MTU Aero Engines AG (OTCPK:MTUAF) Q3 2022 Results Earnings Conference Call October 30, 2022 5:00 AM ET
Company Participants
Claudia Heinle – Senior Manager Investor Relations
Reiner Winkler – Chief Executive Officer
Peter Kameritsch – Chief Financial Officer
Conference Call Participants
Robert Stallard – Vertical Research Partners
George Zhao – Bernstein
Ben Heelan – Bank of America
Harry Breach – Stifel
Chloe Lemarie – Jefferies
Christophe Menard – Deutsche Bank
David Perry – J.P. Morgan.
Richard Schramm – HSBC
Claudia Heinle
Good morning, ladies and gentlemen, and welcome to our Q3 Earnings Call. First of all, I would like to apologize on behalf of Thomas Franz who is unable to participate in our conference call today as he is unfortunately ill. Get well soon, Thomas.
As usual, we will start with a review presented by Reiner. Peter will provide the financial overview and details on the segments. Finally, Reiner will guide you through our latest outlook on the remainder of the year. This concludes our presentation and we will open the call for questions.
Let me now hand over to Reiner for the review.
Reiner Winkler
Yeah. Thank you, Claudia. And also very warm welcome from my side. The robust positive trend of air traffic recovery continued in August, with passenger traffic reaching 74% of pre-COVID levels. Domestic traffic improved to 86% while international traffic is at 67%. Cargo traffic showed resilience in August, being slightly above 2019 levels. So recovery is underway, but ongoing challenges such as recession fears, price inflation, and a new wave of COVID-19 infections during winter, they remain. So, this needs to be monitored closely.
Our new parts repair shop, MTU Serbia, officially opened its facility near Belgrade. It has a capacity of 470,000 repair hours and will increase its workforce to more than 400 employees over the coming years.
Repair instead of replacement. Not only is this a major cost saver, but more than that, it is also a driver to a more sustainable business. The additional MRO capacity in Serbia will further improve our strong and flexible network and boost our ability to offer competitive services in the global markets.
We have signed an agreement detailing our aftermarket participation in the PW800 engine program. This enables us to perform full overhauls of PW800 engines at our site in Ludwigsfelde. This further strengthens MTU positions in the heavy business jet segment as the PW800 engine powers four business jet applications. Currently, there are more than 300 engines in operation and the number continues to rise.
Pratt & Whitney has started flight testing with a GTF Advantage on an A320neo aircraft. Flight testing and certification work will continue through the first half of 2023. The entry into service is expected then in 2024. The GTF Advantage configuration would be the most powerful engine for the A320neo family, enabling increased range and payload for airlines. Additionally, it will offer full compatibility for sustainable aviation fuels. We greatly appreciate the decision of the governing board of Clean Aviation program in favor of our proposal based on the WET technology.
Clean aviation is the European leading research and innovation program for transforming aviation towards a sustainable and climate neutral future. And to use WET concept is one of 20 successful projects, which will be supported by a €700 million budget.
We are very happy to announce that Silke Maurer will join our team in February next year. She’s taking over the responsibility for the OEM operation division as Chief Operating Officer. Our present Chief Operating Officer, Lars Wagner, who will become CEO on January 1 next year, will remain responsible for technology and engineering. And additionally, he will be keeping his responsibility for sustainability. By appointing Silke Maurer, we have secured a high profile manager with extensive experience in operations for our company.
And finally, based on the good results in the past month and the stronger US dollar, we raised our full-year expectations slightly. I will give you an update in a few minutes. But let me first hand over to Peter for the financials.
Peter Kameritsch
Yes, Thank you, Reiner. And also, a warm welcome from my side. In the first nine months, total group revenues increased 27% to more than €3.8 billion. Obviously, we had quite some tailwind from the US dollar at $1.07 in nine months 2022 versus $1.20 in the nine months 2021. So in US dollar terms, the revenue were up 14%.
EBIT adjusted decreased almost 50% to €448 million, resulting in an EBIT margin of 11.7%. Net income adjusted increased respectively 45% to €319 million. Free cash flow was €219 million euros, was up 7% compared to last year’s figures, which is perfectly in line with our full-year expectation. Free cash flow generation was still strongly influenced by mainly supply chain driven working capital headwinds.
For now, let’s dive into our business segments starting with the OEM division. Total OEM revenues increased 17% to €1.2 billion. Within that, military revenues were stable at €309 million. Q3 here was a bit weaker than expected, mainly driven by slight delivery delays of some production engines and MRO services.
Commercial business revenues rose 24% to €950 million euros. And within that, new engine deliveries were up in a mid-single digit percentage number. GTF deliveries further improved. And sequentially, we saw also improvements in the GEnx deliveries caused by the pickup of deliveries of the Boeing 787-2 airlines in August.
Organic spare parts were up in the high teens, perfectly in line with our full-year guidance. Main drivers were obviously narrowbody and freighter engines on the one hand side. On the other side, we also see good demand for bizjet engines as well as for the GEnx platform. This favorable business mix overall resulted in an EBIT adjusted of €251 million, with a margin of 20%.
Let’s move on to the Commercial MRO segment. Reported MRO revenues increased 32% to €2.6 billion, while US dollar revenues were up 70%. The GTF MRO share is lower than our expectation for the full year, rather in the 30% area.
Over the past nine months, we saw a lower number of GTF engines in the shop. In addition, these engines needed a smaller work scope than anticipated due to better durability of certain parts of the engine. We saw this already in the half year and the situation remained more or less stable.
For Q2 2022, we expect an increased level of GTS MRO output, but revenue share will remain below the 40% which we expected at the beginning of the year.
EBIT adjusted in the MRO segment almost doubled and reached €196 million, resulting in a strong margin of 7.4%. The higher EBIT margin is especially driven by the mentioned stable business mix of independent versus GTF MRO. In addition, we see a healthy IGT business. And, of course, the current US dollar exchange rates are supportive.
At this point, I would like to hand back to Reiner for some words on the guidance 2022.
Reiner Winkler
Yeah. Thank you, Peter. Based on the strong results achieved over the first nine months and the current environment, we can slightly increase our guidance. We have upgraded our group revenue outlook in euros to the range of €5.4 billion to €5.5 billion based on the stronger FX rate of an average $1.05. Within this, the expected revenues for the Commercial MRO revenue to increase from a growth in the high teens to growth of about 20%. The top line outlook for the military commercial OE and spare parts business remains unchanged.
The EBIT adjusted is expected to grow stronger than initially anticipated, and we now expect a growth in the low 30% range. Our previous expectation was mid 20% growth.
The outlook for the cash conversion rate is also confirmed and we have now forecasted a narrower range of 60% to 70% from a broader mid to high double-digit percentage range. So, with this positive outlook, we end the presentation.
Thank you very much for your attention. And we are now ready to answer your questions.
Question-and-Answer Session
Operator
[Operator Instructions]. Robert Stallard from Vertical Research, may we have your question?
Robert Stallard
Two from me. First of all, I was wondering if you could clarify what the spare parts growth was in the third quarter of the year, whether you’re expecting any positive impact from the pull forward of the Pratt & Whitney price increases in the fourth quarter?
And then secondly, could you give us an update on your expectations for the energy situation in Europe and whether you’re facing any shortages?
Reiner Winkler
Coming to your first questions regarding spare parts, and so in the third quarter, it was roughly up – spare parts portfolio was roughly up 20%. And yes, the September was a bit stronger compared to its July and August. And that might be driven by spare parts price list increase by Pratt & Whitney. But you cannot obviously quantify that. But definitely the September was the strongest month in the quarter.
Peter Kameritsch
On the energy situation, I think there’s no news flow from that. Actually, at MTU, we do not see any shortages for energy. I think we have mentioned it already that we have a very low exposure, especially to gas. And we have also switched to other energy sources in many regions. So, I would not expect for this year and for next year, huge issues for MTU.
Robert Stallard
Just a quick follow-up on that, Reiner. I think Airbus had said that they’d started to do some sort of buffer stocking in case there was an energy problem in the winter. Have you been doing anything similar to that? Have your suppliers been doing anything like that?
Reiner Winkler
I don’t know that. Sorry. But we can check it, but – no, we didn’t create a buffer stock for, let’s say, a blackout or something like that. So we don’t foresee such a scenario currently.
Operator
Mr. George Zhao from Bernstein, may we have your question?
George Zhao
First, on the guidance, I guess what drove the organic revenue guide upgrade for the MRO division, considering that the GTF work has been coming in lower than what you expected? And then second one, turning to, I guess, the cargo, I guess what’s your outlook for just cargo traffic? And how do you assess the trade-off between recession risks and the slow widebody recovery for your dedicated cargo fleet?
Reiner Winkler
I wouldn’t call it weakness because doing less on PW11 or the PW1100 fleet is finally a good message as we don’t have the aftermarket cost, the contracts are finally – the aftermarket contracts are finally more profitable. A part of the, let’s say, weakness was sorted already in the half year. And now, we have a bit stronger business in the independent MRO contracts, like the V2500, for example. And what we currently see is really a strong business with IGT, so industrial gas turbines, which we do in our Berlin facility. So we see very rich and heavy work scopes that is very healthy and also very profitable business.
Cargo, currently, I would see the cargo situation, let’s say, with our customers more or less stable. In the summer regions of the world, there was more demand versus our possibilities to offer slots. For our cargo universe, I wouldn’t foresee a big impact or a slowing down of our business with cargo operators. We also don’t see that in the spare parts business. You know we have the CF6 engine, we have the PW2000 engine in our portfolio and we don’t see, let’s say, less demand now driven by lesser demand from cargo operators or so. I would rather call it a stable situation in the cargo market.
Peter Kameritsch
There’s no indication for any slowdown.
Operator
We will take our next question. Please stand by. Mr. Ben Heelan from Bank of America, may we have your question?
Ben Heelan
I’ve got a few. So, on military, you mentioned delays in production and maintenance. Could you give us a little bit more color exactly what is happening there? Is it a supply chain issue? Is it an issue with the customer? So that will be the first question.
Second question on GTF. It feels like things are improving and you’re seeing those deliveries come through. When we think about the profitability impact of GTF when we go into 2023, you’re going to have higher volume, better fixed cost coverage, but also it’s a loss making engine, so there’ll be a headwind from there. So is there any color that you can give us today in terms of how we should think about the headwinds or tailwinds from GTF ramp as we go into 2023?
And then, a final question on associate income. It looks like there was a drop in associate income in 2023. Could you just talk to you a little bit about what actually drove that?
Reiner Winkler
Ben, so military business, it’s a supply chain issue. So, parts deliveries and also parts from the partners in the program, the EJ200 program and also in the Tornado engine, so the parts are missing. So, the supply chain is currently a little bit weaker. Handful of engine, they will go into the fourth quarter. If you look where we are after the third quarter with a little bit more than €300 million and the expectation for the full year, which is roughly at €500 million, so you can expect a quite strong quarter in the military business. So, that’s what we expect.
We recently did the forecast and the forecast was committed. But it’s adjusted into the fourth quarter, and that is OE production, but also, if parts are missing, it also hits the aftermarket, obviously. When you do an overhaul of an EJ200 or an RB199 engine and you need a new spare part and you don’t have the spare part, then the delivery to the customer moves into the fourth quarter.
Associated income, that’s driven by the LeaseCo company. That’s the company which is managing the lease pool of the of the GTF engine, and that moves downwards significantly in the nine months 2022 versus last year. Two reasons. So, on the one hand side, we did that all already in Q1. So we fully wrote down the leasing pool, so they leased out engines to Russian customers. So that is a magnitude of, let’s say, €6 million, €7 million or something like that. We adjusted that and EBIT adjusted. And on the other side, they did a lot of overhaul of the GTF lease tool. So that drops into the cost of the company. And so, that’s why the equity contribution of this company dropped from, let’s say, €50 million last year to zero this year. But it has nothing to do with the Zhuhai. Zhuhai is more or less stable at equity contribution. It’s, as I said, attributed to the leasing company.
GTF, head and tailwinds. On the one hand side, we are working on obviously improvements in the profitability also on the manufacturing cost of the GTF platform. So PW1100, PW1500 predominantly. And yes, we have a higher fixed cost coverage driven by the volume. As you know, the production of the GTF engines are highly automated. So, for 2023, we will talk about that in our Capital Markets Day a bit more. I would see the ramp up rather in the neutral area, so next year versus this year. So, no tail and no headwind.
Operator
We will take our next question. Harry Breach from Stifel, may we have your questions?
Harry Breach
If I can ask maybe three. I guess when we think about GTF deliveries, can you give us any feeling about how the number of deliveries sort of increased in this third quarter versus the second quarter and whether the fourth quarter should be up sort of in the same range versus the third quarter as the third versus the second? I’m trying to get a feeling really for what the headwind to margin could be as we go into the fourth quarter.
And secondly, I know in the press release, I think you said that you expected a commercial MRO that the mix of GTF revenue should be back up towards 40% in the fourth quarter. I’m just wondering, can you help us for the sort of the reasons behind that thinking is? Is it based strictly on the engines for induction into the shop in the fourth quarter or the completed engine shipments out of MRO in the fourth quarter? So you’ve got high confidence in saying that?
Maybe just a quick one. In terms of Commercial MRO overall, earlier in the year, I think you spoke about engines outside facilities at Hanover and elsewhere. Just wondering if the sort of pent up demand, if you will, the waiting lists are still around the same as they were earlier this year? Maybe coming down a little bit? Maybe even going up a little bit? That will be very helpful.
Peter Kameritsch
No, I would say there’s a pent up demand. So your last question, it’s rather neutral. So, it’s still more or less on a quite high level. You see this globally that MRO capacity is shorter. And that hasn’t changed that much in the course of the year. Even I would say, I would even say that the situation – so the balance between supply and demand is getting more negative. So, there’s demand really – strongly growth and not a lot of additional capacity comes online.
Regarding GTF MRO share in the fourth quarter, yes, we have quite a visibility there because we do GTF MRO not only in our Hanover facility, we do it in our Polish facility, so the EME joint venture with Lufthansa Technik, and also in Zhuhai now. And we have a lot of engines in the shop in Zhuhai and also in EME. So that ramps up. So that ramps up during the year and we know that we have a lot of engines in the shop, we know that we will bill them to the customer in the fourth quarter. So that is quite tangible.
Regarding OE deliveries, the first two quarters in the year were a bit weaker. So, we have really a sequential improvement now. And we have seen that, in the third quarter, let’s say, OE sales were up in the 20% range for the whole portfolio. And, obviously, if you do the math, then you can see that, in the fourth quarter, OE deliveries have to grow 40% to 50%. We kind of see a lot of ramp up of deliveries for the PW1100 engine. This is not only, let’s say, our work shelf. Obviously you know that also Raytheon said in the second quarter and first quarter this year that engine shifts to the end of the year because of their supply chain problems. And now we see a lot of recovery of the delivery just from the first and the second quarter in 2022. And that will happen now in the fourth quarter. But not to forget, we see also sequentially a pickup of deliveries of the GEnx engine. We know that Boeing has restarted deliveries to customers for the airframe in August, I guess mid-August. And that also triggers, again, deliveries of our GEnx models to GE and then further from GE to Boeing.
Operator
We will take our next question. Chloe Lemarie from Jefferies, may we have your question?
Chloe Lemarie
I have a couple actually. The first one would be on the spares momentum and what you’ve seen in Q4 in terms of volume versus pricing. So, I’m thinking you would have kind of low teens growth in Q4. And I would think that most of it would actually come from price increases. So if you could quantify that a bit, that would be great.
And also, how would you qualify the discussion with customers on pricing, now that I would assume they’re pretty significant versus last year? So, are you seeing them pushing back a little bit more than usual?
And my second question is on China and the activity that you see in Zhuhai because traffic has been relatively poor this year. So, how you see the level of demand, specifically in Zhuhai, for shop visit? Has it come down by any means?
Reiner Winkler
In the spare parts guidance, also in our original guidance, there was a certain level of spare parts price increase incorporated into the guidance. And, yes, it’s something like a low teens spare parts growth in the fourth quarter. That’s correct. A significant part of that comes from spare parts price increases. You know that Pratt has increased it in the low teens. Also, CFM and IGE are more or less in the same ballpark, but I think they come in a little bit later in the year. The most important driver for spare parts growth is pricing.
China, Zhuhai, I would say, second half of the second quarter, we saw a dip in deliveries, reduction of shop visits due to the lockdown situation in China. But now, we have received, let’s say, at least a recovery of deliveries to our facility. So, for especially the V2500 engine, also to a lesser extent the CFM56 engines, and what we currently do is we ramp up also PW1100 in Zhuhai. So, these are also heavy shop visits and creates quite some workload. The facility reserves are currently in the process of building their second test site, which will be up and running in the second quarter 2023. So then we will have more capacity also in Zhuhai.
Claudia Heinle
Discussions with customers on price increases.
Reiner Winkler
No, as I said, especially in the MRO business, the situation that there’s less capacity than demand, so there are no discussions about pricing or discounts or whatsoever. No, they don’t take place.
Operator
We will take our next question. Christophe Menard from Deutsche Bank, may we have your question?
Christophe Menard
I have three questions. The first one was on the MRO margin, which in Q3 is actually a good level, considering the circumstances. I was wondering what was the overriding element? Is it gas turbine? Is it FX? Or is it the lower share of GTF? Or a little bit of everything, you may say?
Reiner Winkler
You said it already.
Chloe Lemarie
And how should we think about the gas turbine profitability? Okay, right. Okay, well. Should we be thinking about gas turbine profitability as better than independent MRO? Or is it same type of margin level?
Peter Kameritsch
The industrial gas turbine is typically more profitable than the independent MRO business.
Chloe Lemarie
So it’s a mix of everything. The second question is the target rates for hedging. You improved your hedging in this quarter – for 2023 and beyond. Do you have in mind target rates for 2023? And 2026 is obviously very appealing. But do you have a sequence in mind or how should we be thinking about this? And the other questions are around HR. So that’s the last one, it’s around the salary renegotiation, if you can give us an update. And also, more specifically, around SCAF, have you stopped the hiring plans for additional engineers or are you still hiring people for the SCAF program?
Peter Kameritsch
Regarding hedging, no, we don’t have a target hedge rate or so to say. We have our step hedging model. So, theoretically, we can hedge out until 2026. We have a lower band and a minimum band, minimum level and a maximum level for each quarter and we execute that on a more or less mechanical way. So, we don’t speculate. And we really do that not [indiscernible] or something like that. You do that only with clean forward contracts. So, we do hedge accounting. So, the unrealized gains and losses go into the equity and the realized go into the P&L.
So, typically, we start with 90% hedge cover in Q1 and then it goes down to – the latest quarter is between 0% hedge coverage and 30%. So, you can go to zero, let’s say, in 2026 and it can go to 30% hedge cover in – to 30% in 2026. And so, obviously, when you can lock in forward contracts at $1.04 for 20206, you do that. Is it best possible point of time to lock that in? I don’t know that. So, I don’t have a glass bowl. But what I can say is that a hedge of $1.04 in 2026 is probably a good thing. For us, it’s a very FX rate. And so, we have a model in place with minimum and maximum levels. But, obviously, we go up and down depending a little bit on all our expectation. But we don’t have a target hedge rate in mind.
Reiner Winkler
Coming to your other questions, starting with the salary increase negotiations, they are going on. I would say I would expect a solution or a result maybe in the course of second half of November. Yes, it will be higher than in the past due to the – actually, situation of inflation and so on. On the other side, you should have in minds that we have also some contracts where we can pass the higher cost to the customer in military business, but also in some commercial activities with some time delays for sure. But it’s possible.
On the FCAS, we hired already in the fourth quarter of last year some, I would say, 680 engineers. And after the situation that the contract was not finally signed, we stopped that. We use these engineers for other activities. And during 2022, we have not hired yet additional engineers. We expect a solution in that program also towards the end of this year and then we can start beginning of next year with hiring additional engineers.
Operator
We will take our next question. David Perry from J.P. Morgan, may we have your question?
David Perry
Reiner, can I just start by embarrassing you a bit because I think it’s your last call.
Reiner Winkler
Yes, it’s my last call.
David Perry
So, listen, can I just congratulate you on huge success MTU has been since the IPO under your leadership. I just checked that you are the best performing European A&D stock since the IPO. So congratulations. And I wish you well for the next phase of your life, although I think we will see you at the CMD.
Peter, I have two questions for you. And I know you’re going to try and resist answering, but let me try. So, look, at the CMD last year, you gave guidance for 2024. It was a bit open ended. All you said was EBITA in 2024 could be above 2019. But, look, FX is now $0.12 better. I just wondered if you plan to be more precise about 2024.
And I guess following Christophe’s question, it’s clear on your slide today the big open FX exposures in 2025. So, will you extend the guidance out to 2025? That’s the first question.
And then just a second one, just on FX. Can I just clarify what is your net dollar exposure, i.e. your gross dollar revenue less your dollar costs? So, if I look at that slide today with the FX position, can I assume that the $1.4 billion of hedging in 2022, does that mean your net dollar exposure is $1.4 billion in 2022 and that will grow as the business grows, if that question makes sense?
Peter Kameritsch
Your last question, yes, 2022, we are more or less completely hedged. So, you can assume that $1.4 billion is our US dollar exposure. And that obviously grows as the business grows. Yeah, that’s a good rule of thumb there. Exactly. So, in 2023 and 2024, obviously, the hedge cover declines. You see that, in 2026, we have placed the first edge contracts there at the rate of $1.04. But it’s below 10% of the exposure, obviously – below 10% of the exposure in 2026.
The structure of our guidance on the Capital Markets Day will be the same. We will be more precise for 2023, obviously, given the business drivers and so on. And then we will talk about the business development until 2025.
David Perry
You’ll just extend your envelope one year?
Peter Kameritsch
Yes. Nobody knows where the fixed rate will be in 2025. So it’s a tricky one. Forecasting a fixed rate is not so easy.
David Perry
Well, I guess if I can just follow-up on FX, we sort of had a message from Airbus at their CMD a month ago. I guess it was saying, look, we won’t keep all of the FX benefit because we think it will be consumed by things like inflation and other headwinds. Is that a framework to think about MTU? Obviously, we don’t know what the FX will be? Let’s assume it stays at today’s rate, do you think you can retain a lot of the upside?
Peter Kameritsch
At least we can retain. The ambition would be we can retain – I can’t say all of the upside, but at least a share of the upside, yes, that’s definitely the ambition. Regarding inflation, obviously, we try to try to pass on as much to customer as possible. And also, obviously, we can work also on our internal efficiency, also with the methods of digitization and things like that. Yes, part of the inflation will hit our P&L, but the most of it, I think we can compensate.
Operator
We will take our next question. Richard Schramm from HSBC, may we have your question?
Richard Schramm
I’m not sure if I missed it. I have a question concerning the cash flow statement and just would like a bit of more information about these huge turnarounds, the changes in provisions and liabilities, which, at the end of the day, was the trigger for this increase in cash flow and free cash flow you could achieve despite this huge uptick in working capital. So, maybe you can shed a bit of light on this one.
Peter Kameritsch
If you look at the cash flow statement, then the change in provision and liabilities is finally a correction of what is booked in the earnings. So, it’s not the reason for the higher cash flow. And what you can say is that, from the €200 million change in provision, half of that comes from FX. So, as you know, most of the provision are US dollar denominated. And if you start the year with $1.13 and at the end of Q3, it was $0.997, then you have $0.16 valuation difference. Obviously, that drives up the value of the provision in euros significantly upwards. You have the same impact, obviously, on the receivables, but you don’t see the impact of the receivables in the provision line. You see them in the working capital line. So, that moves the working capital upwards. So if you look on each line item, then you have to offset, let’s say, provisions with working capital change. It’s a valuation…
Richard Schramm
It’s fair to say that this is also then driven by the tailwind from the US dollar you see on the earnings side, but also on the cash flow side then?
Peter Kameritsch
Sure, sure. A lot of our business is US dollar driven. A lot of balance sheet positions are US dollar denominated, and they are all subject to revaluation in euros based on the spot rate at the respective quarter. So, you have a lot of valuation effects in the cash flow statement. Not only in the provision line, but also on the working capital line. If you buy spare parts at the value of $100 and you have a spot rate of $1.20, then you might have €80 on the balance sheet. And if you have $0.97, then you have, let’s say, €103 on the balance sheet. So, you have an increase of 30% working capital, but it’s the same part.
Operator
There seems to be no further questions. So I would like to hand back to the speakers for closing remarks.
Operator
Thank you very much for your attention.
Claudia Heinle
If you have any further questions, please feel free to contact the Investor Relations team. Thank you very much and have a good day. Bye-bye.
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