MTU Aero Engines AG

XETRA:MTX

Earnings Call Transcript 2019-Q1

[Operator]

Welcome to the conference call of MTU Aero Engines first quarter results 2019. The speakers of today's conference call are Mr. Reiner Winkler, Chief Executive Officer; and Mr. Peter Kameritsch, Chief Financial Officer.Firstly, I will hand over to Mr. Michael Röger, Vice President, Investor Relations. Please go ahead, sir.

[Michael Röger, Vice President of Investor Relations]

Good morning, ladies and gentlemen. Welcome to our conference call for the Q1 2019 results. We will start with business and financial highlights presented by Reiner Winkler. Peter Kameritsch will give you an overview of the changes which were implemented in our 2019 numbers, such as the new accounting standard for leases. Afterwards, Peter gives more details on the segments. Reiner will close the presentation with the 2019 guidance. Finally, as always, you will have the time to answer your questions. Let me hand over to Reiner now for the business highlights.

[Reiner Winkler, CEO & Member of the Executive Board]

Yes. Thank you, Michael, and welcome also from my side. Let me start with the key highlights. First of all, the key market indicators remain to be in a good shape, so passenger traffic was up by 6% in the first 2 months, and also the load factors remained stable on high levels of above 80%. The further ramp-up of the GTF engine is the main focus in the commercial OEM business. The GTF deliveries are expected to increase by another 30% for this year. Actually over 400 aircrafts powered by GTF engines are operated by 36 airlines worldwide, and so far the GTF fleet has accumulated over 2 million flight hours. In our MRO business, we signed new MRO contracts in the value of USD 1.3 billion since January. That includes a 12-year G90 maintenance contact with United Airlines. And in addition, we won contracts totaling over USD 700 million for the PW2000 engine. This once more confirms that we meet the demand of our customers with tailor-made solutions for aero engines across the whole life cycle. Our innovative service portfolio has been further sharpened through the launch of MTUplus Intelligent Solutions in April. In the military business, we see upside potential from national campaigns for the Eurofighter and also technology work for the Next European Fighter Engine. The German Ministry of Defence announced its intention to replace 33 Tranche 1 Eurofighter jets with new ones. We may see the final decision in 2019. Together with Safran, we are planning to take over the lead for the engine for the next-generation combat aircraft. A technology and demonstrator program is expected to start by mid of this year. Engine to service for the European fighter aircraft is expected for [ 2014 ].The Annual General Meeting approved a dividend of EUR 2.85 per share. This is an increase of EUR 0.55 compared to last year and corresponds to a payout ratio of 31%. The improvement of the free cash flow that we expect in the coming years will allow us to increase dividend further. And as you know, our target is a payout ratio of around 40%. In Q1 2019, we implemented the new accounting standard, IFRS 16, so leasing, which will have some impact of net debt and also free cash flow. Additionally, we implemented the changes already communicated at the Capital Markets Day last year, and Peter will give you a little bit more color in a minute. Let's have a look on the key financials. In Q1, our revenues increased by 11% to EUR 1.1 billion driven mainly by a strong OEM business. The group EBIT adjusted increased by 7% to EUR 188 million and sliding in a margin of 16.6%. Net income was also up by 8%, reaching EUR 134 million, resulting in earnings per share of EUR 2.59. Free cash flow was very strong in the first quarter. It was EUR 141 million mainly due to lower cash flow from investing activities. Let me now hand over to Peter for more details on the business segments.

[Peter Kameritsch]

Yes. Thank you, Reiner, and also hello from my side. Let me first give you a brief overview about the 3 changes affecting our number for 2019.Firstly, we have implemented the new IFRS 16 leasing standard relevant mainly for our engine lease business. Former operating leases will be treated as financial leases and, therefore, around EUR 150 million additional financial liabilities and right-of-use assets show up on our balance sheet. Hence, lease payments of around EUR 30 million are reclassified from cash flow from operating activities into cash flow from financing activities. This will improve our free cash flow by EUR 30 million for the full year 2019. Net debt is inflated by around EUR 150 million. 2018 numbers will not be restated. Second topic. As already communicated at the Capital Markets Day last year, we changed the presentation of GTF and GEnx OEM-MRO revenues. Until 2018, these service revenues were recognized in both segments, which, as a result, led to a strong increase in the elimination line. From 2019 onwards, these revenues will be only shown in the MRO segment. This will lead to lower OEM revenues and to a normalization of the elimination line but has no effect on group revenues or group EBIT. In the appendix, you find the restated numbers on a quarterly basis for 2018.Finally, as also communicated at the last Capital Markets Day, we changed our contracting and invoicing process at MTU Zhuhai, affecting our MRO revenues only. In the past, MTU Hannover was the sole contract partner for V2500 shop visits, subcontracted by the OEM and MTU Hannover did partially subcontract to MTU Zhuhai. And this company, as you know, is consolidated at equity. From 2019 onwards, MTU Zhuhai will be directly contracted by IAE. We talk about roughly EUR 300 million in MRO revenues, which will not be part of MTU's consolidated revenues anymore. As this is not really an accounting change, we will not adjust 2018 numbers retrospectively. The IR team will be happy to answer further questions on these changes. So let's move on to the business segment details. Total OEM revenues were up 20% to EUR 490 million. Military revenues increased by 15% to EUR 105 million, and commercial business was up 20% to EUR 386 million. Organically, that was a growth rate of 12%. And within that, organic OE sales were up 40%. But remember, Q1 2018 was a comparably weak quarter due to a roughly 4-weeks temporary stop of GTF engine deliveries. Organic spare part sales showed a high single-digit growth. Main driver was the V2500 with a high-teens growth. Additional growth was coming from the GEnx, but also the more mature engine types from [ Pratt & Whitney ], continue to grow slightly. EBIT adjusted increased by 6% to EUR 131 million resulting in a margin of 27% mainly driven by the before-mentioned business mix effects.For next page, some words on the commercial MRO segment. Revenues here increased by 6% to EUR 655 million. Due to the before-mentioned change in the invoicing process in Zhuhai, we show less MRO service revenues as part of our consolidated numbers. Organic MRO revenues in U.S. dollars would have been up high single digits. EBIT adjusted increased by 10% to EUR 57 million, and the margin hence improved to 8.7%. So now let me hand back to Reiner for a quick look on our guidance 2019.

[Reiner Winkler, CEO & Member of the Executive Board]

Yes. Thank you, Peter. Based on the strong Q1 results, we confirm our guidance for 2019. Only the cash conversion will be a bit higher due to the implementation of IFRS 16, as explained.So for military revenues, they are expected to be up by 10% mainly driven by the aftermarket. Commercial OE will be up in the low teens mainly driven by the further ramp-up of GTF, higher demand for the GEnx as well as new business jet programs. Commercial spares are expected to be up mid- to high-single digit, main driver will be the V2500. Mature engine programs are expected to remain stable. Commercial MRO will grow high single digit organically. Reported IFRS revenues are expected to remain stable.These mentioned effects should result in group revenues of around EUR 4.7 billion, assuming an average U.S. dollar rate of around 1.15. The EBIT adjusted margin is expected to reach around 15.5%. This is broadly in line with 2018 assuming equal treatment of V2500 invoicing from MTU Zhuhai to IAE. Net income is expected to grow in line with the EBIT number. We will upgrade our cash conversion rate guidance to a range of 55% to 65%. And this is solely related to the reclassification of lease payments, as Peter explained, from cash flow -- from operating activities into cash flow from financing activities. So thank you very much for your attention, and we are now happy to answer your questions.

[Operator]

[Operator Instructions] And your first question is from the line of Christian Laughlin of Bernstein.

[Christian A. Laughlin, Analyst]

Firstly, I was just wondering if you could provide any comments or thoughts on how you see the phasing of GTF deliveries over this year and how that compared to last year with respect to the production system. And then just secondly, any thoughts or views on trends around demand for shop visit bookings and shop visit lead times across your main engine programs in the aftermarket side?

[Peter Kameritsch]

I mean regarding PW1100 deliveries, I mean the 2018 deliveries were unusual. I mean Q1 2018 was disrupted. Deliveries stopped obviously, so we had -- we now have that 40% increase in the first quarter. But overall, I think we expect roughly 30% increase in shipments for the full year PW1100, and the second half definitely will be regarding deliveries a bit stronger compared to the first half 2019. I mean, as you know, we are approaching a rate 63 at Airbus. That will be for 2021. So we will see an increase in shipments throughout the year but not as huge as in 2018.

[Reiner Winkler, CEO & Member of the Executive Board]

Regarding the MRO shops, I mean as we explained already last year, all the shops are running at maximum capacity. So constantly, let's say, slightly increased. Peter said, organically, we saw a growth rate of around 9%. And we decided, as also explained last year, to invest heavily into the expansion of all the facilities we have. So Zhuhai, Hannover, Berlin, Vancouver, we do some investments to further increase the capacity to allow us further growth for the next coming years.

[Operator]

Chloe Lemarie of Exane BNP Paribas, please ask your question.

[Chloe Lemarie, Research Analyst]

I had a few questions. The first one would actually be on the spare part momentum throughout the year because your partner, especially on the V2500 program, because your partner, Pratt & Whitney, indicated some softness in Q1 due to capacity issues with MRO suppliers. I was wondering if you could see a boost in spare parts in the coming quarter coming from this.The second question was the OE impact on EBIT in Q1 because if you see, you had a significant growth, but an offsetting impact would be the learning curve on the GTF. So was the absolute year-on-year headwind a couple of million euro on EBIT? Or was it more or less than that?And lastly, you've experienced quite a large increase in D&A in Q1 versus last year. So I'm guessing this is from the implementation of IFRS 15. But I just wanted confirmation that this is the case and whether IFRS 16 had any EBIT impact that we should think of in Q1 and for the full year.

[Peter Kameritsch]

I mean regarding the comments, you can see, made on the earnings call on V2500, I mean we cannot talk about that. I mean we saw -- our spare parts momentum was -- we had -- we saw, as I said, a high-teens growth on the V2500. Spare parts, our shops are performing well regarding the V2500, so we are not the root cause for this impact on UTC. So we don't expect any impact on our numbers from that issue. Regarding D&A, yes, you are correct. So the step-up of D&A is due to the fact that, I mean, we have implemented IFRS 16. So we have capitalized EUR 140 million for the first quarter around a few assets, and that is obviously amortized and that creates something like a EUR 10 million increase in amortization. So that is due to the fact that we have implemented IFRS 16.And your second question was regarding OE. I mean we have a small headwind in the first quarter coming out of OE. I mean that is due to the fact that, I mean, the growth was very high in the first quarter. So for the full year, we don't expect the headwind from the GTF. It should stay stable, so there's no further headwind from that one. But the first quarter has showed an unusual growth for this year.

[Operator]

Alexander Hauenstein from DZ Bank, may we have your question?

[Alexander Hauenstein, Analyst]

I have a few questions. First of all, with regard to your GTF delivery guidance, I understand it's about 900 to 1,000 GTFs in 2019, right? And I would like to know if there's a likelihood to be at the end with an outcome finally at the lower end of the range or at the higher end of the range. At the current point of view, is there anything you can comment here maybe?And with regard to your MRO margin in Q1, with 8.7%, this is quite higher compared to last year. And was there some kind of onetime operational effect included? Or is this kind of a new run rate for the rest of the year? Or is the effect purely from the process change in MTU Zhuhai? So what would be the -- or would have been the underlying margin here? If you could comment, please.And last question. Could you please share some more information about the new MRO service portfolio, MTUplus Intelligent Solution? Could you provide some quantitative impact commentary or give us some numbers here, please?

[Peter Kameritsch]

I think we didn't give a guidance regarding the numbers of GTF engines delivered before 2019. I mean the last number which was given to the public was 376, I guess, for 2017. Based on that, we doubled our output for 2018. And based on 2018, we increased the shipments roughly by 30% for 2019. But that comprises obviously all the GTF platforms, not only the A320neo engine, also the A220 engines and the E2 engines and so on. And so we will see how that develops throughout the year. But from today's point of view, we still can confirm the 30% increase in GTF shipments. Regarding MRO margin, the step-up to 8.7%, yes, I mean that is due to the fact that -- I mean one impact is that you see that our equity results increased significantly from Q1 '18 to Q1 '19. That is one positive. Then we took out revenues due to the changed invoicing process at MTU Zhuhai. That is obviously also beneficial for the MRO margin. On the other side, we have a high material content in our shop visits currently and a high share of PW1100 warranty shoppers, which are not very -- don't show a high margin obviously, so that dilutes the margin a little bit. So going forward, I would expect to stay in that ballpark, so between 8.5% and 9% for the MRO for the full year.

[Reiner Winkler, CEO & Member of the Executive Board]

Regarding this new, let's say, MTUplus Intelligent Solution, I mean it's more I would call it a rebranding or branding of all the different activities we started in the past. So we had different approaches to the market like the engine leasing, asset management, repair, things like that. And we, let's say, put it now together into one, let's say, package to offer the customers a specific solution. But it's nothing where you can say it's creating now, whatever, EUR 100 million additional revenues or something like that.

[Operator]

Andrew Humphrey of Morgan Stanley, may we have your question, please?

[Andrew Edward Humphrey, Vice President]

I've got a couple, please. One is on the V2500. You called out some kind of unusual events there in the quarter or a change in the billing process. Pratt also called out -- or UTS also called out some reinspection requirements from some of their other MRO providers during the quarter. I mean is there anything in particular, any type of disruption or change to arrangements there that we should be thinking about? I mean it seems coincidental that a couple of things have happened for 2 main [ contract partners ] in the same quarter.

[Peter Kameritsch]

I mean the 2 issues has nothing to do together. So I mean we already announced our changed invoicing process at our Capital Markets Day last December, so there's not a big surprise. So I mean IAE subcontracts shop visits to MTU. So in the past, the sole contract partner for IAE was Hannover. Hannover subcontracted some shop visits to Zhuhai, and Zhuhai billed it backwards. So Zhuhai billed Hannover, Hannover billed to IAE, so the other revenues flew through our consolidated revenues number. Now Zhuhai is -- it's a 50-50 joint venture with China Southern. It's consolidated at equity. And now, from 2019 on, Zhuhai is directly contracted by IAE. So Zhuhai bills directly to IAE, so we lose that revenue share. So that's a pure contracting-billing issue, which we announced 4 months ago. So that is not a surprise. So the reinspection requirement, as I said, has nothing to do with MTU. It doesn't affect us. So if you want to know any details on that, well, you have to call UTC.

[Andrew Edward Humphrey, Vice President]

Of course. And maybe also on the supply chain as well. I think looking at companies that have already reported, there's been significant reporting of tightness in forging and casting with longer lead time items. We know your midterm CapEx guidance includes some budget for increasing narrow-body production beyond what's currently been announced by the airframers. Could you maybe talk about how you see that situation in terms of investing for long lead time items and whether that's all on track from your point of view?

[Reiner Winkler, CEO & Member of the Executive Board]

I mean I would say, actually, we are on track to, let's say, to fulfill our commitments of what has been agreed with Airbus, so the increase to, I think, it's rate 63. Any other increase, and then we are talking about more than, let's say, 2022 onwards and nothing for the next 2 years, has to be investigated. And yes, as you said, forging and casting are, I would say from today's perspective, the key issues of bottlenecks. And I think we explained also on the Capital Markets Day that the further increase will require some additional CapEx for us. And I think we also quantified in the -- let's say, something around EUR 50 million of additional CapEx just for MTU. But as I said, nothing for the next 2 years. It's more mid to long term then.

[Operator]

Your next question is from the line of Frederik Bitter of Hauck & Aufhäuser.

[Frederik Bitter, Analyst]

So I would have 2 questions, please, maybe it is best to do one by one. The first one would be on the free cash flow for Q1, which came out quite strongly, I think. And I just want to get to know how much of that is related to IFRS 16, please?

[Peter Kameritsch]

IFRS 16, roughly EUR 10 million. So EUR 10 million tailwind for the cash flow.

[Frederik Bitter, Analyst]

Yes. Great. And then the second one would be on -- I hope you could comment at least a bit on it. It's regards the Boeing 787. Obviously, what's been discussed in the press, what's up in North Carolina and what -- or has happened in the factory in North Carolina. I mean if you could make any comment on the production side there.

[Reiner Winkler, CEO & Member of the Executive Board]

We have no insight in that one, so that's something you have to talk to Boeing, not to us.

[Operator]

Your next question is from the line of Robert Stallard of Vertical Research.

[Robert Alan Stallard, Partner]

A couple of questions from me. First of all, on the margin, strong result in OEM this quarter. The guidance would imply that's coming down through the year. Is that the GTF mix that's causing that? And then secondly, with regard to the German government's ban on export licenses to Saudi Arabia, has that had any impact on your business in the quarter?

[Peter Kameritsch]

I mean obviously, I mean the -- we're going to have higher volumes of new engine business in the second half of the year, that will bring margins a little bit down, yes. That is the major -- the business mix is the major driver for development of the margin throughout the year.

[Reiner Winkler, CEO & Member of the Executive Board]

So regarding Saudi Arabia, first of all, we have to say that all the exports we are doing are fully in line with the German federal government principles covering these arms exports. So we are absolutely in line with it. And they cover only European joint programs, that means engines or propulsion systems for Tornado and Eurofighter. Actually, we have an export license for these deliveries, and we are not affected from that halt for 2019. So no impact for the actual year on that.

[Operator]

And your next question, from the line of Christophe Menard of Kepler Cheuvreux.

[Christophe Menard, Head of Aerospace and Defense Sector]

Two questions. The first one was your view on -- I mean the free cash flow again was very strong in Q1. Looking at the numbers, one reason was that the net investment in financial assets was relatively flat. The question is how do you see that line throughout the year? Where is it heading to? Any kind of details on this would be helpful. And the second question is more on the new contracts you managed to book on MRO, especially the G90 contract, which is quite a sizable win in my view. What made the difference? I mean I understand there was an incumbent. You should be the incumbent on this one. What made the difference? Where was your added value to win that contract? Just to understand your positioning vis-à-vis peers. I mean to my knowledge, it's probably the biggest contract you've won on G90s to date. Is it the case?

[Operator]

Are you happy to take one more question, sir? Ladies and gentlemen, please continue to stand by. Presentation will begin shortly. [Technical Difficulty] Ladies and gentlemen, apologies for the interruption. Presenters, you may continue. [Operator Instructions]

[Peter Kameritsch]

I mean the -- Christophe?

[Christophe Menard, Head of Aerospace and Defense Sector]

Yes.

[Peter Kameritsch]

Can we -- so your question was regarding the investment in financial assets, I guess?

[Christophe Menard, Head of Aerospace and Defense Sector]

Yes. I mean that was the first -- I don't know where -- it seems there was an interruption. Yes, the first question was net investment in financial assets throughout the year, what should we expect? Because it was very -- I mean it was very low in Q1. And the second question was on G90, your contract, you booked a large MRO contract in Q1. Yes, it was in Q1. Seems to me it's the largest contract you ever booked on G90, but please confirm. And I was keen to understand what made the difference because you won the contract from an incumbent, so you -- obviously your commercial offer was better than the incumbent, so what made the difference?

[Peter Kameritsch]

For the investment into financial assets, looking into Q1 2018, I mean the major contributors to the minus EUR 49 million was 2 equity contributions: so we contributed roughly EUR 40 million to the lease cost, so the leasing company for the PW1100; and we contributed EUR 5 million, EUR 6 million to our EMEs for the joint venture with Lufthansa Technik in Poland. And so in 2019, Q1 had a -- each have a positive EUR 5 million, so we didn't contribute anything to the leasing company. We made a small contribution to EME, but we had a positive inflow from an airline customer where we did customer financing. And this customer paid back EUR 11 million, that is a positive, which is then adjusted further downwards to minus EUR 10 million. The major portion is the adjustment of that payback.

[Reiner Winkler, CEO & Member of the Executive Board]

Regarding the G90, yes, I think it's the biggest contract we won in the MRO business for this engine. But it's difficult for us to explain to you what have been the reason for, let's say, making the deal. I mean at the end, it's a combination between commercial terms and condition but also maybe some technical issues like, whatever, commitments and turnaround times and things like that. But it's -- I think you have to ask the customer, United, why he made that decision here.

[Operator]

And your next question is from the line of Harry Breach of MainFirst.

[Harry William Freeman Breach, Research Analyst]

I just wanted 2 very, very simple ones. Can you give us any feeling -- was there anything unusual in the first quarter in terms of your Geared Turbofan deliveries and the mix between spare engines and installed or on-wing engine deliveries? And can you give us a feeling about whether that sort of mix is maybe coming down to more normal levels in 2019?And then a completely different question, really, just looking at the commercial OEM spares growth, Peter, I think you mentioned earlier on in the presentation high single-digit growth in the first quarter. Anything sort of -- as we look out sort of towards the rest of the year, any sort of particular dynamics, things you're highlighting? I know the full year guidance is up mid to high single, so a little bit better than the first quarter. Is it trending fairly strongly in terms of what you're seeing day to day at the moment?

[Peter Kameritsch]

Well, at least, I mean, as you said, I mean our guidance for the full year stands at mid to high single digit. We are a bit ahead of our guidance, and we're going to review that. I mean we still need a confirmation of one more quarter, in the second quarter, then we're going to review our guidance mid of the year together with our H1 results.

[Harry William Freeman Breach, Research Analyst]

Yes. And then the spare engine mix, Peter? GTF?

[Peter Kameritsch]

Nothing unusual to comment on. I mean we still will add some spare lease engines, obviously, but not -- I mean regarding the ratio, it's going to be below the ratio, which we have in -- which you saw in 2018.

[Harry William Freeman Breach, Research Analyst]

Yes. Was the 2018 ratio, was it -- I think in the -- was it 2017 we saw sort of very unusual sort of rich spare engine mix? Was it about 20% that year? Is that sort of be trending down towards the low double digit?

[Peter Kameritsch]

We never talked about the ratios exactly.

[Reiner Winkler, CEO & Member of the Executive Board]

But it's coming down.

[Peter Kameritsch]

It's coming down, yes.

[Harry William Freeman Breach, Research Analyst]

Is it coming down -- just without talking about a number, is it coming down compared with where it was 2 years ago in terms of the ratio maybe dividing in half? Is it quite that level of significance? Well, it's okay if you don't want to talk about it, but I'm just trying to gauge whether it's a gradual decline or if it's quite a significant step down, that was all.

[Peter Kameritsch]

Yes. It's rather a gradual decline of spare engine issues. So...

[Operator]

[Operator Instructions] And there are currently no further questions. Please continue.

[Reiner Winkler, CEO & Member of the Executive Board]

So we would like to thank you very much for your attention. If you have any further questions, I think our IR team is available and happy to give you more color on your questions. Thank you very much, and enjoy the rest of the day. Bye-bye.

[Operator]

Thank you. We want to thank Mr. Reiner Winkler and Mr. Peter Kameritsch and all the participants of this conference. Goodbye.