Carbon fiber materials maker Hexcel (NYSE: HXL) creates products that enable jets to cut fuel consumption, cars to be lighter and stronger, and wind turbine blades to get bigger and more efficient. Here we evaluate how the company scores on The Motley Fool's environmental, social, and governance framework.
Hexcel is based in Stamford, Connecticut, with manufacturing facilities in the U.S., Europe, and China. It rakes in about $2.3 billion in revenue per year, netting nearly $300 million on the bottom line. That makes it one of the largest manufacturers of carbon fiber fabrics and composite materials in the world. These high-performance fabrics, when molded into shapes by infusing them with resins, offer great stiffness and strength, enabling engineers in many industries to create stiffer, stronger, lighter, and longer-lasting structures than can be achieved with legacy materials like steel, aluminum, titanium, or fiberglass.
Carbon fiber retains the allure of a super-high-tech miracle material. (Thousands of YouTube videos are dedicated to faking a carbon-fiber look for truck, car, and bike parts.) However, the explanation for its fast-growing use is much simpler than that: Carbon fiber composites offer more stiffness per weight than just about any other material out there. It's also very strong. (Stiffness is the ability of an object to resist deformation when a stress is applied, whereas strength is the ability of an object to withstand a stress without breaking.) This makes it ideal for use in manufacturing airplanes, where a lower weight translates into significant fuel savings, ultimately saving money while limiting its environmental impact.
For decades, most of a commercial (or military) airplane, from skin to structure, was made of aluminum. Aluminum is light and cheap, but it's not very stiff, and it has a pretty lousy fatigue response, which you can test yourself by bending a piece of aluminum a few times. However, properly engineered aluminum airplanes were excellent. They were safe, reliable, and long-lasting. Carbon fiber started out being prohibitively expensive and thus was relegated to exotic uses. As carbon fiber has become cheaper and more companies have gained expertise in using it, its use has come to make more economic sense.
The higher (but lower-than-they-used-to-be) up-front costs of carbon composite parts can be offset over the life cycle of an airplane, for instance, because reduced weight means decreased fuel consumption and savings on other load-bearing systems in the machine. Carbon fiber composites' lack of oxidation problems and near-infinite fatigue life can also mean decreased maintenance costs. It's no surprise that a Boeing 787 is about 50% composite by weight, and an Airbus 350 is 55% composite by weight. It's likely that carbon fiber composites will make further inroads in aircraft and that carbon fiber will also be increasingly adopted for ground vehicle use (especially in electric vehicles, which can benefit from extended ranges). Outside of transportation, more carbon fiber is likely to be used in very large wind turbine blades, which need adequate stiffness and lower weight to continue development. As a leading provider of high-end carbon fiber materials, Hexcel stands at the forefront of this transportation and renewable energy revolution.
Hexcel produces and sells a full range of carbon fiber and related materials, including the polyacrylonitrile (PAN) precursor fiber that is baked at high temperatures in controlled conditions in special furnaces to make carbon fiber tow.
Carbon fiber tow. Image Source: Hexcel.
Think of tow as the yarn or thread that's woven into fabrics you wear, except in this case, the tow is sold to other customers or woven by Hexcel itself into various types of carbon fiber fabrics.
The fabrics are then used by customers (or Hexcel itself) to create products. These fabrics must be molded or otherwise shaped while being surrounded in a hardened matrix of resin in order to reach the specified stiffness, strength, and weight of the needed part. This is commonly done by using "prepreg" carbon fiber fabric cut that's then molded and baked in kilns. This fabric is preimpregnated with an epoxy resin that is activated by the heat of an oven, allowing it to bond adjacent layers and cure into a final shape, which remains solid and delivers the necessary performance at normal temperatures. Much of this process can even be automated, as shown in this video of robots and factory technicians creating carbon fiber B-pillars for cars.
Carbon fiber fabric. Image Source: Hexcel.
Aerospace customers are the biggest purchasers of Hexcel's prepreg carbon fiber fabric cut, but those fancy carbon fiber bikes are also largely made from bladder-molded prepregs. To make a frame, a mold in the shape of that frame is lined with prepreg, and an inflatable bladder is run inside the hollows. The top part of the mold is placed, then the assembly is baked while a bladder pushes out against the mold, yielding dense, consistent parts.
Another way of creating the shapes is molding them using dry fabric that is impregnated with a liquid resin at the time of part layup. These are then compressed by some means (including large vacuum bags) in order to push out excess liquid resin and produce a dense composite structure. After curing, the hardened parts are machined to specification. (This old-school technique is used by hackers making carbon-fiber bicycles in their garages, but it's also how some high-end parts for military aircraft are made.)
Carbon fiber composites are used increasingly in the primary and secondary structures in aircraft, including fuselage panels, wings, struts, and even the fan blades in jet engines. Hexcel is a major supplier for the Airbus A350. The A350 XWB contains 53% composites, including major portions of the wings and fuselage. The specific product uses are neatly summarized in this Hexcel video. Carbon fiber is even used for new jet engines, and not just where you'd expect, such as shell surfaces. Newer, composite-rich planes like the A350 are much more efficient -- about 25%, according to Hexcel. That's a lot less fuel burned and therefore a lot less CO2 emitted into the atmosphere.
It's even the material of choice for fan blades, thrust reversers, cases, and cowls. A final thought to underline the incredible opportunity here: Aircraft using composites for the primary structure (the A350 and the Boeing 787) comprise less than 5% of the global commercial airline fleet. The Boeing (NYSE: BA) and Airbus (OTC: EADSY) backlog at Hexcel is already worth more than $9 billion, which implies a long runway of profitable growth ahead.
As wind turbine blades get larger (which makes them much more efficient), stiffness becomes tougher to achieve at an acceptable weight using fiberglass. Although fiberglass is quite strong, the mass required to get adequate stiffness becomes untenable as blades get bigger. (Some of these blades are as long as football fields.) Making internal struts from carbon fiber beams is one way to enable progress. Another is using more carbon fiber for the blade surfaces. Both advancements would meaningfully increase Hexcel's sales to the wind industry.
Image Source: Hexcel.
While Hexcel's fabrics are its main product, it also makes specialty products including lightweight honeycomb materials used to create stiff, strong, lightweight panels for use in planes, satellites, or the solid disc wheels on the backs of racing bicycles. It also manufactures specialty materials for creating much lighter-weight factory tooling for fabricating subsequent parts. (This tooling is normally made out of metal because carbon fiber couldn't provide accurate tolerances demanded by the industry.) And it increasingly offers specialty products to enable hybrid structures, such as carbon fiber fabrics that enable easy, one-step molding plus bonding to metal parts, including aluminum.
This is an important step to getting more carbon fiber into ground vehicles, but it's a difficult interface to manage. (The chemistry of carbon-to-aluminum contact means it is prone to oxidation problems and subsequent failure.) By offering simple manufacturing systems to car and boat makers that allow the incorporation of carbon fiber structures where they can do the most good, Hexcel will help drive higher performance at lower weight and thus enable lower emissions.
Composite materials (the fabric) provide 80% of current sales, with major customers including Airbus, Boeing, Bombardier (OTC: BDRBF), Embraer (NYSE: ERJ), General Electric (NYSE: GE), Spirit Aerosystems (NYSE: SPR), Trek, United Technologies (NYSE: UTX), Vestas Wind Systems (OTC: VWDRY), Sikorsky Aircraft, which is owned by Lockheed Martin (NYSE: LMT), and others.
To dice sales with another blade, Hexcel's sales are 70% into commercial aerospace, 17% into space and defense markets, and 13% into industrial sectors. Commercial aerospace is largely Airbus and Boeing. Space and defense uses are helicopters, military jets, satellites, and launch vehicles, and the industrial sales go to wind energy, automotive, and recreational use. By geography, Hexcel's sales are typically about 50% to U.S. companies, with the rest of sales to Europe, China, and Africa. More details are available in Hexcel's latest annual report.
Hexcel's major manufacturing facilities are located all over the globe, from Arizona to Austria, with most concentrated in the U.S. and Europe and one in China. The engineered products, which make up 20% of sales, are sold to a smaller roster of aerospace customers, including those named above. The manufacturing for engineered products takes place primarily in the U.S., with a few plants in Belgium, Malaysia, and Morocco.
Hexcel has published sustainability reports and has a sustainability webpage. To get a deeper understanding of the company's commitment to ESG, we'll score Hexcel using The Motley Fool's 10-question framework for ESG investing.
1. Does the company treat its employees, customers, community, and other stakeholders well?
No. We'll focus on employees here, because, to phrase this generously, it's Hexcel's best opportunity for improvement. Hexcel employs 6,626 people. I'm giving Hexcel a fail on this question, because I don't think it treats employees well enough, to judge by Glassdoor reviews. There are a lot of negative reviews, one-star reviews in particular, even more than seems typical to me for a company that requires a lot of manufacturing plant employees who cycle through quickly.
Pay and benefits don't seem to be the problem. Workers give the company low marks for having supervisors and managers who don't keep positions staffed and who demand too much overtime, leading to inevitable problems for work-life balance and toxic career politics. There are frequent complaints about lack of opportunity for advancement, with upper-level employees complaining that senior positions go to outsiders instead of promoting from within. Some attribute the problems to the rapid growth over the past few years. This is something Hexcel needs to address to become a better corporate citizen as well as a successful company for investors.
On the other hand, Hexcel looks better than the average SEC-reporting company on the metric of CEO pay compared to employee pay. Among SEC-reporting companies, the average CEO makes about 200 times what the average employee makes. At Hexcel, this ratio is 105. That's still an egregious difference, but it's less horrible than at hundreds of other companies. On Glassdoor, 80% of reviewers approve of CEO Nick L. Stanage.
The company has a Code of Business Conduct with policies to ensure worker safety.
Areas for improvement: Hexcel needs to work to build an employee-centric culture that promotes training, development, and career advancement along with a fair work-life balance. If Hexcel is able to improve its worker churn and employees' attitudes about the company's culture, then it could be a candidate for Forbes' annual list of Best Midsize Employers.
2. Is the company a good steward of the environment?
Yes. Hexcel has incorporated some important systems and controls into its operations to improve its environmental sustainability, safety conditions, and workforce culture, as well as to reduce waste and costs. Most of its sites are already ISO 14001 certified, with a goal of having all operating sites certified to this environmental management standard by 2020. Hexcel also monitors its suppliers' commitment to environmental stewardship. Roughly 80% of its raw material spending goes to suppliers that are completely or mostly ISO 14001 certified.
Hexcel's environmental policies include significant renewable power purchases, as well as efforts to reduce energy consumption. Hexcel actually cut its energy use by 15% globally from 2015 to 2018 at the same time it added new plants and expanded capacity, increasing its sales by nearly 20% over the same period. About 25% of Hexcel's current energy consumption comes from renewable power. That's important because making carbon fiber demands a lot of energy (including furnaces that can reach thousands of degrees). Finally, Hexcel recycles much of its waste and continually works to improve the amount recycled. (In one clever program, nitrogen-rich wastewater from one factory is reclaimed and used by a nearby golf course, reducing its need for fertilizer.)
3. Does the company promote diversity and inclusion?
Yes, but it could do better. With one-third of the board comprising women from related industries, Hexcel has done a decent job of breaking up what could easily be an industrials/defense industry old boys' club. However, there's always room to do better. Four of the 13 executives are women. Hexcel doesn't have a formal policy regarding diversity for directors, but its proxy states that this is one of the criteria considered for board nominees. The company's Code of Business Conduct addresses diversity and inclusion and says Hexcel values all employees' input. Management says it provides a workplace free of harassment and bullying and that it doesn't tolerate offensive or disrespectful conduct.
Areas for improvement: Hexcel has a solid green-tech story. If it prioritizes treatment of employees and diversity and inclusion, ESG investors would like Hexcel to get recognition for improvement by showing up on various ESG lists such as the Dow Jones Sustainability Index and annual publications like Forbes' Best Employers for Women and Best Employers for Diversity.
4. Does the company have ethical corporate governance principles?
Yes. Hexcel has a diverse board and executive team, eight independent directors, a mandatory retirement age of 70 for directors, annual elections, a single voting class for stock (rather than the special, founder-owned supershares that are common today), and stock ownership guidelines for executives and directors, along with prohibitions on pledging or hedging that stock. It also has an annual "say on pay" stockholder vote, limits on maximum incentive payouts, multiyear vesting of stock awards, and claw-back policies on incentive-based compensation for executive officers.
Stock ownership guidelines require the CEO to own stock worth 6 times her or his base salary. For executive vice presidents, that rule is 3 times. Other executive officers must hold 2 times their base salaries, and other officers must hold 1 times their salary. Directors are required to hold 5 times the annual cash retainer fee. All members of those classes, except for the three most recently added, are in compliance. Those who are not compliant must retain 50% to 100% of all net shares received until the ownership guidelines are met.
5. Do the company's business model and its investments promote ESG principles?
Yes. With a substantial portion of current and future product devoted to use in energy-saving technologies (like those fuel-efficient planes) and renewable energy-producing products (like wind turbine blades), Hexcel is a major enabler of better global energy policy on both the production and consumption sides.
Renewable energy and reduced emissions from mass transit are more than environmental issues. They offer big benefits to economically disadvantaged populations, since many of the effects of climate change (more destructive storms, rising seas) tend to have a disproportionate effect on lower-income world citizens. Similarly, reductions in emissions offer bigger quality-of-life gains to the people living nearest the power plants, who also tend to be lower-income citizens.
6. Does the company have a healthy balance sheet?
Yes. Hexcel carries just more than $1 billion in debt, but its interest coverage is 9.1 times. The majority of that debt ($700 million) consists of bonds and notes at rates of less than 5%, and it's due in 2025 and 2027. The $378 million in revolving credit matures in 2024 and carries a 4.4% rate. With the company generating more than $200 million in free cash flow over the past 12 months, with more expected, debt isn't a problem.
7. Can the company generate organic revenue growth supported by long-term tailwinds?
Yes. Hexcel is at the forefront of two secular changes that not only help the planet, they make for a near guarantee of long-term growth in the total addressable market for Hexcel's products.
Air travel continues to grow at a high rate, and demand remains very high for new airframes that consume large quantities of carbon fiber. This is a decade-type opportunity for the current generation of aircraft. It's inconceivable that future airframes won't use even more carbon fiber to further reduce weight. The benefits to the airlines in terms of fuel costs -- and to the environment in terms of CO2 emissions savings -- are that important.
On the renewable energy side, wind turbine blades, currently a smaller portion of its business, should grow larger as wind turbines scale up. Solar is a very competitive renewable option, but the sun doesn't shine all day, and utility-scale energy storage is currently in its infancy. That means utilities all over the world will continue to look at wind, especially now that the industry has smoothed over some of the daunting technical (and political) issues to installing big offshore wind farms. Larger blades are more efficient and generate much more electricity, but they demand more and better carbon-fiber composite content in order to be able to meet the required mechanical specifications. That should provide a growing business line for Hexcel.
8. Can the business generate growing free cash flow (FCF) and sustain high returns on invested capital (ROIC)?
Yes. In anticipation of the continued demand for airframe composites, Hexcel recently went through several years of heavy investing, which suppressed free cash flow for a time. Ramping up several new facilities, including upping its capacity for creating the precursor fiber for making carbon fiber, not only cost up-front capital, but it will also keep margins lower than optimal until all that capacity is used. That said, even during this period of investment, Hexcel has generated large amounts of free cash flow. The current FCF yield is more than 3%. We calculated Hexcel's 5-year average ROIC at around 13%, or 4 percentage points better than our estimate of its total cost of capital of around 9%.
Image Source: Hexcel.
9. Is the management team focused on long-term profitable growth?
Yes. Hexcel's returns on equity and invested capital over the past few years illustrate that management tends to make good strategic decisions rather than chasing short-term, earnings-boosting tactics. The investment in plant capacity -- at the cost of near-term results -- in order to meet and profit from longer-term opportunities also speaks highly of management's priorities. While many managers can talk a good game on the conference call or when hiring a copywriter for the annual report, looking back at the numbers shows evidence that management is doing the right thing. The 10-year trajectory of Hexcel's margins suggests it's got the business well in hand.
|Cash flow from operations margin||17.1%||16.2%||20.0%||21.7%||19.2%|
Gross margin was 22.4% in 2009 and peaked at 28.6% in 2015 before retrenching slightly during the last few years of investment and heading back up again. FCF has become more consistent as well as much healthier in absolute value. Operating margin has nearly doubled, to 17.7%, over the past decade. That doesn't usually happen in a big industrial business with worldwide competition unless management is doing a great job and planning long-term strategy well.
Hexcel's executive compensation plans reward both long-term and more immediate stewardship via metrics including EPS, EBIT, and cash from operations (for annual cash compensation) and metrics that are better for longer-term compensation like stock awards. For instance, Hexcel's CEO receives the majority of his equity bonuses in performance share awards (these comprise nearly 40% of other officers' equity awards as well). These are based on meeting an ROIC metric for two-thirds of the award and relative EPS growth for the other one-third.
10. Does the company have a medium- or lower-risk profile?
Yes. Hexcel is a medium-risk company. To start with what could seem scary: Hexcel has significant revenue concentration with Airbus and Boeing (and their subcontractors). Approximately 70% to 75% of Hexcel's sales typically go to these two companies. Airbus is typically around 40% to 45%, Boeing about 25% to 30%. Around 95% of those sales are for commercial aircraft, and about 5% are for space and defense use.
Hexcel is classified as medium risk despite that concentration because there is a significant backlog of commercial aircraft worldwide. Worldwide travel continues to grow at a rate far exceeding global GDP, and to meet that demand, many new aircraft are needed. For reasons described above, most of these aircraft will have significant -- and growing -- amounts of carbon-fiber composite materials incorporated into their design.
Hexcel gets a high score
Hexcel scores 9 out of 10 on The Motley Fool's ESG Compounder Checklist. That's an A grade in our books, Fools. Anyone seeking a solid ESG stock idea -- one that furthers the greater good and serves its stakeholders well (including shareholders) -- should consider adding Hexcel to their watch list.
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