MTU Aero Engines AG (MTUAF) CEO Reiner Winkler on Q2 2020 Results – Earnings Call Transcript


MTU Aero Engines AG (OTC:MTUAF) Q2 2020 Earnings Conference Call August 3, 2020 5:00 AM ET

Company Participants

Thomas Franz – Vice President, Investor Relations

Reiner Winkler – Chief Executive Officer

Peter Kameritsch – Chief Financial Officer

Conference Call Participants

George Zhao – Bernstein

Milene Kerner – Barclays

Chloe Lemarie – Exane BNP Paribas

Andrew Humphrey – Morgan Stanley

Ben Heelan – Bank of America

Alexander Hauenstein – DZ Bank

Zafar Khan – Société Générale

Christophe Menard – Kepler

Joachim Kotze – Morningstar.

Harry Breach – MainFirst

Richard Schramm – HSBC

David Perry – JPMorgan

Operator

Ladies and gentlemen, thank you for standing by and welcome to today’s MTU Aero Engines First Half Results 2020. For your information, the management presentation including the Q&A session will be audited and streamed live or made available on demand on the Internet. They can be in the conference call. Advance permission for audio recordings intended for publications 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, sir.

Thomas Franz

Good morning, ladies and gentlemen. Welcome to our conference call for the H1 2020 results. We will start with the business review of the second quarter and the financial highlights presented by Reiner. Peter will give you a more detailed view on our OEM and MRO segment. Following that, Reiner will give some information about our view on the current situation and lead you through our revised guidance. After that, we will open the call for questions.

Let me now hand over to Reiner for the review.

Reiner Winkler

Yes. Thank you, Thomas, and welcome also from my side. Let me start with the market environment. The latest IATA forecast shows a 55% decline in passenger traffic for 2020. After the absolute low in April, we see first signs of recovery. The worldwide domestic market shows improvements whereas international flights are still down close to 100%. As a result, we now see the contraction in demand for our new engine and aftermarket business. Peter will give you some more details in a few minutes.

In our MRO segment we used available capacity to accelerate the GTF retrofit work. The cost reduction measures which we announced after Q1 are implemented and start delivering results. However, these have not taken full effect yet. Currently, we use the instrument of short-time work across all German sites. This helped us to achieve a steep reduction in capacity in April and May. In June, we increased the capacity according to the actual demand.

In addition to that, we announced the reduction of our total personnel capacity by 10% to 15% until year-end 2021. To reach this target, we will make use of partial and early retirement schemes and also individual arrangements. Further actions are the hiring freeze, a way to fill vacant position and reduction of working hours. However, we already had to lay off several employees at some locations. Restructuring charges are not yet accounted for. This will happen in the second half of the year.

In the second quarter, we increased our liquidity headroom significantly. We issued €100 million promissory note and increased our revolving credit facility to €700 million. Further, we successfully placed the €500 million bond, which boost our total accessible liquidity to currency around €1.5 billion. And finally, we recently published our new outlook for 2020 and I will give some more details after the Peter’s presentation.

Let’s have a look at the financials for the first half of 2020. Our revenues decreased by 9% to €2 billion. Organically, group revenues would be down by 11%. The group EBIT adjusted declined by 39% to €224 million, resulting in a margin of 10.9%. Respectively, the net income is also down at €161 million and the free cash flow decreased by 47% to €125 million in the first half of 2020.

Let me now hand over to Peter for a more detailed look into the business segments.

Peter Kameritsch

Yes. Thank you, Reiner, and good morning, everyone. Let me start with our OEM segment. Total OEM revenues were down 18% to about €814 million. Military revenues decreased 15% to €183 million, mainly due to reduced working hours from the three-week shutdown in April and the subsequent short-term working scheme in our Munich facility.

However, we expect a full recovery by year-end, implying a strong H2 in the military segment. Commercial business declined 18% to €631 million. And within that organic OE sales were down high single digits, versus the six-months 2019. Q2, 2020, in OE was down in the mid-20s versus Q2, 2019. The main reasons there are, obviously, lower aircraft deliveries and aircraft production rate cuts at Airbus and Boeing.

Organic spare part sales declined in the mid-20s versus six-months 2019 and in the quarterly comparison they were down roughly 15%. The business mix and a lower fixed cost coverage led to a reduced EBIT adjusted of €128 million, resulting in a margin of roughly 16%.

Let’s switch to the MRO segment. Reported MRO revenues remained almost stable at €1.3 billion. Organically, in U.S. dollars, they would have been down 3%. Our core MRO business was down in the mid-teens, compensated by higher workload for GTF retrofits. In the quarterly comparison, MRO was down in the mid-20s versus Q2, 2019.

EBIT adjusted decreased 21% to €96 million, resulting in a margin of 7.6%. The lower EBIT margin results mainly from a higher share of GTF royalty work and some bad debt provisions we booked in Q2.

At this point, I hand back to Reiner for some more color on our guidance.

Reiner Winkler

Yeah. Thank you, Peter. You see we are still navigating through a lot of uncertainty. Our look to the market and the basis for our assumption follows the IATA’s latest published scenario for July. After the standstill of the majority of aircraft around the globe the recovery started in domestic markets. The restart in international travel has not yet taken place.

Today’s knowledge led us to a broad range of scenarios and possible developments in the current year. And all assumptions are subject to reservation, but from today’s perspective we have enough confidence to give a new outlook for the current year.

Our military business remains to be largely unaffected. The commercial OE and aftermarket business would see a significant demand reduction on the grounding of the maturity of the fleet. This results in strongly reduced demand in the second and third quarter improving from the end of Q3 onwards.

The MRO segment expects a significant reduction in demand from passenger airlines. And this will be partly compensated by higher volume from trade operators and higher share of PW1100 work. Benefits from the implemented measures will have its effect as planned until end of 2020. And activities to control our working capital are implemented and we’ve reduced a lot of energy to achieve our targets there.

This frame sets the basis for our new outlook for 2020. As mentioned before our outlook is based on our current knowledge and assumptions and is still subject to considerable uncertainties. Military revenues will be slightly up. Commercial OE will be down by mid to high 20s driven by overall lower GTF and GEnx output.

Commercial spares are expected to be down high 20s. Aftermarket remains to be hit hardest by the market weakness. MRO revenues will be down by low to mid-single digits. Stronger reduction in core MRO business will be partially compensated by higher GTF work.

Given GTF revenue contribution is highly dependent on the exact work scope and is therefore even more volatile. As you know this work does not add EBIT to the bottom-line.

All-in-all these different developments lead us to an estimated revenue between €4 billion and €4.4 billion for the group based on an average euro-dollar rate of $1.15. The EBIT adjusted suffers from the reduced volume and worsening mix and is expected to be in the range between 9% and 10%.

Net income adjusted is expected to develop broadly in line with the EBIT number. And finally as already indicated at our Q1 call our clear target is to achieve a positive free cash flow for the full year.

So this ends the presentation and we are now open for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Okay. We will now take our first question and it comes from the line of George Zhao from Bernstein. Please go ahead.

George Zhao

Hi. Good morning, everyone. Could you share the organic spares growth in Q2 for the V2500, CF680 and PW2000? And I guess, how much of the spares activity in Q2 would you say was related to work that had already been contracted before the start of the quarter?

And my second question is related to freight. I mean clearly freight has been more resilient than commercial in this environment but it seems like the freight spares have seemed to significantly outperform the freight traffic as well. So I was wondering do you think there has been any pull forward in the freight maintenance activity as the operators have taken advantage of the availability of the MRO capacity? Thanks, Reiner.

Reiner Winkler

Let me just give — I mean the V2500 was down like 50% to 60% in Q2 whereas PW2000 and CF680 are more or less stable environment. And I mean in case of the PW2000 you should not forget that a large part of the fleet is military operations. So that is the power plant for the C17 freight and that was quite strong. I mean the commercial part of the PW2000 also fell in the — I mean also prep gate the numbers therefore it was down like 80% or so but more than compensated by demand for the military business. But typically you don’t have orders like three or four months in advance.

So that is really the orders for spare parts. They come in on a monthly basis as long as you don’t have — you are not the holder of the flight hour contract. I think for the full year we expect that trend to continue more or less. So more demand from freight operators as lending capacity is really short because international flights are not very active. And they can send more shop visits as planned initially. So wasn’t the answer to the question? If yes, then we can take the next question.

Operator

Okay, sir. We will now take our next question and it comes from the line of Milene Kerner from Barclays. Your line is now open.

Milene Kerner

Yes. Hello. Thank you for taking my question. I have three quick questions. First on this impairment charge the €3 million you had at MRO. I mean, can you give us a bit more color about this charge? My second question, I know that Reiner you said that the GTF retrofit work can be very volatile. But I mean, you used to expect €400 million increase for this year compared to last year. I mean what kind of revenue contribution we should now assume in the restated guidance?

And then lastly, the profit that came from the companies that you account under the equity method was much higher than what I was expecting in Q2. I was wondering if you can – I mean, how do you expect this to track in the second half of this year? Thank you.

Reiner Winkler

We ended the small charge in MRO. You can have a call with Thomas. So we don’t have the answer here right now. Regarding the equity, I mean, Zhuhai is quite stable. So we saw – I mean in – we saw demand in Zhuhai not falling as in other location as China. You know the Chinese pattern is a bit different compared to the European one. So we had the trust probably in air traffic in February or mid-March and so volumes are increasing right now. So Zhuhaimore or less regarding an equity results more or less stable. So that is the reason why you see that. I didn’t get the revenue question. So €400 million. What was your question? Could you repeat that please?

Milene Kerner

I mean, how much increase you expect in revenue related to the GTF retrofit work?

Reiner Winkler

So that we – do you mean on a quarterly basis? Or on a yearly basis?

Milene Kerner

No sorry on a yearly basis, I mean pre COVID you used to expect about €400 million increase this year versus last year related to the GTF retrofit work. I was wondering if you can share maybe a range because I understand that I mean it can be volatile. But a range of revenue increase that you’re expecting this year related to the GTF retrofit?

Reiner Winkler

It will be a bit more than that actually. So maybe €500 million or so – €500 million to €600 million but that’s really heavily depends on the work scope and especially on the material content. In a shop visit you have maybe 70%, 80% of the revenue is really building in new spare parts, especially in case of these retrofit shop visits and that can fluctuate a lot. So that number is really volatile. But that is today’s perspective at least now.

Milene Kerner

Okay. Very clear. Thank you so much.

Operator

Okay, sir. We will now take our next question. It comes from the line of Chloe Lemarie from Exane BNP Paribas. Your line is now open.

Chloe Lemarie

Yes, good morning, gentlemen. Thank you for taking my question. I had a couple if I mayThe first one is on comments you made to the press earlier this morning, regarding expectation of €800 million of cash or slightly less by the end of the year. So taking into account the €400 million bond that was issued in July, this would imply below free cash flow in H2. Is that correct? Or am I missing other debts and below free cash flow movement in H2?

And the second I’m trying to understand the assumptions on margin behind your guidance. If we take the midpoint of sales and EBIT, you seem to expect better performance in spare parts, military and MRO in H2 than you did in Q2 and yet the drop in margin is actually quite high in H2, almost 100% compared to 40% in Q2. So are there any element of one-offs or anything we need to consider for H2 to explain the steep margin? Or is it just driven by fixed cost under absorption and the dilution from the GTF? Thank you.

Peter Kameritsch

I mean the €800 million was a rough number I stated in the press call. I mean, we have – obviously if you look at into our numbers now liquidity of €300 million and we did – and in the €300 million liquidity that the bond is not included as the bond closed at the 1st of July. So if you add to €300 million, the €500 million inflow from the new bond then you come up with €800 million.

I mean, the free cash flow doesn’t change a lot compared to the €125 million we had to – we had in H1. Maybe it goes down a little bit in H2. There the volatility is also very high because I mean regarding cash collection for customers you have not a full transparency but also not inventory flow into the factory, inventory outflow in direction of the airframers. So there are a lot of volatile elements in that cash flow. That’s why we didn’t give an exact number or an exact cash conversion rate. I stated that the target is to remain in the positive territory for the cash flow. And yes I mean below the free cash flow line you have also some – the payment for the IAE upshare which is paid to Rolls-Royce.

We have still two quarters to pay, but obviously also on a lower basis because the flight hours are lower. I mean for the margin trajectory, I mean we expect definitely a second half of the year which is stronger in the military business. I mean if you look on the guidance we gave that we expect a number close to €500 million and we had a little bit short of €200 million for the first half year. So we’re going to generate something like €300 million of military revenues. That is definitely a tailwind to the margin.

We don’t have the interruption of production in our German sites. So I mean we shut the facility here for three weeks in Germany, Munich, and also in Berlin and we were at short-time work beginning what is 100% then we had a period where we were two days at home and three days working. And now we are rather one day at home and four days working.

And so we expect more or less for the German site mix which is for the rest of the year 4x work and one day at home. So that fixed cost absorption should be higher in the Q3 and Q4 compared to Q2. And obviously we expect — I mean, when you listen to Reiner that we expect also a slight acceleration of spare parts demand from end of Q3 on. But we don’t – obviously, we don’t have full transparency when that exactly will happen. And all that means that we expect margin for the year between 9% and 10%. I hope that answers your questions.

Chloe Lemarie

Yes. Thank you.

Operator

Okay. We will now take our next question. It comes from the line of Andrew Humphrey from Morgan Stanley. Your line is now open.

Andrew Humphrey

All right. Thanks very much. Just a couple of questions from me if I may. One of them following up on the question that was just asked around second half versus first half, I wonder if you could tell us by the business lines that you disclosed what the implied organic growth rate is for commercial spares and commercial OE and MRO, in particular in the second half and how that compares to Q2?

And for the MRO component of that, I’d be grateful if you could tell us what the underlying number is, so say ex-GTF retrofit just in terms of what would be baked in say at the midpoint of guidance? And the second question is on margins kind of looking ahead, I mean clearly in 2021 you should be through most of the retrofit work on GTF. But clearly the industry will be somewhere below previous levels in terms of activities. I wonder if you could share with us what assumptions you might make for 2021 in terms of the headwind from fixed cost absorption and therefore any margin improvement we may start to see there?

Reiner Winkler

Maybe I’ll start with the second question. I mean we cannot — definitely cannot give today any indication for 2021. We see how volatile the business actually is. Every four weeks we have a new forecast from the IATA which have different impacts. So I think it’s definitely too early. I think the only thing that everybody expects that 2021 will be also a difficult year. And as you see let’s say, 2022, 2023 recovering to achieve level of 2019 in business travel and in the business.

And that’s more or less for the narrow-body market. And for the wide-body market will be delayed by another year. But today it’s definitely too early for — to give let’s say margin expectations or cost absorption fixed cost absorption for 2021.

Peter Kameritsch

Regarding our expectations for the second half year, I mean it is pure math. I mean if you go through our business lines I mean — in the military business, we were down slightly in H1 and obviously, we expect for the full year military revenues to be slightly up. So we should have as I said a strong second half in the military business. I think the implied growth rate is something between 5% and 10% for the second half year.

And that is not so much due to the fact that there we expect more orders. I mean we have all these orders in our order book. But — so generating revenues obviously we have to do the work. And the three weeks of interruption here in Munich and the following subsequent short time working scheme hinders us to really — did a lot of work in booked and revenues to the customers and we kind of see a pickup effect in the military space in the second half year.

In MRO, for the half year, we’re down 3% organically for the half year. In the first quarter, we were organically up 19%. In the second quarter, we were down 25%. And we expect for the rest of the year something in that range, I would say down 5% organically. So, overall, then as a result, we have for the full year commercial MRO down low to mid-single-digit. That’s going to be the result, but with a higher share of GTF retrofits. That’s definitely the case which is margin dilutive. Yeah.

And I think in the spare part, I just mentioned that the spare part business in Q1 was more or less stable in U.S. dollar terms. Q2 2020 was comes to 50% down. So, H1 was something like 25% down. And for the second half of the year, we expect something in the range of let’s say, 30% down. So, overall for the full year, down high-20s. That is the base case for our guidance.

Andrew Humphrey

That’s very helpful. Thank you.

Operator

Okay. Our next question comes from the line of Ben Heelan from Bank of America. Your line is now open.

Ben Heelan

Yes. Good morning, gentlemen.

Peter Kameritsch

Good morning.

Ben Heelan

Peter, I was wondering if I could just come back on that answer that you gave Andrew, going from down 50% in commercial spares in Q2 and seeing an improvement to down 30% in the second half of the year, seems quite a material improvement. Do you mind kind of giving a little bit of color about what kind of reinforces you belief that you do have visibility on that. Is it fray? Is it V2500?

And then secondly, back on a question that you asked earlier. I just wanted to clarify. So you see potential for cash flow in the second half of the year to be neutral, but there’s obviously some volatility that could be around that? Thank you.

Peter Kameritsch

Yeah. I mean I gave some elements on that before. I mean in Q2, we think we saw that the trust in spare parts demand, especially for the V2500. V2500 was down something like 60%. And going forward, we think — I mean everybody I mean one in — the one is obviously the global V2500 fleet flies less.

The other element is obviously that worldwide MRO shops have provided at the end of 2019, and also in Q1 2019, they expected obviously a higher level of shop visits, and so had spare parts in their stock for a higher number of shop visits. And now obviously expectations have come down and the order flow for new spare parts is limited, because all MRO shops have a lot of step-up in stock.

And once you — I mean shop visits are happening, and once these high level of spare parts, are consumed via shops then you’re going to see an acceleration of spare parts demand. So, — when that exactly will happen nobody really knows. We think somewhere at the end of Q3. We expect an acceleration here on the V2500. And on the PW2000 and on CF6, we expect a stable business more or less as in — also in Q2. But the main effect is really higher demand for the V2500.

And yeah, I mean, we think that in H2 on a cash flow can be broadly neutral, but it could also be slightly down up. Really the volatility is really, really high due to — I mean payment behavior from airline customers obviously also, how quick can we really bring our supply chain down to the new expected demand of 40 narrow-body — 40 A320s and five 787s. So, really adjusted to, new delivery schedules. So, we have some homework to do there and the ambition is to stay positive territory at least for the free cash flow.

Ben Heelan

Thanks a lot Peter. And just on the airline customers, receivables were not that much of a headwind in the second quarter of the year. Do you think the risk is that receivables could be a bigger headwind as we move into Q3 and Q4?

Peter Kameritsch

Ben, we are in between negotiations also on the MRO side with customers. So, maybe a longer payment terms and so on that could happen. But on the other side obviously, through lower business volumes overall that is also a driver for lower receivables lower payables, lower working capital overall.

Ben Heelan

Okay. Great. Thank you.

Operator

Okay. Our next question comes from the line Alexander Hauenstein from DZ Bank. Your line is now open.

Alexander Hauenstein

Hi, yes. Hello, Alex Hauenstein from DZ Bank. Thanks for taking my question. I’ve got three questions. First of all, coming back to the GTF retrofit. You mentioned obviously that there is no margin on these retrofits, but is it really a no margin thing to fix them? Or is it even a negative margin attached to it? That will be the first one.

And the second question is coming back to your guidance. I was a bit surprised to see you coming out with the concrete guidance. I appreciate it but compared to others, I mean what gave you more confidence and more visibility apart from what you have been speaking about already in this call, but what makes you more confident here compared to the OEMs and especially — or pretty differently in which case there could be any risk to the guidance and the short-term outlook here?

And the last question a bit more generally. I was wondering what’s your view about some further overcapacities building up in aircraft engines over the next one or two years coming from small and midsized airlines, potentially going bust maybe in East Asia, maybe in Latin America, or elsewhere.

Would that in some cases put any pressure on the used engines prices and also your margins on the spare side, et cetera, et cetera? And so maybe you could share some of your views here on this part of the market. Thank you.

Peter Kameritsch

The GTF margins although they’re slightly positive with a couple of other you have — fixed cost coverage attached to that. So, they are slightly — still slightly positive based on a full cost basis so to say. So, it’s not as good as a typical airline shop business, but it’s not a negative margin.

Reiner Winkler

Regarding the guidance what makes us more confident? I mean it’s difficult for us to say why others did not give guidance. We think we have enough information to provide the market with the guidance. But as we indicated there’s much more uncertainty in that guidance compared to previous guidance we gave.

In environment in the market how it is and we thought that the market would appreciate to receive the guidance. So, also gave the guidance. So, some do some don’t. So, it’s difficult to judge on other companies.

Yes, there is potentially pressure from airlines going to bankruptcy or Chapter 11 or whatever. But I think that is the basis for the market forecast already. I mean if we look into the market environment what the IATA expects in passenger traffic and you see then what capacity is available, I think that is already considered. But of course it could — we could get more pressure or less. That’s depending really on customer-to-customer or airline-to-airline. And then some of them will be restructured and come back in the market, some will disappear, but it’s really as I said a lot of uncertainty actually.

Alexander Hauenstein

Okay. Thank you.

Operator

Okay. Our next question comes from the line of Zafar Khan from Société Générale. Your line is now open.

Zafar Khan

Thank you very much. Good morning everyone. I have three questions please. The first one is just on the GTF warranty work. Clearly in answering Milene’s question, you were suggesting that it could be €500 million to €600 million this year and the previous guidance is €400 million. So, I just wonder whether there will be any spillover of this work in 2021. Or do you think the warranty work will have been completed by the end of this year? That’s the first question.

The second one is just on the H2 restructuring costs. I just wondered if you were able to quantify that and just give us the phasing of the expenditure of that restructuring cost.

And the third one is just on dividend. Now, you suspended the 2019 dividend when you issued the statement back in March. I know the AGM is in a couple of days’ time. Is that going to be on the agenda? Is there a chance that you may pay a dividend for 2019? What will the management team be recommending to the Board on that?

Reiner Winkler

Okay starting with the dividend. The AGM is commencing this week and the proposal is to just pay a legally required minimum dividend of at least €0.04 per share. That’s a legal requirement in Germany, but we really — definitely decided that in these times, it’s more important for the company to have enough liquidity, so cash savings or liquidity. And therefore we decided just to go for that minimum dividend. I think the question is–

Peter Kameritsch

Restructuring cost.

Reiner Winkler

Restructuring cost. I think we are still let’s say evaluating that number, but a rough estimation would be some I would get around €30 million something like that €25 million. So, it’s not such a significant number, but in that range.

Zafar Khan

Just on that, I understand that with the furlough scheme in Germany, this can be extended to perhaps three years. So is that why you don’t need to do a huge restructuring, because you can furlough for quite a long time?

Reiner Winkler

I would say, it’s for two years, factoring that.

Peter Kameritsch

I mean, now it’s for 12 months and we expect in September that the German government decides to prolong it to 24 months. But, I mean, the reasons why we did the 10% to 15% is that we also expect at the end of 2021 after RCF may — so the furlough schemes, more or less at the end we expect that we have a lower demand at that point of time. But it’s not — I mean, it’s a soft reduction. So, early retirement contract and something, so in that range, so we don’t close like the sites or so.

Zafar Khan

And just the one on the GTF.

Peter Kameritsch

So in GTF — warranty work will also continue in 2021. But I can’t give you a number now.

Zafar Khan

Okay. But I imagine that the MRO 2021 versus 2020, in that case, will report sales probably down a little bit on the 2020 number?

Peter Kameritsch

Well, I mean, now we don’t give a guidance for 2021, so far.

Zafar Khan

Okay. I’m sorry. That was a cheeky follow-on. I apologize.

Peter Kameritsch

Okay. Then, next question.

Zafar Khan

Thank you. Thanks.

Operator

Okay. Thank you, sir. Our next question comes from the line of Christophe Menard from Kepler. Your line is now open.

Christophe Menard

Yes. Good morning. I had three quick questions. The first one is more a general question. Can you comment on the dynamic of the recovery in aftermarket? I mean, yes, in aftermarket and spare parts? And then, do you think it will precede or come after the OE demand or recovery?

Second question is on the CapEx. You had a pretty steep CapEx reduction in Q2, which can be easily understood. How are you looking at CapEx in the full year? And even though you’re not giving any guidance for next year, do you think it will be for down next year?

And the last question is on the German defense programs. Are you confident in those programs coming to fruition? I’m thinking about Eurofighter? And are you expecting — can you remind me if you’re getting any prepayment on those or if not, basically?

Reiner Winkler

Maybe, I’ll start with the last question. Yes, we are confident that these orders will be placed in the second half of this year mainly — but especially, the replacement of the tranche, one of the Eurofighters maybe in the fourth quarter. That’s the time line actually, so we are confident in that, but there will be no significant prepayments for that all.

Peter Kameritsch

Recovery, I mean, the question is, what is the basis for your recovery. I mean, if, let’s say, Q2 is the trough for OE and for spare parts or MRO activities, then my clear view is that aftermarket will recover earlier compared to OE. I mean, you see the signals from Airbus and Boeing.

So, I mean, the 787 is actually at five per month going down and rate 40 on the A320 and I don’t think that in the next months or so we’re going to see higher, higher production rate. But we think that aftermarket activity will increase from – at the end of Q3 on. Yes. So, that’s I would say, the answer to that question.

CapEx, there is no clear guidance on the CapEx. I mean, we have — as a reaction on COVID, we have, I mean, put several CapEx projects on hold and we’re going to review that and extend the base also on the — what we see from the customers, cash collection from new customers and capacity needs for the next years, where do we really need to invest and where also not. But definitely, we’re going to see a significantly lower PPE CapEx number in 2020 versus 2019. But what 2021 will be like, that is really too early to say, Christophe.

Christophe Menard

Okay. Thank you very much. Thank you.

Operator

Okay. Our next question comes from the line of Joachim Kotze from Morningstar. Your line is now open.

Joachim Kotze

Hi. Good morning, gentlemen. Thank you for taking my questions. Two questions, if I may. The first one relates to your customers and specifically the aftermarket customers. Are you seeing any difference in the areas of aftermarket customers relating to timing materials and rate of supply to our customers? And then, just how that translates into a longer-term recovery? Specifically, are you seeing the outlook for accelerated growth and rate of flight hour contracts? Or you’re seeing a bit more reluctance when a customer was there?

And then the second question relates to the competitive environment for the MRO business. You’re obviously sitting with a bit of spare capacity in the short to medium term. Do you think — do you see any opportunities to fill that capacity from work performed by weaker players in the market?

Peter Kameritsch

Yes, I mean, it depends on obviously how steep and longer prices will be. But I mean there in the last — following the last financial crisis, a lot of smaller and weaker players in the MRO field left the market and that could also happen now. So I mean, we from — I mean 10 years ago, I would say, we had the market share in MRO like 6%, 7%. And in the last 10 years, we were able to increase that to 10%, 11% or so. And I mean long-term, I think we are optimistic to gain a higher market share in the world engine MRO market. But there is nothing which will happen in the next one or two quarters now. [Indiscernible] [43:00] our customers there’s not really a big difference in behavior. So I mean, every airline is now currently in cash conservation mode. Also that everybody is looking in postponing payments, delaying shop visits and so on. That is the general behavior of airlines.

Joachim Kotze

But I was just wondering if there’s any difference because I mean the cash flow — the cash payments for our [Indiscernible] customers are essentially different to plan of material customers. So they’re really paid advanced payments are you seeing some of those customers perhaps using this opportunity began to bring their [Indiscernible] [43:44] for service, since they have already…

Peter Kameritsch

That happens obviously. I mean, a customer which has paid 90% or 95% of the cost for shoppers in the last let’s say years, this customer will sent the actions sure. I mean, they’re happy to send an engine while the [Indiscernible] [43:31] is grown. I mean the same is also true for the let’s say the PW1100 warranty work. I mean that would have been much harder for us to conduct that warranty program when the fleet would have been in the air completely yes. So that is obviously — airlines don’t want to have interruptions because you pull the engine and so on. So that has also in the warranty program for the PW1100.

Joachim Kotze

Okay. Thanks. And just — I mean do you think the coronavirus or COVID has accelerated the appetite for entering into these rate of flight hour contacts? Are you expecting to sign more of these contracts going forward than you did previously?

Peter Kameritsch

No, I don’t — we don’t think so. I mean together with the new engine platform, the contract style of choice for all airlines is the flight hour contract and there — we always say 80% is fly by hour because 20% is undecided. So typically leasing companies which then like the final operator of the engine side on the aftermarket contract. But I think the new engine generation will be more or less completely covered by flight hour agreements.

Joachim Kotze

Thank you very much.

Operator

Okay. Our next question comes from the line of Harry Breach from MainFirst. Your line is now open.

Reiner Winkler

Harry, can you hear me?

Harry Breach

Yes. Now I can. Sorry for the delay guys. It was silent. And thanks for taking my question guys and thanks as well for trying to put together some guidance for us all in a really challenging environment. My question is just hopefully fairly simple ones. Firstly guys, when we’re thinking about commercial MRO and we’re thinking about non-retrofit shop visits. So just the normal course of performance restoration shop visits over the second half of this year into next year. Have you seen that sort of stabilize? I’m sure over the last four months there’s been a lot of deferral of bookshop visits. Is that sort of situation stabilizing? So you now think that you’ve got better visibility on commercial MRO, especially looking into the fourth quarter and early next year?

Then second question guys and this one might show my ignorance a bit. Can you help me understand the second quarter was clearly very disrupted relative to normal manufacturing operations with facility shutdowns and changing workflow sanitation activities. And what I was trying to understand guys was in terms of what cost gets absorbed into inventory versus just expense during the period, did you sort of take excess costs over the direct — sorry the direct cost of production than the allocated overhead normally? Did you take the sort of the coronavirus excess above that and just expense it during the period as some of that being absorbed into inventory and we’ll see it affect margins as you go through later quarters this year and into next year?

And then finally, this one is maybe for Reiner and the crystal ball. I’m wondering can you give us any feeling clearly with lower production volumes on the GTF looking forward given the rate changes from Airbus, can you give us any sort of sense about roughly when you think GTF sort of gross profit breakeven might be now, or how many years it might have moved out? Any feeling you could give us right, Reiner?

Reiner Winkler

I mean, Harry, I mean nobody really knows where the production rates will be in 2025 or so. I mean, that is completely — I mean even Airbus cannot say that. I mean it’s not a lot of big surprise. I mean, the GTF production is highly automized. You know our outlook facility in Munich at least compared to the V2500 a larger part of production cost depreciation of facilities. And, obviously, when you have lower volumes I mean that is an impact to the margin. So that’s one of the answer, we don’t know when that will happen.

Peter Kameritsch

Some years to go.

Reiner Winkler

Some years to go, definitely. On your working capital, I wouldn’t say that. I mean, we have — I mean, looking in our inventories line in the working capital that is more or less stable compared to the end of 2019. But we expect I mean at year-end, we expect it to be lower than today. I mean in the first quarter and also in the second quarter, we still get deliveries of raw materials finished parts and so on.

Based on the higher production rate, I mean based on a rate of Airbus so that will — it will take some time that we can bring inventories down to adjust our inventory to product rate of 40 in the A380 or five of the oldest 757. So, that’s — but there’s no abnormal cost allocation to inventories also in the first half year.

What was your third question? You had a third question.

Harry Breach

Yeah, guys it’s just about — when we think about commercial MRO, and we think about the normal business, okay, so performance restoration, shop visits and so on, are you getting clarity and more stability in the bookings for engine inductions in the third, fourth quarter and beyond?

Reiner Winkler

Yeah. I mean, a large part I mean we typically don’t have a lot of spot business in the MRO. So we have a long — I mean typically a rather long-term contracts on with our customers be it by hour agreements, but also long-term service agreements with the customer spending over 10 years. So, the thing is rather that we have to discuss with our customers when they send the engine. And yes I mean compared to the end of April, so compared to Q1 we have better visibility, which sets us also in a position to give a guidance on the MRO, but we don’t — do we have 100% visibility? No. I mean there’s still volatility also depending on how exactly the recovery in air traffic will be. I mean, once let’s say 80% or 90% of the narrow-body fleet is back in the air again, I mean airlines has less opportunities to swap aircraft, so using aircraft, shop visits are far in the future. So once they have a larger part of the fleet in the air then you’re going to see also activities increased heavily. But how that curve or that pattern will look like in H2, there’s still some uncertainty. So we don’t have the glass bowl. Okay.

Operator: [Operator Instructions] Okay. Our next question comes from the line of Richard Schramm. Your line is now open.

Richard Schramm

Yes. Good morning, gentlemen. Just a few clarifications from my side please. Concerning the restructuring charges you mentioned was about €30 million. As you have given a relatively wide range of capacity cuts here in trust fund of 10% to 15%. Is this already kind of worst case, or should we expect that there is a risk that some additional costs might occur next year also in this respect? Or is it already trying to cover the full maximum you expect from this side?

Reiner Winkler

I mean, we stated that it is a first rough estimate we are still evaluating. From today’s perspective it should be in that range. Can I exclude anything for next year? No. But I think more or less that provision it should be done. But it depends also, let’s say how the market recovers. Is there another capacity necessary from day to day? No. That’s what we think is necessary. But as we said, volatile times and nobody knows what really will happen. But based on the model we have in place when will the market recover, how will it recover that’s the, let’s say the actual case we are following.

Richard Schramm

Okay. And second yes, I have to come back to this GTF issue because I’m a bit puzzled, as you mentioned in the Q1 call that volume would be about €400 million or so for the current year. Now we are at €500 million to €600 million. And I wonder where this additional volume comes from? And especially, as you mentioned that there might be still some work spilling over to 2021. I thought that you mentioned in the Q1 call that it would be more or less done already with the current year and that 2021, we’d see no further burden from this side. So what has changed here that the volume obviously is much bigger than expected and when will this definitely be out of the way?

Reiner Winkler

I mean it’s quite easy. I mean, when we get you the number of €400 million and now it’s €500 million to €600 million something like that the main reason for that is capacity is available. It was always a bottleneck. Is there enough capacity and network to do all these retrofits – retrofits at that time were planned for 2020 and also in the next years? Now some of them could be forwarded into this year because capacity is available in the network. So that’s the reason. Will it be 100% down until year-end? Not 100%. Some will also be driven to 2020 mark, 2021. I think as Pete [ph] mentioned it also in the call the majority of the retrofits will be done this year we started this year but there will be also some for the next year.

Richard Schramm

But this should be then definitely a minor amount obviously?

Reiner Winkler

I don’t know the exact number, no.

Richard Schramm

Okay. And last point concerning your order book, could you please split it up between OEM and MRO? And concerning the value of the contracts I mean, especially in MRO I wonder if the contract volumes you have agreed with customers can be still valid because of the massive change of the environment also for the longer-term here? Isn’t there a risk that contract volumes might turn out at the end of the day, clearly lower than they are currently in your books here?

Peter Kameritsch

Roughly two-third of the order book is MRO and one-third is the OEM business. So I mean that’s clear because I mean the new pension business in – under IFRS 16 is – follow because a lot of things are booked against revenue. So that’s clear that OEM order book is lower compared to MRO.

In the MRO order book we have typically, as I’ve just mentioned before so 10 – five-year contracts, up to 10-year contracts and the order book is the expected revenue contribution from these long-term contracts and we assess these contracts on a quarterly basis. And also we had added new contracts to the order book.

So there is every time some volatility. So yes, maybe the volume after one or the other contract where one shop visits – one shop visit due to less flight activity in 2020 or 2021 so one shop visit falls out of the MRO contract. But is a huge impact. So long term no. So once the assumption is that at the end of 2022 or 2023, so the narrow body fleet is more or less fully active as in 2019.

Richard Schramm

Okay. Thank you very much.

Operator

Okay. Our next question comes from the line of David Perry from JPMorgan. Your line is now open.

David Perry

Just two questions. First one it’s very simple. What is your FX assumption for the year please?

Peter Kameritsch

1.15.

David Perry

FX assumption, please?

Peter Kameritsch

Yes. 1.15, David.

David Perry

1.15. Right

Peter Kameritsch

At average – spot rate yearly average is 1.15. The 1.15 average is the basis for our revenue number.

David Perry

Okay. And the second one is a bit more complicated. Maybe I’m being a bit slow here but I just don’t understand how you’re thinking about H2 margins in OEM. I think it’s not too hard to figure out MRO but you had a 4% margin in Q2 in December and it looks like you’re looking for a much stronger margin and it’s certainly double-digit maybe getting to mid-teens in OEM in H2 on a similar revenue drop. Can you just sort of talk me through the positives and negatives driving EBIT in H2, please that would be really helpful?

Peter Kameritsch

I mean, I think I mentioned that the one thing is that we had a very low military volume in Q1 and also in Q2 and we expect a far higher military volume in the second half year. Point number three, we had three weeks – closed here our facilities for three weeks — closed here our facilities for three weeks. So, you had more or less three weeks of all the salaries on, but without obviously working and generating revenues and profits. Then that three-week closure of the facilities we had — were followed by the short-time working schemes. So, one week with more or less 100% short-term working, then two or three weeks with three days working, two days at home. And now we are at 4:1, so four days here in the facility working and one day at home.

So, that is obviously a lot of fixed costs which hits your P&L. That is point number two. So, we don’t see that in Q3 and Q4. And then our expectation is also that spare parts business in Q2 was the trough. So, we expect throughout the H2 a recovery of spare parts demand. So, these are I would say the three major elements for a better OEM margin in H2.

David Perry

Yes, I mean the only thing is the sales — I mean military fine, but the commercial sales are going to be down the same in H2 as they were in Q2 based on your guidance or very similar. So, it doesn’t really matter whether the factories closed or short time or not, the sales or the sales. That’s what I’m struggling with. Maybe you could talk a bit about the restructuring the payback on the restructuring just to help us kind of take it through? I think R&D also helped us in H2.

Peter Kameritsch

I mean the payback will be then after 2021 and it depends how exactly the split will be. So, there are the short time working scheme means that there are — for example they are — they remain one year in the company working and then one year they are at home with a lower salary, but they are still on the payroll.

And after the two years, they go for the normal state pension. But it can also be that some of the guys do it like six months working, six months at home and then directly into the state pension.

So, how the exact mix will be between the people who go for the early retirement scheme, we don’t know that yet. So, we are just at the beginning by talking with the employees which are eligible for that scheme. So, there we really don’t know it yet.

David Perry

All right. I’ll have a think about it. Thanks a lot Peter.

Operator

Our next question comes from the line of Richard Schramm. Your line is now open.

Richard Schramm

Yes. Sorry a quick — I forgot this restructuring costs. This is included in your margin guidance or is this excluded by the way?

Reiner Winkler

Typically we adjust the restructuring costs. I think this is one of the very few elements we will adjust in the EBIT number.

Richard Schramm

Okay. So, then it’s excluded. Okay. Thanks a lot.

Thomas Franz

Okay. I think we’re at the end. Thank you everybody for joining us and yes, have a good day.

Peter Kameritsch

Thank you.

Reiner Winkler

Bye, bye.

Operator

Okay. We want to thank Mr. Reiner Winkler and Mr. Peter Kameritsch and all the participants of this conference. Good bye.





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