KAISER ALUMINUM CORP quarterly report, Q1 FY2017

Kaiser Aluminum Corporation — Q1 2017 Form 10-Q

Business context and reporting period. Unaudited results cover the quarter ended March 31, 2017, compared with the quarter ended March 31, 2016; balance-sheet comparisons are with December 31, 2016. Kaiser produces specialty semi-fabricated aluminum products for aerospace and high strength (Aero/HS), automotive, general engineering (GE), and other industrial markets. It reports one operating segment, Fabricated Products.

Financial performance and liquidity

Shipments rose 3% to 163.6 million pounds. Value added revenue, which excludes hedged metal cost, fell to $203.9 million from $210.7 million; value added revenue per pound declined to $1.25 from $1.32. Reported operating income benefited from a $15.1 million unrealized derivative gain, versus a $4.0 million gain a year earlier. Fabricated Products operating income excluding the company’s identified non-run-rate items was $56.0 million, down from $59.0 million.

GE sales increased to $123.2 million from $105.4 million, while Aero/HS sales declined to $167.5 million from $176.9 million. Automotive Extrusions sales rose to $53.0 million from $48.4 million. Management attributed these movements mainly to strong GE demand and restocking, offset by aerospace supply-chain destocking.

At March 31, cash and cash equivalents were $34.4 million and short-term investments were $195.5 million. Total liquidity, including $286.2 million of net revolver availability, was $516.1 million, down from $561.5 million at year-end. The company had no revolver borrowings; $7.7 million of letters of credit were outstanding. Long-term debt was $368.9 million on the balance sheet; the outstanding senior notes have $375.0 million principal, a 5.875% coupon, and mature in 2024. Current assets were $636.2 million and current liabilities $153.9 million. Cash, cash equivalents, and restricted cash totaled $46.7 million, including $12.3 million of restricted cash.

Material changes and management commentary

• Sales growth reflected 3% higher shipments and a slight increase in average realized selling price per pound. The average hedged metal cost increased, while value added revenue per pound fell amid competitive pricing and a less favorable product mix.
• Reported operating income improved, but the company’s adjusted Fabricated Products segment operating income declined $3.0 million year over year. Lower sales margins and product mix were partly offset by scrap-cost benefits, lower maintenance and incentive costs, and manufacturing efficiencies.
• Operating cash flow decreased, principally reflecting working-capital needs and $20.0 million of annual VEBA contributions. Financing cash outflows included $32.6 million of share repurchases and $9.3 million of dividends. The company repurchased 415,346 shares at a weighted-average $78.69 per share.
• Management expects commercial aerospace destocking and lower sales margins to continue. Planned Trentwood modernization outages and construction are expected to materially disrupt Q2 production, raise maintenance expense by approximately $5 million to $7 million versus Q1, and reduce shipments and value added revenue. Excluding non-run-rate items, management expects operating income as a ratio of value added revenue to decline approximately 6% from Q1; inefficiencies are expected to affect Q3 to a lesser extent.
• Management expects 2017 Aero/HS shipments to be similar to 2016 despite destocking and capacity constraints; it anticipates aerospace application demand growth approaching 10% annually in 2018 and 2019. It continues to expect double-digit 2017 Automotive Extrusions shipment growth and mid-single-digit value added revenue growth. GE demand is described as strong, though Q2 Trentwood outages constrain the opportunity.
• The Trentwood modernization is a multi-year, approximately $150 million investment. Management expects construction to be largely behind the facility near the end of Q3, with quality, cost, and capacity benefits beginning in the second half of 2017. Expected full-year 2017 capital spending is approximately $80 million.

Risks, contingencies, and unusual items

• Environmental accruals were $17.1 million. The company says reasonably possible additional undiscounted costs could total up to an estimated $12.3 million, with remediation and monitoring potentially continuing for 30 or more years; estimates may change as investigations and regulatory reviews proceed.
• Aerospace demand is exposed to production changes and supply-chain restocking or destocking; automotive demand depends on build rates and dealer inventories. Metal, alloy, energy, and foreign-exchange movements can affect results despite hedging. The company also noted customer and supplier concentration: two customers represented 29% and 10% of Q1 sales, and its five largest primary-aluminum suppliers supplied 86% of volume.
• The company had an ongoing Salaried VEBA contribution obligation and a final variable Union VEBA contribution, capped at $12.8 million, accrued at $11.5 million at quarter-end. It paid $20.0 million of VEBA contributions during Q1.
• Management identified possible impairment risk at the Chandler, Arizona extrusion facility if it cannot reduce costs or increase sales in the near term; no impairment was recorded in Q1. Legal proceedings had no material developments since year-end, and the filing reported no material changes to risk factors.
• New accounting standards: the company expects revenue standard adoption in 2018 and is assessing effects, including over-time recognition for some Aero/HS and Automotive Extrusions contracts. It expects the 2019 leases standard to have a material financial-statement impact.

Important facts for investors to verify

• Whether Q2 and Q3 Trentwood outages and modernization work produce the forecast production, cost, and margin effects, and whether the project delivers expected benefits on schedule.
• How much reported earnings depend on derivative mark-to-market gains versus underlying conversion margins; monitor value added revenue and adjusted segment operating income.
• Whether aerospace destocking persists and whether the stated 2018–2019 demand recovery and automotive growth expectations materialize.
• Liquidity composition and availability, including restricted cash, short-term investment maturities, revolver borrowing-base capacity, and cash needs for capital spending, dividends, repurchases, and VEBA obligations.
• Potential changes in environmental remediation estimates, particularly at Trentwood and Newark, and the Chandler facility’s impairment risk.
• Customer and primary-aluminum supplier concentration, as well as the effect of metal, energy, and alloy price changes on hedge values and operating results.