Kaiser Aluminum Corporation
Q2 2021 Earnings Call Transcript

Published: 22 Jul 2021

[Operator:]

Welcome to the Second Quarter 2021 Earnings Conference Call. My name is Jackie and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. I will now like to turn the call over to Melinda Ellsworth. Ms. Ellsworth, you begin.

[Melinda Ellsworth:]

Thank you. Good afternoon, everyone, and welcome to Kaiser Aluminum's second quarter and first half 2021 earnings conference call. If you have not seen a copy of our earnings release, please visit the Investor Relations page on our website at kaiseraluminum.com. We’ve also posted a PDF version of the slide presentation for this call. Joining me on the call today, our President and Chief Executive Officer, Keith Harvey; Executive 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 three 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.

[Keith Harvey:]

Thanks, Melinda, and welcome to the second quarter 2021 Kaiser Aluminum earnings call. Turning to Slide 6. Our second quarter results reflect the first time we have included the financial impact of our Warrick Rolling Mill acquisition, including revenue, operating expenses and costs associated with integrating the business into Kaiser. We delivered strong value-added revenue of $318 million and adjusted EBITDA of $59 million for the quarter. We continue to see improving conditions in all of our end markets with automotive sales being the exception for the quarter as strong demand was offset by ongoing shortages of computer chips, that once again impacted North American light vehicle production. In today's inflationary environment, our operations and commercial teams have been working diligently to identify and pass-through rising costs associated with freight, labor and materials. In addition, while our workforce has risen to the challenge of meeting increasing demand, we are facing the same challenges as other employers, including the ability to efficiently attract and add labor to meet that demand, which has led to slightly higher labor costs.

[Neal West:]

Thanks, Keith, and good morning, everyone. Turning to Slide 8. Value-added revenue of $490 million for the first half of 2021 increased to $184 million for 60% compared to the second half 2020, primarily reflecting the $132 million of value-added revenue contributed from our first full quarter of the Warrick acquisition in addition to the continuing improvement in each of our other end market applications. Value-added revenue for the second quarter of 2021 of $318 million increased to $143 million or 82% compared to the prior year period, driven by the previously mentioned packaging applications and continued improvement in our general engineering and automotive applications.

[Keith Harvey:]

Thanks Neal. So let's turn to Slide 15. So we're now seeing strong recovery from the pandemic in all the key markets we serve. Aerospace is beginning to build momentum as our shipments and future bookings have started to increase as commercial air travel begins to recover. As we have stated since the onset of the pandemic, we expect the aerospace market to recover to record 2019 levels by 2023 or 2024 and then resume its pre-pandemic 3% to 4% compound annual growth rate. Our anticipated timing for this recovery aligns with that of our major customers. And we expect the recovery to be the catalyst for restarting our previously announced Phase VII expansion at our Trentwood rolling mill to support the expected growth of heat treat plate for our aerospace and general engineering customers.

[Operator:]

Thank you. We will now begin the question-and-answer session. And our first question comes from Curt Woodworth with Credit Suisse. Please go ahead.

[Curt Woodworth:]

Yes. Thank you. Good afternoon.

[Keith Harvey:]

Hi, Curt.

[Curt Woodworth:]

My first question is with respect to Warrick, I wondered if you could provide some more detail on the expansion in terms of how much incremental capacity you'll get from the new mill. And with respect to sourcing substrate, can you talk to that too? Is the expectation that you'll take in more metal from the Warrick smelter or are you looking at more recycled material? And then how do you see kind of the end product mix of that facility going forward?

[Keith Harvey:]

Sure. Well, the volume focus here, this is more of a mixed focus for that facility. A good portion of that mill is already participating in coated products. We have a very strong position with many of our customers there. And as we continue to see the growth ramp overall in food and beverage, the coated side continues to be an area that we see significant opportunity. During the due diligence process, we highlighted this opportunity and we're determined as part of the acquisition strategy to try to initiate this growth going forward. So this provides us a significant amount, more of mix for coated, which for us is a higher margin opportunity. As far as substrate goes, Curt, we're obligated to take a portion of our business from the Alcoa smelter for a period of time and we will do so. But the long-term expectations are is that we will continue to bring in more scrap material, more UBCs to manage that. The end customers are requiring more sustainability; the greenhouse gas, the footprint, carbon footprint. So the message is very clear. We will be moving over the years towards a more and more scrap-based type substrate. And other than that, we do purchase some and you get on the outside. And we typically manage that with the other two items in understanding. And then the third part, Curt, can you tell me – remind me what the third part of your question was?

[Curt Woodworth:]

Well, just how the product mix…

[Keith Harvey:]

Around the product mix?

[Curt Woodworth:]

Yes.

[Keith Harvey:]

Yes. Currently, a significant portion over half of our business really focuses on coated materials out of the facility. And we're large participants with not only beverage, but also food cans. And all of the customers that we continue to talk with, continue to see growing demand, the need and the desire for more domestic material. And that not only covers the body stock, but it also covers the coated in stock and the other items, especially as they relate to the food products. So we're seeing that demand and we're probably, I think, best suited to take advantage of that opportunity. And so we're moving in sync with our major customers to try to shore that up and provide more of that domestic product in those applications. So we see that mix becoming a larger share of our total operating mix out of the Warrick facility.

[Curt Woodworth:]

Okay, great. That's helpful. And then with respect to the current, I guess, operating footprint, you've got some obviously artificial issues with auto with the chip shortage and we know aero is basically at near bottom. I was wondering, can you talk to your current utilization rates across your system? And how successful have you been to be able to redeploy, some say, that spare aerospace capacity into other markets like GE, other types of plates? Thank you.

[Keith Harvey:]

Yes. Actually, we've been very successful. And you can see that if you look in the shipments and the breakout in the various markets that we're in. You'll see that our general engineering shipments are up substantially through the period and we expect that to continue. That is the ability that comes in two areas; one is the Trentwood facility, which we ran into the situation where we couldn't meet the aerospace demand and general engineering demand in 2019. We're seeing very strong demand in the general engineering products. And so we pivoted early last year and that just continues to expand every quarter at Trentwood. So we see that continuing on into 2022. The other side that we're doing a very good job, the teams are doing an excellent job is on the automotive side. So on the automotive facilities that we participate, they also I think every one of them also have a component of their business where we supply to the general engineering to our service center customers. And so as that demand has continued to meet levels as I stated, stronger than we've seen in many years, we've just pivoted that capacity from the auto and moved those – that volume through our presses over to supply the general engineering. And we have a pretty good supply chain to be able to provide that. So that's been fairly seamless and it's been an area where it's been very profitable too. The opportunity there, as we've stated with the costs that have been ratcheting up around freight and others, we have been rapidly increasing prices and passing through those costs, and we've been able to do that through that general engineering side as well.

[Curt Woodworth:]

Okay, great. And then just one final one. I know you have the excellent position within distribution. Did you feel like the supply chain has – is there more restocking to go? Do you feel like – clearly in aero there had been some excess inventory issues at the start of the year, but do you feel like the supply chain has restocked at this point? Or what's your sense for where we stand? I know it varies among end product, but thank you.

[Keith Harvey:]

Yes, it does. But in the past, Curt, when Jack would answer this question, we would follow the road and bar from the MSCI. We would look at – watch inventories there and sales and shipments from mills to the service centers. We haven't seen that in a couple of months, but the last time we saw that, we have – our sales had started to ramp up in the fourth quarter of last year, maybe even part of the third quarter. And as we watched in December, I know in our first quarter call, we mentioned that, look, we're seeing a significant increase in shipments and bookings, but as we watched the inventory levels, the inventory levels are not coming up at the service centers. So – and I anticipate as we know that the whole supply chain is in a restocking mode, but we're clearly seeing strong rebound from the pandemic as well. So I think you're going to see restocking continued through the balance of the year. And we think things will continue to be strong in 2022, but we'll keep our feelers out. But for now, I think with lead times – lead times in some of our long products are out to 20-plus weeks, and then on our flat-rolled products in that category we're out to 13 and 14 weeks. So we've got a pretty good handle on that demand going forward. And we think the balance of the year is going to be very strong and very tight.

[Curt Woodworth:]

That's great color. Thanks very much. Best of luck.

[Keith Harvey:]

Thank you, Curt.

[Operator:]

Thank you. Our next question comes from Josh Sullivan with Benchmark. Please go ahead.

[Josh Sullivan:]

Hey, good afternoon.

[Keith Harvey:]

Hi, Josh.

[Josh Sullivan:]

Just on the inflationary pressures, can you detail what was labor and what was freight just in the quarter? And then on the labor side, some of these capital investments you're planning, are you designing in any more automation or ways to combat labor inflation long-term?

[Neal West:]

Yes. So you combine the cost. If you compare the first quarter where we were roughly 20%, 22% on our margins, EBITDA margins, and this quarter we came in roughly around an 18.5%. That's about the difference between mainly freight and additional planned overhead as we ramp up, and some of the inefficiencies. So that really is the difference there in that category. And then absolutely quite frankly, here are the components that are very – have to be assertive, have to be identified and have to be evaluated in any investment. One, what are the market conditions? And do we have the support to get the return on the investment? So we remained very disciplined in looking at those and when we will launch these investments. And then second, we take a look, not at just on the commercial opportunity. We’ll look at how do we improve efficiencies and/or how we lower the cost? So automation is continuing to be a major part of what we look at. AI is continuing to be evaluated in every investment we look for, and some of those opportunities apply we're able to launch the Phase VII and get more productivity out with the lower investment upfront figure. So we’ll take a look at that. And then final another component that we're evaluating with every investment and everything we're doing is the sustainment potential. You know, how does that help on our carbon footprint? How does that help move us toward our objectives of what we're trying to achieve on our environmental, social governance type focus? So every one of those questions have to be addressed with every investment and then we get a good idea of what the impact can be to the overall business.

[Josh Sullivan:]

Got it. And then just with regard to the commercial aerospace plate outlook, you might've kind of answered it with Curt's question, but how does that breakdown between service distributor demand and then directly to the aerospace OEMs? And then just related to that, you know Airbus has come out here with some longer-term guidance, giving the industry something to sink their teeth into, but can you detect your level, any discrepancies on plate pull-through between the OEMs at this point?

[Keith Harvey:]

Well. As we've stated all along Josh, we've been talking with the OEMs at the very beginning of the onset of the pandemic. And some have announced that we're also looking and speaking with them. So we're seeing the ramp up of their needs. We already have some clear clarity into next year what their needs are going to be and then as we go forward. And we are seeing a little bit of more urgency of putting that in place and positioning for. We're looking at extensions of our major contracts, so that give us – that gives us more confidence in the volumes that are going to be required and the needs of our overall business. But one area that really stands out and I think it needs to be discussed more in, in 2019 as we saw the record levels for at the time for aerospace. And we expect to get back there as I stated in 2023 and 2024. At that time, we were turning away business for general engineering plate. And we weren't able to meet the – satisfy the demand from our customers and we intend to address that with this Phase VII in a big way. So we're preparing not just for the return for aerospace, but we're preparing to continue to supply and grow our general engineering participation specifically with the service center customers. So that's going to be our commitment and another area of quite frankly, the – making sure the investment is substantially backed up with orders. And that's our intent with the Phase VII expansion. We haven't launched that yet. We haven't had approved. We're going to be evaluating the markets. We're going to be evaluating the needs, but again we're looking at the aerospace recovery. We're looking at the growing general engineering demand for plate for domestic plate. And we'll pull that shot when it's time to do so.

[Josh Sullivan:]

Got it. And I guess taking that all together, the long-term guidance or outlook that you're putting out there, how should we think about the cadence or timeline to get to that?

[Keith Harvey:]

Well, if you follow the – how we've outlined, and if the markets behave as we expect. We expect to be back to the 2019 levels at which time we were squeezed on capacity for Phase VII, for Phase VI at the time. And it was really the impetus for launching Phase VII. So we intend to get back there in 2023, 2024, we believe. That may be pushed up as if general engineering continues to grow and if indeed there's been a change as we suspect with the need for domestic supply. So when we take a look at that, we'll have to back up 18 to 24 months to begin to place the equipment orders and so forth, to be prepared for that demand in 2023 or 2024. So we'll be evaluating this here over the next six to 12 months and see what the timing for that will be. On the $150 million for Warrick on the roll coat line, that need is immediate. It's urgent. I wish I had it in the ground. I wish we had started this the day we started our talks. Our customers are – have been very supportive and we're aware. The reason we exited packaging in the 1990s is that, we could not sustain investments and the market was a little bit on the demand supply side, not going with us. So we're being very cognizant of that growth going forward. But as we see it, we've stated, we're sold out for 2021, 2022 through 2024, looks extremely strong. And our customers are asking for more capacity and are willing to back that up with long-term commitments. So we're going to start that. We've already started that process and hope to begin it, and we are beginning it and plans are to have it in the ground and operational early 2024. So we're – as usual, we're being very disciplined in our approach, it's backed up by demand and when that's there and we can justify the investments we're going to act accordingly.

[Josh Sullivan:]

Got it. And then just on the automotive side, you mentioned the lead times for aerospace. And what do the lead times on the automotive side look like just as that 3Q, 4Q ramp on the OEM side picks up?

[Keith Harvey:]

It's an interesting point, Josh and I was a lot more comfortable before we came this morning, but General Motors came out this morning prior to our call and announced that, on the T1 line which is their light-truck and anticipation, they're anticipating more shutdowns for third quarter. And we're still seeing a number of new programs launched and those have been successful in growth, but this chip shortage continues to be around. We're talking with customers, we're going to watch, evaluate, but the good thing for us at this moment, if we see continued decline on the automotive, those plants can quickly go over and try to meet the general engineering need, which is strong, robust and continues to have extremely long lead times comparatively speaking. And so we'll adjust that capacity to meet the needs in general engineering.

[Josh Sullivan:]

Okay. Thank you for the time.

[Keith Harvey:]

Thank you, Josh.

[Operator:]

Thank you. We have no further questions at this time. I would like to turn the call over to Keith Harvey for closing remarks.

[Keith Harvey:]

Okay. Well, thank you for your interest in Kaiser Aluminum. We appreciate your attendance here and your interest in our company. We look forward to talking with you next quarter on the third quarter outlook. So thank you and have a good day.

[Operator:]

Thank you, ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.