HWM: Aerospace Giant Soars as Strong Results Defy Market Skepticism

High conviction Howmet Aerospace Inc. (NYSE:HWM) investors held firm during its recent volatility, as the market compelled a capitulation. Dip buyers who recognized the bear trap or false downside breakdown as a fantastic opportunity to buy into its battered stock helped provide robust support. As a result, HWM has recovered to levels last seen in early September, clawing back most of the losses over the past three months. I urged HWM investors to ignore the gloom and doom over the wide-moat aerospace company, even as pessimistic investors fled, believing its operating performance could worsen. I also reminded investors that while execution risks are expected to remain, given the scale of the recall, they are mostly priced in. The sharp recovery has justified my bullish thesis that HWM hit peak pessimism. Accordingly, HWM has recovered nearly 23% from its early October lows through this week's highs. In addition, it has also outperformed the S&P 500 (SPX) (SPY) over the same period based on my previous two updates in September and October (pre-Q3 earnings).



Management's commentary at its third-quarter earnings conference corroborates my conviction. HWM revised its FY23 free cash flow (FCF) estimates upward to $4.8B, a $500M improvement from its recently downgraded outlook. Management assured investors that HWM doesn't anticipate "significant additional financial impacts" on the affected fleets due to the powdered metal manufacturing quality challenges linked to its Pratt & Whitney engines. As a result, I believe HWM has provided adequate confidence to the market that the company remains in control of its execution and recovery, lifting the credibility of its "primary focus on maintaining customer and partner trust."

The company also presented several critical metrics, including a record backlog of $190B in Q3 and a book-to-bill ratio of 1.19. The company is exposed to the recovery tailwinds in the commercial segment, with "growth beginning to normalize." As a result, commercial capacity should continue to recover to pre-COVID levels, bolstering HWM's overall growth momentum. HWM sees the ongoing geopolitical conflicts as a benefit to its defense segment, providing a much-needed tailwind. Collins Aerospace is expected to mitigate the near-term challenges in Pratt & Whitney, with the "potential for increased profitability."

Observant investors should be aware that Collins Aerospace is the crucial margin driver for HWM, as it delivered a segment margin of 15.6% on an adjusted basis compared to the corporate estimated adjusted EBIT margin of 12.1% for FY23. Moreover, analysts' estimates have remained cautious, notwithstanding management's assurances. In other words, there could be further re-rating potential for HWM moving ahead if the rectification of the Pratt & Whitney engine issues progresses better than expected. HWM accentuated that it's still "comfortable" with its $7.5B FCF outlook for 2025. However, Wall Street analysts project a markedly less optimistic estimate of below $7B in FY25, suggesting the bar has been lowered for HWM to outperform potentially.



As a result, I believe the risk/reward balance remains favorable, given the significant bottom that HWM formed in early October. Seeking Alpha Quant assigned a "C" valuation grade to HWM, notwithstanding the recent recovery. Its forward EBITDA multiple of 10.8x is still below its 10-year average of 11.3x. Therefore, the potential upside in HWM remains favorable, supported by constructive price action.

HWM's price action indicates that it has held on firmly to its long-term uptrend bias, notwithstanding the pessimism over the past six months. The false downside breakdown in October helped normalize the doom and gloom, taking out over-pessimistic investors who fled at its bottom. Notably, HWM has recovered the pivotal $80 support zone remarkably in three months, suggesting its long-term uptrend remains undefeated. With that in mind, I believe HWM should be on its way to grind higher and re-test its all-time highs (consistent with an uptrend thesis) subsequently, supported by its wide-moat business model and relatively attractive valuation.

Rating: Maintain Buy. Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.