audit we passed with flying color. So that was another good step in direction for both Boeing and for the FAA to gain confidence in the support of Boeing from the supply base. And then, of course, more recently we've read some press articles concerning fitment of doors on that aircraft. And so, it's become a little bit more clouded. So instead of that recertification happening at the back end of this year, I think it's more likely a Q1 issue. And therefore the bill that was anticipated was cut from five down to two in the fourth quarter of this year.
But given the current problems, I mean, we know that certainly as we see it, they had 90 days of zero bills and then they would start back up. And so, we're not really sure exactly where it's at the moment. Clearly compared to the componentry that they had ordered, there has to be some form of inventory correction during Q4 and probably Q1 of next year. And that's why I chose to say for our Fastener business that we would possibly see another couple of months delay before recovery.
Okay. Maybe we can shift to the commercial aftermarket or your aerospace spares. Can you talk about your expectations there? The latest COVID variant might have thrown a wrench into the recent reopening of the skies, but your thoughts on growth in 2022. When do you think commercial spares will be significant for you guys again? And what kind of visibility do you actually have into that market?
We started to see growth in the third quarter of this year for the spares and that was across regional jet, business jet and also single aisle. So that was positive for us. It was a significant percentage increase given the very low denominator in terms of absolute dollars. It wasn't something that we'd want to shout about, because it was not significant in the revenues of Howmet. We expect that to continue to show improvement from that very low level in Q4 and in the first part of next year. But in terms of the question you asked, when do we think it become more meaningful that really is more towards the second half of next year. And that's based upon the continued I'll say very robust say flights on narrow-body for domestic use around the world.
But also I think as we all know international flights have also been commenced in many I'll say from many countries and continents which is very positive on the other hands. And therefore, we were thinking that's very, very good for us because to have the wide-body spares market begin to pick up would be very helpful in addition to the freight market, but Omicron, I don't know what it does. I have a view that says, I'll say relatively uninformed view I'm going to say is a rider to it, but it's probably overblown by coming out in the press day after Thanksgiving, where there wasn't a lot of news. And so, it was splashed across headlines around the world. And so, we just hear a new word. I mean last, let's say, six months ago it was Delta and that's come and seems to be gone.
And now it's Omicron and my view is that will come and go. And I don't see that we know enough at the moment to say. It's really going to have a lasting effect on international travel. I don't see it having any effect on domestic travel at all. And so, I think we have to try to separate ourselves from very newsworthy headlines. There's shouting from the rooftops about a new name and maybe next month I'll come up with something begin with a P or an S or a T, it's like think of another letter and let's splash it. And we get worried over – almost over our own shadows at this point. So my view is all it's going to do is potentially at the most effect the angle of recovery, but not the fact of recovery. So we need to be put things in perspective.
Thanks. That's helpful. Maybe we'll move over to defense. I think you've called out relatively flatish sales for next year, given the right pressures on F-35, but maybe disaggregate that a little bit, talk about where you're seeing growth as well as any other pressure points beyond F-35.
Yes. Well, F-35 is about 40% of our defense sales, so very significant. The rest of these other 60% is very solid and with some prospects of growth in the next couple of years coming from the, I will say, certainly the re-engineering for the heavy duty rotorcraft business for the military. So that's positive in terms of F-35 specifically and trying to pick that apart. The last couple of years Lockheed has significantly under built their original stated production. And in 2020, it was claimed to be COVID related to do with more of their own labor, this year is combination of their own labor plus, I'll say, supply position. And so compared to the expectations of builds then they've been below that.
Previously, the anticipated, I'll say, this quite skyline for F-35 builds have been one where it was going be, I'll say, healthy, similar in 2022, but then declining there afterwards, but then Lockheed put out a plan, which said that they were going to flatten that builds. So rather than take it up and then take it down, because they're taking up to a 100s – high 160s would have been a very significant increase on the last couple of years, they would flattened it more like 152 build I think or something like in the 150s.
So the implication of that is that for those parts that they’d already ordered for a higher level of build for the last couple of years, then I do see the potential for some inventory burn off. And the question is what rate does that occur? On the other hand, the build itself compared to this year and last year will be higher. And so it’s pretty mixed picture to try and pick through. I did note that the engine build according to Pratt & Whitney, we will be reduced. On the other hand, the spares content will be increased. And it’s increasing given the numbers of aircraft on the ground through lack of spares, packages both for our own air force and for other countries’ air forces around the world.
And so, picking it all apart, sticking it back together, again, the factors which are influencing it. So at this point we say it’s fairly flat, but with our normal seasonality where we’ll see the defense sales for Howmet’s we always are a little bit lighter in the first quarter and first half of the year and always a little bit heavier, particularly in the second half and fourth quarter of the year. These are normal seasonality one, use it or lose it basis upon military budgets. So I expect that picture to continue. So that’ll start a little bit light and then show increasing defense sales of F-35 sales in the back end of the year and then with the prospects of further growth in 2023.
Okay, great. Maybe we’ll shift to the Wheels business. Can you talk about the growth you’re seeing there currently and maybe talk about the larger opportunity for further market penetration in underpenetrated geographies like Europe?
Yes. So specifically for here and now, there is no growth in that business, in the second and third quarters, but it was not that there wasn’t fundamental demand for trucks. The issue is one more of the supply chain and that’s the one segment of our business where while it’s not our supply chain is Howmet, but it’s the supply chain for the commercial truck manufacturers where they just can’t get it, whether it’s let’s call it silicone or electronic parts or even some shortages of glass and tires and resins and so on. So that build, which was intermittent in the second quarter of commercial truck manufacturers around the world taking down their production almost haphazardly according to parts availability, became more sustained picture in the third quarter where some customers decided to abandon their third shifts waiting stabilization of input supply position.
When you look at the fundamental order intake, it’s actually been very, very strong. So the backlog in that industry is probably the highest it’s ever been. And so it gives us a picture of secure growth through 2022 and 2023, and with the potential of emissions issues to be sorted out in 2024, back to even above level, not a build in 2023. So again, it’s one where it’s not a lack of fundamental demand. In fact, it’s a truly outstanding picture for us. It’s just a matter of specific customers. And can they build order intakes as it had been healthy from fleets into dealerships. Dealerships are actually held off taking orders until the 2020 pricing lists are sorted out, given, the – I’ll say metals inflation in particular, but next year’s demand is very significant.
And it's all question of what’s the supply chain allow potential quantities to be built. So our picture is one of I say cautious start to the year given, I don’t think there’s anything magical about the first of January in terms of the supply chain, but then again, in improving picture. So that by the second half of next year will have been truly in 15 plus maybe 20 months of supply chain issues. And bit by bit, they are being sorted out. Capacity is being brought to bear both by the chip manufacturers and also in other sectors.
And so the kinks which have appeared in supply chains, whether it’s been low cost country, supply positions from Malaysia or Vietnam or China, those have all being ironed out and another six months. And I think, the supply chain issues, which were really caused by I'll say, the result of COVID, but COVID giving excess demand for a period of time or the interruption of the supply chain. It’s all being sorted out. So again, keep the bigger picture in mind and what’s currently topical will begin to go away and they’ll start building trucks, commensurate with the demand and we’ll all be very happy.
On the truck demand in North America, there’s a mission standard change that comes in 2024. And typically you have a pre-buy ahead of that. So you could set up for a very strong 2023, sometimes historically they’ve been up to 400,000 trucks. Do you think that causes a big issue like, will the supply chain be ready for something like that just your thoughts?
Again, it’s a big question. I’m not sure as I’m best positioned to answer. I know that Howmet will be prepared and able. And given the margins that we have in that business, it would be truly, I’ll say a superb outcome for us.
Okay. What about growth in the other, just the industrial markets, energy, IGT, talk about the growth there and it’s not as big of a part of the business anymore, but the margin profile of that business when it’s performing well, does that kind of fit in well with the rest of the portfolio margin wise?
Yes, IGT demand is very solid. We have as – it’s the one probably hot spotted Howmet at the moment, where we’ve not been able to keep pace with customer demand where we have this unusual position of both good aftermarket sales because of the running of the existing turbine fleets say longer, particularly around the use of natural gas, because of its input price advantage. But then you combine that with a whole new generation of yachting J-class larger turbines, which are being brought to market. And that basically is a fundamental upsizing of those gas turbines often with dual or triple use input fuels for them.
But it’s the same picture actually for aerospace, where with those new, larger engines with the increased temperatures that they operate at with the increased pressures that are involved and Howmet has a particularly unique position in providing that size of turbine blade for those new turbines, then it’s a good business for us.
And we are trying to increase our production have been doing so this year in each quarter and expected, will continue to improve, make improvements as we’re going to next year. The margin profile is very healthy as you’d expect going along with a number one position in the world in that market. And so the question we’re asking ourselves now is trying to have a long range outlook for it to decide at what level of increase investments would be appropriate for that part of our business.
Oil and gas, it’s actually still been given the price run up of oil. We were thought it would’ve started to pick up a little bit more than it has given increase in rig counts that have been going on. I mean, we still have far less than we had in 2019, but our expectation is with, even though oil has been volatile in recent months, peaking at just above 80 for West Texas, and now in the 60s, it’s still much higher than it was a few months ago.
And so, we are optimistic that there may be a positive outcome for our oil and gas sector, but again, we currently thinking, we shouldn’t plan on that. We are just hoping that it does.
Okay. Maybe we should move to the supply chain and the labor markets as the aerospace market starts to pick up both on the OE and the aftermarket side. Just for Howmet is your supply chain ready for the increases over the next couple of years? You think the overall supply chain is ready and then as things ramp up, talk about like labor turnover and labor, are you able to get enough people?
Yes. The broad question about supply chain, I think that we’ll be ready. It’s difficult for me to comment regarding the wider supply chain for the whole aerospace for surrounding narrow body. I’m sure it’s something that both Airbus and Boeing are working at situationally at the moment and are you intimately aware of the hotspots that they might face and therefore will be prepared to commit both resource of people and money to address that. So I have no reason to believe at this point that the industry will be able to pick up to the stated rates of the mid 50s for Airbus, for narrow body and in the 30s for Boeing.
Turning to the specificity of the labor question. We’ve recruited in the last quarters of net 800 people. To get 800, we’ve had to recruit more than that because of natural wastage we have in the company even now. About 65% to 70% of those people have been – people we’ve recalled either under recall rights from a union contract or recall people who previously worked with the company.
And therefore let’s say 30%, 35% has been fresh labor to Howmet. So far, we have not experienced any undue problems in recruitment of labor. Now, whether that's because the industrial workers for the aerospace sector, rather than service sector employees, I don’t really know. It did require us to change our base rate in a couple of plants to address the very low base rate issue. But it doesn’t change the labor profile of cost for those plants and also the recruitment methods that we are applying.
And so we’ve increasingly modernized ourselves in using social media for recruitment of labor and that combined with any rate issues that we’ve done. And incentive arrangements have meant that we’ve had no issues in getting that labor so far now, does it continue? It’s always – it’s a future event, so we don’t know. But at this point in time, we have not experienced the labor issues that are recorded again in the press. And I’m sure that they are real. But at the same time, how significant they would be for a relatively higher paid sector of economy. I don’t know. So, we shouldn’t extrapolate from news headlines neither for labor nor Omicron in terms of the – it's doomsday scenario. It’s not. So I am optimistic, right.
That’s great. I think we're on time, maybe if we can sneak one in on capital allocation, just, debt pay downs or shuffling of the term structure of the debt. Maybe you guys can talk about that a little bit?
Yes. I feel as though we’ve not only paid a lot of attention to our profitability and addressing the cost base to gain a margin, which at this stage of the business to be in the, I say top decile of aerospace companies we also paid at the same time, a lot of attention to our balance sheet. We’ve been able to do so because of the very healthy cash flows of the company, which I did comment would be further improved next year.
So we’ve taken the opportunity to pay down a significant amount of gross debt this year getting close to $1 billion. We’ve also refinanced part of our debt structure to meet the opportunity of a lower interest rate environment and also neutralized any premiums by just further debt pay down so that the interest carrying costs are some, I think 70 plus million less on a run rate basis, which I think is good and obviously helps our earnings per share calculations going forward at our free cash yields.
Over and above that, we’ve also taken the opportunity. I think over 200 million exact number Ken probably has, but maybe it’s quite a bit more than that, but 200 plus maybe 250 plus million of share buyback plus we’ve reinstated a dividend. So we’ve been very active on debt paid, refinancing, returning debt, improving his profile, reducing its carrying costs, buying stock back, reinstating a dividend. So great live activists or maybe Ken, you could count on the exact number in through the some of the third quarter.
Yes. On the share buybacks 225 million year-to-date through the third quarter.
Okay. And with that guys, I think we’re out of time.
Brian, thank you for your questions and look forward to chatting again. Thank you.
Thanks guys. Have a great day.