HWM - From Spin-Off To Takeoff: How Howmet Aerospace Aces The Aerospace Industry

2023-08-03 12:06:24 ET

Summary

• Howmet Aerospace emerges as a strong aerospace player, benefiting from post-pandemic recovery, robust commercial aviation and defense demand, supply chain improvements, and a positive outlook.
• 2Q23 earnings reveal impressive YoY revenue growth of 18%, driven by strong commercial aerospace and defense sales, marked by a 23% rise in the former and 17% in the latter.
• HWM's diversified segments, including commercial aerospace, defense, transportation, and industrial markets, contribute to its solid performance and improved balance sheet, supporting stock repurchases and potential dividend growth.

Introduction

I've covered Howmet Aerospace ( HWM ) since it became an aerospace-focused aerospace play after spinning off the Arconic Corporation ( ARNC ) in 2020.

Since then, the stock has become a huge outperformer. Since early 2021, the stock has doubled, as it is now benefitting from a wide range of tailwinds, including a very steep recovery in commercial aviation demand, strong defense demand, easing supply chains, and a great outlook.

Since I wrote an article titled Why I Strongly Believe In Howmet Aerospace in September of last year, the stock has returned 33%, which means it's time for an update.

And what better way to update the thesis than by incorporating the just-released 2Q23 earnings, which confirmed strength across the board, resulting in higher guidance?

So, let's dive into the details!

HWM Is Back On Track

Howmet Aerospace has a fascinating stock price history. Since early 2020, the stock has been (more or less) a pure-play aerospace play. Before 2016, it also included Alcoa ( AA ) and Arconic. Alcoa was spun off in 2016 to become a pure-play aluminum and alumina player. Arconic was spun off in 2020 to turn HWM into a value-adding aerospace play.

Arconic is a supplier of aluminum sheet, plate, and extruded products for the aerospace, automotive, and transportation industries (among others).

In other words, the pre-2016 Alcoa Corporation has spun off into three separate companies that each dominate one part of the aluminum value chain: from raw material to finished aerospace parts.

The 2020 spin-off was exciting. As I've always been interested in aerospace stocks, I was quite excited. Unfortunately, the spin-off came during the pandemic, which did a number on aerospace demand. While the company quickly recovered, it was followed by severe supply chain issues that kept a lid on the stock between the summer of 2021 and the end of 2022.

Now, HWM has broken out quite violently, as everything is going in its favor.

In the opening remarks of the 2Q23 earnings call on August 1, John Plant, CEO of Howmet, highlighted the strong performance of the company.

• Revenues surged by 18% year-over-year and 3% sequentially.
• Notably, the commercial aerospace segment demonstrated strong growth, increasing by 23% year-over-year, driven by anticipated increases in Boeing ( BA ) 737 build rates.
• Defense sales also displayed strength, rising by 17%.
• EBITDA showed a robust 16% year-over-year increase and sequential growth.
• Earnings per share reached $0.44, exceeding the high end of the company's guidance, which marks a 26% year-over-year growth.

Looking at the overview below, we see that the company saw strength in every single segment, even cyclical non-aerospace markets, on a year-on-year and sequential basis.

Digging a bit deeper, we find that the commercial aerospace market's upward trajectory has persisted for nine consecutive quarters. It now accounts for 47% of total revenue. This is down from 60% prior to the pandemic, which is somewhat of an indication of how much growth is left until normalization in the industry.

According to the company, commercial aerospace as a percentage of total sales is expected to rise further due to the expanding widebody recovery, a robust backlog of commercial aircraft orders, and spare parts growth.

Note that when suppliers talk about widebody recovery, they mean long-haul flight demand, which is almost always international flight demand. Narrow-body, short-haul demand quickly improved after the pandemic. Long-haul demand is a different story, as various countries (like China) stuck to pandemic restrictions.

Having said that, the company saw strong growth in spare demand for commercial aerospace, which is expected to approach approximately 95% of 2019 levels by year-end.

Looking at the biggest segment, Engine Products, we see a 26% increase in revenue, driven by higher build rates in commercial and defense markets and strength in oil and gas. While costs were a short-term headwind, adjusted EBITDA improved by 25%.

In general, defense aerospace also saw a 17% year-over-year increase, driven by the F-35 and legacy fighter programs.

Transportation, impacting Forged Wheels and Fastening Systems, grew 8% year-over-year and 2% sequentially due to heightened volumes.

Industrial and other markets saw a 20% year-over-year increase, with oil and gas rising by 36%, IGT by 20%, and general industrial by 11%.

Based on this context, the company maintained a very healthy balance sheet.

The net leverage ratio improved to a record low of 2.5x (EBITDA). Howmet Aerospace has no debt maturities in 2023 and redeemed $200 million worth of 2024 notes in July.

Thanks to the aforementioned tailwinds and a healthy balance sheet, the company repurchased $100 million of common stock in the second quarter, continuing a streak of common stock repurchases for nine consecutive quarters.

Howmet's Improved Guidance & Outlook

The guidance part is the most interesting part, as the outlook matters more than what happened in the past. Not only with regard to Howmet but also because I have roughly 20% aerospace exposure in my dividend growth portfolio, which means I love to hear what suppliers have to say.

During its earnings call, the company focused on its improved outlook, driven by what it calls an extraordinary backlog of commercial aircraft orders at Boeing and Airbus.

The demand increases have led to higher revenue growth expectations for 2024, 2025, and beyond.

Furthermore, growth in aircraft quantity is further bolstered by advancements in engine technology upgrades by General Electric ( GE ) and Pratt & Whitney for narrow-body markets.

These upgrades address fuel efficiency and time on wing issues, increasing the value of Howmet's differentiated products.

Additionally, the company expects improvements in widebody production featuring composite technology, enhancing the value of Howmet's titanium structures and fasteners, which perfectly underlines an issue I have raised in the past: aerospace innovation and more rapid replacements require more advanced materials.

When it comes to defense, the company noted that markets are robust, with increased revenue anticipated in 2024 due to destocking completion for bulkheads and rising engine spares as shop visits increase.

The F-35 backlog is also growing, with recent orders from various governments. Having analyzed every major defense contractor's earnings in 2Q23, I can confirm that defense demand is improving, which should result in strong demand for HWM for years to come.

Howmet is also looking to increase the dividend by 25% later this year, which would result in a $0.05 per share per quarter dividend.

It would translate to a 0.4% yield, which isn't something to write home about.

However, on a long-term basis, the company could end up with a 5% free cash flow yield (using 2025 estimates). That would pave the way for long-term buybacks and dividend hikes, adding to what will likely be an impressive future total return.

Valuation

Howmet is trading at 16.1x NTM EBITDA. That valuation is fair. This year, EBITDA is expected to grow by 14%, followed by 12% growth in 2024 and 10% growth in 2025.

The current consensus price target is $53, which is 10% above the current price.

In this case, I agree with the outperform rating from Robert W. Baird. This rating came in on July 25 with a price target of $61.

On a long-term basis, I expect HWM shares to outperform the market and the industrial ETF ( XLI ).

The only reason why I do not own HWM is because of my significant exposure to defense contractors. I'll diversify first before adding more exposure to this industry.

Takeaway

After closely monitoring Howmet Aerospace since its aerospace-focused transformation in 2020, the stock has proven to be a standout performer. With a doubling in stock price since early 2021, HWM benefits from multiple tailwinds, including a strong recovery in commercial aviation demand, robust defense sales, improved supply chains, and a promising outlook.

The just-released 2Q23 earnings confirmed the company's strength across the board, with notable year-over-year and sequential growth in revenues, EBITDA, and earnings per share. The commercial aerospace segment's trajectory is particularly impressive, with a continuous upward trend and potential for further growth.

Backed by a healthy balance sheet and positive guidance, HWM is well-positioned to capitalize on the extraordinary backlog of commercial aircraft orders and advancements in engine technology.

Investors should keep an eye on this aerospace gem, as it has the potential to outperform the market and industrial ETF in the long run.

With a dividend increase in the cards and an attractive valuation, Howmet Aerospace presents a compelling case for long-term investment.

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