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Edited Transcript of KALU earnings conference call or presentation 25-Jul-19 5:00pm GMT

Q2 2019 Kaiser Aluminum Corp Earnings Call

FOOTHILL RANCH Jul 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Kaiser Aluminum Corp earnings conference call or presentation Thursday, July 25, 2019 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jack A. Hockema

Kaiser Aluminum Corporation - Chairman & CEO

* Melinda C. Ellsworth

Kaiser Aluminum Corporation - VP of IR & Corporate Communications

* Neal E. West

Kaiser Aluminum Corporation - Senior VP & CFO

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Conference Call Participants

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* Curtis Rogers Woodworth

Crédit Suisse AG, Research Division - Director & Senior Analyst

* Joshua Ward Sullivan

Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst

* Martin John Englert

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Kaiser Aluminum Second Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, today's program may we recorded.

I would now like to introduce your host for today's program, Melinda Ellsworth, Vice President, Investor Relations. Please go ahead.

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Melinda C. Ellsworth, Kaiser Aluminum Corporation - VP of IR & Corporate Communications [2]

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Thank you. Good afternoon, everyone, and welcome to Kaiser Aluminum's second quarter and first half 2019 earnings conference call. If you've 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; 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 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 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 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 nonrun rate items, for which we've posted 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?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [3]

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Thanks, Melinda, to everyone joining us on the call today. Our second quarter results were solid despite the impact of Trentwood planned maintenance outage on our largest casting complex, the hot line and the large plate stretcher. Excellent planning and execution by our Trentwood team resulted in a onetime EBITDA impact of approximately $10 million from maintenance cost, operating inefficiencies and lost production and shipments, substantially less than the previously anticipated $15 million impact. Aerospace shipments continue to reflect the strength of our order book. Similar to the first quarter, general engineering shipments were constrained as we prioritized allocation of heat treat plate capacity to meet aerospace customer commitments. Auto shipments in the second quarter reflect the transition from old to new programs. We expect new programs to gather momentum in the second half, and we remain very optimistic for strong automotive content in 2020 and 2021. While the first half results include a negative impact of approximately $15 million from a combination of the planned Trentwood outage in the second quarter and unplanned downtime in the first quarter, first half EBITDA excluding the drag from the Trentwood downtime, reflects an implied run rate of approximately $60 million per quarter and EBITDA margins in the high 20s, further reinforcing our expectation for strong second half results.

Moving to Slide 6 and a summary of our outlook. We anticipate normal major maintenance in industrial demand seasonality in the second half, and we are well positioned with a very strong aerospace order book and with new automotive product ramping up. Our outlook for the full year is unchanged, as we continue to anticipate low to mid-single-digit percent year-over-year increase in both shipments and value-added revenue, with EBITDA margin above 25%. Although timing for resolution of the Boeing 737-MAX is uncertain, our second half aerospace order book is robust. We have had extensive communications with all of our strategic aerospace customers and we expect a very strong order book in 2020. In addition, we expect significant growth in automotive extrusions content in 2020 and 2021.

I'll now turn the call over to Neal to provide additional detail on the second quarter. Neal?

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Neal E. West, Kaiser Aluminum Corporation - Senior VP & CFO [4]

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Thanks, Jack, and good morning. Value-added revenue in the second quarter was slightly lower than prior year quarter and lower shipments, partially offset by improved pricing. Aerospace value-added revenue improved 6% from the prior year's second quarter and a 6% year-over-year increase in shipments, which was driven by our strong demand for aerospace products. Automotive value-added revenue decreased 32% compared to the second quarter of last year on a 21% reduction in shipments and a shift to a lower value-added mix. As noted in previous earnings call, 2019 is a transitional year for automotive as old programs roll off and new programs launch and ramp-up. The timing and visibility of transitions are often uncertain because they are driven by the OEMs. General engineering value-added revenue was up 3% year-over-year and a 13% reduction in shipments, reflecting improved pricing. The decline in shipments is primarily related to the reallocation of a portion of our heat treat plate capacity from general engineering to aerospace plate to meet the strong aerospace customer commitments. In addition, overall, plate capacity was temporarily constrained by the planned Trentwood outage. For the first 6 months of 2019, total value-added revenue improved 4% on a 5% lower shipments, reflecting improved pricing for noncontract sales, higher aerospace shipments and lower shipments for automotive and general engineering applications.

Turning to Slide 9. EBITDA for the second quarter 2019 of $48 million declined compared to $55 million in the prior year quarter, primarily reflecting the approximate $10 million EBITDA impact from the planned Trentwood outage. Improved pricing on noncontract sales was partially offset by lower automotive shipments and other cost inefficiencies. EBITDA margin for the second quarter was approximately 23% compared to approximately 26% in the prior year quarter. EBITDA for the first half 2019 of a $104 million was comparable to the prior year period, reflecting continued strength in demand for our aerospace products and improved pricing on noncontract sales, that offset the negative impact of approximately $15 million related to the Trentwood planned and unplanned downtime, and lower automotive shipments due to program transitioning. EBITDA margin decreased to 24% in the first half of 2019 as compared to approximately 25% in the prior year period, driven by the drag from the planned and unplanned downtime at Trentwood.

Turning to Slide 10. Operating income for the second quarter 2019 was $32 million. Adjusting for $3 million of nonrun rate, noncash losses, operating income for the second quarter of 2019 was $35 million compared to $44 million in our prior year quarter, reflecting the items previously mentioned, and an approximate $1 million year-over-year increase in depreciation expense. Reported net income for the second quarter 2019 was $19 million or $1.18 per diluted share, reflecting an effective tax rate of 27%. Adjusting for nonrun rate items, net income for the second quarter was $23 million compared to $28 million in the prior year quarter, again, due primarily to the planned downtime at Trentwood. Adjusted earnings per diluted share in the second quarter declined to $1.40 from $1.68 in the prior year period. For the first half 2019, operating income, as reported, was $75 million. Adjusting for $4 million of nonrun rate, noncash losses, first half 2019 operating income was $80 million, down slightly from $81 million in the prior year period. The decline primarily reflects an approximate $2 million increase in depreciation expense. Reported net income for the first half 2019 was $47 million or $2.89 per diluted share. Adjusting for nonrun rate items, first half net income was $53 million compared to $56 million in the prior year period. Adjusted earnings per diluted share for the first half 2019 was $3.24 compared to $3.28 for the first half of 2018. Capital spending totaled $16 million for the second quarter and $30 million for the first half of 2019. We expect capital spending for the full year will be approximately $75 million to $80 million. During the first half of 2019, we returned $49 million of cash to shareholders in the form of share repurchases and dividends. At June 30, cash and short-term investments totaled approximately $147 million, and borrowing availability on our revolving credit facility was approximately $292 million, providing us with significant financial flexibility.

And now I'll turn the call back over to Jack to discuss our outlook. Jack?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [5]

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Thanks, Neal. Turning to Slide 12 and a summary of our comments today. We had excellent execution of the planned outage by our team at Trentwood in the second quarter, and we delivered solid results despite the short-term challenges at Trentwood and the transition from old to new products in our auto operations. Our outlook for 2019 remains unchanged, and we continue to anticipate a strong second half and improved full year -- year-over-year results compared to 2018. Demand for our aerospace product remains very strong, and our robust order book for the second half is expected to continue into 2020. While our automotive product mix transition resulted in weak shipments in the first half, we expect growth to resume in the second half, with strong content growth anticipated in 2020 and 2021, driven by the transition from expiring programs to new ones. 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 continued steady improvement in underlying manufacturing cost efficiency to drive additional value for all stakeholders. 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.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Martin Englert from Jefferies.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [2]

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So while you've noted a strong second half aero order book despite the Max grounding, are you seeing any signs or changes in order activity or channel inventory adjustments associated with the Max program? Or is that the case where it's -- is it maybe being absorbed by other programs?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [3]

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No. Well, I think it's -- certainly, a part of it is being absorption by other programs. But in our view and we made comment on the prior call that it had begun to appear to us that the destocking that we saw in 2017 and 2018 was overdone. And as we've had a lot more conversation over the past couple of months with all of our strategic customers, we're more convinced that that's the case. And it goes to a lot of the comments made by Boeing and others about the need to restore health to the supply chain. So we think the supply chain got stretched very, very thin. And that's why we have a strong order book now, and we have had for really the past 12 months or so. But we're really looking at strengthening the second half and getting very, very strong indications about a very strong order book in 2020.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [4]

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And can you provide a little bit more color on the inventory destocking headwinds? Do you think that's fully embedded at this point? And that your shipments in the back half of the year and going forward will be more reflective of true underlying demand?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [5]

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Yes. But in fact, I think, it's reflecting more than underlying demand right now, because the destocking was overdone in our view. So really the strong order book we're seeing now is making up for insufficient orders in 2017 and 2018.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [6]

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So fair to think of it as a combination of robust program demand, coupled with some inventory restock?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [7]

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Yes. That's exactly how I would characterize it. And then the anticipation with -- once we get the Boeing 737 resolved and Boeing starts ramping up the builds on the 737 with all of the other ramp-ups, we continue to see really strong growth going forward here.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [8]

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Okay. And if I could one another on the automotive. So while I understand there is uncertainty due to the program changeovers, do you have any visibility on a sequential basis on how volumes might compare or trend in 3Q versus 2Q, given the notable weakness in the Q2 volumes?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [9]

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Yes. Right now, we're -- our internal forecast is up substantially year-over-year in terms of shipments in the third quarter. I won't give you a number, but it certainly is up.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [10]

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Okay. More comparable to prior quarters before 2Q here? Or exceeding...

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [11]

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Yes. I think you can really throw out the first half of this year, this is when we really saw the big impact from old programs coming off. And now we're starting to see the new programs began to ramp-up. So the first half is really a flyer. And frankly, there was some of that already in the fourth quarter last year, we had begun to see some programs running off in the fourth quarter. So we're pretty confident now as we move into the second half that we've got the curve headed the other way. And we'll see strong year-over-year growth. And we're really optimistic about 2020 and 2021.

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Operator [12]

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Our next question comes from the line of Josh Sullivan from Seaport Global.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [13]

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Just following on the automotive trend there. What is the time line for the automotive content growth in 2020, 2021? You kind of hit on it, but are those contracts in-hand? And is there any way you could say whether you're weighted to trucks, SUVs or another category at this point?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [14]

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Well, yes, it is bird in the hand. And yes, it is more heavily weighted to large vehicles than small. However, there is a significant portion of both.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [15]

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Okay. And then historically, I think you've talked about the aluminum penetration story in automotive being about 6% above SAAR. Is that still the metric? Or are how you thinking about just growth of the penetration versus SAAR going forward?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [16]

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Yes. Our outlook still is the 5.5% to 6% CAGR in terms of content growth.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [17]

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Okay. Got it. And then I understand you're moving some capacity around for the strong aerospace demand. How does the general engineering market look in isolation outside of what you've moved around here?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [18]

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Well, there are really 2 components here: one is that industrial growth is slowing, it's not negative, but is slowing. Also, from some of the industry metrics we see, the distributor metrics are canary in the coal mine, which is rod and bar. Actual distributor shipments to their customers are down slightly year-over-year, and we think that's really supply chain rather than real demand. So there is a combination of those that really makes our demand in general engineering relatively flat compared to what was really robust demand last year. But it's still strong. It's just the growth has slowed compared to the really strong growth we had previously.

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Operator [19]

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Our next question comes from the line of Curt Woodworth from Crédit Suisse.

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Curtis Rogers Woodworth, Crédit Suisse AG, Research Division - Director & Senior Analyst [20]

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I was wondering if you can talk about the -- I guess how tight the extrusion market is looking. So you obviously have a pretty compelling platform launch cycle ahead of you. But do you think that will also translate into higher value-add revenue and in terms of the pricing of that backlog, relative to what has been running off?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [21]

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No. I wouldn't say it is higher pricing, I'd say, it's comparable pricing in aerospace -- or auto, I'm sorry, in automotive, yes, yes.

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Curtis Rogers Woodworth, Crédit Suisse AG, Research Division - Director & Senior Analyst [22]

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Okay. So basically you have operating leverage, but the -- I guess, the unit margin should be similar to what you've been seeing?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [23]

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Correct. Yes, we're not seeing margin expansion on automotive sales.

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Curtis Rogers Woodworth, Crédit Suisse AG, Research Division - Director & Senior Analyst [24]

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Okay. And then on aero, could you just update us on what you think your capacity capability is. So if next year, you have a very strong environment it looks like you will and then you get 737-MAX back into the mix, what do you view as kind of your potential volume there? And then can you talk about your strategy to optimize your mix in terms of allocating your highest margin products or are you seeing emergent demand, where you can get quick big margin spot sales, and basically just trying to formulate a little bit more of a view on next 12 months.

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [25]

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Sure. Our expansion at Trentwood, the $150 million modernization basically is complete. The equipment's in the ground and installed, however, we continue to have opportunities to capture the full potential there as we convert practices over from the old processing to the new way of processing. And then the second component next year compared to this year is this year we had the big planned outage here in the second quarter, that restricted our capacity, and we had the unplanned outage in the first quarter. So our throughput has been restricted compared to what our actual capacity is this year. So yes, we expect to have more capacity next year than this year. I won't put a number on it at this stage, but we certainly have opportunities to continue to grow our aerospace. And longer term, we're pleased with what we've seen out of the investment that we've made, particularly on the hotline, we're seeing a lot more hot rolling capacity potential from the investment that we made that bodes well for long term. We have a lot of downstream model mix, but we know exactly where we need to go to add capacity as the market demands it in future years.

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Operator [26]

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(Operator Instructions) And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to Jack Hockema for any further remarks.

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [27]

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Thanks, everyone. We were pleased with the second quarter and how well Trentwood performed under some really difficult circumstances with the major outage they had out there -- up there. And we're really, really optimistic about the strong order book we have going here in the second half and what we're hearing about 2020. So we think we got some clear sailing here, and looking forward to strong results as we go forward. Look forward to updating you in the third quarter conference call in October. Thank you.

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Operator [28]

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Thank you, ladies and gentlemen for you participation in today's conference. This does conclude the program. You may now disconnect. Good day.