Kaiser Aluminum Corp Q4 FY2020 Earnings Call

Welcome to the Fourth Quarter 2020 Earnings Conference Call. My name is John, and I will be your operator for today's call. I will now turn the call over to Melinda Ellsworth.

Thank you. Good afternoon, everyone, and welcome to Kaiser Aluminum's Fourth Quarter and Full Year 2020 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 President and Chief Executive 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 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. 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 the company's annual report on Form 10-K for the full year ended December 31, 2020. 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. Reconciliations of certain forward-looking non-GAAP financial measures to comparable GAAP measures are not provided because certain items required for such reconciliations are outside of our control and/or cannot be reasonably predicted or provided without unreasonable effort. Any reference in our discussion today to EBITDA means adjusted EBITDA, which excludes non-run rate items for which we've provided 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 Keith Harvey.

Thanks, Melinda. And welcome, everyone, to Kaiser Aluminum's Fourth Quarter and Full Year 2020 Earnings Call. Our fourth quarter and second half results were slightly more favorable to the outlook we had previously provided due to strength in the automotive and general industrial business in the quarter. We delivered strong performance under severe business conditions as we navigated the significant decline in commercial aerospace demand during the back half of the year, while managing strong demand for our general engineering, automotive, and defense products. For the full year 2020, value-added revenue of $697 million was down approximately 19% compared to our 2019 results, reflecting a strong first quarter, followed by significant COVID-19-related disruptions to our operations and end markets during the remainder of the year. Despite the significant decline in value-added revenue, we reported full year adjusted EBITDA of $154 million and EBITDA margin at a solid 22% in an extremely challenging environment. Our results reflect solid execution of our business cycle strategy and our ability to quickly flex cost and operating levels as we responded to rapidly changing business conditions throughout the year. Aero and high demand experienced the most significant decline year-over-year reflecting the global pandemic's impact on commercial airline travel, delays in recertification of the Boeing 737 MAX and destocking within the supply chain. Value-added revenue for our aero and high strength applications for the full year 2020 was down 28% compared to a record 2019, reflecting record performance in the first quarter and strong contractual commitments that carried us through the remainder of the year. While commercial aerospace demand fell sharply in the second half, we continue to see strong demand for our products in the defense industry, specifically from the Joint Strike Fighter program and other legacy military aircraft programs throughout the year. Automotive extrusion demand remained strong following temporary COVID-19-related supply chain shutdowns in the second quarter. Planned program launches for multiple new platforms ramped up during the second half. New programs were awarded and overall demand improved as North American vehicle build rates increased to 13 million vehicles from 12.3 million vehicles as the industry had previously forecast. Value-added revenue for our general engineered products reflected steady underlying demand, driven in part by strength in semiconductor and automotive applications. Strong customer preference for our KaiserSelect plate and restocking in the supply chain. Pricing remains stable. At Kaiser, as with many other companies that successfully navigated the year in an extremely challenging environment, we owe much of our success to our people and the way they followed our playbook and executed our strategy. There were a number of accomplishments I'd like to share. First and foremost, we operated our business safely. Not only did our organization quickly move to mitigate the spread of COVID-19 in our facilities, we did so by executing with record safety performance for the entire year. It's a significant accomplishment and a testament to our people and the strength of our culture. Our long-term planning process facilitated a smooth CEO succession as well as the transition of other key senior management positions in the company. We continue to maintain rigorous customer satisfaction metrics and strong customer relationships as we continue to deliver leading products and services to our customers. Our strong balance sheet and financial flexibility facilitated our ability to maintain our quarterly dividend and to opportunistically pursue further growth with our pending acquisition of the Warrick rolling mill, which is expected to close on March 31. I'm very proud of the performance of the Kaiser team given the unprecedented challenges we faced in 2020. I will now turn the call over to Neal to review additional detail for the fourth quarter and full year 2020, and then I'll return to discuss our outlook for 2021.

Thanks, Keith. Turning to Slide 8. Value-added revenue for the full year 2020 was $697 million, down from $856 million in 2019, showing a decline of about 20% in shipments, mainly due to the significant impact of COVID-19 on commercial aerospace demand. Additionally, in the second quarter, most of the North American automotive supply chain halted operations, which temporarily reduced demand for our automotive applications. However, demand for our general engineering applications remained strong throughout the year. Aerospace/high strength value-added revenue was $369 million, which represented a roughly 28% decline year-over-year due to a 37% drop in shipments compared to the previous year's solid demand levels. The record first quarter of 2020, strong demand for our defense-related applications, and an extra $15 million in revenue recognized in the third quarter from modifications to multi-year customer contracts partially offset the COVID-19 impact on commercial aerospace demand, as well as a significant drop in shipments during the second half of the year. Automotive value-added revenue was $83 million, an approximate 11% year-on-year decline with an 11% decrease in shipments, reflecting strong shipments in the first quarter followed by the COVID-related OEM shutdowns in the second quarter and a robust recovery starting late in the second quarter which continued into the second half of the year as the automotive supply chain resumed full production and new program launches increased. General engineering value-added revenue rose about 3% year-on-year to $239 million on relatively stable shipments and pricing for the entire year. For the fourth quarter of 2020, value-added revenue stood at $152 million, showing continued strength in demand for our general engineering, automotive, and defense-related applications. Detailed information on value-added revenue and shipments by end market can be found in the presentation appendix. Moving on to Slide 9. Adjusted EBITDA for the full year 2020 was $154 million, down approximately $59 million from $213 million in 2019, mainly due to a negative sales impact of about $74 million and $14 million in manufacturing inefficiencies, balanced by a $17 million decrease in plant and corporate overhead costs and $12 million less in major maintenance and incentive expense. Despite the significant drop in sales, the EBITDA margin for 2020 was 22.1%, which is favorable compared to 24.9% in the previous year, demonstrating our variable cost structure and effective management in adjusting costs and operations with changing market conditions. Adjusted EBITDA for the fourth quarter of 2020 reached $29 million, which translates to an EBITDA margin of 18.8%. On to Slide 10. Reported operating income for 2020 was $81 million. After adjusting for $21 million in non-run-rate charges, the adjusted operating income was $102 million, down from $164 million the previous year. The drop in adjusted operating income primarily stemmed from the decline in EBITDA discussed earlier and an increase of about $3 million in depreciation expense. The $21 million in non-run-rate charges mainly included an $8 million restructuring charge for severance and benefits, a $5 million increase in reserves for ongoing environmental cleanup projects, and about $6 million in diligence and legal fees related to the Warrick acquisition. Reported net income for 2020 was $29 million, compared to $62 million in 2019. Adjusted for non-run-rate items in both years, the adjusted net income was $48 million in 2020 versus $111 million in 2019. The $48 million adjusted net income reflects the effects of lower operating income and an increase of about $16 million in pretax interest related to our recent bond offering. For 2020, our effective tax rate was 26%, aligned with our expected blended federal and state rate. We expect our long-term effective tax rate to remain in the mid-20% range under current tax regulations. Our federal cash tax refund in 2020 was $12 million due to monetizing our A&P and other tax credits. We believe our cash tax rate will stay in the low single digits until we exhaust our federal net operating losses of about $94.6 million by year-end 2020. Our earnings per diluted share were $1.81 in 2020 compared to $3.83 in 2019. Adjusted earnings per diluted share were $3.01 for 2020 and $6.85 for 2019. Turning to Slide 11. The adjusted EBITDA of $154 million covered all our cash needs for the year, including capital investments, interest, dividends, and share repurchases. The reduction in working capital resulted from lower inventory and customer receivables due to decreased shipments. In the second quarter of 2020, we improved our liquidity and financial flexibility by issuing $350 million in 6.5% senior unsecured notes maturing in 2025. Total capital spending for the year was around $52 million, focused primarily on essential capital projects and organic investments to support automotive growth and increase efficiencies across our operations. For the year, we returned a total of $56 million to shareholders, which included $43 million in dividends and about $13 million in share repurchases. We paused share repurchases in early March 2020. Management and our Board are committed to maintaining and potentially increasing our quarterly dividend. We announced a 7.5% increase in our first quarter 2021 dividend to $0.72 per share, paid in early February 2021, following a 12% increase in early 2020. By the end of 2020, we had approximately $780 million in cash and over $252 million in borrowing capacity in our revolving credit facility, leading to total liquidity of $1 billion. There were no borrowings under our revolving credit facility in the quarter, and the facility remained available for use. As Keith mentioned, we plan to finalize the acquisition of the Warrick rolling mill and related operations on March 31, 2021, at which point we will utilize $587 million in cash on hand for the transaction, while also assuming about $83 million in other post-retirement benefit liabilities. Now I will hand the call back to Keith to go over our outlook for 2021.

Thanks, Neal. I'll now review our 2021 outlook beginning on Slide 13. Although we expect continued improvement from the second half 2020 run rate, we anticipate full year 2021 value-added revenue to be down 5% to 8% year-over-year, following a record first quarter and strong first half 2020 as demand in commercial aerospace continues to slowly recover and destocking continues in the supply chain. We are encouraged by positive signs supporting long-term recovery in this market, including the recertification of the 737 MAX late last year and an expected 20% to 30% increase in build rates for the Joint Strike Fighter in 2021. We expect shipments to continue to improve throughout the year. Ongoing dialogue with our commercial aerospace customers continues as we work to manage short-term needs and plan for longer-term opportunities as we anticipate a full recovery in the 2023-2024 time frame. We continue to believe that aerospace demand will return to a long-term 3% to 5% compound annual growth rate and remain committed to meeting the long-term needs of our customers. Although we have placed our previously announced Trentwood capacity expansion planned on hold, we will continue to evaluate market conditions, and we'll be prepared to move forward with our investments as we gain more visibility and clarity around the expected recovery for large commercial aerospace demand. Moving to Slide 14. We anticipate exceptionally strong shipments and value-added revenue for our automotive extrusion applications in 2021. North American build rates are expected to increase from 13 million vehicles in 2020 to over 16 million vehicles in 2021 and for several years beyond that. While we experienced lower demand in 2020 due to COVID disruptions in the supply chain, we successfully initiated multiple program launches in the second half of the year. With more program launches planned throughout 2021, combined with low inventories of vehicles, we expect shipments and value-added revenue, both to increase 35% to 45% year-over-year in 2021. As we look forward, we anticipate growth for our aluminum extrusions at a 10% to 20% compound annual growth rate for Kaiser content growth over the next three years, with long-term growth returning to the mid- to high single digits. Moving to Slide 15. Our outlook for general engineering continues to reflect strong demand for our products, driven by a number of end markets, including semiconductor, manifold bar, automotive applications and a strong demand from our service center customers, who are working hard to meet the needs of their customers and restock their inventories. We anticipate value-added revenue and shipments for our general engineering applications will increase 10% to 15% year-over-year, driven by strong demand and a continued trend towards reshoring of OEM supply chains to minimize risk and further disruptions. Moving to Slide 16 and a summary of our 2021 outlook. For the full year 2021, we anticipate continued improvement from the second half run rate with total value-added revenue up 5% to 10% year-over-year and an adjusted EBITDA margin comparable to 2020. We anticipate capital spending for 2021 will be $50 million to $60 million, primarily focused on sustaining capital investment. We will provide further updates to our capital spending for 2021 following completion of the pending acquisition of Warrick as we have identified additional organic growth opportunities during the diligence process. Moving to Slide 17 and a brief discussion around our pending acquisition of Warrick, as we announced in late 2020 and the outlook for North American beverage and food can packaging industry. We anticipate closing on the transaction on March 31 and look forward to welcoming the Warrick employees to the Kaiser family. Our planned acquisition of the Warrick rolling mill provides an opportunity for further value creation with strong secular growth in the noncyclic packaging industry. The transaction is expected to be immediately accretive to earnings and cash flow. As we noted at the time of the announcement, Warrick generated value-added revenue of approximately $500 million and adjusted EBITDA of approximately $90 million for the last 12 months ending September 30, 2020. We will provide a further update on our consolidated full year outlook for 2021 during our first quarter earnings call in April. The outlook for beverage and food packaging markets is strong and favorable demand and industry dynamics driving growth for the foreseeable future. Demand for these products was up 5% year-over-year in 2020 and is projected to increase an additional 3% to 5% in 2021. North American food and beverage can market continues to be supplemented with import material due to demand versus domestic supply imbalances. And these domestic supply deficits are expected to continue through 2025 at current forecast, driven by the growing demand and recognition of aluminum as the material of choice due to its infinite recyclability and a preference for its use in growing specialty drinks and some still water products by consumers and can makers. The Warrick rolling mill is one of only four dedicated can sheet mills in North America, and we expect to become a significant participant in the supply chain solution in meeting the growing North American demand. Turning to Slide 19 and a summary of our closing remarks. We finished a turbulent 2020 with solid performance, a strong balance sheet with $1 billion in liquidity. We entered into a definitive agreement to complete a transformational acquisition which is anticipated to close on March 31 and is expected to be immediately accretive to earnings and cash. The Warrick acquisition diversifies our portfolio into the noncyclic packaging industry. It's highly complementary to our aerospace, automotive, and general industrial cyclic end markets and provides excellent opportunities for long-term growth. We have strong positions with blue-chip customers in each of our served markets and are poised for further growth. While commercial aerospace demand has a slightly longer path to recovery, we have solid long-term agreements in place to secure our positions with full recovery expected in 2023 and 2024. Our long-term defense contracts are expected to continue to partially offset lower commercial aerospace demand with solid growth expected in 2021. Both automotive and general engineering markets are expected to be robust in 2021, and we are well positioned with capacity, new programs, long-term supply agreements, and strong relationships with our automotive and service center partners. Our Kaiser business cycle strategy, which guides us in operating in volatile market conditions, has us well positioned and poised to improve margins in our operations as volumes and market conditions improve. Our balance sheet remains solid and is expected to remain so after the closing of the Warrick transaction. We recently announced our tenth consecutive year for dividend increases, with an announced 7.5% increase in 2021, following a 12% increase in 2020. Our commitment to return excess capital to our shareholders remains one of the pillars of our capital allocation priorities. As we look forward, 2021 will be a very exciting year for our company. We celebrate our 75th anniversary this year, and I think our founder, Henry J. Kaiser, would be proud of how we have positioned the company for continued success for years to come. We remain focused on executing our strategy while continuing to work safely in a very tough environment disrupted by the pandemic. But our future is bright, and there's a growing excitement as we add a thriving packaging business into the Kaiser portfolio and welcome the 1,200 Warrick rolling mill employees to Kaiser Aluminum. With that, I'll now open the call to any questions you may have.

And our question is from Josh Sullivan from The Benchmark Company.

Just on the Warrick acquisition and the operations, can you tell us about any customer contracting that might be up for renegotiations this year? Or just what we should be thinking about as far as the contracting cycle at Warrick?

Sure. Cyclic contracts for that packaging business appears, what we've seen, to be in the 2- to 3-year type framework. We know that through the diligence, there were already begin negotiation with some contracts in 2020, and that is continuing through 2021. So the short term, most of the contracts are billed. The facility is basically booked for the balance of this year. And they're currently looking out through the 2023-2024 time frame.

Sure. As you consider the expansion efforts that were once limited to Trentwood and now include the Warrick operations, can you discuss how you plan to approach expansion or how you will distribute those capital improvement funds moving forward?

The pandemic created a pause for us, which may ultimately be beneficial. As I mentioned earlier, during the diligence process, while the team at the Warrick facility has performed exceptionally well, we see opportunities for immediate investment to enhance the growth and momentum there. We're able to make these investments during the aerospace slowdown. In our planning and capital prioritization, we are considering how to fund both growth areas. When aerospace activity resumes, we fully intend to reinstate that program and increase capacity to meet the long-term demands of our customers.

Got it. And then just 1 on automotive, given the growth you're looking at with the new product launches here, can you talk a little bit about the penetration of aluminum content on those new models? I think in the past, you've talked about aluminum penetration growing at about 8% above SAAR. Just curious what the new models suggest as far as that kind of penetration starting.

That's a great question. Looking at the growth of SAAR year-over-year, we expect roughly a 23% increase. We're announcing a type of increase in the range of 30% to 40%. You can see that our penetration is in the range of 8% to 10% and above, which we've mentioned for the long term. This is still on track, and we're seeing it accelerate slightly over the next few years.

Okay. And then just one last question regarding the general engineering side, specifically the semiconductor exposure. Can you discuss the visibility in that area? How significant of a cycle do you anticipate in demand as they expand their capacity?

Yes. Everything we see and hear, Josh, is that this thing, which has had legs in 2020, we see this continuing throughout 2021. It's been well publicized, the shortages of semiconductor chips and all of that. And what we're seeing is continued growing demand. We expect to probably place even more growth in the GE business as we go forward this year because of that demand. And so we see that well through 2021, maybe into 2022.

Thank you.

And we have no further questions at this time. I'll now turn it back to Keith Harvey for final remarks.

Well, thank you very much for your time and interest in Kaiser Aluminum. I look forward to updating you on our first quarter results and our outlook and plans for the balance of 2021 during our first quarter earnings call in April. Have a good day.

Thank you, ladies and gentlemen, that concludes today's call. Thank you for participating, and you may now disconnect.