Is Howmet Aerospace a Buy at Its Premium Valuation?

Howmet Aerospace (HWM) - Motley Fool Scoreboard Review

This summary details a review of Howmet Aerospace (HWM) by Motley Fool analysts Matt Frankel and Lou Whiteman, who provide a 1-10 rating across several categories.

Key Concepts

Aerospace Components: Specialized metal parts, primarily for aircraft engines, including fasteners, structural, and rotating components.
Intellectual Property (IP) & Patents: Howmet holds patents on a significant portion of its products, including many aluminum alloys used in aircraft.
Competitive Moat: The strong IP and patent protection create a significant barrier to entry for competitors.
Industry Cyclicality: The business is subject to the health of the new and used aircraft market, introducing commodity and cycle risk.
Management Succession: Concerns regarding the age of the current CEO and the lack of a clear, younger succession plan.
Financial Health: Revenue and earnings growth, debt reduction, free cash flow generation, and shareholder returns (dividends and buybacks).
Valuation: The stock's current valuation, particularly its forward Price-to-Earnings (PE) ratio, and its implications for future returns.

Business Strength

Rating: Matt: 9/10, Lou: 8/10
Core Business: Howmet Aerospace manufactures highly specialized metal parts, predominantly for aircraft engines, including fasteners and other components.
Market Dominance: Lou highlights that Howmet makes "90% of all 'structural and rotating components for aircraft engines'," emphasizing its critical role in the industry.
Intellectual Property: The company possesses "tremendous intellectual property" and owns patents on "pretty much everything it makes," including many aluminum alloys used in aircraft. This provides a "massive competitive advantage."
Diversification: Howmet serves a "great range to a bunch of different platforms," offering diversity in its customer base and product applications.
Origin Story: The business was originally a collection of entities assembled by Alcoa. While Alcoa may have "overpaid" and struggled with integration, its "loss has been shareholders' gains" as Howmet, spun off, has thrived under new management.
Performance: The company has seen significant growth, with Matt noting it's "up 1000% over five years."
Risks: Matt points out "commodity and cycle risk" due to the business's dependence on the "health of the new and used plane market."

Management

Rating: Matt: 7/10, Lou: 7/10
Turnaround Success: Lou credits CEO John Plant, who took over in 2019, with transforming the company from a "bit of a basket case" to its current success. Plant has a strong prior reputation from his work at TRW.
Succession Concerns: A primary concern for both analysts is the age of CEO John Plant, who is "72-years-old." While he has a retention award with RSUs vesting in 2028, indicating he's not leaving immediately, the lack of a clear succession plan is a point of concern.
Internal Bench Strength: Lou notes that even potential internal successors, such as the CFO and COO, are "all in their early 60s," suggesting a lack of a "great natural succession plan within the business."
Comparison to Berkshire Hathaway: Lou draws a parallel to Berkshire Hathaway, where Warren Buffett's longevity led to successors also being in their later years.
Management Team: Despite succession concerns, both analysts acknowledge the presence of a "good team" and a "bench" within the company.

Financials

Rating: Matt: 7/10, Lou: 7/10
Record Performance: The company achieved "record breaking performance in the most recent quarter in terms of revenue and earnings."
Profitability Growth: Earnings are growing "at more than twice the rate of revenue," indicating "benefits of scale and demand."
Debt Reduction: Howmet has reduced its debt load by "more than two billion since 2020."
Free Cash Flow: The company expects "about $1 billion in free cash flow this year."
Shareholder Returns: With decreasing debt, Howmet is increasingly focused on returning cash to shareholders. The "share count is down 7% in the last five years," and the dividend was "boosted by 20%."
Balance Sheet Weaknesses: Despite improvements, the balance sheet still requires attention. The company has "$3.4 billion in debt and just 500 million in cash."
Incremental Gains: Matt believes "the low hanging fruit is picked" in terms of finding value, suggesting future gains will be "more incremental."
Debt Load: Lou considers the debt load "totally reasonable for a company of its size and revenue and profitability."
Buybacks: Lou anticipates buybacks "ramping up and being opportunistic."

Valuation

Rating (Next 5 Years Returns): Matt: 7/10 (5-10% returns), Lou: 7/10 (10-15% returns)
Safety Score: Matt: 7/10, Lou: 7/10
Key Concern: Valuation is the primary issue. The stock is at an "all time high" with a "forward PE of approaching 50."
Priced-in Growth: Matt believes "an unrealistic amount of future growth might be priced in at this point."
Market Performance: Matt expects "slightly underperforming the market" with 5-10% returns over the next five years. Lou is more bullish, expecting "market beating" returns of 10-15% due to strong order books for Boeing and sustained demand.
Sustainability: Lou questions "how long they can sustain this" level of growth, but believes for the "next five, it's probably all right."
Safety: Both rate safety at a 7/10, acknowledging that "aerospace is not disappearing" and Howmet is a vital part of the supply chain. The question is "growth from here, not sustainability."

Overall Score

Average Score: 7.2 out of 10

Conclusion

Howmet Aerospace is recognized as a high-quality business with a strong competitive moat due to its intellectual property and market dominance in critical aircraft engine components. The company has demonstrated impressive financial performance, including revenue and earnings growth, significant debt reduction, and a commitment to shareholder returns. However, concerns about management succession, particularly the age of the CEO and the lack of a clear younger successor, temper the overall assessment. The current valuation, with a high forward PE ratio, also suggests that significant future growth may already be priced into the stock, leading to expectations of solid but potentially not market-beating returns over the next five years. Despite these concerns, the fundamental strength of the business and its essential role in the aerospace industry provide a degree of safety.