Hexcel Corporation (NYSE:HXL) Q4 2022 Earnings Call Transcript

Hexcel Corporation (NYSE:HXL) Q4 2022 Earnings Call Transcript January 26, 2023

Operator: Good morning, my name is Emma. I will be your conference operator today. At this time, I would like to welcome everyone to the Hexcel Fourth Quarter 2022 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. Thank you. Patrick Winterlich, Chief Financial Officer, you may begin your conference.

Patrick Winterlich: Thanks, Emma. Good morning, everyone. Welcome to Hexcel Corporation’s fourth quarter 2022 earnings conference call. Before beginning, let me cover the formalities. I want to remind everyone about the Safe Harbor provisions related to any forward-looking statements we may make during the course of this call. Certain statements contained in this call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. They involve estimates, assumptions, judgments and uncertainties caused by a variety of factors that could cause future actual results or outcomes to differ materially from our forward-looking statements today. Such factors are detailed in the company’s SEC filings and last night’s news release.

A replay of this call will be available on the Investor Relations page of our website. Lastly, this call is being recorded by Hexcel Corporation and is copyrighted material. It cannot be recorded or rebroadcast without express permission. Your participation on this call constitutes your consent to that request. With me today are Nick Stanage, our Chairman, CEO and President; and Kurt Goddard, our Vice President of Investor Relations. The purpose of the call is to review our fourth quarter 2022 results detailed in our news release issued yesterday. Now let me turn the call over to Nick.

Nick Stanage: Thanks, Patrick. Good morning, everyone. And thank you for joining us today as we share both fourth quarter and full year 2022 results. Many of our key markets have seen a robust return to growth in 2022, especially in Commercial Aerospace, where air travel has experienced a strong and much welcomed rebound. Our Space and Defense markets have remained strong and have grown nicely over 2021. There’s also been a year of supply chain challenges, inflationary pressures and a tight labor market. Hexcel has remained focused on meeting our customer’s needs and overcoming the headwinds faced. We achieved a roughly 20% step up in annual revenues and delivered double-digit operating margins, a 500 basis point improvement over 2021.

The strong recovery and return both to domestic and international travel are appealing to airports that now are crowded with travelers and high load factors for airlines globally, and we see it as airlines are reportedly returning into service, older aircraft that are not fuel efficient, simply because they cannot get new planes fast enough to meet passenger demand. The opportunities for growth are tremendous and I continue to believe that no company is better positioned than Hexcel to benefit from the strong pull for new composite intensive, lightweight aircraft that are more fuel efficient. Hexcel advanced materials are enabling enhance sustainability and will continue to do so for decades to come. In 2022, we celebrated numerous times with supplier recognitions from customers including Airbus, Boeing, Lockheed Martin, CTRM Aero Composites, Sunseeker and the list goes on.

Our customer intimacy throughout these challenging times has never been better. So many times over the past several months customers have asked, how are you doing it, how does Hexcel just keep delivering when others are struggling? I give credit to our one Hexcel team. They have done a phenomenal job. They go above and beyond, not only to ensure that we succeed, but to further position us for an incredible future. I could not be prouder of the team as they stay the course, remain focused and never wavered in their commitment to our customers. Now let’s turn to some specifics reported in our earnings release last night. First, I will cover the fourth quarter results and then full year 2022. Fourth quarter sales of $429 million are 19% higher than Q4 2021.

Adjusted diluted EPS in the fourth quarter was $0.40, compared to $0.16 last year. Turning to our three markets in Commercial Aerospace, fourth quarter sales of more than $256 million represented an increase of almost 29% in constant currency when compared to Q4 2021 and up 23% sequentially over the past quarter. We have now realized six consecutive quarters of double-digit sales growth in this market. Other Commercial Aerospace increased almost 45% in the fourth quarter compared to Q4 2021. Business jets and regional jets, both grew strongly year-over-year. Virtually every platform from narrow-body to wide-body to business jets is growing and the customers continue to ramp as fast as the supply chain allows. As the market recovers, Hexcel benefits from the continued penetration of lightweight composite materials, as well as our relentless commitment to innovate with our customers on new materials and processes for next-generation programs.

The same is true in Space and Defense, fourth quarter sales of $126 million represented a 22% increase year-over-year in constant currency. This was broad-based growth across the submarkets we serve and also geographically with growth in programs in the U.S., Europe and Asia. We were pleased last quarter to see the U.S. Navy confirm all production for the composite rich CH-53K heavy lift helicopter. This will become a top defense platform for us in next few years as production ramps. Industrial sales of $47 million were down 7% year-over-year in constant currency. Given the economic pressures, the wind energy industry has changed structurally and opportunities for our legacy glass prepreg products have limited. However, we have seen stability in our wind business in the second half of 2022 focused on our European market.

Our Industrial business is pivoting away from wind energy to other markets, including automotive, consumer electronics, marine and recreation. I mentioned earlier that some of our customers have recognized us this year and I wanted to specifically mention the sustainability award we received in November from Airbus Defence and Space. The award granted to Hexcel recognizes a partnership we announced in 2021 with Fairmat to recycle carbon fiber prepreg composite offcuts from Hexcel’s European operations and our customers. The offcuts are reused in manufacturing composite panels sold in the industrial markets. It’s an award that recognizes a key collaboration, an important milestone in our relentless pursuit of innovations that in partnership with our customers will lead to a more sustainable future for us all.

Now let’s turn to our full year 2022 results. Sales were $1.58 billion, up almost 22% year-over-year in constant currency. Adjusted diluted EPS for the year was $1.28, compared to $0.27 in 2021. Adjusted operating income as a percentage of sales was 10.4%, which is almost doubled our 2021 results. In our markets, Commercial Aerospace sales were led by the Airbus A320neo and A350 programs combined with strong growth of about 63% year-over-year for other Commercial Aerospace driven by business jets. We are encouraged as we begin 2023 by strong order activity for both narrow-bodies and wide-body. Our two largest Commercial Aerospace customers, Airbus and Boeing delivered 1,141 commercial aircraft in 2022 combined up 20% over 2021. Backlogs are growing with more than 12,600 aircraft in total for Airbus and Boeing.

Airlines are ordering again as they refresh and increase their fleets to meet increased growth in passenger demand and as we strive toward meeting their sustainability goals for emission reductions to greater fuel efficiency, which is achieved in great part by replacing heavy metal components with lightweight composite materials. The recent order from United Airlines for 100 Boeing 777s and 100 737 MAX jets reflects the largest order for years for wide-bodies as demand increases, especially for international travel. With the Chinese Government recently lifting its strict COVID entry requirements, air travel within China and cross-border is expected to expand rapidly, another positive factor for new commercial aircraft demand. Now turning to Space and Defense.

The invasion of Ukraine, tightening global concerns for the need to strengthen national defense, and as a result, we see governments around the world committing to increase defense spending and that leads to increased opportunities for us over time. Hexcel composites are the benchmark in this market and our products are on over 100 programs, which provides us with a diversified foundation for a strong future. Finally, Industrial sales were negatively impacted by the decline in wind energy business, which was mostly offset by growth in a variety of Other Industrial markets. At the end of 2022, we closed our industrial wind energy plant in Tianjin, China due to a decline in wind energy orders that led to a stop in prepreg production earlier in the year.

Our Industrial business suits over 30 different markets from a manufacturing site in Austria, including legacy wind business. This legacy European wind blade business is forecasted to remain stable for a period of time, supported by existing contracts. While we no longer have manufacturing operations in China, we will continue to maintain a sales office in Shanghai to serve our customers in the region including COMAC. Our focus is set firmly on a solid growth trajectory in 2023. With the increased demand we forecast across the business in the coming years, we have reinitiated construction on a carbon fiber line in Decatur, Alabama. This new line should be operational and qualified in 2025 for aerospace-grade carbon fiber production. When the line is completed, the Decatur plant will be home to our first combined fan and carbon fiber production facility in the U.S. Reflecting confidence in our return to growth and our capacity to generate cash in the coming years, the Hexcel Board announced yesterday an increase in our quarterly dividend from $0.10 to $12.5 per share.

As the revenue news release last night, we are issuing 2023 financial guidance with double-digit growth in both sales and EPS. We are guiding to $1.725 billion to $1.825 billion in sales for 2023 with adjusted diluted earnings per share of $1.70 to $1.90. Our guidance on free cash flow is to generate more than $140 million, while continuing to tightly manage accrued capital expenditures we spend approximately $90 million. Now, I will turn it over to Patrick to provide more details on the numbers.

Patrick Winterlich: Thank you, Nick. As a reminder, the majority of our sales is denominated in dollars. However, our cost base is a mix of dollars, euros and British pounds as we have a significant manufacturing presence in Europe. As a result, when the dollar strengthens against the euro and the pound are translate — our sales translate lower, while our costs also translate lower leading to a net benefit to our margins. Conversely, a weak dollar is a headwind for our financial results. We hedge this currency exposure over a 10-quarter horizon to protect our operating income. As a result, currency changes are laid into financial results over time. As a reminder, the year-over-year sales comparisons and I will provide are in constant currency, which thereby removes the foreign exchange impact to sales.

Turning to our three markets, Commercial Aerospace represented approximately 58% of total fourth quarter 2022 sales. Fourth quarter Commercial Aerospace sales of $256.2 million increased 28.9% compared to the fourth quarter of 2021. The Airbus A320neo and A350 grew the strongest followed by encouraging growth from both the Boeing 787 and 737 MAX. Business and regional jets grew strongly year-over-year. Space and Defense represented 29% of the fourth quarter sales and totaled $126.5 million, increasing 22% from the same period in 2021. Strength was broad based globally with growth in all of our various sub-sectors including fixed-wing rotorcraft and space. Industrial comprised 13% of fourth quarter 2022 sales. Industrial sales totaled $46.7 million decreasing 7% compared to the fourth quarter of 2021 on lower wind energy sales.

For wind energy, the year-over-year fourth quarter comparison was somewhat challenging, as they were still wind energy sales in Asia for the prior year period, but no sales in the fourth quarter of 2022. Wind energy sales stabilized in the second half of 2022 with sales virtually unchanged sequentially from the third quarter to the fourth quarter of 2022. Recreation and Other Industrial sales grew year-over-year whereas automotive was unchanged. On a consolidated basis, gross margin for the fourth quarter was 23.1%, compared to 19.2% in the fourth quarter of 2021. Higher sales volume is driving favorable operating leverage, although inflationary cost pressures and the productivity challenges related to a less experienced workforce remain headwinds.

Additionally, energy costs continue to pressure margins and we are working to minimize near-term volatility. We do this by locking in forward contracts typically for 12 months and these assumptions are built into our guidance for 2023. As a percentage of sales, selling, general and administrative expenses and R&D expenses were 12.3% in the current quarter, compared to 12.2% in the fourth quarter of 2021. The fourth quarter saw a rebalancing of an unusually low third quarter SG&A expense. For the year SG&A and R&D expenses were 12.3% of sales, compared to 13.6% of sales in 2021. Adjusted operating income in the fourth quarter was $46.3 million or 10.8% of sales. The year-over-year impact of exchange rates in the fourth quarter to adjusted operating income was favorable by approximately 40 basis points.

The financial impact of closing the Tianjin, China wind energy plant was not material. The plant size is just under 90,000 square feet. So relatively small for Hexcel. Most of the assets were fully depreciated and the charges incurred were primarily severance related. Now turning to our two segments. The Composite Materials segment represented 83% of total sales and generated a 12.7% operating margin strengthening year-over-year on higher sales to support increased capacity utilization. The operating margin in the comparable prior year period was 8.7%. The Engineered Products segment, which is comprised of our structures and engineered core businesses represented 17% of total sales and generated a 14.4% operating margin, driven by favorable sales mix.

The operating margin in the comparable prior year period was 4.2%. The effective tax rate for the fourth quarter of 2022 was 17.7%. For full year 2022 the effective tax rate was 21.1%. Changes in the geographic mix of profitability, as well as changes in valuation allowances impacted the effective tax rate in 2022. Net cash generated by operating activities for 2022 was $173.1 million, compared to a $151.7 million in 2021. Working capital was a use of cash of $72.7 million in 2022 increasing to support higher sales. Capital expenditures on an accrual basis was $69.8 million for fiscal year 2022, compared to $41.4 million for fiscal year 2021, with the growth largely reflecting the construction of the new R&D innovation center at our Salt Lake City, Utah facility and the expansion of our engineered core facility at Casablanca Morocco.

Free cash flow was $98.7 million for the fourth quarter of 2022 and was $96.8 million for the fiscal year 2022. Rising profitability was favorable to cash generation, partially offset by higher working capital that is supporting our sales growth along with higher capital expenditure in 2022. In 2021, free cash flow generation was $123.8 million. The Board of Directors declared a $12.5 quarterly dividend yesterday payable to stockholders of record as of February 10th with a payment date of February 17th. We did not repurchase any common stock during the fourth quarter of 2022. The remaining authorization under the share purchase reprogram on December 31, 2022, was $217 million. Finally. I would like to share additional details regarding our 2023 guidance.

As Nick stated, we are forecasting sales in the range of $1.725 billion to $1.825 billion, adjusted diluted EPS in the range of $1.70 to $1.90 and free cash flow of greater than $140 million. Accrued capital expenditures are forecast in the range of $90 million. This forecast includes ongoing maintenance capital expenditures, as well as the spend related to the reinitiated fiber line construction, the completion of the work on our R&D center in Salt Lake City and the expansion of our facility in Morocco. We expect full year 2023 Commercial Aerospace sales to compromise approximately 58% of total sales. Our sales forecast are based on publicly stated OEM aircraft build rates and expectations. We expect Space and Defense to comprise approximately 29% of total sales and we expect Industrial to comprise approximately 13% of total sales.

Additionally, we expect depreciation to remain similar to 2022 levels. We have locked in much of our forecast energy and intended trial needs for 2023 to minimize the impact on our margins of any price volatility experienced in those markets. Consistent with prior year’s selling, general and administrative expenses are forecast to be higher in the first quarter of 2023 compared to the following quarters, reflecting the timing of recording stock-based compensation expense. Continuing on this seasonality, we expect free cash flow to be stronger in the second half of the year. Our 2023 forecast foreign exchange exposure is more than 80% hedged today. Based on our existing hedges, foreign exchange is forecasted to be a tailwind in 2023 and is incorporated into our guidance.

We estimate that a 5% movement in relevant exchange rates would have approximately $2.5 million impact on earnings net of our hedges. We expect the effective tax rate in 2023 to be approximately 23%. With that, let me turn the call back to Nick.

Nick Stanage: Thanks, Patrick. Before I turn it over to questions, I wanted to share with you that earlier this month I had the pleasure of welcoming the Hexcel team to our 75th anniversary and to set the stage for a year-long celebration of the pivotal moments and people in our past that have propelled us to this significant moment in our history. This anniversary provides us with a rare opportunity not only to look back at our shared legacy as a company but also to look ahead to all that Hexcel can and will become in the next five years, 10 years or 25 years from now when we celebrate our 100th anniversary. Our history at Hexcel is rich and diverse. It was in 1948 that two 20-something-year-old mechanical engineers who had recently graduated from the University of California, Berkeley and completed service in the US Navy took $500 moved into a basement workshop and changed the aerospace industry forever with some fiberglass, honeycomb-dipped in resin.

And although much has changed in the world and with Hexcel, since the time of our founding, one thing has never changed and that’s lightweight. It was our first innovation and for 75 years, we have continued building a strong, broad portfolio of lightweight materials for our customers. We have changed the world for the better. Over its 75-year history, Hexcel has completed more than 20 mergers and acquisitions. All that we are today reflects all that we have been in the past and challenges us to continue building a strong foundation for the future. Hexcel has been a composite leader for 75 years and will continue to lead our industry for at least 75 more. Lightweight composites are the future of sustainability. Hexcel has the products, the knowledge, and most importantly, the people to deliver that sustainable and profitable future.

Emma, we are ready to take questions now. Thank you.

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Q&A Session

Operator: Thank you. Your first question comes from the line of David Strauss with Barclays. Your line is now open.

David Strauss: Thanks. Good morning, everyone.

Nick Stanage: Good morning, David.

Patrick Winterlich: Good morning.

David Strauss: Could you touch on the margin outlook implied in the guidance for 2023, it looks like you are implying somewhere in the mid-30% incremental margin range, if that’s correct? And you have previously talked about getting back to the mid-teens margins when you get back to $1.8 billion to $1.9 billion on revenue, is that still how you are thinking about progression from here?

Nick Stanage: Yeah. Hi, David. So, I mean, firstly, yes, you are in the ballpark that is kind of the leverage shape that we are seeing. You can do the math that’s built into our guidance. So I would agree with that. And then, I mean the caveat there, I mean, we will drive it as strong as we can as we always do with incremental volumes and margins we are going to continue to push. So we will do that as much as we can. And I guess in relation to that, I mean, we called it out, I mean, I mentioned it in the analysis we do have some headwinds around the edges of our cost range. We do a very good job on sort of long-term contracts for our resins and major fibers and hedging FX and hedging acrylonitrile, but we do have inflationary exposures around minor raw materials, freight, packaging, energy, expect the energy in Europe.

And so those mid-teens margins 14% to 16% range are more challenged right now, but we are not giving up on those targets and we are going to push as hard as we can, especially as the revenue continues to grow in the next sort of a couple of years up towards that, yeah, $1.8 billion, $1.9 billion and plus range. So we will keep driving, but there are headwinds today that makes it a bit tougher.

David Strauss: Okay. And in terms of capital deployment from here, you obviously announce the dividend increase, you have been paying down a bit of debt, obviously, you still have authorization on the share repo program. How should we think about what you might do with the cash that you are going to generate next year, would you see yourself getting back to buying back stock? Thanks.

Patrick Winterlich: Yeah. I mean, our priorities remain the same. We are always going to look after our organic growth, but we are doing that comfortably now. We should be under that 100 level of CapEx as we called out for a few years now. M&A is definitely on our agenda. We are staying focused and disciplined for opportunities. We see that as part of our growth. But in the meantime, we announced what we believe is a very positive dividend increase, the 25% from $10 to $12.5. And yes, stock repurchases will come onto our agenda if the cash starts to come in. This year, next year, the next two or three years we are going to generate a lot of cash, it’s going to start to flow. And undoubtedly, I would expect stock repurchases to emerge at some point, but M&A we are staying disciplined increase in dividends and then balance that with some stock repurchases is how I would look at it.

David Strauss: Thanks very much.

Operator: Your next question comes from the line of Pete Skibitski with Alembic Global. Your line is now open.

Pete Skibitski: Hey. Good morning, guys.

Nick Stanage: Good morning.

Pete Skibitski: Maybe you could — can you speak to sort of raw material and labor inflation and your ability to kind of pass that through to customers kind of understanding you have hedging? And then also part two of that is, on all the new hires that you have made, how long do you expect it to take to get the new hires up the learning curve? Thanks.

Nick Stanage: So in terms of, I mean, we have talked about the raw material inflations and even just to David, as I was saying, we do a good job for some of our key raw materials to mitigate the impact, but we are not immune to inflationary pressures and so we have seen them. I think we probably 2022 saw bigger inflationary pressures and hopefully, we are going to see in 2023, we are starting to see it dissipate. Energy costs, however, in Europe are high. Where we can part pricing through or sort of increase pricing to sort of cover those cost increases we do, we have a lot of long-term contracts, some of which have formulas that led us to pass it through and we obviously take advantage of that wherever we can and work with our customers to manage pricing.

Industrial, we have more flexibility that tends to just flow straight through formulas. So we do have some price increase flow-through, but a lot of the time we are taking efficiency and productivity to manage and overcome the inflationary pressures. In terms of labor, you can’t give someone five-years, three years of experience in six months or nine months, but we are working as hard and are focused as hard as we can on training and accelerating it. And we were very encouraged by the output, and the production we saw in Q4, which really underpinned our ability to get out of a high level of sales. By the end of Q3, we called out the strong demand and we certainly saw that in the fourth quarter. So we are still working on training, it’s not a short-term fix and working on pushing it through 2023.

Pete Skibitski: Sorry, you guys cut out for a minute there. I appreciate the time. I will let it pass on. Thanks.

Nick Stanage: Thanks, Pete.

Operator: Your next question comes from the line of Sheila Kahyaoglu with Jefferies. Your line is now open. Pardon me, so next question, oh, my apologies.

Unidentified Analyst: Sorry, this is on for Sheila. Just on the organic sales growth of low-teens in 2023, how are you thinking about the contribution from narrow-bodies versus wide-body ramp given disruptions to the MAX and 787?

Patrick Winterlich: We have already given.

Nick Stanage: I think I heard the question, Patrick.