Kaiser Aluminum Corp (KALU) 2019 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kaiser Aluminum First Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Melinda, you may begin.

Good afternoon, everyone, and welcome to Kaiser Aluminum's First Quarter and 2019 Earnings Conference Call. If you've not seen a copy of our earnings release, please visit our Investor Relations page on the website at kaiseraluminum.com. We've 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; Senior Vice President and Chief Financial Officer, Neal West; and Vice President and Chief Accounting Officer, Jennifer Huey.

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 when filed, the company's annual report on Form 10-K for the full year ended December 31, 2018. 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've 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 nonrun 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. Welcome to everyone joining us on the call today. Continuing the positive trend from the second half of 2018, we reported strong first quarter results driven by improving aerospace demand and higher value-added prices for our noncontract business. The strong sales results were partially offset by approximately $5 million of cost and efficiencies at Trentwood. Compared to the strong run rate in the second half of 2018, value-added revenue increased another $11 million and EBITDA increased $5 million despite the cost inefficiency at Trentwood, which was related to a combination of unplanned equipment downtime that temporarily interrupted our finishing operations and purchased rolling ingot costs necessitated by planned casting furnace rebuilds. Improved value-added pricing was an important driver for our first quarter results as our proactive pricing actions have successfully restored our sales margins to a level consistent with prior experience under similar market conditions.

Turning to Slide 6 and the current business environment. The temporary reduction of Boeing 737 production from 52 per month to 42 per month before ramping up to 57 in September has introduced uncertainty regarding industry demand for our products. Boeing has indicated a focus on the health of the supply chain during this period of reduced production. In other words, the supply chain is producing at a pace higher than the Boeing build rate. While it is likely that this supply chain restocking, while 737 build rates are low, could eventually lead to some level of supply chain destocking, the impact and timing are uncertain until the 737-MAX is recertified. Meanwhile, demand for military aircraft continues to grow for the F-35 Joint Strike Fighter and the modernized F-15X Super-fighter and F/A-18 Super Hornet. For our automotive applications, underlying demand remains strong. As a reminder, 2019 is a transition year with numerous end-of-life programs rolling off and a number of new program launches. We expect strong automotive shipments growth in 2020 and 2021 following the transition of programs this year. Although demand for our noncontract general engineering products remained strong, we allocated a portion of our capacity in the quarter to address strong aerospace demand. This contrasts with 2017 and early 2018 when relatively soft aerospace demand enabled capacity to shift toward noncontract general engineering products. We continued to incur tariff costs of approximately $200,000 per month, while decisions by the Department of Commerce remain pending on specific exclusion request. If we receive approval for the exclusion request, we expect to recover approximately $3 million of previously paid tariff cost and eliminate the current $200,000 per month cost.

Moving to Slide 7 and a summary of our outlook for 2019. While facing some uncertainty in aerospace and automotive demand this year, we continue to focus on executing our strategic initiatives to capture the full efficiency and capacity benefits from the recent Trentwood investments and to position the company for expected strong automotive extrusion shipments growth in 2020 and 2021 as we transition from old to new programs. As we previously discussed, we plan significant maintenance activity and equipment downtime at Trentwood in the second quarter for casting the hotline and the large plate stretcher. We estimate a onetime EBITDA impact of approximately $15 million in the second quarter from related operating inefficiencies, maintenance cost and lost production and sales. While we continue to monitor the 737-MAX situation, at this time, we have no specific information to warrant any change in our full year 2019 outlook for EBITDA margin above 25% and low to mid-single-digit percent year-over-year increase in both shipments and value-added revenue.

I'll now turn to Neal for additional detail regarding the first quarter results. Neal?

Thanks, Jack. Turning to Slide 9. Value-added revenue for the first quarter of 2019 increased $16 million or 8% to $218 million and a 2% decline in shipments as compared to the prior year quarter. Looking at our end markets, value-added revenue for our aerospace applications increased approximately 17% from the first quarter of 2018 and a 17% increase in shipments reflecting strong underlying aerospace demand and moderating aerospace supply chain destocking. Value-added revenue for our automotive extrusions declined approximately 15% from the prior year quarter and a 4% decrease in shipments. The decline in shipments reflected the winding down of end-of-life automotive programs and lower VAR reflects the trend to lower value-added mix. Value-added revenue for our general engineering applications increased approximately 2% and a 15% decline in shipments compared to the first quarter of 2018. While fully benefiting from the price increases implemented in 2018 and early 2019, as previously mentioned, we reallocated a portion of our heat treat plate capacity from general engineering to aerospace plate to meet the strong aerospace demand. EBITDA for the first quarter of 2019 of $56 million increased approximately $8 million or 17% compared to the prior year quarter. The increase in EBITDA reflect a higher value-added revenue and pricing of noncontract sales, partially offset by a higher cost associated with purchased ingot and unplanned downtime in Trentwood, as Jack mentioned in his earlier comments. EBITDA margin in the first quarter of 2019 increased 190 basis points to 25.7% compared to 23.8% in the prior year quarter.

Now turning to Slide 10. Consolidated operating income as reported for the first quarter 2019 was $43 million, net income was $28 million and earnings per diluted share was $1.71. These results compare favorably to reported operating income of $37 million, net income of $26 million and earnings per diluted share of $1.51 in the prior year quarter. Adjusted for noncash nonrun rate items, first quarter adjusted operating income increased to $44 million compared to $38 million in the prior year quarter. Reflecting the items previously noted, that drove the year-over-year improvement in EBITDA in addition to approximately $1 million of additional depreciation expense. Adjusted net income for the first quarter was $30 million and earnings per diluted share was $1.85. This compares favorably to the adjusted net income of $27 million and earnings per diluted share of $1.60 in the prior year quarter. Our effective tax rate for the quarter was approximately 26% compared to an effective tax rate of 18.6% in the prior year, which reflected a few discrete tax benefits. We anticipate our 2019 full year blended federal and state-effective tax rate will be in the mid-20% range and our cash tax rate in the low to mid-single digits. Capital investment in the first quarter was approximately $14 million and we anticipate full year capital spending to be approximately $80 million to $90 million. During the first quarter, we returned approximately $29 million of cash to shareholders through dividends and share repurchases. We continue to maintain strong liquidity and financial flexibility. At quarter end, cash and short-term investments totaled $138 million with borrowing availability of approximately $292 million on our revolving credit facility, which remains undrawn.

I'll now turn the call back to Jack.

Thanks, Neal. Turning to Slide 12 and a summary of our comments today. We delivered strong first quarter results driven by improved aerospace demand and noncontract value-added pricing. Although the 737-MAX situation has introduced additional uncertainty to our overall outlook for 2019, we continue to anticipate improved year-over-year results. As we look longer term, we remain well positioned to capitalize on the secular demand growth for our aerospace and automotive applications. In addition, we expect to continue steady improvement in underlying manufacturing cost efficiency to drive additional value for all of our shareholders. Our strong balance sheet and cash flow generation support our growth and capital deployment priorities and provide sustainability through industry cycles.

We will now open the call for questions.

(Operator Instructions) And our first question is from Jeremy Kliewer from Deutsche Bank.

Looking for a little additional color on some of your industrial pricing. You know It jumped about 30% year-over-year and I didn't know is that due to the product mix or is it more on supply-side constraints that it may be switching off to different industries or something along those lines?

No. There is some mix in there but most of it is just raw price increases. Our prices had become extremely compressed on noncontract business a year ago in the first quarter and we passed through price increases second quarter last year, we passed through additional price increases January of this year. And so we have our sales margins including covering the additional freight cost that we commented on last year. We now have sales margins back in the territory that's typical for this kind of business environment.

All right. So we should anticipate those should continue?

Yes.

All right. And then, if I may, on the unplanned downtime at Trentwood, it was about $5 million cost this quarter but you kept your $15 million headwind for 2Q unchanged. So will there ever be kind of a release of that $5 million, like, less CapEx spend in 2019 or beyond?

No. The first quarter was completely unrelated to the second quarter. Roughly, 1/3 of that $5 million in the first quarter was related to purchasing rolling ingot, outside purchases of rolling ingot while we are rebuilding casting furnaces and we have additional casting furnace rebuilds in the second quarter. So there is that impact but then the bigger impact, roughly 2/3 of it, was related to extraordinary cost created by significant downtime that we had on major handling equipment in our finishing operations that basically ceased our operations there for several days. And then we -- there was a lot of maintenance cost involved to get back online, and then additional overtime cost as -- and lost absorption as we made up for the lost days of production.

Our next question is from Martin Englert from Jefferies.

So you noted no change in the outlook within the release, which includes low to mid-single-digit value-added sales growth as well as shipments. But then we saw slightly lower volumes year-on-year, I imagine some of this could be due to the disruption at Trentwood. And then where we should probably accept some lower volumes due to the planned Trentwood outage in 2Q. So reasonable to assume that you're expecting some catch-up in the back half of the year to make up for that, right?

I don't know if it's catch-up, but we expect very strong demand in the second half of the year. So long as Boeing sticks to this current plan, where they have reduced production for just a few months here before returning to 52 and then a 57 build rate in the third quarter. We're expecting really strong demand. General engineering continues to be strong. We expect automotive is going to improve in the second half. We're suffering now in the early part of the year, as Neal mentioned, from some of the end-of-life programs hitting us, but we're ramping up some of the new programs and expect some of that to begin to hit in the second half. So we're expecting, once we get past this Trentwood -- major Trentwood outage here in the second quarter, we're expecting strong demand and really strong results in the second half of the year. And that's despite the fact that we had $5 million or so surprise in the first half -- or first quarter from the downtime and the repurchased ingot here. So we're still -- we're very optimistic here about second half of the year, so long as this Boeing situation gets resolved and recertified relatively promptly.

That's very helpful. And then when thinking about the guidance here and more so kind of heading into 2Q and the implications, so you provided the $15 million headwind. But how should we think about that, so this quarter was $56 million or so adjusted EBITDA, add back $5 million or so to that. But should we take like a $60 million EBITDA and then be pulling out about $15 million for a rough run rate for 2Q, given the outage or will there be some positive partial offsets there?

That sounds like a question from an analyst who has really worked hard on his forecast. So yes, I mean all your rationale make sense here. We're not going to comment on our second quarter outlook, but basically we're saying, we're looking -- we're expecting roughly $15 million from a normal run rate kind of operation. You saw what we did in the second half of last year. We had really, really strong results in the second half. And even with the $5 million hiccup in the first quarter, we had really, really strong first quarter. So it's pretty obvious that we've got really strong momentum underlying in our business. And clearly, the first quarter would have been a $60 million-plus pace and high-20s EBITDA margin. So long as market conditions stay the same and we get through this outage in the second quarter, we're expecting really strong results going forward.

Okay. But nothing else to call out as far as positive partial -- offsets that you'd expect in 2Q there, right?

No, no. I mean basically, it's -- we lose sales and production here in the second quarter as we go through the outage. One could say with the Boeing situation it turned out to be good timing, which is just an accident for us. But no, the second half demand was there. It's really that strong going forward, at least under the current situation.

(Operator Instructions) And our next question is from Curt Woodworth from Crédit Suisse.

So first question just on the aerospace dynamic. Can you talk to, I guess, maybe pre the Boeing event when you had all of your OEM nominations sort of settled in the first quarter, how your aerospace volume nominations looked this year relative to last year? And have you seen any change in spot lead times as a result of the Boeing build rate cut?

The nomination for this year is up from last year, which you would anticipate with the build rate increases that they've announced here. We've seen no change in order patterns given the situation, Boeing on their call this morning just reiterated that they're using this period of time to work on the health of the supply chain. As we view it and we see what's happening with orders here and we've got -- still got despite the cut back to 42, we've got really, really strong pressure on our plants to deliver on the orders that we have on the books here. Our view is that the destocking situation that we endured for 1.5 years, all of 2017 and the first half of 2018, it would appear to us that, that went on for too long and the supply chain wasn't ready to meet the 52 rate and certainly the 57 rate. And so that's why we still see strong demand in terms of order rate here given the plans to ramp back up to 52 and then 57 in the third quarter. They're working hard on the health of the supply chain. So we think that destocking was too pronounced, there clearly is restocking here with the supply chain producing at a rate above the 42 that Boeing is building planes at. But that appears to be getting everything back into equilibrium to meet that 57 demand. So long as they get recertified, relatively promptly as they hope to do, we think this should be pretty clear sailing going ahead if the ramp up happens as planned here. But we put the caution in here primarily because who knows when, with all these government entities involved now, who knows when we're going to get the recertification and what the implication may be for the future, because everything is full go to ramp back up to 52 and 57 here later in the year.

Okay. That's super helpful. And then just where your lead times stand now for your more spot-exposed aerospace business?

We're -- just as I responded on your prior question, we've really seen no change in our order outlook at this stage. And as we commented on the prior call, a couple months ago, we basically are fully booked. We've allocated capacity for the remainder of the year to our strategic customers based on their request and we still stand there. We're basically fully booked at Trentwood for the rest of the year and have very strong demand throughout the rest of our aerospace and general engineering operations.

Okay. That's helpful. And then I guess in terms of framing the MAX issue, can you help investors understand a little bit of exactly what the magnitude of the impact could be in the sense that like how -- like what percent of aero plate demand would be just from that one plane? Just because I think it's hard for investors to understand kind of the scope of really what it means.

Yes. It's not a huge number, the 52 to the 42, in terms of percent of total aerospace demand. I mean you still have Airbus going at their rate, you have a lot of wide bodies being produced and as we mentioned in our comments, we're seeing some nice growth in the military applications as well. So it's not a big hole there. But obviously, if they back off -- stay at 42 for a long time or have to back off from 42, that'll start to have a bigger and bigger impact.

Our next question is from Josh Sullivan from Seaport Global.

I mean it sounds like you're mirroring essentially what Boeing has communicated here, which makes sense. But if we do see some destocking on the 737 front, what are the thoughts about transitioning demand back from the general engineering side? It sounds like you had given up some of that general engineering capacity for aerospace, but how would that work in the reverse direction? I mean do you think the market could support that?

Yes. I mean at this stage, demand is strong, it -- the question is how big is that breadbox? But certainly there is flexibility to move back and forth between general engineering or really between noncontract business. Our first priority, we must fulfill our contractual commitments to our -- based on our long-term contracts. And that's why we ask for declarations a year ahead of time, so that we can then look around what our contractual commitments are to our major long-term customers. So if there is a change in that outlook it'll be a similar situation to what we did if you go back and look at 2017 and first half of 2018, you'll see really strong general engineering shipments and that was with strong general engineering demand. And with a pretty significant destocking situation in the entire aerospace supply chain. So there is flexibility, can you turn it on $0.10? No. But over a period of months, yes, there's flexibility there. The bigger impact would be if it's a major reduction in total demand then it starts to shorten lead times and weaken overall demand and there could be longer-term pricing implications, but we're a long way from anything like that.

Got it. Got it. And then just on the auto extrusion content transition here. Yes, I mean the automotive penetration of aluminum, it's going on a couple of years here. Have there been any changes in the duration or the terms of the contracts with the OEMs, just as that matures with some of these newer platforms?

No. It's basically business as usual there and I mean there's no change from the last 30 years. Every new contract, there is tremendous pressure on pricing, but we've been dealing with that for decades. So it's pretty much business as usual.

Our next question is from Jeremy Kliewer from Deutsche Bank.

Yes, the follow-up on the extrusion side. Where I guess are you seeing particular areas of strength or particular areas of weakness?

Are you -- you're talking extrusions in general?

No, auto extrusions. So like it...

Auto extrusions?

Yes, yes.

Well, it's the macro situation. You've got the shift in the OEMs, shifting from -- to less sedan production and even more larger vehicle production. And that trend obviously continues, GM and Chrysler have made those announcements as well as Ford that they're going to make that change in terms of the mix of vehicles that they're building. So that continues to go forward. There's really no change from that long-term trend, other than it accelerating.

All right. But you're not seeing anything that's caught you by surprise. I mean you warned of the first half weakness on the model kind of ramp down before the new models ramp up, but there's nothing that's out of whack there?

Yes. There is no surprise because, as we said on the last call, we have no idea how it's going to pan out this year. So we can't be surprised. So it just happened. Yes, some of the end-of-life came a little bit faster than we anticipated. But again, it's just a normal transition here. You just -- you don't know when they're -- how they're finally going to ramp down a vehicle, because they don't know exactly how it's going to sell when they're taking it out of service and then the flip side when they have a new model they're introducing, it's a question whether the dog's going to eat the dog food here. So they have their forecast in terms of how many they're going to sell, but then reality hits when we -- they go out there and start to sell them.

Our next question is from Piyush Sood from Morgan Stanley.

The question around capital allocation. As you look to this year, assuming the economy holds up, Boeing's orders normalize, your cost will likely fall further into next year, your automotive shipments will pick up further, so next year appears to be shaping pretty well. So just wondering how you're thinking about capital allocation going forward, not really for this year, but a little beyond, would you be looking to increase investor returns or would you be setting it up for some kind of growth?

Our capital allocation priorities have been consistent for more than a decade here. So as we've said on prior calls, we expect to be making organic investments in this $80 million-plus territory for the next few years here. We continue to look for good, attractive, inorganic growth opportunities with the same thing, we'll only do them if we can do it in a business that we understand and create long-term shareholder value, and then we go to our regular dividends, and last is share repurchases. So there's nothing really on the horizon at this stage that would change or shift the priorities among those 4 areas.

Okay. And one more, looking at the historical VAR per pound for aerospace, looks like the $1.86 level in 1Q brings it back to the historical levels. So just want to understand that if there is probably some more upside to it, once the Boeing situation resolves itself? Or do you think this is the level where you wanted it to be and it's finally climbed back up to that point?

The value-added revenue per pound, there is such a significant component of the aerospace that is contract business and then the products within that, everyone focuses on plate but we've got a wide variety of products in there that have value-added revenue per pound ranging from couple of dollars up to $8 or $9 a pound. So there's a big mix component in there. There's also a component of what's happening with the noncontract business where pricing actually has improved. But in terms of predicting what the value-added revenue per pound is, it's really -- there's too many variables in there. I mean we have our forecast, but it just depends on how the order base unfolds.

At this time, I'm showing no further questions. I would like to 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 an update on the second quarter coming up here in July. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.