MTU Aero Engines AG

XETRA:MTX

Earnings Call Transcript 2020-Q3

[Operator]

Welcome to the conference call on MTU Aero Engines Third Quarter Results 2020. [Operator Instructions] By attending in the conference call, you grant permission for audio recordings intended for publication on the Internet to be taken. 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. Thomas Franz, Vice President, Investor Relations, for some introductory words. Please go ahead.

[Thomas Franz, Vice President of Investor Relations]

Good morning, ladies and gentlemen. Welcome to our conference call for the Q3 2020 results. We will start with the business review of the third quarter presented by Reiner. Peter will give you the financial overview and a more detailed view on our OEM and MRO segment. Following that, Reiner will give some updates on our guidance 2020. After that, we will open the call for questions. Let me now hand over to Reiner for the review.

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

Yes. Thank you, Thomas. And welcome also from my side. Our market environment remains challenging. So IATA's outlook for 2020 states now a 66% decline in our [ IATA's ] case. And per August, passenger traffic was down 64%. Within that, domestic traffic was down 52% and international traffic was down 70%. Domestic travel recovery is mainly driven by China being back at pre-crisis levels. Freighter traffic was quite robust, being down only 14% to date overall. With a net dedicated freighter aircraft are used more often than before the crisis. This is also reflected in our aftermarket business, which receives ongoing strong demand from freighter airlines while commercial demand remains still under pressure. Some positive news from our independents, MRO business. In the first 9 months, we secured new contract wins worth more than USD 3.9 billion. After contracting the F138 for the C-5 Galaxy earlier this year, we now secured a contract to maintain the F108 engine operated by the U.S. Air Force. Both engines will be serviced at our Vancouver facility. Higher available MRO capacity speeds up GTF durability upgrades. In August, IndiGo's GTF engine replacement exercise has been successfully completed. And the LPT retrofit program overall is on track. Overall, the capacity utilization at all our OEM and MRO facilities have improved considerably. Good news also from the wide-body segment, the GE9X engine, powering the future of Boeing for [ 76s ], received its FAA Airbus certification. This is an important milestone for the expected entry to service in 2022. The government of Germany extended the access to the short time working scheme until end of 2021. In our German sites, we are now evaluating to what extent we will use this possibility. Along with that, provisions for EUR 34 million of restructuring charges for the capacity reduction has been booked in September. And lastly, we sharpened our guidance for 2020, and I will give some more details in a few minutes. Let me now hand over to Peter for key financials.

[Peter Kameritsch]

Yes. Thank you, Reiner, and good morning also from my side. After the first 9 months of 2020, revenues decreased by 13% to almost EUR 3 billion. Organically, group revenues would also be down by 13%. Group EBIT adjusted declined by 44% to EUR 311 million, showing a margin of 10.5%. Respectively, net income adjusted is also down at EUR 290 million at the same pace as EBIT adjusted. Free cash flow decreased by 52% to EUR 145 million, showing also a positive free cash flow in Q3. Now we'll give you some details on our segments, starting with the OEM segment. Total revenues here were down 22% to EUR 1.1 billion. And within that, military revenues were down 8% to almost EUR 300 million. Year-over-year, Q3 revenues were up 5%. Consequently, we expect a very strong fourth quarter with almost EUR 200 million of revenues, mainly driven by aftermarket and services work on EJ200 and RB199 platforms. Our commercial business declined 25% to EUR 850 million, and therein, organic OE sales were down roughly 20% in the first 9 months 2020, reflecting obviously production rate cuts at Airbus for A320neo and Boeing for the 787. In the quarter, OE sales were down roughly 40%. Organic spare part sales declined by around 30%, which is more or less in line with our view for the full year. In the quarter, spare parts were down by roughly 40%. This improvement compared to Q2 2020 is driven by continued strong demand on platforms with freighter or military applications, such as the CF6-80 and PW2000, and a sequentially slightly higher demand for B25 spare parts. EBIT adjusted declined by 47% to EUR 194 million, showing a 17% margin. The mentioned business mix continues to put pressure on our EBIT margin. So let's turn to the commercial MRO segment. Here, reported MRO revenues were down by 6% to EUR 1.9 billion. Our core MRO business was down in the mid to high 20 percentage range, widely compensated by a higher workload for GTF retrofit shop visits. Even Q3 revenue revenues were down by 12%. EBIT adjusted decreased by 38% to EUR 160 million, resulting in an EBIT adjusted margin of 6.2%. The lower EBIT margin results from a higher share of GTF warranty work, bearing a small margin and some bad debt provisions already booked in Q2. At this point, I hand back to Reiner for an update of our guidance.

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

Yes. Thank you, Peter. Based on our 9 months results, we have narrowed our guidance. We know -- group revenues are now expected in the range of EUR 4 billion to EUR 4.2 billion. The outlook for our military revenues, commercial OE sales and commercial spare parts remains unchanged. The MRO revenues are now expected to be down by a mid- single-digit percentage number, which is the lower end of our previous guidance. Strong reductions in core MRO business will be widely compensated by higher GTF work. Besides the market development pressure from a weaker U.S. dollar results in a slightly reduced revenue outlook for MRO. The EBIT adjusted margin is expected to be around 10%, and this reflects the upper end of our previous guidance. Net income adjusted is expected to develop broadly in line with EBIT adjusted. And finally, as already indicated at our half year results call, our clear target is to achieve a considerably positive free cash flow for the full year. This ends the presentation, and we are now open for your questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Robert Stallard, Vertical Research.

[Robert Alan Stallard, Partner]

Reiner, this is probably a question for you. Airbus commented earlier this morning that their production plan is for narrow-body rates to move up to 47 a month in the second half of next year. I was wondering if there are any implications for MTU in terms of CapEx staffing or inventory on the back of this move? And then secondly, another question. The freight boom that you're seeing at the moment, that's helping your spare parts, how sustainable do you think that is?

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

Starting with the first question, potential rate increase. I mean we are now, let's say, internally, we are planning with the previous number, let's say, in the range of 40 aircraft a month. In case they will increase the number, I think we are well prepared for that. We have always some, I would say, flexibility in our system. So buffer concept with our suppliers and things so on. But there's no additional CapEx or something necessary for that. And we are coming from a rate above 60 down to low -- to around 40 actually. So there's enough flexibility in the system and there's no additional CapEx or working capital pressure from that. How sustainable is the freighter?

[Peter Kameritsch]

You might know that -- I mean, 50% of the cargo capacity in the worldwide aircraft system comes from passenger aircraft. I would say my answer will be as long as wide-body aircraft do not fly or are grounded widely, you're going to see the freighter fleet being utilized very heavily. So I think for the foreseeable future, for the next at least 12 months, you're going to see a sustainable development here.

[Operator]

Your next question comes from the line of George Zhao from Bernstein.

[George Zhao, VP & Research Analyst]

So if you go back to the quarter, you had talked about an expectation of destocking at some of the MRO shops driving the improved spares trends in H2. So for the commercial programs, first, did you see some of those destocking in Q3? And given the slow traffic recovery for the past 3 months, do you still see that trend playing out in Q4 for the commercial programs?

[Peter Kameritsch]

Well, destocking, yes. I mean, not a dramatic development, I would say. I mean what we see is that, I mean, we saw sequentially a slightly higher demand for V2500 spare parts. I mean, Q3 volumes were higher compared to Q2 volumes. Is that a complete turnaround? No, definitely not. It's a very cautious recovery, I would say. It's only a small effect, which we have seen in Q3. We expect, indeed, a little bit more to come in Q4.

[George Zhao, VP & Research Analyst]

Okay. And -- I mean, on the freight side, right? We've seen the capacity for the dedicated freighters up almost 30% in some of the recent months. So how does that translate into the performance of the spares for your freight aircraft, right? Like have we seen the high utilization leads to more shop visits? Or are they going to represent more of a deferred maintenance that would need to be caught up over time?

[Peter Kameritsch]

Well, I would say the first one. So I think the higher utilization of the freighter fleets needs to more shop visit -- I mean, at least from our -- what I can say from our customer base, we have in our Hannover facility, we have some cargo operators as a customer. They do send more engines compared to, I would say, compared to pre-COVID levels. That is not deferred maintenance, but really a higher utilization of the freighter fleet compared to pre-COVID levels.

[Operator]

Your next question comes from the line of Chloe Lemarie, Exane BNP Paribas.

[Chloe Lemarie, Research Analyst]

I have 2, if I may. The first one is on MRO. Actually, I was wondering if you could help us understand the margin pressure that we saw in Q3. How much came from the GTF retrofit work and how much is really fixed cost underabsorption from lower organic volumes, and roughly how you see the margin performance recovering from there? The second one, might be a bit soon, but on 2021 outlook, can you share your thoughts on what would be the big moving part in terms of organic performance? Notably, obviously, your key partner mentioned no major step-up in aftermarket expected next year. And also on free cash flow because you may face some CapEx catch up. So that would be very helpful.

[Peter Kameritsch]

I would answer your first question regarding MRO margin. I would say the major part of the margin pressure in MRO really comes from the sales mix. I mean our largest facility in Hannover is utilized at a very high level with PW1100 shop visits and there the limit is not so much through the qualification of the blue collar workers here being allowed or being able to work on the PW1100 engine. So really the sales mix coming from lower share of independent MRO shop visits compared to a higher share with MRO, and there, especially PW1100 retrofit shop visits, that is the main driver for lower margin in Q3, and we're going to see the same development also in Q4. So probably, I think for the full year, we're going to end the year with a margin, making the MRO division by -- in the magnitude of 5% or so.

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

Regarding the other questions to 2021, we will not give indications today for 2021. But I think in a couple of weeks, 2 weeks, we have our Capital Markets Day. And there, we will give first indications what we expect in the different business divisions for the next year.

[Operator]

Your next question comes from the line of Ben Heelan, Bank of America.

[Benjamin Michael Heelan, Analyst]

The first question I have was on the OEM margins. The Q3 OEM margin of 19.9%, it was definitely ahead of where I was expecting. Is that a similar level of run rate that we can expect into Q4? And are there any key moving pieces that we should be aware of within that? And secondly, on cash, are you still on track to see positive cash flow this year? And is there any color about what the key moving pieces could be as we move into 2021?

[Peter Kameritsch]

No. I think the OEM margin is, I would say, a normalized OEM margin, which we would see also roughly in Q4 -- I mean, I think rather the Q2 margin was very, very low, driven by the facts, which I explained also in the Q2 call. So a very high level of underabsorption in Q2 coming from the closure of our facilities in April, very low military revenues and very low staff at offices. But that -- this were the main driver for -- and we also booked some bad debt provisions in Q2. So that was the main driver for the very low-margin in Q2. So Q3, obviously, we saw a recovery. In Q4, we're going to see something similar. I mean, we have indicated before that we're going to have a very strong quarter for the military division with roughly -- a little bit below EUR 200 million of revenues. Also, hopefully, sequentially a little bit better spare parts and also more or less the same level of deliveries in the OE. So we think we can sustain a margin in that area. I mean, cash flow, so -- I mean, there's a high share of uncertainty around cash flow, I would say. So what we really can expect is that the inventories will fall further. So I think we saw sequentially it really go from quarter-to-quarter. So we can see a little bit of destocking in our MRO division and also in the OEM division. So -- following our capability to really to take less part also from our suppliers and deliver also more engines from our consignment store. So we're going to see there a falling tenancy in inventories. On the receivables side, I think it it's quite unclear. So there's -- so a lot of airlines are in a financial difficult situation and which airline will pay in December or in January, there's -- that's -- is not really clear. So -- but definitely, I mean, we are now at a free cash flow level of EUR 145 million. So we're going to end the year with a significantly positive free cash flow, but what the number exactly will be, it's not really tangible today.

[Operator]

[Operator Instructions] Your next question comes from the line of Richard Schramm, HSBC.

[Richard Schramm, Analyst]

I have a question concerning the projected reduction of headcount. So far, we have seen a minus of 2% and your target is 10% to 15%. Can you update us how this is going forward, what we should expect end of this year and what is left for 2021? And will the EUR 34 million of provisions you booked in Q3 be really covering the whole program or is there more to be expected in the next year maybe? Because to me, this amount looks relatively moderate compared to the number of headcount reduction you are targeting, I must admit. And then second question, please, just on the visibility you have for Q4 as you're obviously implying your guidance, a strong quarter-on-quarter improvement in more or less all segments here. Military seems to be quite safe, I would assume. But what about the civil segments here? What is the risk that targets are not achieved here.

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

So maybe I'll start with the capacity reduction and headcount. First of all, it's important to know that this announced 10% to 15% is not only staff, it's capacity. So that includes also working hour reductions where a lot of people -- we had a lot of people having a 40-hour contracts, where the agreement of the union is, in general, a 35-hour contract. So we canceled all these contracts, which is a 5-hour reduction for a significant number of employees. Secondly, there's a significant number of leasing staff we had on board before, which we also stopped. And leasing staff is not included in the headcount number. So it's -- and the -- the remaining part will come from voluntary agreements with people or with these early retirement plans. The EUR 34 million restructuring charge will cover the entire program. So no additional charge in 2021 for that. And we have actually roughly, I would say, between 60% and 70% of the target is already under contract and the people will leave the company at the end of 2021. So we'll see the full impact then in 2022. And I would say roughly 50%, 60% of the impact in 2021.

[Peter Kameritsch]

Okay. Your second question was around the risk that we achieve -- risks associated with our guidance. There's not a big risk. So I mean, in the military space, I think we have a very good visibility. I mean, the orders are there. We have to work on these. We have to reach the milestone, so that can be built, that you can send the bills to the German Air Force, but there's has to be a very limited risk. In the MRO, all engines which we're going to bill in Q4 are already in the shop or waiting in front of the shop. So there's -- so the shop visit volume is not at risk also, I think, from the delivery side to what's the others at Boeing. We have a very good visibility. So overall I think there's not a lot of high-risk at the end of October that we can achieve our guidance for the year. So it's something like EUR 4.1 billion with a 10% margin. So that is still the sort of target, I would say.

[Richard Schramm, Analyst]

Okay. Just coming to the headcount reduction. So in fact, the clear number of your, let's say, own staff would be more than in an area of 5% or so? What should we expect here just to get an idea of what we should see here?

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

Yes. Yes.

[Operator]

Your next question comes from the line of Andrew Humphrey from Morgan Stanley.

[Andrew Edward Humphrey, Vice President]

Just one, if I may. On spares, it seems like -- can I check, firstly, did you say down 40% in Q3? If so, that seems a little lower than you have been indicating over the course of the second half? And I guess the kind of follow-on question is, what does the guidance imply for Q4 at the midpoint in terms of spares year-on-year?

[Peter Kameritsch]

The guidance applies a 30% decline in Q4.

[Operator]

[Operator Instructions] Your next question comes from the line of Harry Breach, MainFirst Bank.

[Harry William Freeman Breach, Research Analyst]

Just a quick one for me. There have been some third-party forecasts globally looking at the engine MRO market next year and beyond. Can you give us how you're thinking and what you're seeing in terms of independent MRO sort of shop visit bookings looking into 2021 and how you see the volumes for the retrofit shop visits, if you can, please?

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

Harry, as already said before, we should wait. It's only 3 weeks when we have our Capital Markets Day. And I think that's a good opportunity to talk more in detail about 2021, what we expect for independent business and also for the GTF retrofit programs, but I would really ask you to wait for this event.

[Operator]

And your next question comes from the line of David Perry from JPMorgan.

[David Howard Perry, Head of European Aerospace and Defense]

Hello. Can you hear me, Peter, Reiner and Thomas?

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

Yes.

[David Howard Perry, Head of European Aerospace and Defense]

Look, one question, you may or may not want to answer because, obviously, you're going to keep us waiting fair enough for the CMD, so I look forward to. But just conceptually, I just sort of want to know where your kind of your heads are and your take on the market. As you're thinking about your guidance today that you're preparing for us, would you say things today look more challenging than you saw last time you spoke to us about the same, better, just so I can sort of be interesting to have your views on that, you're willing to share them.

[Peter Kameritsch]

You mean for 2020 or for 2021?

[David Howard Perry, Head of European Aerospace and Defense]

No, for '20 -- your views today on '21 -- 2021 compared to how you might have been thinking at the time of the H1 results. Would you say things are on track, things looking nothing more challenging? Just to frame what's coming at the CMD.

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

I think it's not more challenging than what we saw at the H1 results. I think we have now, let's say, a couple of months with more, let's say, visibility on the market. And I would say, I mean still it's not the same as in previous years, but I would say that compared to what we saw in July, we have no better picture on what we expect for 2021, especially on, let's say, I would say, on the MRO market, but -- and also on the new engine sales, maybe on the spare part sales, it's a little bit more. But as Peter mentioned already, we have a portfolio which is a little bit more robust maybe than the other competitors have with the exposure to freighters and also for some military application, which definitely helps us.

[David Howard Perry, Head of European Aerospace and Defense]

Okay. And in terms of just air traffic, do you think it will be where you thought it would be or a bit ahead, a bit worse?

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

Difficult to answer air traffic.

[Peter Kameritsch]

I would say, when you look into China, I think the recovery was quicker compared to our expectations several months ago. I think in Europe or North America, the situation still is quite volatile now adding -- the COVID-19 cases increasing and so on. So it's going to be -- for the next -- for the winter months, I would say, it's going to be a bumpy ride, but we definitely expect going into 2021, a recovery in the -- especially in our most important market, narrow-body market now.

[David Howard Perry, Head of European Aerospace and Defense]

Yes. And then just last one, if I might. It was very helpful for you to say might. You're assuming minus 30 for spares in Q4. Would you care to share your freighter assumption in that? Presumably, that must be quite positive because I would have thought passenger planes would have been -- spares would be quite a bit weaker than that?

[Peter Kameritsch]

Yes. I mean, I wouldn't go so deep, but I mean, for Q4, we expect on the B -- on the B25, we expect something like 40% down so that magnitude. And for the PW2000 and CF6-80, I mean, that is a mixed bag. You have -- especially of the PW2000, we have obviously a high share of military applications. And CF -- and the PW -- a little bit of freighter also on the PW2000, CF6-80, obviously, a high footprint in the freighter market. So for these 2 engine platforms combined, we expect even a slight growth, so mid-single-digit up or so in that magnitude. So that's going to definitely show growth compared to 2019 now. But also help, not only by the freighter market, also what we see currently a high level of aftermarket work for the F-117 engine for the military version of the PW2000.

[Operator]

Sorry, I think we lost the line of David.

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

Yes, he might rejoin us. So we got to take the next question.

[Operator]

Okay, perfect. Your next question comes from the line of Milene Kerner from Barclays.

[Milene Kerner, Research Analyst]

Just 3 questions for me, and sorry if you have already answered those. I mean, the first one, can you reconfirm the rate of OE decline in 3Q, please? My second question is on the restructuring provision of EUR 34 million. Can you confirm that, that is excluded from the adjusted EBIT, it's only in the reported EBIT? And then just a follow-up on David's question. Can you also comment the trends you have seen for your 3 main engine in 3Q, V25, CF6 and PW2000?

[Peter Kameritsch]

So confirm -- so the EUR 34 million restructuring charge is -- was obviously adjusted, EBIT adjusted. So it's in EBIT reported, but not in EBIT adjusted. OE sales in Q3 were down around 40%. And regarding spare parts, you mean in the quarter or 9 months?

[Milene Kerner, Research Analyst]

Oh no, in the quarter, please? [indiscernible] 40%? Yes.

[Peter Kameritsch]

Yes. I mean, in the quarter, so -- be roughly in the 50% range, and the PW2000 and CF6-80, so something like low to mid-single-digit [indiscernible].

[Operator]

Your next question comes from Chloe Lemarie from Exane BNP Paribas.

[Chloe Lemarie, Research Analyst]

I have 2 quick follow-ups. On the spares, actually, I was wondering if the contributors we tend to overlook like business jet and industrial gas turbine. What are the trends you're seeing there? And have they become more sizable contributors now? And the second one is the military. I understand you're quite confident in achieving your guidance. But can you just help us explain what would drive that significant growth in Q4? I mean is it just a timing of revenue recognition? Is it just a catch-up where you're absolutely confident that you can achieve it? That would be very helpful.

[Peter Kameritsch]

I think a large share is -- this concept of milestone billing. So once you reach certain milestones in a military services contract or aftermarket contract, you can send the bill to the customer. So it's not unusual that in the military space, we have a higher share of revenues in the fourth quarter. So there we are quite confident. So it's not that we -- in Q4, we do a lot of more work compared to Q3 or Q2, but we can bill the work we have in part also done in Q3, for example, we can bill that part of the work in Q4 than -- or at year-end. And business jet -- IGT business is quite stable. I mean it's not a big part of our business, but we do IGT MRO work in our Berlin facility that is part of our MRO division and we sell, obviously, on the LM6000 platform, which is the aero derivative of the CF6-80. We have some spare parts, and that business is, I would say, broadly stable, quite untouched from the crisis. Business jet engines are -- spare parts are a little bit down there, but not like 30%, 40%. It's less than that. But they are also down.

[Operator]

[Operator Instructions] Your next question comes from Christian Cohrs, Warburg Research.

[Christian Cohrs, Analyst]

Three questions left for me. First, R&D expense has gone -- has come down in the 9 months, but also for the third quarter. Is this just attributable that you are hitting the brakes? Or is it just a reflection over the cycle? And should we expect R&D expenses to go up mid-term again as things will hopefully normalize. Second question relates to your balance sheet. You have quite a junk of -- quite a bunch of program values in your balance sheet now given that the outlook for aviation is deteriorating these program values at risk? And last but not least, with regards to your defense business, maybe looking down the road, is it fair to assume that defense budget could come under pressure given that public finances get a hit, and therefore, that politicians might have to reallocate money away from defense towards health care, et cetera?

[Peter Kameritsch]

Okay. Then we -- I start with number one, R&D. I mean, we have -- as we have announced our savings -- our measures to mitigate the COVID-19 impact, we already communicated that we're going to cut R&D by 30%. So in alignment with our partners and that you see the consequence of that, obviously, in the P&L that R&D falls. So you're going to see that for this year. And what happens in the coming years, I would say that is a question we also kind of touch in part on our Capital Markets Day. But -- I mean, there's no new engine platform on the horizon currently. I think a dramatic increase in R&D spendings will happen when -- once we -- a new aircraft program, and in consequence, an engine program will start on. So that is not -- currently not tangible. You have -- you also asked about our intangible assets on the balance sheet. I mean, in every year, the intangible assets on the balance sheet are subject to impairment tests, so we're going to conduct -- do conduct it at -- we did that together with half year results, and we're going to do that at year-end, obviously. So what was -- the outcome will be, I cannot comment today. There is obviously -- I mean, especially with some wide-body program base, there's a certain risk that we're going to see a small impairment also. But it's not like 30%, 40% of the intangible assets are at risk or so.

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

Okay. Coming to your last question regarding defense budget. No, we do not see them being at risk -- under pressure in the future. I think actually, we are waiting for a replacement order of the first Eurofighter tranche that will support the military business, then you know in the next coming years, there will be a decision to replace the Tornado fleet, which is an upside potential for that business and the most important one. And definitely, these German, French project about the new fighter aircraft program where we developed the engine together with Safran, where we expect also in the next year that the -- that the next phase of R&D will be approved by the Parliament. So we think that the military business outlook is unchanged compared to what we said in the past.

[Operator]

There are no further questions at this time. Would you like me to remind again or should I pass back to you, sir?

[Thomas Franz, Vice President of Investor Relations]

I think it's okay. Back to us.

[Operator]

Thank you. I'll hand the call back over to you for closing remarks.

[Thomas Franz, Vice President of Investor Relations]

So this marks the end of our call. Thank you, everybody, for joining. And if there are further questions, please contact the IR team. Thank you, and stay safe.

[Operator]

Thank you. That does conclude our conference for today. Thank you for participating. You may all disconnect.