Kaiser Aluminum Corp (KALU) 2018 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kaiser Aluminum First Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Melinda Ellsworth, Vice President, Investor Relations and Corporate Communications. Ma'am, you may begin.

Thank you. Good afternoon, everyone, and welcome to Kaiser Aluminum's First Quarter 2018 Earnings Conference Call. If you have not seen a copy of our earnings release, please visit the Investor Relations page on our website at kaiseraluminum.com. We have also posted a PDF version of the slide presentation for this call. Joining me on the call today are Chief Executive Officer and Chairman, Jack Hockema; President and Chief Operating Officer, Keith Harvey; Executive Vice President and Chief Financial Officer, Dan Rinkenberger; and Vice President and Chief Accounting Officer, Neal West.

Before we begin, I'd like to refer you to the first 2 slides of our presentation and remind you that the statements made by management and the information contained in this presentation that constitute forward-looking statements are based on management's current expectations. For a summary of specific risk factors that could cause results to differ materially from those expressed in the forward-looking statements, please refer to the company's earnings release and reports filed with the Securities and Exchange Commission, including the company's annual report on Form 10-K for the full year ended December 31, 2017. The company undertakes no duty to update any forward-looking statements to conform the statement to actual results or changes in the company's expectations.

In addition, we have included non-GAAP financial information in our discussion. Reconciliations to the most comparable GAAP financial measures are included in the earnings release and in the appendix of the presentation. Any reference in our discussion today to EBITDA means adjusted EBITDA, which excludes non-run rate items, for which we've provided reconciliations in the appendix. At the conclusion of the company's presentation, we will open the call for questions.

I would now like to turn the call over to Jack Hockema. Jack?

Thanks, Melinda. Our first quarter results were driven by margin compression due to escalating metal and freight costs. Growing aluminum -- growing automotive and industrial demand and continued improvement in manufacturing cost efficiency provided some benefit, cushioning the margin squeeze. Higher year-over-year shipments reflected continued demand growth for our general engineering applications and continued growth in automotive extrusions, which more than offset the impact from continued destocking in the commercial aerospace supply chain. Despite the higher shipments, value-added revenue declined slightly due to a lower value-added product mix as well as a significant increase in contained metal costs that squeezed value-added prices on certain noncontract shipments.

Overall market conditions are improving as aerospace supply chain destocking begins to moderate, and we have initiated pricing actions to mitigate the margin squeeze from rising freight and metal costs. We will continue to pursue additional actions as required to address these rising costs.

During the quarter, we benefited from the additional capacity and improving cost efficiencies from our recent investments at Trentwood, which served to partially counteract headwinds experienced in the first quarter. We're continuing to work through installation of handling equipment at the light gauge plate furnace and expect increasing benefits as we complete the projects and implement practice changes to realize the full potential of the investments.

Before discussing our outlook, I'll turn to Dan for additional color on the first quarter. Dan?

Thank you, Jack. Compared to the prior year, our first quarter 2018 shipments were 2% higher and total value-added revenue was 1% lower, reflecting continued growth in lower value-added automotive and general engineering shipments and softer aerospace demand due to continued supply chain destocking. In addition, value-added revenue compressed in the first quarter on certain noncontract sales due to higher year-over-year contained metal costs.

Value-added revenue for aerospace applications declined 5% from the first quarter of 2017 on a 5% decline in shipments as well as price pressure on certain noncontract sales.

Automotive extrusion value-added revenue, however, improved 3% in the -- from the prior year quarter on a 5% increase in shipments, driven by strong double-digit growth in bumper programs.

General engineering value-added revenue improved 6% on a 4% higher shipment compared to the first quarter of 2017 as we were able to capitalize on continued strong general engineering demand due to incremental capacity from last year's investment at our Trentwood facility.

First quarter 2018 EBITDA was $48 million, down from $54 million in the first quarter of last year. This decline was due to rising contained metal costs as well as the increase in freight costs that Jack mentioned, which were partially cushioned by improvement in underlying manufacturing efficiency. EBITDA margin was 23.8% compared to 26.6% in the prior year quarter.

Turning to Slide 7. As reported for the first quarter, consolidated operating income was $37 million, net income was $26 million, and earnings per diluted share was $1.51. This compares to operating income of $59 million, net income of $36 million and earnings per diluted share of $2.04 in the prior year quarter. The prior year period included $15 million of net non-run rate gains, predominantly noncash mark-to-market gains on hedging positions.

Adjusted for noncash and non-run rate items, first quarter operating income was $38 million, a decline from $45 million in the prior year quarter, reflecting the impact of escalating metal and freight costs as well as $1 million of depreciation expense incremental to last year.

Our effective tax rate dropped to 19% in the first quarter of this year, from 34% in the first quarter of 2017, primarily reflecting the impact of the new federal tax laws. The lower tax rate largely offset the year-over-year decline in adjusted operating income, resulting in $27 million of adjusted net income in the first quarter, which was comparable to the prior year quarter. However, adjusted earnings per diluted share in the first quarter of 2018 increased to $1.60 from $1.52 in the prior year quarter, reflecting both the lower effective tax rate and fewer shares outstanding.

In the first quarter, we made our final contribution to the Union VEBA, totaling $12.8 million, and paid the Salaried VEBA $2.9 million. Going forward, while we have no further funding obligation to the Union VEBA, our obligation to the Salaried VEBA continues, with a maximum contribution of $2.9 million per year.

Capital investment in the first quarter was $20 million, and we continue to anticipate full year spending will be approximately $80 million.

During the first quarter, we returned $16 million of cash to shareholders through dividends and share repurchases, and we continue to maintain strong liquidity. At quarter end, cash and short-term investments totaled $219 million, and borrowing availability on our revolving credit facility was $292 million.

Lastly, we adopted ASC 606, the new revenue recognition accounting standard during the first quarter of 2018. For some of our products, our past practice of recognizing revenue upon customer delivery is consistent with the new standard and no change is necessary. But for certain types of contract sales, the new standard requires us to recognize revenue over time as we incur manufacturing costs. The effect of this change should merely be a timing issue, but there could be variability in period-to-period comparisons, especially when comparing periods of 2018 under the new standard to periods prior to 2018 that were under the old standard. Upon adoption, we recorded a $10 million adjustment in December 31, 2017, retained earnings, that was an increase, to reflect the cumulative effect of applying the standard to affected contracts. Slide 29 in the appendix of this presentation provides more detail on the financial statement impact of adopting ASC 606.

And now I'll turn the call back to Jack to discuss market trends and our outlook.

Thanks, Dan. Turning to Slide 8, demand for our automotive and general engineering applications is strong, and aerospace demand is strengthening as the supply chain destocking we've experienced over the past several quarters is beginning to moderate.

Confirming the strengthening demand, our lead times for plate products have expanded from approximately 10 weeks earlier in the year to approximately 20 weeks. Meanwhile, primary aluminum prices have been trending steadily higher over the past 2 years. More recently, Section 232 tariffs and sanctions on Rusal have caused additional aluminum price volatility. The current squeeze on value-added revenue in sales margins results from a lag in passing through higher costs on certain noncontract, high value-added products. We've experienced this in the past when market conditions were similar.

Last year, we discussed the market environment that drove our sales margins to a level comparable to the historic lows of 2014, when conditions were similar with aerospace destocking, combined with escalating contained metal costs. In the first quarter, we experienced similarly unfavorable market conditions, intensified by additional cost pressure from high freight costs. As a result, first quarter sales margins were even leaner than we experienced in 2014.

The recent introduction of aluminum tariffs and sanctions have created significant short-term aluminum price volatility. As we indicated during our fourth quarter earnings call, we believe that the long-term impact of Section 232 tariffs for Kaiser will be relatively neutral to positive. For our foreign sales, virtually all shipments are covered by long-term contracts, with provisions to pass through U.S. metal prices. For our domestic shipments, industry practices to pass through contained metal costs, although there is typically a lag on certain high value-added noncontract products as evidenced by the margin squeeze in 2017 and the first quarter. A potentially positive consideration is that tariffs implemented on products imported from China and South Africa could serve to eventually moderate the price pressure on general engineering plate products.

The impact of U.S. sanctions on Rusal is uncertain. After significant turbulence following the announcement of the sanctions, implementation has been delayed until October, providing time for the markets to adapt.

In addition to all the uncertainty surrounding metal costs, new federal regulations have caused a truck driver shortage, resulting in much higher freight costs across the nation. As I noted in my opening remarks, we'll continue to proactively increase prices to address the margin squeeze precipitated by the steep increase in freight and contained metal costs, even if we forgo some volume in the short term.

Despite all the noise during the quarter, we're confident that we will have success passing through the price increases while we continue to focus on execution of our strategy to grow our sales and invest and manage our business for further operating leverage and manufacturing cost efficiencies.

Turning to Slide 9 and a discussion of our end markets, our positive outlook for aerospace and high strength applications is unchanged. We expect improving demand through 2018 and 2019 as supply chain destocking runs its course and as airframe manufacturers continue to ramp-up build rates to address the large 9-year order backlog. This outlook is reinforced by recent comments by both Boeing and Airbus regarding the strength of demand and the need for build rate increases. In addition, the new defense budget and increased demand from U.S. allies strengthens the outlook for the F-35 Joint Strike Fighter, the F/A-18 Super Hornet and other military applications. We're well positioned in the marketplace, and with supply chain destocking expected to moderate as we proceed through the year, we expect mid-single-digit year-over-year growth in our 2018 shipments for these applications.

Turning to Slide 10. Our positive outlook for automotive extrusions is also unchanged. North American build rates are expected to improve modestly 1% or 2% year-over-year. We expect mid-single-digit year-over-year growth in our shipments and value-added revenue for these applications while we prepare for a significant number of new crash management, brake chassis and structures applications launching in 2019.

Turning to Slide 11. Our shipments and value-added revenue for general engineering applications have grown at a 6% compound annual growth rate over the past 3 years. As Dan indicated in his remarks, our fourth quarter -- first quarter value-added revenue was up another 6% year-over-year for these applications, driven by strong demand and increased capacity facilitated by the recent investments at Trentwood. We continue to be cautiously optimistic regarding the outlook for these general engineering applications.

Moving to Slide 12. Overall, our outlook for 2018 is unchanged. We expect improving demand for aerospace applications throughout the rest of the year as destocking begins to moderate. Automotive and general engineering demand is strong. Although we expect continuing margin pressure from escalating freight and contained metal costs, we will be proactive in implementing price increases to mitigate the price cost squeeze. And as always, we will continue to focus on sales growth and manufacturing cost efficiency benefits from our investments across the platform.

Overall, as we have previously stated, we expect mid-single-digit year-over-year growth in shipments and value-added revenue in 2018, with EBITDA margin in the mid-20s.

Turning to Slide 13 and a summary of our comments today. Although we experienced significant headwinds in the first quarter, particularly in the form of rising contained metal and freight costs and continued aerospace supply chain destocking, we expect that these headwinds will moderate as we proceed through the year. Longer-term, we are well positioned at our served markets to capitalize on the secular demand growth for our aerospace and automotive applications and are encouraged by the growing demand for our general engineering products. In addition, we expect to continue to achieve increasing cost efficiency in our manufacturing operations to further drive value for all of our stakeholders.

We will now open the call for questions.

(Operator Instructions) Our first question comes from Edward Marshall with Sidoti & Company.

So I wanted to get your perspective on pricing. I would imagine that a rising environment such as what you're in would allow you to capture pricing a little bit easier than the environment we've been in recently. Could you quickly comment on that? And then I have a second follow-up.

Okay. You broke up a little bit there, Ed, but I think I got most of your question. I think you inferred that the environment is improving, and one of the statements that we just made in my remarks here is the manifestation of that. Our lead times on plate products, which were approximately 10 weeks or less a few months ago, have expanded now to 20 weeks, which shows a broad strengthening in demand for our plate products across-the-board, which obviously creates a more favorable environment from a pricing standpoint. We implemented what I'll characterize as some modest price increases that became effective on April 1. We implemented some not-so-modest, pretty aggressive price increases that will take effect on May 1. We're confident that those will stick in the marketplace. As we said, we may suffer some short-term volume dilution from that, although we think that will be modest, but we're going to stick with these price increases. We've seen the marketplace accept these pretty well.

And I guess the last time you saw this type of inflation in the material cost in 2010, it looked like it quickly subsided and then value-added price per pound stayed up for a significant period of time. Was there something unusual in that? Or does pricing tend to be a little sticky after that inflation environment?

No. The best comparison to what we're experiencing over the last 15 months or so is actually 2014, where we had a similar situation with sharply rising metal prices over an extended period of time, in conjunction with aerospace destocking, which created slack in demand for all aerospace products and plate products in general. So -- and we reached historic lows in terms of our sales margins in 2014. Last year, we commented a few times on earnings calls that we had sales margins that were approaching that 2014 low and then the rapid run-up in metal prices we saw, plus the freight cost expansion that we saw in the first quarter as a consequence of federal regulations further exacerbated that situation and really hammered us in the first quarter. But as we -- as I just indicated in the prior answer, we're seeing strengthening demand and we're seeing now the ability to get price increases to stick, and we've moved pretty aggressively here. So we expect that we'll see improvement as we go forward, and we'll continue to act proactively, depending on the situation here to get our margins back up.

Got it. And then finally, I just wanted to ask about the 2019 auto launches and programs. I think typically, you talk about a 5% to 6% penetration rate over production. Does that increase in 2019 as a result of the new programs? Or are these cannibalizing existing programs?

Yes. There will be a lot of new demand there, more than just replacements. I'm not ready to quantify what that is at this stage because when you go through a big launch year, there are lots of variables that get involved. So as we get into February, we'll start to put some additional color on that. But I'm sure I'll give you plenty of caveats because launches are really, really uncertain until things settle down.

Our next question comes from Jeremy Kliewer with Deutsche Bank.

Just a follow-up on the 300 bp margin squeeze that you announced in your prepared remarks. How much of that was at the end of the quarter versus the build-up through March, considering the prices have increased in April as well?

It was actually pretty consistent through the quarter. The metal price spiked up in January, and it was -- it only changed a $0.01 or so month-to-month, as I recall, during the quarter. And the same with freight costs. Freight costs got hammered immediately because the new federal regulations took effect on January 1. So I mean, we -- when we -- if you bifurcate the 300 basis points, it was really roughly 200 points on what -- our typical margins over metal, and it was another 120 points from freight. So we really got hammered with freight as well. It was a combination of the 2 that -- it was a combination of 2 bad rules, rule factors there in the first quarter.

All right. And then with regards to Russia and Rusal, are you procuring any of your metal units from them, and do you have to replace those? Or do you see any kind of issues moving forward following the October kind of cutoff to get aluminum to where you need it?

Yes, we buy from a number of global sources, so we don't really disclose what our mix of suppliers are. But to the real point of the question, we're very confident that our metal supply is secure as we go forward.

Our next question comes from Novid Rassouli with Cowen and Company.

I just wanted to start with the price increases. Jack, you were mentioning some of them become effective on April 1. And then it sounded some more aggressive ones become effective on May 1. I just wanted to get a sense of is that -- are those trying to build in the price increases that we saw in the first quarter? Is that what those are attacking?

You mean the cost increases?

Yes. Sorry, cost increases.

It's reflecting a number of issues here. We included a chart on the market environment slide here during my remarks that shows the metal price going back to 2016. And you can see it's been steadily increasing since early 2016. So we've got more than 2 years now of increasing metal costs. And then we got hammered by freight costs, and we had an unfavorable environment to really get pricing because of the aerospace destocking. So we made some moves to capture some of the metal on April. But as we saw the complete magnitude of the freight and everything else and the really strengthening demand, we made some pretty significant moves here in May. But to quantify, I don't want to quantify it at this point. It's hard to pick a point of what we're comparing to. We're just looking at what we think are realistic pricing moves based on what's happening to our cost and what the market environment is, the capacity to receive price increases.

Right. So I guess what I was trying to really focus on is your guidance. I mean, if we look at all-in costs for the first quarter, the delta relative to the fourth quarter is actually smaller than the delta. If you take the quarter-to-date average for the second quarter thus far and we say that that's where prices end up, the delta is actually larger from 1Q to 2Q. And so I'm just trying to understand the pricing, the lags on your pricing increases because it just seems like -- I'm not sure what the offsets would be, but it seems tough for margins to improve materially in the second quarter given the dynamic that we're seeing. Primarily, it seems like because of Rusal. And so I'm just trying to make sense of your guidance. If we're in this range that we saw in the first quarter in the second quarter, that would mean that margins would really need to pick up in the third and fourth quarter just to get to the bottom range of that guidance. And so I'm just trying to understand the puts and takes there of how we get there.

Yes. Well, there are a number of factors when you start looking at quarter-to-quarter. You get wide swings in major maintenance costs when you compare quarters that has a big impact on margin. There are impacts on -- from part number mix that we're supplying and customer mix inside those major product lines. And I really didn't refer to it, but some of the margin compression that we had in the first quarter is we had an unusually lean, what I'll call, part number mix. Even on some of our contracts, the mix that came through the orders were leaner than we typically experienced. So we kind of had a combination of a lot of negative factors in the first quarter. We're pretty confident that's going to be as bad as it gets in terms of sales margins. But there are just so many factors in there. And I don't want to give any guidance on the second quarter at this point. I'd just point out that we're moving aggressively, and we still feel comfortable holding to our 24 -- or our 2018 full year forecast.

Got it. And then last question. The price increases, those lags, how long will it take for those to kind of show -- come through to the P&L for us to see?

They will come through immediately. As I said, we raised prices effective April 1, what I characterize as relatively modest price increase, and then we passed through a much more aggressive price increase that will become effective May 1. Unlike some others in our space, we're implementing it on orders already on the books. So they're taking effect immediately, and we'll see that effect immediately. Also, contrary, when you start listening to other earnings calls versus ours, there's one huge difference. Virtually all of our competitors use their cost on a FIFO basis. We cost on a LIFO basis. I established that policy more than 20 years ago intentionally because I wanted pressure on our product managers. When costs are going up, I wanted them to see the immediate impact on their margins so they had intense pressure to move their prices. Some of our competitors don't have that same kind of incentive where they can live on 3- or 4-month-old metal costs.

Our next question comes from Curt Woodworth with Crédit Suisse.

So I guess with respect to the May 1 price hike, if that goes through, would that cover you relative to where you see the contained metal pressure today?

It gets back to compared to what? Every time we...

Let me be more -- the 300 basis point of headwind in 1Q, given the May 1 hike which you said was pretty substantial, would that recapture that contained metal margin pressure?

I don't want to go there yet. We just have to wait to see what happens to mix, to how much total acceptance we get in the marketplace because we've put some pretty aggressive price increases out there. We don't know -- there are some competitors out there who may be capricious, and we're not going to back off from these price increases. So they may try to book some short-term orders, and we're going to hang in there so we may lose some volume. So there are just too many factors involved right now to predict what the short-term impact will be. We're just confident that, over the long term, we're going to get this back in equilibrium where it belongs.

Okay. And then last year, you talked about scrap spreads being a decent size tailwind to the business since spreads have widened out a lot. Year-to-date, can you comment on what the scrap spread benefit was to you in the first quarter?

Yes. It was exactly the same. The margin -- sales margin benefit from what we characterize as metal profits, which is essentially the scrap spread, was exactly the same as the last year average for the full year and the first quarter of last year.

Okay. Why would that be because spreads have widened out pretty significantly year-on-year?

Well, it depends on what spreads you're talking about or what you're reading. Again, you have to remember, we're in a very narrow slice of the market, and we're in high-performance alloys typically. So when you read those scrap spreads, and I read some of those scrap spreads too, they have absolutely no correlation necessarily with what we're seeing on scrap spreads.

What's your mix between ingot or casthouse product versus scrap across your system?

It varies product by product, plant by plant in terms of what our consumption is. But our scrap utilization in the first quarter was very consistent with what it was first quarter a year ago and throughout the year last year. We mentioned last year that we'd made a significant gain increasing our scrap utilization. We basically held that in the first quarter. And frankly, a little surprising to us, we expect widening spreads. But on the mix that we buy, we did not see wider spreads in the first quarter.

Okay. Interesting. And then just one last one, can you comment on the M&A environment? Obviously, there's been speculation with Aleris and just rolled products in general. Do you -- would you say your pipeline is more full than it's been? Can you comment on sort of your appetite to digest potentially [as large a] transaction?

Yes. I don't think there's any real change in that environment. We're not seeing more or less activity, and we're certainly not seeing anything other than expectation for outrageous multiples that we won't pay.

(Operator Instructions) Our next question comes from Piyush Sood with Morgan Stanley.

First question, staying on the raw material mix, how effectively are you able to pass through both regional premiums and shaped premiums?

Piyush, could you repeat that again for us, please?

Could you speak up? You sound pretty distant.

How effectively are you able to pass through both regional premiums or/and shaped premiums, either pass them through or hedge the amount?

Regional premiums or/and what premiums?

Shape premiums, so slat premiums, billet premiums.

Yes. The -- we pass through the LME plus the Midwest premium, the U.S. Midwest premium. So all of our contracts are predicated on passing through the full U.S. cost of prime. We do not make any distinction for what our scrap utilization is. We pass through the cost of prime. That's built into our pricing structure. On freight, I know you didn't ask about freight, but I'll comment on freight. Freight affects our entire product mix, not just noncontract. We don't pass through freight cost on our contracts as well. So that's an impact across the board and something that we're looking to address with the price increases that we're implementing effective May 1 as well.

And what about passing through any kind of billet upcharge or some kind of a slat premium, which is over and above the Midwest premium?

Yes, we basically manufacture all -- we buy prime and scrap. So we make all the billet and ingot in-house, with some minor exceptions. We have a little bit of purchase material, but it's negligible. So we really don't have an issue on that, where you've seen the widening spreads on -- in the open market on ingot and billet.

That's good to know. And a question on the new revenue recognition standard. What was the -- either the headwind or tailwind to EBITDA in 1Q and if you will be able to quantify it?

Yes. If you were to compare this as we reported to what it would have been if we'd been using the old standard, our EBITDA is favorable now to what it would have been by about $1 million. And the revenue, net revenue is about $2 million, again favorable under the current recognition than it would have been under the prior recognition.

Our next question comes from Josh Sullivan with Seaport Global.

Is there any way to characterize how you see the moderating of the aerospace destocking through the year? Is that more from an acceleration of customers taking the product? Or just have inventories finally hit that point where there's less slack?

I think it's a combination of the 2. They're continuing to ramp up their build rates, and the inventory is beginning to deplete. And again, it's -- the best way we can measure it right now is the fact that our lead times have doubled here over the past few months.

Okay. And then you also mentioned you had some pickup at Trentwood capacity this quarter. How should we think about the additional gains just through the year on Trentwood as some of these projects finish up? Or should we look for more capacity or more margin focus through the rest of '18?

Well, we got a lot of the -- let's say we got a bump based on the investments that we made last year, just from the equipment that we installed. But we'll continue to get additional capacity benefits as we revise our manufacturing practices, the rolling practices to manufacture the products, and that will be over the course of several months or perhaps even into 2019 before we completely get our practices fine-tuned to take full benefit of the capacity and the cost efficiency that we should get from this. So we expect we're going to see continuing growth in benefits from the Trentwood investment over an extended period of time.

And I'm currently showing no further questions at this time. I would like to now turn the call back over to Jack Hockema for closing remarks.

Thanks, everyone, for joining us on the call today, and we look forward to updating you on our second quarter call in July. Thank you.

Ladies and gentlemen, this concludes today's conference. Thanks for your participation, and have a wonderful day.