HEXCEL CORP annual report, FY2016

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Hexcel Corporation — FY2016 Form 10-K

Reporting period: Fiscal year ended December 31, 2016. The filing also reports fourth-quarter results. Hexcel develops and manufactures advanced composite materials and structures, primarily for commercial aerospace, space and defense, and industrial markets.

Financial performance and position

  • Revenue: $2.004 billion, up 7.7% from $1.861 billion in 2015 (7.9% in constant currency). Commercial Aerospace accounted for 71% of sales, Space & Defense 16%, and Industrial 13%.
  • Profitability: Gross margin was $564.6 million, or 28.2% of sales, versus $532.8 million, or 28.6%, in 2015. Operating income was $360.1 million, up from $332.4 million; operating margin increased to 18.0% from 17.9%. Net income was $249.8 million versus $237.2 million; diluted EPS was $2.65 versus $2.44.
  • Fourth quarter: Sales were $483.5 million versus $464.9 million in Q4 2015; operating income was $87.0 million versus $81.2 million; net income was $59.5 million versus $53.9 million; diluted EPS was $0.64 versus $0.56.
  • Cash flow and investment: Operating cash flow was $401.4 million, compared with $301.0 million. Capital expenditures were $327.9 million; company-defined free cash flow was $73.5 million, versus negative $4.3 million in 2015. Accrual-basis capital expenditures were $320.2 million.
  • Debt and liquidity: Total debt was $688.7 million, up from $576.5 million; cash was $35.2 million, leaving net debt of $653.5 million. Working capital was $335.1 million. The company had $332.9 million available under its $700 million revolving facility, which matures in June 2021. It reported compliance with debt covenants.
  • Capital returns: Hexcel repurchased $111.1 million of stock and paid $39.8 million in dividends in 2016. The board authorized an additional $300 million repurchase program in February 2017.

Material changes versus 2015

  • Commercial Aerospace sales rose 11.1% (11.3% in constant currency), led by ramping A350 and A320neo programs. New-program sales to Airbus and Boeing and their subcontractors increased more than 40%, while legacy aircraft sales declined 8%.
  • Space & Defense sales declined 4.6% in constant currency, primarily reflecting lower rotorcraft sales. Industrial sales rose 6.4% reported and 7.4% in constant currency, with Formax acquisition benefits partly offset by weakness in recreation and other industrial markets.
  • Composite Materials sales increased to $1.610 billion from $1.459 billion; Engineered Products sales decreased to $394.3 million from $402.5 million. Engineered Products operating income fell to $50.0 million from $55.8 million.
  • Interest expense increased to $22.1 million from $14.2 million, reflecting debt levels and the 2015 issuance of $300 million of 4.7% senior notes due 2025. Debt also rose amid share repurchases, dividends, investments, and the Formax acquisition.
  • Operating cash flow improved by $100.4 million, with management citing higher earnings and lower working-capital usage. Capital spending continued to rise as Hexcel expanded manufacturing capacity.

Outlook, commentary, risks and unusual items

  • Management expected 2017 capital spending of $270 million to $290 million and positive free cash flow above $100 million. It expected first-half cash needs to be funded by available borrowings. Airbus and Boeing projected combined 2017 deliveries just above 2016 levels; the filing does not provide a specific company revenue or EPS guidance figure.
  • Capacity expansion includes the Roussillon, France carbon-fiber facility, expected to be completed in 2017 and qualified in 2018, and a Casablanca, Morocco engineered-honeycomb plant expected to be operational in the second half of 2017.
  • Customer concentration is significant: Airbus and its subcontractors represented 41% of 2016 sales and Boeing and its subcontractors 28%. Commercial Aerospace demand, aircraft production schedules, program ramp-ups, and customer pricing pressure are key sensitivities.
  • Other risks include reliance on limited or sole-source qualified raw-material suppliers; manufacturing and qualification delays; foreign-exchange exposure; potential reductions in defense spending; and environmental, safety, and international operating risks.
  • Environmental accruals were $3.2 million. Hexcel’s allocation of Lower Passaic River remediation costs remains uncertain; the EPA estimated the selected remedy for the lower eight miles at $0.97 billion to $2.07 billion, excluding the upper river. The company noted that its recorded environmental accrual could be $16 million higher if estimated at the high end of certain ranges.
  • 2016 included $6.6 million of tax benefits, primarily from releases of uncertain-tax-position reserves; the adjusted effective tax rate excluding discrete items was 30.0%. The company also acquired the remaining Formax interest and invested $30 million in affiliates, including Oxford Performance Materials, Luminati Aerospace, and Carbon Conversions. An additional $10 million OPM investment was made in January 2017.
  • Management reported effective disclosure controls and internal control over financial reporting; the auditors issued unqualified opinions on the financial statements and internal controls.

Important facts for investors to verify

  1. Whether commercial aircraft production and new-program ramps support the expected sales and margin trajectory, particularly given dependence on Airbus and Boeing.
  2. Whether large capacity investments convert to qualified production on schedule, and how capital spending affects free cash flow and debt.
  3. How the decline in Space & Defense and lower Engineered Products profitability develop, including program transitions and rotorcraft exposure.
  4. The ultimate cost and timing of environmental obligations, especially the Lower Passaic River matter, relative to the recorded accrual.
  5. How tax benefits, foreign exchange, raw-material availability and pricing, and continued repurchases affect recurring earnings and liquidity.